Here's How Traders Can Flame Out In Quiet Markets

It is old news by now, but there can be little doubt that the current market is rather challenging for traders. The only ones who seem to not have a problem are those who bought a few weeks ago and still are long....I am not one of them.  Such is life. The strategies that I have used for many years still work; the problem is that that there are only a handful of opportunities each day, and then, spotting them without being lulled in my "noise" adds another layer of difficulty. I have been through these periods before, they do not last forever, but it seems like they do. I am confident that yet again I will walk away with something to show for my efforts and more importantly yet, a better perspective on how my trading style works.

There are many however who simply cannot let well enough alone. When their strategy is dead, they cannot accept this, they feel the urge to move on. Either their buddy told them about some new system that is kicking butt or the infamous message boards make you feel like you are the only one who is struggling. Guess what? All traders are challenged by this market, yes there may be a handful of exceptions, but by and large, those that are honest will admit this.

Let me use some dramatics here. The longer this market remains quiet, the greater the probability that traders will flame out.  The reason? Overtrading.

"Most of us believe our primary goal in the markets is to make money. This isn't true. Our real objective is to trade well at all times, because profits will come naturally if we do that. Of course, the mental shift required to get from the effect to the cause can be very difficult.

The profit chase forces us into bigger positions and bigger plays. As in baseball, market players who swing for the fences strike out a lot and have poor batting averages. The bottom line is that most traders never overcome the big losses they incur while trying to make the big plays.

The second type of overtrading relates closely to the first. We may keep our trade size at tolerable levels but take too many positions at the same time. This can be more dangerous than the first error. In many cases the overall capital commitment is even larger, exposing our equity to much greater losses.

Each trade has its own dynamics, pattern and eventual outcome. This means we have to watch all of our positions closely to make sure they do what we expect. But we can't give each trade the attention it deserves when we have too many stocks to watch at once."

--Alan Farley

Now, let's consider what many never do: Not trading at all. Depending on your style, it is very possible for there to be times when the setups that you look for simply do not show up. For me, my trade frequency is way off. On average I am doing about five HVT trades in any given day. Remember, the market emits more noise than patterns many times. Do not get sucked in.

"We love trading and want to be in the market at all times. This leads to frustration when we can't find good setups. If we lose our focus, the creative mind will fill in the missing pieces and construct opportunities that don't exist."

--Alan Farley

Please do not construe this column as being negative or pessimistic, far from it. The fact of the matter is that this market is unique to most of us (it resembles the tape on a Friday afternoon in August) and we need to make adjustments, that is it, no dire predictions.

In terms of market perspective, let me share these observations from my friend and fellow trading colleague, Bo Harvey:

A look at the charts and you can see that, should we get a pullback in the market, several stocks are set up to retest their 200-day EMAs ((TXN | Quote | Chart | News | PowerRating), (WMT | Quote | Chart | News | PowerRating), (HD | Quote | Chart | News | PowerRating), (KLAC | Quote | Chart | News | PowerRating), (NSM | Quote | Chart | News | PowerRating), (IBM | Quote | Chart | News | PowerRating), (C | Quote | Chart | News | PowerRating), and (MWD | Quote | Chart | News | PowerRating)). Whether the stocks and indices hold the 200-day EMA on any retest will be a vital sign of whether this has been just another bear market rally that sucks as many in as possible*, or the start of a more sustained multi-month advance.

*Equity mutual fund inflows for April were at their highest since April 2002.

P.S. I also have a new trading module available which teaches how to trade my HVT style through bar-by-bar chart simulations. Click here for information about the module.