2 Ways to Gain an Edge and Defy Fear

06/26/2012 9:50 am EST

Focus: STRATEGIES

Effective market timers have a proven edge over time, writes Frank Kollar of FibTimer.com, and those who stick with their strategy while minimizing short-term losses are most likely to be profitable in the long term.

As a market timer, the one thing we must always remember is that the markets can, and most definitely will, throw every possible hardball, curveball, fastball, knuckleball, etc., at us.

The reason we invest in the stock market is because we recognize the huge potential for profits. But we are timing in a freely traded market that is subject to the emotional whims of traders. And when money is involved, those emotions can, at times, be extreme.

We became market timers because we have realized that not only is there no easy money, but also that the stock market will do all it can to relieve us of our money.

We are more than uncomfortable with the buy-and-hold approach to investing, and realize that although buy-and-hold may be fine if you are willing to wait 20-30 years, it can lead to huge losses over shorter time frames. The most current example was seen in 2008 when the S&P 500 and the Nasdaq Composite gave up 50%, resulting in huge losses.

The stock market is the ultimate big league, and there are traders who understand the psychological warfare you are facing and know how to use it to take your money.

Understanding those big league rules will put the winning odds back on your side. The timing strategies at FibTimer are designed to identify and follow trends. They allow profits to ride and cut losses short. This is what the professionals do, but most individuals have great difficulty doing.

See also: Why Selling Is Just So Darn Hard

Market Timing Is Unique

Market timers face psychological battles that very few people ever face in their entire lives. There are so many differences between the emotions experienced in trading the financial markets and what we experience in our lives that it can easily interfere with our ability to trade.

If we can identify those emotions, we can take steps to protect ourselves from them, stop them from influencing us, and become winning (profitable) market timers and traders.

See also: Don't Let Emotions Get the Best of You

For example, in the workplace, working hard and expecting to be justly rewarded for it are part of the American dream. Who would argue with the logic?

But in the stock market, work as hard as you can and the markets will still reverse on you and give you losses. Make the perfect trade and it can still go bad.

This is because timing the markets is not about our work ethic. It is not about genius or luck. It is about numbers and probability.

Numbers and Probability

Toss a coin 50 times and you can expect 25 times it will land heads up and 25 times it will land tails up. But there is no rule that says the first seven tosses will not all come up tails.

Once we realize that over time the numbers "always" add up in our favor, we can more easily endure the short-term swings. The market "hardballs," and being prepared for all that the market can throw at us helps us to stick with our trading strategy.

Once you face the fact that market timing isn't easy money, or that you won't become rich overnight, you will be able to prepare yourselves mentally for the long haul.

If you expect that at times there will be losing trades, you won't be disappointed when they happen. You will have your eyes set on the big picture, which puts the odds in your favor over time.

NEXT: 2 Components of a Successful Market Timing Strategy

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The Trading Edge

There are two important aspects of any successful market timing strategy or trading plan, and both need to be considered.

  1. Probability: We know that over time, if we flip that coin enough times, it will land 50% heads up, and 50% tails up. We can count on this. A string of tosses that have the same outcome mean little, as long as we keep tossing the coin.
  2. Risk vs. Reward: Potential rewards (profits) must be greater than risk (losses).

By looking at the history of the stock market over many years, we see that most of the time it is either trending up or trending down. In fact, about 80% of the time, it is in long-term trends. The fact that trending markets are the norm is our market timing "trading edge."

Knowing that the laws of probability are on our side over time, if we can establish that risk vs. reward is in our favor, we can use these odds to create a trading strategy.

If each toss of the coin has even odds, but some tosses remain "profitable" for long periods of time, while those tosses that are unprofitable are of short duration and limited unprofitability (losses kept small), we know that we will win over time as long as we make all the tosses.

At FibTimer we trade all trends. No one knows ahead of time which trend is the one that will continue for many months and make the big profits. All we know for certain is that the markets will spend more time trending than they will in trendless, or sideways trading.

The risk is that trading all trends produces some losses if the trend does not follow through. By trading all trends, we keep losses small because we do not stay with a losing trend. If the trend changes, we reverse position or go to cash according to the strategy used.

The reward is that we will never miss a trend, and since the markets are in trends more than they are not, and we make larger profits when the markets trend than the small losses from trend failures, we are profitable more often than not.

It is the in-between times (trendless markets) that require market timers to understand this logic. Stay the course, make all the coin tosses, and over time, you'll win.

Conclusion

Scary ideas are no longer frightening after you've acknowledged them and know not only to expect them, but that they will not harm you if you hold true to your course.

The more you can identify the scary aspects of market timing (or any trading), and prepare for every possibility, the more likely you'll be able to persist in the face of adversity.

Market timing is challenging. Many who start fall by the wayside after they realize that it is not going to make them rich in days or weeks (amazing, but some really do expect that), or after one or two small losses.

Remember, there are many timers out there who have met the challenge and have the winning track record to show for it. Look at FibTimer's historical trading numbers. No emotion is involved so they look great over the years. But in the short term, there were some small losses.

Focus on the war, not the small battles along the way. Stick with the trading plan and you will be successful.

By Frank Kollar of FibTimer.com

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