By Dan Zanger
Albert Einstein once said that insanity is doing the same thing over and over again and expecting different results. In trading, that would be comparable to losses week in and week out without re-evaluating your approach.
Take the Trader’s Insanity Test
So here is a quick test to see if you qualify for the trading loony bin. It’s imperative that you be brutally honest with yourself in your answers.
– When markets are open do you compulsively trade no matter what?
– Do you use the same methods and indicators pretty much all the time in every market even when they don’t work?
– Do you use your gut to make trades and often find yourself in situations without stops, specific targets or pre-determined support and resistance levels?
– Do you believe that a written trading plan is fine for others but just isn’t your style?
– Are you proud that you learned to trade through the ‘school of hard knocks?’
For most of us, habits are hard to change, even in the face of overwhelming evidence showing that they are counterproductive or even destructive. And when it comes to stock trading, one bad habit will put you out of business.
One of the most difficult lessons for most traders to learn is to sit and do absolutely nothing. You’d think that would be easy but it’s not. Traders are for the most part Type A personalities. We like to take charge. If there is a problem, we have to fix it. If a stock is moving, we have to buy or sell it. But just sit there and watch without doing anything? Forget about it!
Learning how to sit at your trading desk and simply watch is the key. We never know when the next big up move is going to happen. Above all, traders need to pay rapt attention to be ready to jump when the stock does. Timing is everything – jumping in too early is always a risk.
Figure 1 – Before and after daily chart screenshots of Facebook showing the breakout from Dan Zanger’s Technical Buy Area (TBA) issued on July 23, 2013 in his newsletter at far left of chart on the left-hand chart and the double top chart pattern sell signals on right side of the left-hand chart then the ugly chop that followed (right-hand chart). Charts courtesy of https://chartpattern.com
Vive la difference!
So how do you avoid chop? First you need to be able to recognize the differences between a trending and trading range market. That may seem easy but you’d be amazed at how many traders get caught out in chop.
I think it’s a matter of not seeing the forest for the trees. We can get so focused on the stocks we love to trade, that we don’t see when overall market conditions are changing. My favorite stocks, those that I cover in my newsletter three times a week that are leading the market, tell me what the market is doing. When they change as a group, I take notice! I have included some examples of previous trades here.
Figure 2 – Before and after daily chart screen-shots of GoPro showing the move following the Technical Buy Area issued in Zanger’s newsletter August 22, 2014 newsletter. GPRO was a market leading stock in the left-hand chart. Not so much on the right-hand chart. Charts courtesy of https://chartpattern.com
Figure 3 – Before and after daily chart screenshots showing the breakout from Dan’s Technical Buy Area in early July 2014 and the move that followed in yellow. The right-hand chart shows the move and what followed afterward – loose chop that can eat you alive if you are in a long buy and hold type trade or trying to buy the breakouts. Charts courtesy of https://chartpattern.com
Determining when a stock is trending or in a trading range is as simple as drawing a trendline. I say simple but it’s not easy since so many get it wrong. If you can draw an up-sloping trendline that forms support at the lows, it’s trending up (see Figure 4). Ideally the stock should be heading up in a channel so that a set of train-track lines encompass the highs and lows. One big caveat here is that if the channel is sloping up too much and is very narrow, it can signal what I call a frozen rope pattern which is can be very bearish and signal exhaustion.
If on the other hand a support line that encompasses the lows is horizontal, it’s in a trading range and that’s when it becomes even more important to find and trade the right stocks.
Another key to separating trading range from trending markets is volatility. During a trend, volatility tends to be low. In a trading range, market direction is far less certain and option premiums, that are priced based on volatility, can get a lot more expensive.
Figure 4 – Daily chart of Ambarella (AMBA) from the January 30, 2015 Zanger Report newsletter showing the two trendline support lines. Note the TBA from $42 then exit with the break of the upper most trendline marked in yellow with stops at $54. Chart courtesy of https://chartpattern.com
In a trending market, I look for the stocks that are leading the market, making the biggest moves. But these stocks can also make you money in a trading range market. As we see in the charts I’ve included, stocks like Bitaulo (BITA), Gilead Sciences (GILD) and GoPro (GPRO) made huge gains in up trends even when the overall market was stuck in a trading range. The trick is in knowing which stocks to trade and when. Stock picking becomes even more important when markets trade sideways!
Figure 5 – Weekly charts of another previous market leader showing the huge move from Dan’s Technical Buy Area in October 2013 and what followed after the move was over on the right-hand chart. Charts courtesy of https://chartpattern.com
Stop Being Crazy Already
If you answered yes to any one of the questions at the beginning of this article and you are not making money, it’s time to re-evaluate your approach to this business. If you answered yes to all five and are losing money, consider taking a long vacation and when you return instead of trading again, find a good trading mentor or coach.
If after an honest self-evaluation you realize that you fit Einstein’s definition of insanity consider yourself lucky. Realization is the first step to making meaningful change. A great place to start the change process is to take a look at my 10 Golden Stock Trading Rules at https://www.chartpattern.com/10_golden_rules.html
All great traders exhibit three key characteristics. First, they are incredibly determined. They have made the commitment to themselves to do whatever it takes to be successful. Second, they do their homework. That involves looking at hundreds of chart patterns every night as part of their homework ritual. Finally, when markets are open they are completely focused on those stocks they’ve identified the night before. When these stocks are surging ahead, the trader has to be ready to pull the trigger. When these stocks are struggling, best to sit tight and not waste effort and cash on low reward/risk trades.