An Excerpt from the Timely Trades Letter.
Trading is a statistical business, traders focus on risk management using systems that have been shown to provide an edge. Trading stock tips, news stories, stocks you are familiar with, and similar approaches can lead to mixed results. No one guesses right all the time. Trading is not about guessing or hoping. Traders need tools that are well understood, like an old friend. You usually know how a friend will react in a given situation, sometimes you are surprised but more often than not you have a good idea of their reaction to things. Trading needs to be the same way. No system reacts as expected all the time, if they did everyone would be driving a BMW to their Yacht. A traders job is to find a system that has an edge, learn how it behaves in different market conditions, and then be positioned to profit if the system does the normal thing.
Trading involves more than just picking a stock and entering a position. You don’t have a profit until you are back in cash. Exit strategies and money management techniques are important aspects of trading. Traders need to vary their position sizes and the number of trading positions used based on the current market conditions. In order to do this traders need to know how their trading systems perform in different market conditions. We cannot control what the market is doing, but we can react to it. During conditions that result in lower success rates for a trading system we need to either switch to a different trading system, or reduce positions sizes, as a way of reducing risks.
I went to a high school football game to watch my oldest daughter play in the band. After awhile I walked over to the refreshment stand to get something to drink. As I was walking toward the stand the crowd noise greatly increased, and people were cheering loudly. I knew from the increased noise level that something important had happened so I turned around and saw the end of a long yardage play. Stock volume is a similar indicator, when stocks are moving on volume there is
a lot of interest in the play and traders should turn and pay attention.
If Sears has been selling a hammer for thirty dollars and they suddenly raise the price to forty dollars they would expect to sell fewer of them. Sears would see the volume drop off, and conclude that the price may not be sustainable. The same idea applies to stocks, when the price moves up on declining volume the price change may not be sustainable.
There are several interesting techniques for determining market conditions. Drawing trend lines, along with horizontal support and resistance areas on the market chart make each of the three market conditions clear. This technique is simple, but it also works. Markets trading above an ascending trend line are in a bullish environment. Markets trading below a descending trend line are in a bearish environment. Markets trading between horizontal support and resistance areas are in a trading range environment.
Trading is based on being positioned to profit if the stock, or the market, does the usual thing in a given situation. Since stocks often bounce from support, candidates with a larger distance to support from the entry are more attractive because they have more ‘room to run.
I apply the concepts of support, resistance, and accumulation to the market itself to determine if trading is appropriate. If I am trading shorts and the market is approaching support I become cautious. The reason is that the market often bounces or bases near support and thus shorts would be less attractive. When the market is clearly trending and well away from support I will use larger position sizes in my trades than when the market is approaching a support level. I cannot influence what the market does, but I can react to it and reduce my risks by taking smaller position sizes when the market is approaching a support level.
The upper Bollinger Band will often act as resistance to market moves, particularly in trading range markets. This tendency to retrace from the upper band during trading range conditions is something that can be used as part of a traders money management strategy. In strongly trending markets the market may ‘ride the bands’, but it is quite common for the market to base or retrace when hitting the upper band during a trading range environment. Since I always want to be positioned to profit when the market does the normal, or usual, thing I take profits on positions when they approach the upper band during a trading range environment.
Steve Palmquist a full time trader who invests his own money in the market every day. He has shared trading techniques and systems at seminars across the country; presented at the Traders Expo, and published articles in Stocks & Commodities, Traders- Journal, The Opening Bell, and Working Money. Steve is the author of, “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. 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 sample@daisydogger.com. Steve’s website:www.daisydogger.com provides additional trading information and market adaptive trading techniques.
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