In trading and in life, hot romance based on promises of undying adoration usually ends in disappointment. Like a fickle lover in a Country Western song, once Wall Street was certain of the Fed’s affections, it turned its back on its suitor and walked away. Did this surprise you?
Last week I wrote that institutions were “primed to sell whatever good news Mr. Bernanke’s accommodating Fed comes out with.” I made this prediction because the market has a well-known penchant for Mad Hatter logic, in which scary rumors are bought and happy reality is sold.
TOP TRADERS DO THIS
But when you think about it, it is really not so mad after all. Top traders approach trading tactically, buying when folks are anxious and uncertain about approaching events, and selling into the relief buying when “confirmation” finally arrives.
Buying when lots of folks want to sell means that prices are low, so bargains abound. Selling when the majority feel relieved about the market means prices are probably high. There is an art to this, however, because it’s best to ply this tactic in the direction of a trend.
RECIPE FOR TRADING SUCCESS
So here’s the recipe: Buy pessimism in an uptrend and sell into enthusiasm; sell hope in a downtrend and buy back into moments of despair and panic. This trend following technique takes advantage of trader emotion rather than becoming a victim of it.
When Extremely Good News morphs into Extreme Selling it leaves a distinctive trace on the price chart. We can see this in the hourly chart of the Dow tracking stock (DIA). The telltale sign of this emotional heartbreak is the parabolic swan dive that fills the September 16 gap.
It’s one thing to resist the emotions of the crowd, but let’s bring this closer to home with a gut check. Some traders are emotional by nature. Are you?
FADE THE CROWD
If you find yourself feeling bullish when the Good News finally arrives, be careful. In order to prevent emotional whipsaw and heartbreak in your trading, you must learn to fade not only the crowd, but your own feelings, as well.
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Join Dr. Kenneth Reid, a trading coach, each Wednesday on TraderPlanet for The Dr. Is In column.
