Now, before you shoot me down, I’m well aware of the old financial planning adage that goes: It’s not about timing the market, it’s about time in the market.
But I’m not talking about these asset allocators. Their job is to gather money, work out your risk profile and manage client relationships. They’re professional nice guys! They usually hand over the heavy lifting to professional asset managers.
However, if you’ve decided to take control of your own investments, you’ll immediately know it’s not as simple as just getting invested and staying invested. All professional asset managers face decisions on a regular basis. You’ve identified a company you like, but when do you pull the trigger on the new investment position?
If you’re a self-directed trader planning to buy and sell securities on your own behalf, you’ll need to make decisions like this over and over again. It doesn’t matter if you’re a short-term day trader, planning to hold the position for the next few hours, or a longer-term investor planning to stay invested for the next ten years. If you’re doing the buying and selling, you need to decide the exact moment of purchase.
Now, working as I do in stockbroking and trading, I’ve literally had to make execution decisions hundreds of thousands of times. And I can tell you, it does become easier with time. But even for the most experienced trader, there’s still that moment of uncertainty just before you execute a trade:
• Are the markets too high?
• What if my analysis is wrong?
• Have I done enough due diligence?
The questions spin around in your head and if you’re a novice investor, this uncertainty is enough to paralyse your ability to make a decision. But if you make no decision you guarantee failure!
Today, I’m going to expand on last week’s support and resistance article to empower you to make better entry and exit decisions.
The Brutal Truth About What
Successful Traders Want...
Take a guess?
Money? Cars? First Class plane tickets?
No… This is NOT what successful traders want.
You can achieve this through a normal 9-5 job….
You can achieve this through saving money for years on end.
You can achieve this from starting your own business and working your way up…
Successful traders want something far deeper and MUCH more meaningful…
It’s a self-fulfilling prophecy
It might not be obvious, but a financial market is made up of millions of different independent actors. They all think differently, but they’re all looking at exactly the same price action. Everyone can see the chart. And almost anyone with a chart and ruler can draw a support and resistance trend line.
A lot of new traders think: It’s too simple! It can’t be this easy to make money!
But the truth is, because using support and resistance is so simple, it’s also popular. And because it’s popular it forms a part of almost every technical traders’ system. And because it forms part of so many systems, many people act in unison around these key levels. And because all these market participants have the same idea, the system works.
And when an indicator works, then people keep using it reinforcing its ability to influence the market.
Yes, it’s a self-fulfilling prophecy!
The more people that believe it works - the better it works and the system remains stable.
But how does this work?
Now that we’ve answered the why, let’s look at the how.
In the chart below, traders would trade off the support and resistance channel between A and F. Looking to the right of the chart, a new channel is being set up between F and G.
The letters are key areas in which support and resistance are kicking in.
Now last week I promised that we’d discuss break trading versus mean reversion trading.
In the chart above, using a support and resistance system a mean reversion trader would perform the following actions:
• Buy at A,
• Sell at B,
• Buy at C,
• Sell at D,
• Start to get concerned at E, and
• Get very concerned and exit at F
This type of trader will trade back into the channel. They believe the support and resistance trend will hold and will generally wait for the turn and then ride the trend as it oscillates through a channel.
A break trader is different. They see the same chart with the same support and resistance lines. But instead they try to look for the change of trend.
They want to see the trend line “break” and then capture the first (usually large) move as the pattern changes.
A break trader would be taking the other side to the trade at B and then take a stop loss as it drops back into the channel.
A break trader would perform the following actions:
• Buy at B
• Sell as it drops back into the channel on the failed break
• Sell at C
• Buy back as soon as it rises back into the channel
• Ignore D as there is no break,
• Ignore E as there is no break, and
• Buy at F and again between F and G riding the move higher.
A break trader is more aggressive as they’re looking for a change in trend.
They are prepared to take small stop losses often, knowing they will make a significant gain when the trend does change.
The mean reversion trader makes regular smaller profits and then takes some losses. The longer the trend or channel holds for the higher the performance. They tend to do very well in regular predictable markets.
If you analyse the decisions above you’ll see that even though there are two sides to trading support and resistance, the fact that both the mean reversion trader and break trader take stop losses actually add fuel to the price move.
As the break happens between F and G all the mean reversion trades stopping out help to create the spike higher. On the other hand, as the break trades stop out, they force the price back into the channel re-enforcing the channel.
This creates an ever-stronger reason for the support and resistance line to hold.
This is just one of the many techniques you can use to help improve your trading and gain confidence in making those crucial decisions.
If you’re interested in exploring more about technical trading, I’ll be hosting a FREE live webinar in two weeks’ time on the 16th of September 2020. We’ll be covering some basic technical analysis techniques and looking at a few live trades.
The best part is webinars are interactive. You have the opportunity to you ask professional traders questions directly and analyse charts of your choosing! You can register to attend here
Private Client Trader