The most important rule in trading

  • February 23, 2006
  • Andy Swan


Andy Swan created and
co-founded DaytradeTeam Service five years ago on a principle of empowering
individual stock and options traders with the techniques and analysis methods
typically reserved for elite professionals. His expertise in technical
analysis and commitment to educating members earned DaytradeTeam a top-ranking
among advisory services for several years.

One of the most over-looked
aspects of trading is knowing the type of market you are in.
There are three basic types of markets, and for each, different
trading approaches:




Uptrend:

This is everyone’s favorite. Making
money seems easy as all you have to do is buy. CNBC will hype the
markets, bringing more money in, pushing stocks higher until
eventually the rally dies.

Keys to making money in an uptrend:

  • Cut losses early

  • When buying, let winners ride, use
    trailing stops

  • When shorting, take profits early

  • Don’t be too eager to ‘call the
    top’ of the market, just accept that eventually you will have a
    few losers when the market tops and try to make as much money as
    possible before then

  • Pay attention to the upper end of
    trend lines. Take profits only when your stocks hit the upper end
    of their trend-channels.

  • Favor buying over shorting



Downtrend:

Booooo.
Everyone hates a downtrend. But you shouldn’t. Making money in a
downtrend is probably easier than an uptrend. All you have to do is
short short short.

  • Cut losses early

  • When shorting, let winners ride,
    use trailing stops

  • When buying, take profits early

  • Don’t be too eager to ‘call the
    bottom’ of the market, just accept that eventually you will have a
    few losers when the market bottoms and try to make as much money
    as possible before then

  • Pay attention to the lower end of
    trend lines. Take profits (while shorting) only when your stocks
    hit the lower end of their trend-channels.

  • Favor

    shorting     over buying

Consolidation (sideways trend)

Boring!
This is by far the trickiest market to trade in. However, once you
identify it, making profits are easy:

  • Take profits early and often

  • Try to pinpoint market tops and
    bottoms often

  • Think range-based: Always buy low
    and sell high

  • You should be neutral between
    buying and shorting

  • Don’t try to predict when a market
    will start to run (in either direction). Just assume it will stay
    range based and profit off it as long as you can. Once it switches
    gears, you can adjust.


Now for the $100,000 question. What market are we in
now?

Let’s take a look at a weekly bars
chart of the Qs, since 1999 or so:

As you can see, the NASDAQ market has been in 2 distinct uptrends
and one downtrend since 1999 and is now in a consolidation
pattern. Be sure to read the rules above for trading in a
consolidation pattern.

Keep in mind the most important rule
of trading:


Know your market and don’t try to predict a change.

Just accept the fact that when this
market decides to break out (up or down) you are going to lose a
little money. This would have happened 3 times (about 1-3 months
each) in the last 7 years (highlighted in yellow). Until the next
one, you’ll be cashing in.

Andy Swan