How to Adjust to the Roller Coaster Market

09/15/2014 6:00 am EST

Focus: STRATEGIES

Gregory Harmon, CMT

Founder and President, Dragonfly Capital Management

Technician Greg Harmon of Dragonfly Capital outlines the three steps to take when the market changes direction and how to avoid the chop.

This short-term choppy market can give you agita if you are trading the wrong time frame. You do your homework, and find your trades, and they trigger…only to reverse lower. Here is where the agita part comes in. Your longer-term analysis shows that the uptrend in the market is still intact. Yet with each breakout in a stock you like, it pulls back and looks to trigger your stop. You feel you are right, but you have had it drilled into your head to trust your stops and just move on. If you are wrong and remove your stop, what happens if it just keeps going lower? When do you release your rising trend conviction? How are you supposed to rectify these two conditions?

chart
Click to Enlarge

The answer often comes down to three things. First, change your time frame to suit the current market. If there is chop on a swing trading time frame, either move to a day trading style or to a longer position trading style. Avoid the chop. The second thing to do is change your position sizing. Whatever size you use for a swing trade, that can move day to day and get you stopped out at 3-4% lower, should be smaller to accommodate a wider stop for a position trade. Conversely if you move to a day trading style with tighter stops then you could increase your position sizing. the important thing to realize is that your position size needs to correspond with your stop, and your stop will be determined based upon your style of trading. Once these are set do not change them. You developed a trade based on a style, with a stop and position size suited for that style. If you change a day trade to a swing trade, for example, you will likely be carrying too much risk overnight, and a position trade to a swing trade then you may be taking profits too soon.

The third adjustment is to use options, if you are not already doing so. Stock replacement, buying in the money calls instead of stock, can shave 90% or more off the capital at risk in a trade. Using options collars can protect against measured downside risk. Selling premium in the form of covered calls can also lower your basis in a trade.

By Greg Harmon of Dragonfly Capital

Related Articles on STRATEGIES