In my observation of everything, not just stocks and trading, but all my human endeavors and experiences, people defer.
What do I mean? I mean rather than become self sufficient, they go the complete other way and look to another to make the decisions and to think for them. Or they don't think at all. That was me for a long time. Neither deferring or thinking critically. There is a difference in asking to learn, and asking to avoid learning. The funny thing, is that I hate deferring because I like to understand shit on my own. And this time, because I thought Tim Sykes was a good teacher, I deferred. I wanted to learn from a master, as quickly and efficiently as possible. I watched hundreds of hours of video trying to learn, and what my discovery is at the moment, is that the majority of that learning has gotten in the way. Let me clarify.
Knowing what to do with current setups, based on past setups is important of course as history repeats itself. What I am referring to though is that trading price action seems to be 90% of the real point of success here. Reacting to what is actually happening is crucial, because price is all that matters. I don't mean to under-emphasize the importance of reading SEC filings or looking at long term charts, or understanding the catalyst (or lack thereof) as they are great clues that can give you perspective about what the best odds are at any given point on the chart.
The problem with me, was that I was thinking far too much about those things to the point that it kept me from using my time efficiently, causing me an actual lack of prep and sleep. That then discouraged me from wanting to trade at all because I hadn't been able to digest and build a thesis on all the stocks that were on my scanner.
The solution for me has been to zoom out and go back to the most common sense perspective I could comprehend. And by "solution" I don't yet mean profitability, or consistent profitability. While I may achieve that because of this shift, I have have not had enough time with it to know. It has so far however, been a great help in allowing me to actually be an active, level headed participant. Here's my summation:
Trade the chart, because the chart is never wrong. It may look like it is shaping up to do something, and usually it will if you understand the patterns, but be prepared for the opposite to happen. You must remember that each moment is unique and thus the playing out of each "Pattern/setup" will reflect the uniqueness of each moment. The key things to pay attention to are price levels, how the those levels were formed, the volume, and the order flow, building context around the catalyst for the stock including any details that may effect sentiment positively or negatively. I'll reiterate that each trade needs to be given context, and that is what I failed to even realize up until a year or so ago.
Even when I was trading the news releases for Forex, all I cared about was the reaction. Now, that in itself is actually a good thing but it's not the only thing. A lot of traders get caught up focusing on the information instead of the reaction to the information, but the reaction is far more important because it tells you what the present psychology around the stock is.
Lets break these down for further clarification:
Price levels and how they were formed.
It took me a long time to think about these things, and I have to give credit to Tim and his successful students for getting me to think about these things. In the market perception is everything, and price is part (yes only part) of revealing that perception. What someone is willing to pay for something is basically the only thing that matters. The edge that people seek in the markets, is in trying to have an insight into what current perception is, and what it will be at a given point in the future. It sounds needlessly obvious to point out to most perhaps, but charts show (with varying levels of detail) what the overall consensus was at any point drawn on them in the past. Any turning point on a chart shows a shift in sentiment of either the price being perceived as too low or too high to continue the trend. In fact, any trade at all that takes place is on the premise that there are two parties simultaneously thinking price is not accurately established. The perception of accurate valuation would stifle any new interest in trading , while perhaps causing those previously involved to exit their positions if they perceived prices were where they belonged. I could go on in depth about the scenarios, but what I want to take a moment to focus on is paying attention to how a stock price arrived at where it is. The journey of price fluctuation throughout time is very revealing if you become familiar with the various journeys that repeat themselves. That is a large part of the work that a trader ultimately needs to be obsessed with.
There is a beautifully fitting quote that seems to be widely (and inaccurately) attributed to Mark Twain, in which he says “History doesn't repeat itself, but it does rhyme". There is also a quote that he actually did say: “It is not worthwhile to try to keep history from repeating itself, for man’s character will always make the preventing of the repetitions impossible.”
I find these both really great quotes. The first being great because it speaks beautifully to the nature of humans and repeating psychological patterns, and eludes to all the variables that exist which uniquely effect each situation individually. The same overall outcome is produced, yet takes a different path to that outcome.
The second quote is an important observation that goes unseen to many because the nature of man ironically, is also to live in denial. Fear and greed (which is just another facet of fear) will be ever present in humans, and thus as long as the markets exist and are traded by humans, opportunity will continue to manifest. Successful traders must be acutely self-aware, and establish/maintain habits that minimize these evolutionary traits that both provide the opportunity, and also hamper those that partake of the opportunity.
The journey of price towards the point of perceivable opportunity is what we call a setup. It is the visual story of what actual market participants have thought up until now, and because humans rhyme in their behavior, what they might be thinking next. The variables can be many indeed, and certain ones hold more weight and must be paid attention to. On a price chart, a change in the behavior of price is the most concrete way of determining if a setup is valid, or it if is breaking down. While news, one of the largest potential influences on perception, may be contradictory to what the current sentiment is, it may not take effect in a period of time the trader thinks it should. The famous saying is "The market can stay irrational longer than you can stay solvent". That is true because humans are irrational. It is our job as discretionary traders to perceive what is happening as accurately as possible, knowing and accepting that we are the very flawed things that cause the irrationality to begin with.
One of the simplest setups, and one that I am using the majority of in my practice, is dip buying earnings winners and other stocks that have proven themselves with a reaction.
The ideal setup is simple in theory.
- A stock shows up on a % gainer scan with earnings released or a significant catalyst. (something that can garner more interest in the recent future)
- The stock has good volume.
- The stock dips quickly and cleanly (ideally in the morning) down to a level of support that has been tested several times, making it a "key level". Also Ideally, back down to a level of support that represented a significant breakout of multi week, month, or year time period.
- The stock has little resistance (tests) between it's recent high and the level of support it came down to (hence the "clean" movement comment) and little resistance above highs for continued further running.
Now, this situation is ideal and doesn't come about very frequently. One reason most traders lose consistently is obvious if you think about it. It's a cliché at this point that is taken for granted, but the average trader simply doesn't wait for the best opportunities. That's actually where the liquidity comes from that the successful traders need to profit from. As with most humans, the losing traders are fearful, impatient, and impulsive. If a trader cannot conquer that, it doesn't matter what strategy they know, because they won't use it properly. But that's a whole other discussion.
As I said, price behavior is key to identifying potential breakdown or continuation of a setup. The strange thing is I don't quite now how to express it without saying it so simply it sounds dumb, yet, it really seems to be that simple. I like market symmetry. I like to see V shaped bottoms. In my (limited) experience, when a stock doesn't bounce symmetrically off it's support, the bounce is showing you that it's not a great bounce and that it's likely going to lose steam. Often times that's when the stock starts to roll over and make test or make new lows. I want to be out of the stock if it's not doing exactly what I want or expect it to do. And yet, I can literally sit there and say outloud "The stock is not bouncing symmetrically, I should exit" while continuing to hold the damn stock, as it quite often turns against me. Being right "eventually" doesn't matter if you're not right "right now" in my book. Stocks are either going to hold support and prove themselves or they aren't. The vast majority of my losses have been from
- Buying stocks that have dipped, but not down to a key support level, and
- Holding stocks that aren't bouncing immediately or symmetrically.
- Buying stocks outside of what I have defined as a worthy setup, or the setup at all.
Think about it. The stock is actively telling me the whole time what it's doing. If it bounces and takes longer to recover than it tanked, it should be clear buyers are not as enthusiastic as they should be. If every time a stock approaches highs and quickly rejects when you are hoping for a breakout, what is the stock telling you? I find often times that my immediate winners are the best, and the ones that take a long time, only take a long time because they are going to be losers and I hold them while the signs are clear as day to me. I stubbornly hold what I know ahead of time is very unlikely to work out. If I can just work on that I can do so much better.
Here are thoughts that help me cut when I should:
- Winners tend to make themselves known immediately.
- Small losses suck, but not when compared to devastating, unnecessary large losses that can cripple your confidence and set you back on your journey a very long time, or forever.
- Small losses can always be made back. It's that simple and you will never be successful long term without accepting small losses when they are still small.
You don't just want to know what the setup looks like, but why it has formed and where in the overall cycle of enthusiasm the stock is (frontside or backside of the move). Patterns form and breakdown on a mix of psychology and market mechanics, and while it's part of the whole, that information is perhaps more crucial to understand than a piece of news.
Anyhow, it's thanksgiving, I've been sitting on my ass for hours now and I have family arriving soon. Happy holidays to all.
