It appears as if the market is doing just a bit of correcting, which is a good thing. Corrections, however, often mean some volatility, which, again, can be a good thing, depending on how you play the volatility. Volatility can also mean a difficult trading environment, if you are not prepared to handle the “ups and downs,” and the best way to handle the ups and downs is to have and execute a plan designed for volatility. This plan should be different from the plan you use, say, in a market that is moving steadily higher in a strong economy. My point is that no one plan fits all. One has to adapt to varying market conditions, and one should endeavor to be one step ahead of the “shift” that always comes.
Okay, so “duh” to the above. The advice is trading 101. So why bother to even write it, you might ask. Well, the way I see it, and I could be wrong here, but my thought is that more folks lose money than make money in the markets. Why do I think this? I think this because I am a gambler, and have been one for many years. In that span, I have closely witnessed how the mind can play tricks on us, especially when we let our penchant for seeing what we want to see get in the way of acting objectively according to a plan. This is the compulsive side to gambling, and since trading is a form of gambling, traders are not immune to compulsive behavior when trading.
In markets where one environment has held sway for some time (the current market, for example), traders who act compulsively miss the shift that is always coming. If you think about it in terms of odds and probability, it is easier to see the mistake. In roulette, for example, the odds of hitting black or red never change. You always have one chance in two to get it right (50-50). Consider this, though, if the ball lands in red five times in a row, the odds will remain the same for hitting black or red, but the probability of the ball landing in black increases if the ball lands in red five times in a row. Thus, if your plan is just to play the odds, you can expect that over a long period of up and down, you will eventually do no worse than break even, or come close to breaking even. However, if you play the probability, you just might pick up on the trend and make some money. To be successful at playing the probability, you have to watch the flow of red and black closely, and then you pick your spots based on what you can probably expect.
In today’s market, or the market shaping up for 2011, one has to be able to spot the trend shifts (they will be small) and then quickly adapt his or her plan to the new “trend.” This approach does not allow for compulsive trading. It requires that you understand the flow of the market, and this means you have to understand the context (the big picture) because the elements of the context determine the market direction. If a market has been trending up for some time, the probability is that any bad news (no matter how inconsequential ultimately) will shift the market as traders begin looking for reasons to take profit. In other words, the longer the trend, the higher the probability profit taking will occur for just about any reason. The trick is to adapt your trading plan before the shift happens, or, at least, early on in the trend shift.
Trade in the day; invest in your life …
