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VIDEONow's the Time to Pick a Trading Style and Stick With It
By
Quint Tatro
Jul 22, 2010 7:40 am
Traders stand to make the most when they follow a suitable strategy, especially in a choppy market.
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When the market is trending consistently, it masks many mistakes traders make. A bad entry can be forgiven. Too much risk via inappropriate position size is overlooked when the stock runs in their favor. Not adhering to stops becomes a bad habit when everything bounces in your direction. And the list goes on.
But when a market goes sideways and gets choppy, it accentuates the bad habits traders have formed and leaves them scratching their heads. What seemingly worked in other market environments is now giving them indigestion. They throw up their hands in despair, sure that the trading gods are conspiring against them in some elaborate plan to curb their trading acumen.
While there are several potential explanations for poor performance, I want to touch on merely one facet today. Traders must know their time horizon and align their trades within those parameters. Believe me, it's much easier said than done.
I'm a swing trader, and just last week I found myself getting nicked when I started picking up garbage stocks in day trades. I felt my overall thesis on the market was getting ignored, so while my “bigger ticket” items played out, I decided to throw some morsels to the trading gods in the form of commissions. I put several names on the books that I would never have touched if I was following my normal trading style. And I paid for it dearly via a decreasing bottom line.
I'm not suggesting that traders have to stick to one style exclusively, but I do believe that a trader will be more profitable by focusing on a trading style that fits their time constraints and personality. Additionally, traders need to make sure their trades are initiated and managed from the style they've chosen. Let’s run through an example that may indeed solidify this discussion.
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Here's a weekly chart of the S&P 500 ETF (SPY). Let's assume for a minute that your investment style leans toward buying and holding over longer periods of time. I don't believe in buy and hold forever, as many bankrupt companies can now attest. However, there are sound strategies that allow traders to watch their portfolios on a weekly basis and make changes when necessary.
One simple strategy is to be long when the SPY is above the weekly 50-period moving average and short or on the sidelines when the SPY is below that key level. To smooth out some whipsaw action, putting a 2% filter on those levels dramatically decreases the signals. As the above chart shows, using such a signal would have allowed a trader to sidestep a large portion of the 2008 drubbing and participate in a sizeable portion of the move off of the March 2009 lows. So if you're a buy-and-hold-longer trader, you would have had only a few signals to heed the last three years.
Click to enlarge
For consistency's sake, let's continue the analogy by sliding to the daily chart with a 50-period moving average. In a time period spanning less than a year, the daily chart above shows quite a few more “signals” generated by the moving average than does the weekly chart.
Now, if you were taking your original read from a weekly chart but then started to watch price movement on a daily chart, you'd be tempted to trade in and out of a position when prices broke the daily 50 MA. For longer-term investors, this would necessitate looking more frequently at their holdings, and then dealing with the emotions of moving in and out of positions more rapidly than desired. It would be much better to stick to the plan as initiated and not follow the wiggles and sneezes on the daily chart. Risk should be adjusted by position size and stop levels within the time frame desired.
As it should become apparent, this analogy can be drilled down even further into intra-day charts. Whether a trader concentrates on hourly or smaller ticks, the main thought to keep in mind is to trade from within a time frame and not to get caught up in the minutiae of smaller time frames. If anything, I'd suggest traders pull back to bigger time frames to get a larger perspective. Zooming in will only give a trader more anxiety than their initial trading plan warrants. Typically, this “zooming in” desire comes from boredom and anxiousness over a position. Learn to place your trade, set your parameters for getting out, and then spend your time in other pursuits.
While the ideas I'm presenting aren't new, they're often overlooked. I'd suggest that traders read my words closely and then pull out their written trading plan, account statements, and charting software. Armed with the essentials, traders can then do a thorough review of their trades and decipher where they fall short.
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No positions in stocks mentioned.
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