Are You Afraid to Trade?

10/27/2011 7:00 am EST

Focus: MARKETS

Corey Rosenbloom

Founder and President, Afraid to Trade

When the market doesn’t behave as it’s expected to, traders freeze up rather than making a decision that would result in a smaller loss, says Corey Rosenbloom. He tells MoneyShow.com about the psychology behind these behaviors, and gives his thoughts on how the market might move if the Federal Reserve implements more quantitative easing.

Kate Stalter: Our guest today is Corey Rosenbloom of Afraid to Trade. Corey, you use intraday patterns and index futures to guide your trading decisions, as well as some other indicators. So give us your reading of the current market conditions and what the indicators are telling us to expect right now.

Corey Rosenbloom: What I like to do, starting with the bigger picture, is: I create the narrative, and that really comes down to different kinds of market profile principles or auction dynamics, which is just supply and demand. Who’s in control? Buyers, sellers, bulls and bears?

From there on, the higher timeframe, we’ll look at these key levels. For example, on the S&P, it was recently 1,230. We recently broke above that, and that created what we call a feedback loop or pop stops. Those short sellers who are short in that level were forced to cover. The covering is a buy mechanism, which makes the market move higher, basically.

As an intraday trader, that’s important to me. When a key level on a higher timeframe, especially those—speaking in terms of market psychology—where they’re saying there’s no way this level can break. There’s plenty of reasons: We have recession, we have Europe, we have this, we have that, etc.

All that feeds into the narrative, and then that comes down to the support levels or resistance levels. If we break them, as an intraday trader, I’m looking to trade that breakout.

That’s essentially breakout-style logic. Just really getting a better picture on the lower timeframe of what the supply and demand narrative is. Key levels, where the bulls are positioned, where the bears are positioned, and levels that would force a price movement.

Kate Stalter: Let’s just talk a little bit about some of the recent action. Earlier this week, the S&P and the other indices did break through some overhead resistance. Talk a little bit about what you’re seeing.

Corey Rosenbloom: Sure, pop stops. It’s a component of the kind of style of trading that I do.

It’s based on logic of a feedback loop, or we call it a short squeeze, where again, there are plenty of reasons from the three-month trading range that existed from 1,100 on the S&P to about 1,220 or 1,230. Even looking internally, there were divergences going up into 1,230.

So we have news that says the market needs to go lower, and classical or bigger picture indicators showing odds favoring a continuation of the trading range and a lower move yet to come. That’s not what happened.

One of my favorite statements as an intraday trader, is the statement, “If something should happen, but does not happen, then it often leads to a bigger-than-expected move in the opposite direction.” So that sets up these kinds of feedback loops.

A feedback loop is just a perpetual motion. When you say, for example, from the psychology of it, if you are a short seller, you’ve made a logical play shorting into overhead resistance and that’s common. It’s a new place to stop above that level.

The S&P it was ranged from 1,220, 1,225, 1,230. So as the market gathered momentum, it gathered buyers above those levels, and the short sellers were forced to cover.

As an intraday trader, I’m stepping into buying that breakout. Other traders are buying the breakout too, which combines with the short sellers coming out or essentially buying to cover their short positions. So this is what I’m looking at as an intraday trader. Both sides of the market are making buy positions or buy maneuvers. One side is happy, one side is not.

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So these feedback loops drive intraday decisions. The market, as we speak now, has moved 20 points higher, really in the last couple days, as a result. Once it broke those levels, we will just call it almost like a pressure cooker. It broke violently to the upside, giving intraday traders plenty of opportunities to play the “unexpected resolution,” as the short sellers are coming out and buyers are coming in.

As an intraday trader, you ask really about what kind of day-trading styles or what kind of structures. This is what creates some of the three types of day patterns that I look for as a trader.

This is a powerful trend day. Trend days usually build and often open a gap, especially in a level that has broken in a higher time. So we have a higher timeframe level, have an intraday opening gap in that direction and that shows sort of the psychology of the participants. That’s what creates these powerful trend days of perpetual one-sided motion.

So as an intraday trader, we’re looking to buy pullbacks, maybe it’s a flag pattern, a pullback to a trend line moving average, etc., as the market moves higher in the context of this higher timeframe expectation.

For reference, the other types of day structures are range days, where the market is just neutral. Those are more common, of course. Regular day, the market moves from high to low. We play off Bollinger Bands, divergences, reversal candles in the context of a range day. So the day structure determines the strategies that we use.

Of course, on trend days, we’re looking to play aggressively. Pullbacks, breakouts that form intraday to new highs or above prior levels intraday. Really looking not so much at Bollinger Bands or any kind of indicator like the stochastic or RSI. Looking at moving averages and hand-drawing trend lines really.

The third type of day would be a rounded reversal. That takes place when the market looks like it’s going to form a trend day. We have an initial and balance of supply and demand of what usually looks like a trend day, but then it forms clearer negative divergences, or if it’s a down day, positive divergences when I’m looking at momentum and market internals.

Those would show up ahead of a market reversal, and we’ll play the reversal if we have price confirmation, which to me would be a breakdown of the five-minute twenty-period EMA, which is the exponential moving average—especially the 50-period exponential moving average. We’ll play reversals into the close.

So those are the three types of structures that are day structures that lead to the trades. There is trend day, usually a breakout; range, which is normal and common, we’re playing mean reversions actively; and then the rounded reversal, where it looks like a trend day initially and then falters. Supply and demand balances and the market reverses the other way.

Kate Stalter: You had mentioned a moment ago some of the psychology behind some of these trades. A big part of your business is educating people about the psychology. In fact, that’s the very name of your business, Afraid to Trade. So let’s talk a little bit about some of the factors that do make people afraid to trade, particularly in the context of the volatility we’ve seen lately.

Corey Rosenbloom: Absolutely, I think the example now—and I keep referencing what’s happening currently—but a lot of traders, the ones I’m speaking with and some of the colleagues, too, are kind of trapped in the loop, because it’s a battle of classical indicators and what the markets should do.

So traders come to a lot of different ways to learn about how to trade the markets. A lot of it is just supply and demand.

When the market does what it’s supposed to do, which is coming to a support level—whatever the stock, ETF or commodity—when it bounces off that support as we expected no big deal, no problem. We all tend to make money because that’s what the market should be doing, based upon our methodology or experience. So no harm, no foul, when the market does what it’s supposed to do.

It’s when it doesn’t. The last two days, really the last couple of weeks, it’s been—I wouldn’t say a problem—but that opportunity/problem when the market is showing—and it’s not just the technical indicators, it’s the fundamentals too: Are we going into recession? What about this and this in terms of the fundamental economic indicators? Leading indicators are down, etc., the jobless rate is still high…we have a mentality of bearishness.

So the traders will go and they’ll put a short sell or a hedge trade on. Then the market does the unexpected, so that forces a decision. That’s when the psychology comes in. It’s uncomfortable, and as the market in this case rallies higher, or in the case in 2008, when the market broke and fell lower and lower and lower and traders were getting stopped out the other way, this works in both directions.

Then they have to force a decision. That decision usually determines success or failure rates to traders, because one can develop a deer-in-the-headlights look. Example: When the market does something it should not do, based on your experience or the methods you used or indicators that you’ve been taught, etc…

When the market makes an unexpected breakout or unexpected movement, then psychology plays an important role. Those are going to be more biased. Or the market has to do this behavior and it doesn’t, they tend to hang onto their positions or worse than that, double down.

For example, I’m sure some traders, when the market broke higher, they short sold because it can’t get any worse, this is just a great place to short sell. Of course, we’re 20, 25 points higher, and you’re losing money in that case. So in working with clients, that’s what comes into play.

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Strategies usually are simple. Really when it comes down to it, we can make it as complex as we need to, but it’s simplicity. The psychology problems almost always come when things don’t work the way we want them to.

What happens all the time is traders will spiral. There will be an initial, I wouldn’t say random, but initial movement that is not a problem, and it should have resulted in a stop out or a stop loss with a small loss.

But the trader thinks, “Well this has to happen,” and the ego comes into play and they hold the position longer than expected. Worse than that is what we call doubling down, when the market is moving against them and they make that position that they just made. They’re basically just adding bad money to the good.

Anyway, it’s hard to break that loop and of course one little bad move turns to another and the next thing you know, the trader is losing so much money, and that’s the fear mentality. It’s very common, but it’s easily broken. It’s respecting the market in terms of supply and demand, and not in absolutes as in the market has to come down off of its resistance level or has to or whatever the action is—break this flag triangle or break this flag pattern, break out of a triangle, etc.

So that’s in terms of what I look at. The strategy is simple; the psychology is the harder part sometimes. Once you get that down, because a lot of it is personal experience, risk profiles, basically how we look in terms of risk.

If we’re risk averse, strategies work better and certain things will trip a trader up, someone who is risk seeking. Not so much risk seeking, but was able to take on more risk.

So basically the long story short is: Match your strategy with your temperament, experience, and personality, and if there’s a mismatch, that tends to lead to a lot of psychological—or emotional I guess would be a better word—problems. To me, I work more with the fear than the greed.

Greed, of course, would be the error. Greed is putting on too large a position, being too confident in your trading plan and losing too much money or are positioned too high and the market made just a standard move down. I look for more of a fear, which is the market did something it shouldn’t do, and then that led to a spiral of insecurity, doubt, frustration and I guess it’s more deer-in-the headlights. What do I do? How do I get out of this?

Panic, if the trader freezes, that tends to complicate the scenarios. It complicates the situation much more than just taking a small stop, realize this is just supply and demand, it’s not personal and I’m not a bad trader because I did a bad trade.

If the market did something it shouldn’t do because the supply and demand shifted unexpectedly, that’s a not a problem. Take the loss, it’s not your fault, but sometimes they don’t do that. They take it personally.

Kate Stalter: Right, the market is not personal. Let me switch gears just a bit here, Corey. Any ideas that the indicators you’re watching are showing you right now as names to look at? A lot of our readers here are not only day traders, but folks that have a medium-term or longer-term horizon. Any names jumping out at you for any of these different classes of traders or investors?

Corey Rosenbloom: Sure, what I’m looking at now is: I’ve found a bigger picture. I’ve done the stock world, the sector rotation world, options world. What I’ve focused on personally the last few years has been the index futures intraday, with a narrative coming from the higher timeframe in intra-markets.

So let’s step outside of the intraday world now and talk more intra-market. What I’m looking at now is almost like a pattern repeat. We’re seeing a lot of similarities in terms of the range; the 100-point trading range on the S&P; the headlines—which is the Europe debt situation, possible second recession in the US. What else?

The bigger thematics, and the chart, as well, are similar to these that happened in 2010. So that was after the flash crash, when the market stabilized. It was 1,040 at the low and then I think it was 1,120 at the high, and that was your 100-point range or so.

Anyway, what got us out of that range is a similar thing. The market moved up into the upper resistance, there were divergences, but yet the market broke through. So when we look back, that was the quantitative easing debate.

So the structural component broke out higher, which triggered the feedback loop, so all the short sellers had to come out, and buyers were coming in. The markets went day-over-day-over-day into the May high of I think around 1,375.

So if we continue to see these bullish progressions, what I’m looking at then, was the QE2 thesis, which is it’s almost a thematic or a narrative. The quantitative easing is pushing the dollar lower, is boosting stock prices, boosting commodity prices and that theme tends to work out well.

So we’re seeing debate from three of the Fed governors putting a statement out that said additional QE could be warranted, and maybe we’ll focus more on mortgage-backed securities than Treasury bonds as the last QEs, 1 and 2, did.

But the point is, they may be looking to do QE3. A lot of traders are looking at that. So short term, swing traders and even position traders need to be watching the debate and the discussion on QE3.

If QE3 were to happen, my take and my advice would be take the charts of gold, oil, Treasury bonds, stocks, and the US dollar index. Look what happened from August 27, 2010, because that was rumors. We’re in the rumor phase now. QE began in November, and just look at the charts at what happened.

It’s very similar, and if we do see a Quantitative Easing 3—rumors or the actual program announced itself—the same thing will probably take place, which would be traders will look to be a long US equities, long gold, commodities, etc., and possibly short the US dollar.

So that’s a broader thematic. Traders can look at that and see yes, QE3 or no QE3. If yes, I would say to look back to late 2010 and see how the outcome was and that probably will be what will happen in 2011 into 2012.

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