Truths of Trading
Stockscores.com Perspectives for the week ending August 5, 2011
In this week's issue:
There are little tidbits of wisdom that I have picked up over my years as a trader; here is a list of some things that all traders should take to heart:
Don't apply logic to the stock market
So often I see people make decisions in the market on what makes sense to them. It makes sense to buy stocks when the company insiders are buying. It makes sense to buy stocks that are making positive announcements. It makes sense to listen to what the President has to say about the company's prospects. However, all that matters is what the market thinks of the company and whether the buyers are more motivated than the sellers. So often, the market does things that do not make any sense until we later learn of what motivated the market to do what it did. Remember, the market is forward looking, most times, what makes sense is judged on what has happened in the past.
Never average down on a losing position
Buying more of a bad thing is not much different than continually betting on a losing horse. Winners win for a reason, and until your stock starts to show that it is a winner, don't add more to a bad situation. If you like a company whose stock is losing you money, sell it. You can always buy it back later when the market starts to like it again.
Successful investing is not about being right, it is about making money
Most good traders are usually wrong. They will lose small amounts often and make big amounts occasionally. What matters is how much they make over a large number of trades. Don't try to always be right, simply work to make money.
Resist doing what feels comfortable
We have a tendency to look for the market to prove our decision is a correct one before we make our move. The problem is that this often means we are too late to capitalize on the opportunity. We have to move before the crowd, and that often feels like a dangerous thing to do.
Anyone can get lucky in the short term, only good traders succeed in the long term
Don't confuse making money in the stock market with knowing what you are doing. It is easy to get lucky on a stock or on a sector and enjoy gains that give credence to your analysis method. However, short term winners often give back all of their gains because they fail to recognize their success as luck.
Be patient with your winners, not with your losers
The natural tendency is to sell your winners too early and hold on to your losers, hoping for a turnaround. A simple, but not easy, thing to do is reverse this tendency. When the market proves you right, wait to sell on a signal that indicates the stock is likely to go lower. When the market proves you are wrong, let the trade go and take the loss.
Publicly available information is priced in to the stock, don't rely on it to make decisions
Once information, no matter how good, is made public, it loses its usefulness to you.
Public information is priced in to the stock by the market of investors. Information only has value to you if the market has not priced it in.
Make sure your trading strategy has an edge
A trading strategy is only worth trading if it can be shown that it consistently makes money. Establish your trading rules and test them over a variety of market conditions so you know that it is effective. Time spent testing a strategy to prove it is a money maker can save you a lot of money in the market.
People lie, markets don't
I have learned the hard way to never trust what people say, their actions say much more. Learn to read the market and understand it's message. No matter how much insight a person may have, recognize that they have a bias based on their own emotional attachment to money.
It is easier to trade with the trend than against it
Understand the mood of the market and trade with it. Don't chase euphoria, but seek to buy stocks that are in the control of the buyers. Don't sell on fear, but seek to sell stocks that are under seller control.
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This past week was the strongest selling week we have seen since 2008. That is painful for those that are long stocks but creates opportunity for those who have cash to take advantage of lower prices.
I think that the market is most likely going lower through the remainder of the summer and in to the Fall, making a seasonal bottom sometime in September, possibly October. That will set the market up for its typical rally phase from November till May, a seasonal tendency that has worked most years.
In the very short term, stocks are oversold, which means the sellers have acted too aggressively and pushed prices down too quickly. We can see this by looking at an intraday chart of a market index like the S&P 500 and see that prices have fallen far below the downward trend line. That makes a bounce back in the short term quite likely.
This bounce back will not likely last more than a few days, perhaps a week. Look for a 1.5% to 2% gain in the S&P 500 as short sellers take profits and some traders make an attempt to bargain hunt stocks. That brings the index up to the downward trend line where the sellers will again be motivated to act.
At that point, we could see a break of the downward trend line or the market will revert back to the bearish sentiment that we saw this week. What happens in Europe and what the US Federal Reserve says next week will have a big impact on the test of that downward trend line.
For now, there is a swing trading opportunity to take advantage of a bounce. I see two ways to play a bounce, either go long a market leader which should bounce back with more intensity than the broader market or consider buying stocks that have a chart pattern that shows a high probability of a short term move to the upside. I found one of each on Friday and featured them to readers of my daily newsletter (a trial is available at www.tradescores.com).
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1. AAPL
First, is the market leader, Apple (AAPL). While the overall market was trending sideways, this stock was hitting new highs. It has pulled back with the overall market but has a long term chart that is healthier than the major market indexes. Apple closed well off of its lows on Friday but still below the open and down for the day. That makes it a bit of mixed picture for a swing trade. The intraday chart shows the formation of a head and shoulder bottom through Friday, a break through $378.50 would be a break of the neckline in that pattern and a good confirming entry signal. I have bought a small position already and will add to that position as there are more positive entry signals next week. The right shoulder low today of $370 is a good place to put support for the trade.
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2. AMLN
Second is a stock that has fallen down in to long term support but closed today up and above its open. AMLN trading between $13 and $14 before the selloff began and bounced from support at $10 to close today at $10.60. Support at $9.75.
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References
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Disclaimer
This is not an investment advisory, and should not be used to make
investment decisions. Information in Stockscores Perspectives is often
opinionated and should be considered for information purposes only. No
stock exchange anywhere has approved or disapproved of the information
contained herein. There is no express or implied solicitation to buy or
sell securities. The writers and editors of Perspectives may have positions
in the stocks discussed above and may trade in the stocks mentioned. Don't
consider buying or selling any stock without conducting your own due diligence.
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