A Common Trading Mistake

12/15/2009 12:01 am EST

Focus: STRATEGIES

Ron Wagner

Principal Partner, RevolutionaryTrading.com

This past week, I had a chance to work with yet another fine group of traders in one of our classes. Last Thursday, you may recall, that if you were not in a trade during the first six minutes of the market, the move was over for the day. The market just chopped around all day long, which most likely frustrated most traders. I spent the day showing this group of fantastic people how most will make mistakes and get drawn into low-quality trades. Yes, you heard me right. I didn’t take one quality trade on purpose. I wanted to prove a point and also demonstrate how to control risk and manage even your losses. It’s easy to make money from the market on a regular basis, but most of us learn from the market, and reading the market correctly is paramount to your success. So I purposefully showed this group (and prefaced each trade first that I would not take this trade), why those trades would not work out. 

Some of these trades had resistance overhead, some had very narrow tradable voids, and all were not being helped by the market because the market was at a resistance level with hardly any tradable voids available. We discussed the importance of using Level II information available to also help guide us into the right trades and keep us out of the lousy ones. We also discussed a longer list of other issues to help them take their trading to the next level. Last Thursday was indeed a day for the brokers to make some money, but was not great for most traders. Many of our traders and I often go long periods of time without a losing trade, and you can too with the right tools, knowledge, and most importantly, the discipline to know when to take your trades and when not to.

The market continues to consolidate, and the longer we do this, and if the base tightens up near the highs as it is now trying to do, we just might get at least a short Santa Claus rally. With only 13 more trading days remaining this year, the probabilities increase for that scenario. Remember we have an FOMC announcement this week. Any break below the existing base and we may see some pretty interesting bearish days. Make sure to control your risk, run trailing stops, and be aware that everything resets the first of the year. Always be thinking, “Will the inventory (stock) I buy be higher in the time frame I am expecting it to?” If not, why take the trade?

What most traders have a hard time mastering is the patience part and being objective in knowing when to trade. This is what I want to talk about today.

You Don’t Have to Trade

The mind tends to come up with all sorts of nice compromises for handling lousy conditions, and generally speaking, "compromising" is a slippery slope in trading. In the end, quality and core principles tend to get compromised instead, so we are usually better off having a more black and white attitude about the issue.

Of course, in order to do this, you need a clear system to judge the market environment, and that in itself is too large a topic to address here. However, you've probably already been stimulated to construct at least the rudiments of such a system for yourself.

Our pattern recognition and technical analysis studies lay out the critical underpinnings of any such system by dissecting the basic market unit, and then the transitional phases. Add to this a series of criteria based on the various market internals and you have all the tools you need to design a standardized means of rating the market.

Once you've done that, you then need to decide what actions you intend to take (or not take) once your system gives you an unfavorable rating. Below are the two most viable options of what to do.

1) Stop trading! Really, this is definitely an option. As I've already explained before, you're actually still trading when you stop hitting buy and sell buttons, but remain mentally engaged with the market. This is a deliberate trading action, and one that takes more strength and self-discipline than most people initially realize.

Certainly, novice traders should rely on this option heavily in the beginning. Please remove from your mind the idea that you need to "wrack up" a ton of live trades in order to gain experience. All you'll learn from fruitlessly losing during poor market conditions is not to do it anymore!

2) Shift your time frame and trading style to one that better suits the current market environment. In most cases, this will be a downshift to a smaller and faster time frame, though not always. In the summer doldrums, for instance, the opposite is often advisable.

But here's the deal with this one: Make sure the style in question is a winning style for you! I know this seems obvious, but the reason I say this is because it's very easy to believe that "theoretically" something ought to be working based on the way the market is acting. In fact, you may even know people who are succeeding with the technique in question. But unless your statistics show that you are successful at it, don't start hitting order entry buttons.

After all, why not paper trade the approach first, until your stats are profitable? Even then, try it with 100 shares, just so you get used to the execution, and so that you are not glossing over slippage with your theoretical stats.

The point is, I want to remind you that being busy as a trader is only useful if you are making money. Being busy just for busy's sake is not helpful, especially if you are actually losing money. So it's fine to shift over to another style when the market no longer favors your primary approach. Just make sure it's a style that you have mastered, and if you haven't yet mastered it, remain in practice mode until you have.

By Ron Wagner

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