Matthew Kerkhoff, options expert and editor of Dow Theory Letters, continues his 14-part educational...
Why You Should Constantly Ask “Why” in Your Trading
07/02/2010 12:01 am EST
Why am I constantly missing trades? Why do I cut my winners short? Why do I let my losers go too far? And why do I frequently break my rules? These are just a few questions that a struggling trader should be asking himself or herself. I say this because if you're not producing the desired results in your trading, it's probably due in part to not getting answers to some of these questions. Even an experienced trader has to question himself if he wants to elevate to a higher level of performance, particularly during periods of subpar results. In order to improve in any individualistic undertaking, routine introspection is a must.
Finding answers to what plagues us in our trading is the only way to fix problems and change the outcome. This requires something that can be very difficult for some, and that is being perfectly honest with oneself. As the saying goes, "Denial is not a river in Egypt," but a common affliction among people who find changing their behavior extremely difficult, both in their personal and professional lives.
Getting to the root cause of our actions and committing to change are essential for bettering results. Coming to terms with our strengths and weaknesses is a good start. Perhaps the answers lie in improving how we react to the inevitable setbacks that come with trading, or gaining more confidence in our trading strategy by doing the statistical work that will get us there. Whatever the reason, asking "why" will point you in the direction of progress.
Besides the psychological basis for our why questions, other queries needed for traders should be regarding market behavior. Examples: Why is the market more volatile during bear phases than in bull ones? Why did price move strongly out of that price level? Why does the market tend to turn at certain prior pivot areas? Continuously asking "why" will help you in the price discovery process.
In addition, questioning so-called conventional wisdom with respect to trading and investing can reveal some interesting findings. In my experience, much of what is disseminated by the media and Wall Street, if researched and followed-up with empirical evidence, actually turns out to be less reliable than initially professed.
One such instance is something that has been in the spotlight lately: The fact that the S&P—and a large number of stocks—are trading below their 200-day moving averages. According to Wall Street lore, this makes them undesirable to own, further fanning the bearish flames that are so pervasive now. If we delve in deeper, however, and do some data mining, we find that when the S&P closes below its 200-day moving average for the first time in 200 days, the market shows gains over 70% of the time one month later. Therefore, it seems when this occurs, the facts bear out (excuse the pun) that it's actually a high-probability long-side trade, contrary to the common Wall Street belief.
Why is this? Perhaps because by the time individual stocks and the overall market have pierced the 200-day moving averages, they have fallen enough to attract value investors who buy them at deeply marked-down prices.
On a personal level, my trading career began with a hundred "whys" as I was extremely eager to learn everything I could regarding trading and the markets. My first big lesson came just two months into my career as a stockbroker: October 19, 1987, Black Monday. I remember asking myself as the market was down 400 points, "Why is this happening?" and "Why did I get into this business?" At the time, I had very limited knowledge and thought just like many others that the world was ending. Of course, I know better now, but at the time, it was quite the harrowing experience. While fears of a 1930's-style depression permeated immediately afterward, the market, in fact, launched a fierce rally the following two days. As my career progressed, I began to find some of the answers…but not all of them.
To this day, I still ask "why" because if I stop asking, I can't get answers. Trying to figure it all out is the part of trading I enjoy most. So keep asking "why" and perhaps you'll find your answers.
Until next time, I hope you have a profitable week!By Gabe Velazquez, instructor, Online Trading Academy
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