When I first began trading on the floor of the Pacific Stock Exchange, I traded the same way 99% of the public trades: I tried to pick tops and bottoms. If I surmised a stock to be oversold, I went long. If the stock appeared to be overbought, I went short. On the trading floor of the exchange, this strategy worked great about nine times out of ten. Not a bad winning percentage. But it was always the tenth trade that gave back most or all of the profits I had just made from the previous nine. Sound familiar?
It wasn't until I came in contact with an elite group of stock exchange specialists that I learned how to trade with an edge. Today, I'll share with you one of their secrets-an edge that has saved me literally thousands, if not hundreds of thousands of dollars during the course of my 32-year career as a trader. This edge is called confirmation.
As I mentioned earlier, most traders attempt to buy at the exact bottom and sell at the exact top, regardless of market, time frame, or choice of trading strategy. But just where is the bottom, and just where is the top? As we've all seen in the current market environment, stocks can go as low as they want, and much lower than anyone could have ever expected. Rather than try to pick a bottom, which is often a recipe for disaster, the only thing needed is for a trader to wait for confirmation. This is the assurance that the stock has concluded it's downward course and is now once again headed in an upward direction. Much like a train leaving the station for it's desired destination.
So what exactly is confirmation, and how do we use it? A buy confirmation consists of when a stock, in an uptrend, has sold off to a satisfactory buy level and then reverses and trades higher than the previous bar's high. Conversely, a sell confirmation consists of when a stock, in a downtrend, has risen to a satisfactory sell level and then reverses and trades lower than the previous bar's low. We buy and sell only on confirmation, regardless of the strategy used.
The chart below (Fig. 1) shows a common trading technique used by many traders- buying a stock once the stochastic oscillator had gone into "oversold" territory ("overbought" for sells). Had we purchased the stock at point A, when the indicator first went below the 20 threshold and into supposed oversold territory, we would have had to hold on to a losing trade for a number of days. But had we simply waited for confirmationat point B, we would have entered the trade only after the stock had traded one tick above the previous day's high, a signal that the stock had begun to move in our desired direction. Ironically, this is where most traders would have "thrown in the towel" and exited their original losing position! Using this method would have saved you a lot of money, grief, and heartache. The purpose of waiting for confirmation is not only to get us in at the beginning of a trend, but to keep us out of bad trades as well.
(Fig. 1)
This edge works in any direction...
(Fig. 2)
...in any market...
(Fig. 3)
...and in any time frame.
(Fig. 4)
As you have just seen, if one trades without using confirmation, they are simply guessing as to where to place their buy or sell orders. This guesswork is relative to top picking and bottom fishing-styles of trading that will ultimately yield negative results.
Ultimately, just because a trade has been confirmed does not guarantee that it will become profitable. But by waiting for confirmation, one can substantially increase the odds for a successful trade in their favor. Confirmation is the verification that a directional move has concluded and that the trend has once again resumed. A specialist always waits for his trade to be confirmed before entry.
By Steve Primo of SpecialistTrading.com
