Wednesday, April 4, 2012
Fading a strong trend instead of trading with trend
One of the classic trader's error is to fall in love with their first position. If a trader bought b2 since he may be expecting gap closure or b5 as a possible second attempt to close the gap or 1PB, he may be surprised when the market stops him out and takes out the low of the day.
When he later sees b9, he may see a reversal bar. b12 may appear as a reversal bar after a possible 1 bar FF at b11. b12,13 may appear to be a rather strong 2 bar reversal. The trader may end up buying every one of these and getting stopped out every time. (The alternative, adding on at every new signal is far more dangerous).
One of the reasons I prefer to trade on breakouts of signal bars rather than simply buy on close is that it prevents me from entering into many incorrect trades such as these.
The complementary situation is the trader who was right about the initial direction but fails to see the trend break (b19-b27) and test (b49) and insists on shorting every move up. After a major reversal at b49, there are no more short trades and b58 therefore is not an A2 short. (A common reason for failed A2s is being in denial about trend termination or trend reversal).
A common reason for such behavior is the trader's bias about market direction. This bias may be a fundamental bias caused by reading too many economic blogs or watching TV or other inherent biases about the strength or weakness about the world economy that the trader wants to see reflected in the market today.
Traders who don't watch news are possibly subject to technical bias. They may have an inherent belief in some pattern or indicator and are expecting a strong reaction. It is correct to trade those and natural for some of them to fail. The trader however, should not repeatedly enter a trade in the same direction assuming he would eventually be proven right. This is the need for acceptance and is a strong human trait. You should not let it meddle with your trading since the market is too impersonal to either accept or reject you.
The trader needs to realize that all biases and opinions are always wrong regardless of their direction. Only the market is right and for a day trader, the strength and underpinnings of the economy are meaningless. Patterns and indicators are tools and they fail occasionally no matter how reliable they may have been.
The right way to trade is to accept only what the market presents and be aware that trends can break, trading ranges can breakout and nothing is guaranteed to run forever or reverse eventually.