A new year, a new market: Flexibilty and Patience

Happy new years and cheers to hopefully a trending market. The last 2 months of sideways action have been hard for those who tried to initiate positions in hopes of capturing market moves.

After these 2 months with decent drawdowns (losing trades), I realized the importance of flexibility and patience. I viewed the risk reward favorable for a downside market pullback/retracement (a move in the opposite direction of the longer term trend) during November December months, even though the market is undeniably in a longer term uptrend since the March lows. I didn't see any stocks that had great setups to the upside, plus the number of stocks making 52 week highs were steadily dropping, signaling weakening leadership in the market. Add on the fact that many stocks were forming potential downside patterns (GILD, RIMM), the strongest stocks in the market seemed to have lost upside momentum (AAPL, BIDU) and financials lost their steam (look at GS, WFC, BAC) and I believed I had a case for the downside. There were a few days in which I believed I had the upper hand in being short (Nov 30th, Dec 4th) but everytime the markets approached the lows of the range, selling volume would dry up and the market would trend up ever so slowly (a range is when the market is trading between two prices for a period of time without advancement or decline beyond these two price points). Of course, I had to lose on the shorts I put out and had to reevaluate my trading. Taking a break from trading after several losing trades in a row is a good system to help in reevaluating your trading and your views on the market. After evaluating my trades, which were executed according to my plan, I realized that maybe my market bias is just plain wrong and regardless of the conditions I see, the longer-term uptrend trumps over all these factors. I decided to stop trading for the remainder of December and let the market tell me its direction.

Fast forward to today, and I have entered into a long position today because the SPY and QQQQ have finally broken out of their ranges.* If I had not been flexible with my views, I would not have been able to participate in the beginning of what hopefully is a continued uptrend and would have been sitting on the sidelines. Patience would have saved me a decent chunk of change if I observed it during the sideways action. As an aggressive swing trader, I am always looking for the first buy, sell point to enter into a position. It sounds all dandy, but the downside to being so aggressive is that I am wrong a lot more often than those who wait for confirmation. A confirmation would be a subsequent move in the same direction with relatively high volume. Just look back to Nov 30th and Dec 4th. Even though both days had potential to be a turning point in the market, there was no follow through (confirmation) in the following days to suggest any more downside. I will not change the way I trade but I now have learned that if things are not working the way they should in the market, I can either be patient and wait it out, or trade with less position size. Patience is still a skill I actively try to work on and thus far has been a worthy challenge.


As per Steve's request, here is an example of how I use a stop loss. Let's use my APOL failed short as an example. I have inserted a Yahoo Finance chart to provide visual aid.

I entered into my position Dec 8th, which is the fifth candle after Dec 1st. This is a momentum pattern so it either works immediately or it doesn't. I entered below 54.25, which was the day before's low and set a stop at 55.15, the previous day's high. The day afterwards I was promptly stopped out above 55.15. I normally give the stocks more room, but because this pattern either works immediately or it doesn't, I gave it less than 2%. I entered into a big position, gave the stock no more than 1 point to prove to me that I was wrong and in the end, I was wrong. Now it is entirely possible that the stock could have breached my risk parameter (stop loss), I would be out of my position and it could have crumbled afterwards. Then that would have been my error in judgment. But it hadn't panned out that way and I have saved myself much emotional and financial pain. The point is, anything can happen, so you must use your stops. If you want to give a stock more room, use less position size. If you are experienced enough to decipher a momentum trade versus a trend trade, then you can give the stock less room and use more size.

Feel free to post comments, I will respond and appreciate every one.  Also, if you would like me to discuss a certain topic in my next post, post it in the comment section as well. Until then, never leave home without a stop-loss.

*SPY is a S&P 500 ETF, QQQQ is a Nasdaq ETF and even though both are mostly accurate reflections of their respective futures, it is more a function of institutional sentiment of those indexes. ETFs are exchange traded funds, which are newly introduced financial vehicles which allow participants to enter into futures, commodities, bonds and baskets of indexes that were not available to regular investors. They are traded on the markets daily just like stocks.