I got an email from an excited trader last Tuesday, when the market was down forty five points. He had just taken large short positions because the ‘market was already down forty points and this was surely the end of the run’. The trading plan outlined in the Timely Trades Letter had us holding off on new trades unless the market broke above the ascending trend line drawn through the lows of 08/31 and 01/31; or moved below the 2670 area, which would set up a pattern of lower highs and lower lows. This trader ignored the trading plan and was trading on CNBC induced emotion. When the market popped up fifty points on Thursday the same trader was in a panic to close shorts and take longs ‘because the pullback was over’. Trading on emotion frequently results in losses.
The trading plan is based on how the market normally behaves. The idea of trading is to be positioned to profit if the market does the normal or usual thing in a given situation. Sometimes the market does unusual things, and then profits are not realized. However, by definition the market most often follows the normal path in a given situation; so that is the way to bet for long term success. In the current case the trend line break on 2/23 indicated that conditions were changing, but it does not indicate an immediate switch from up trend to down trend. Rather than guess what the market is up to, I just took my profits from the recent run on the trend line break and will now give the market a few days to set up again. Trying to consistently guess the markets next move is a losing game over the long run. A better bet is to protect profits while the market is in transition, and then pick up new trades when the market shows its hand. I trade what the market is telling us, not the opinions of the talking heads on TV.
After a trend line break the market may base for a bit, resume the up trend or start a new down trend. If the market is going to start a new down trend then it will by definition have to form a pattern of lower highs and lower lows. For this process to start we will need to see a break below the 2670 area. Until then the market is not in a down trend and short positions carry above average risk. New long positions also carry above average risk since the market just broke below an ascending trend line. The trading plan is to hold off on swing trades until the market picks a direction and either moves back above the ascending trend line or below the 2670 area.
The more traders understand exactly how and when their trading patterns work, the more effective use they will be able to make of each tool in the trading toolbox. Back testing does not guarantee future results. There are no guarantees in trading, and no way to know if any particular trade will be profitable or not. Backtesting helps remove some of the emotion, hunches, and unknowns in trading. It can show you how a particular system has performed in different market conditions in the past and what types of filters may be most interesting in prioritizing trading opportunities. Examples of six complete trading systems and how they perform in different market conditions is covered in ‘How to Take Money from the Markets’
Steve is the author of two trading books: “Money-Making Candlestick Patterns, Backtested for Proven Results’, in which he shares backtesting research on popular candlestick patterns and shows what actually works, and what does not. “How to Take Money From the Markets, Creating Profitable Trading Strategies” in which he uses the results of extensive backtesting techniques to smash trading myths and get to the truth of what has worked and what has not. The book provides six fully analyzed and tested trading systems and shows how they have performed in different market conditions. Steve is the publisher of the, ‘Timely Trades Letter’ in which he shares his market analysis and specific trading setups for stocks and ETFs. To receive a sample of the ‘Timely Trades Letter’ send an email to firstname.lastname@example.org. Steve’s website:www.daisydogger.com provides additional trading information and market adaptive trading techniques.