How to Be an 'Adaptive Trader'

Ron Wagner Principal Partner,

Ron Wagner explains how traders can move with the market flow, rather than in spite of it.

When I began trading and investing our own accounts back in 1997, I had no idea how the market moved. I really thought all I had to do was open an account, pick my investments fairly well, and-voila-I would make money. Well, that didn't turn out the way I had expected.

When I ran into an educational firm in 1998, I began to finally learn about repetitive cycles and the various stages that all financial instruments move in. It was hard to break myself of all the preconceived notions I had about the market. It was hard to break me from my old bad habits and beliefs. When I went to the trouble of selecting an investment, it was supposed to work.

I'm laughing out loud now as I remember those days and how far I have come to master my trading method. In order to really appreciate and understand about "fear" and "greed" and where the footprints of money reside on charts is all that matters for me and all of us to make good decisions for our investments and trading.

One of the largest challenges I realize now that I had back in 1997 and part of 1998 was to understand that we can't let anyone or anything cloud our judgment in our decision-making process. I now trade completely without concern if the market goes up, down, or sideways. I choose my trades and investments based on the information in front of me at that time.

After all, money does not care what I think! So, I have learned to adjust my thinking of what the charts are telling me. Each chart tells a story to us. Are you reading that story correctly?

We are on the cusp of getting started on "Show and Tell Time" in the markets. Yes, another earnings season is upon us. Make sure to be objective, as you are going to see a lot of very volatile days over the next six weeks. Be ready to adapt! Don't think you can make the market fit into your plans. Make sure to fit into what the market is doing.

Adapting to Changing Market Environments
Arguably, this is one of the hardest things for a trader to do. Some of the most prestigious fund managers in the world have gone down in flames because they were unable to either spot, or adjust to, changing market conditions.

So let's not fool ourselves and say that only "amateurs" and "the crowd" find these adjustments difficult. It's hard for all of us, and being realistic and honest about the challenges involved gives us a much better chance of maintaining the correct mental flexibility to adapt.

The first thing to recognize is that most human beings don't like change. It's true. I don't. Ask my wife. The average human being would prefer to acquaint themselves with what is directly in front of them, and then become very comfortable and knowledgeable about that precise set of circumstances.

Yes, there is an obvious spectrum-the super-conservative types on one end and the highly adventurous, pioneering types at the other. Still, it is intrinsic to all creatures (and humans are no exception) to feel most comfortable with that which remains static, and to become most anxious around that which is in a state of flux.

The reason I mention this is to help explain the sorts of underlying behavioral impulses we need to counteract when we trade. I remember quite clearly when I first developed some workable techniques as a trader. I got very excited at the thought that these few specific tools and patterns could make money for me day-in day-out, and sure enough, I had some real success with them initially.

I also remember how disturbed I felt when they stopped working during the collapse of the bubble. In fact, throughout the early portion of my education process, I kept looking for that one approach that would work "all the time." And every time a teacher or author or speaker on the subject of trading implied that nothing worked all the time, and that a trader needed to constantly adjust, I felt a sinking feeling in the pit of my stomach.

On a rational level, I suppose it was concern that I would have to learn an endless string of techniques to keep myself profitable in the market. On a more gut, subconscious level, I think I was simply afraid of the constant "unknown" of trading. It was an almost primitive fear of something that could utterly change one day, one hour, even one minute to the next.

Next: The reality of the financial markets


And yet, this is simply the reality of the financial markets. Like it or not, we have to adjust to our ever-changing environment. So, do you think I'm going to now advocate having a massive arsenal of techniques at your disposal, a complicated toolbox from which you will need to draw dozens of different approaches, each on a moment's notice? Do you think that I, "Mr. Specialist," will champion this idea? Not likely.

Just to quickly reiterate the predicament, we were discussing the fact that the market is ever-changing, and techniques that we use one day or week or month may become totally ineffectual the next. The apparent solution to this would be to learn a whole slew of techniques and to keep switching them as the market changes. After all, there is theoretically a way to play every market.

However, given that we are not little "Market Terminators," we are not likely to find this approach very compatible with, well...being human. What, then, do we do?

The first option is the one that you all should have guessed at in your contemplations: simply use your special set of tools when the market accommodates them, and stand aside when it doesn't. This is very much in keeping with my personal concept of the market Hot Zone, and while I have my own definition of what comprises this, based on what I am looking to do as a trader, you could easily come up with your own definitions, suitable to your own approach. So this first solution to the ever-changing market phenomenon is the one that should have leapt to mind most quickly.

However, for those of us who trade for income, and need to not only manage our money well, but also produce sufficient revenue, a little more may be required. After all, no matter what sort of "Hot Zone" definitions you devise, the very premise of this approach implies that there are "Dead Zones". So you will always be "off and on," so to speak, and depending on your style, the "off" stretches may be too long to keep generating the sort of income necessary to meet your needs.

The best way that I know to handle this is to use Primary and Secondary techniques. This is pretty much as straightforward as it sounds, but just to clarify, I'll use my own trading plan as an example.

My primary trading style is to locate market Hot Zones, and launch a bunch of swing trades when conditions seem favorable. I call this my primary approach, because quite frankly, I like it the best. I'd be thrilled if I could do this all the time to the exclusion of everything else. However, the reality is that I have found swing trading to be appropriate only at select times.

Occasionally, we get a very protracted stretch. For instance, 2003 was an absolute dream year not only because the market went up so much, but because the movements were incredibly orderly and predictable. It was just one of those years when you could rack up extraordinary gains as a swing or core trader. Since then, the trading landscape has been much patchier. There have been some very good runs, but they have been fewer, farther between, and significantly shorter in length than what we saw in 2003.

Anyway, to deal with the "patchy" phenomenon, I trade for income and/or take shorter time frame trades holding for less time. I have become a specialist at this type of trading and am passionate about it. I simply wanted to give you an example of how you can utilize a small number of styles-let's say two to three-and thereby keep yourself very busy in the market.

The trick is to view one of them as your primary technique and the other (or others) as you're secondary. Why is this? So that you don't split your focus, and find yourself off balance when a truly lucrative move arrives.

So, in summary, one very tangible way to deal with ever-changing markets is to utilize a primary technique, tailor-made for your favorite type of market. You haul this one out only when conditions are favorable. And then employ a secondary approach that is workable in a different type of market. Utilize it when conditions permit, but always keep your eye on the main prize-which is the deployment of your primary approach.

By spanning the market in this way, you are likely to cover a lot more ground. You are also far less likely to fall into the trap of thinking that what's working now will always work.

After all, the whole "primary and secondary" mentality is founded on the idea that markets change. But, in contrast to loading up with dozens of techniques, it helps keep you from changing around too much. This approach allows you to keep your focus on your strongest suit, while maintaining the necessary flexibility to handle various market conditions.

Ron Wagner can be found at