An interesting note on recent historical events can be seen in a report that was published on Friday September 19th, 2008 by a major news web portal. Although following a week of mostly declining share value this news site proudly announced that the trading day ended with one of “its best run for the past 8 years”. That following Monday saw the beginning of one of the most brutal and rapid declines in history. While such a report may have left investors with a hopeful weekend as a momentary reprieve from recent prior portfolio losses, such hope proved to be short lived. In retrospect this news report is made even more perverse by the fact that so much at exact the time screamed of economic calamity.
For example, it ignored the reality that this one-day extreme bullish move was simply due to a huge bail-out provided by the Federal Government. Ignored too was the report that a major 158 year old investment bank was on the brink of collapse or that the government had already assumed control of a major insurance company because of its financial woes or even that the 12th bank of the year was just forced to close. Yet, this one-day bullish move was purported to be a sign of better times returning once again.
This extremely imbalanced view of market affairs demonstrates how much we can distort our own view despite the obvious. What is apparent to everyone else detached from those affairs can become rather murky when we have an emotional attachment. Such was the case with the writer of that news article. Those that were swayed by such biased ramblings quickly found out just how extremely costly such foolishness really is. The decline following this one-day climb was brutal, to say the least.
This example is but one that proves how important it is to base our decisions on the reality and not simply on what we want to hear. Unfortunately, during the heat of the battle it is often very difficult to tell which is the reality and which isn’t. Here are a few ways to help identify the difference:
Remember, the markets always strive for balance, so avoid trading when it is at extremes such as buying when practically everyone has bought.
Know your market and your trade and know your entry price, stop limit and profit-taking point.
Know why you are taking the trade. If you can clearly explain the reasons for a trade to someone else then you understand it. If can’t explain it then you don’t really understand it either.
Know what has the strongest influence on the market you are trading and make sure you know when those influences are being impacted.
Never enter a trade during a panic or allow yourself to be rushed into or out of a trade.
The first point is a truth about markets in general; all markets seek balance. This is even true if the overall trend is higher or lower. There is a natural equilibrium even if the market is leaning one way or the other. In other wards, if a market is reaching new highs it is often best to wait until it consolidates or retraces slightly unless there is a substantial reason to expect to move to continue uninterrupted. This is because even in strongly trending markets extremes will typically bring a reaction that drops the price even if only temporarily.
The second point is two-fold. The first part is about knowing the particulars of the specific market you are trading. If you are buying T-bonds and don’ realize that interest rates can severely impact that market, then an announcement by the Federal Reserve can be costly. The second part is about having a plan for your trade. If you have a trade planned out and follow that plan then you will avoid allowing emotion to corrupt your thinking.
The third point revolves around having a legitimate reason for making a trade. Whether you trade based on fundamental reasons, using technical analysis, a mixture or both, or based on some other exotic reason, make sure the reason really exists. Demand proof of yourself and be able to defend your position. If you can’t prove the reason for your trade to someone else then likely you really don’t have a legitimate reason for the trade.
The fourth point extends our second point further; understanding not only the market, but what influences it as well. We can thoroughly understand a market, but if we understand little of what influences then it will repeatedly surprise us with unexpected behavior. Most markets will have at least one or two external forces that have a dramatic impact. Know and understand them and you will better anticipate the market they influence.
Our fifth point is one of the hardest rules to keep. If a market is panicking then it is moving very powerfully in a specific direction. It can be very tempting to jump into that market expecting it to continue. The problem is that just at the point you realize it is panic selling or buying so has the rest of the market. The result is most everyone jumps in as well and the market runs out of new buyers or sellers, thereby collapsing on itself. This scenario often results in a very uncomfortable position for those imagining they were going to get in on a quick profit, buying the top or selling at the very bottom. The second part of our fifth point is a reminder not to rush an order. Although waiting too long is also detrimental to any trading or investing, often traders are much too quick to jump in or out of a trade. Patience is a virtue in trading and often makes the difference between a profit and a loss. Relax, take a breath and think. Think a second time or even a third. Be sure about what you are about to do.
As a trader and a teacher of trading, I have learned first-hand that emotions often ruin the very best laid plans. We are our own worse enemy, much more than the markets themselves. Often our actions demonstrate a propensity and determination for failure. It is inherent to our emotional make-up. We will tend to see the best within the worst and the worse within the best. It isn’t about removing emotion entirely from ourselves, but not allowing it to deceive ourselves.
For those that saw beyond the illusion propagated by the media on September 19th, 2008 an incredible profit opportunity was handed to them on a silver platter rather than what it was for most, having their heads handed to them on a platter. Remove the emotional veil and you too will find your investment and trading results worth getting excited about in 2009.