Thursday, June 29, 2006

Just trade the setups, Dammit!

Caution: This advice only pertains to short-term trading and not longer-term investing, swing trading, position trading, etc.

We do not open our newsletters with charts of the Nasdaq, S&P, VIX, discussion of Stochastics, etc., not because we are too lazy but rather because we think it is counterproductive to analyze such matters for the type of trading that we practice.* The more you study the indices and attempt to interpret the stream of information that the plethora of indicators offer, the more you will form an opinion before the market even opens. We follow the leaders of the market and the leaders of the market are usually on the avante-garde of market moves. The leaders will signal when a bottom has formed or when a correction is due. In addition to the leader stocks we watch a host of momentum stocks which are often also great early tells for market moves.

There is a very important reason that we have told our clients in our newsletters-- leave your opinions and emotions at the door before entering your office in the morning. Emotions are the enemy of the trader. Most traders will have heard of the story that if a man sits in front of a great trader and watches him all day, he will not know at the end of the day whether the man made a million dollars or lost a million dollars.

The best traders just simply react to the circumstances. For example -- stock HCPG is approaching the price at which you would like to buy it based on a break of a 2 month consolidation.

Above Average Volume? Check

Is the Trend with you? Check

Is the stock showing greater relative strength than the market? Check

Is the intraday nice and tight without big volatile spikes up and down? Check

Is the breakout coming off of an intraday base instead of a chase of a vertical move which is to be avoided? Check

Trade entered. After that you obey your risk management and profit taking rules for the remainder of the trade. Many traders miss out on great opportunities because they think that the market is too overbought or oversold. Just trade the setups. That's it. When the market finally does decide to turn there will be ample signs and new setups will emerge in the correct direction.

* Usually we aim for 1-3% profits on daytrades and occasionally hold positions 1-2 days. We trade on average probably 1-3x a day, all depending on available setups.

The sitting

Jesse Livermore said it well in the now much-quoted, “It never was my thinking that made the big money for me. It always was my sitting.” He was referring to entering a position, and then sitting on it for possibly months at a time. We as short term traders like to decontextualize the quote and place it within our own reality : It’s the sitting, the waiting for that perfect setup, that makes us the consistent money. Waiting for a setup that meets all your conditions is the most important and the most difficult thing we have learnt from our years of trading.