Wednesday, January 07, 2009

Fear and Greed

Markets are said to be efficient when fear and greed are kept in balance. Market bubbles occur from excess greed and bubbles burst and over correct out of fear. The recent oil and commodity bubble was brought on by greed and the ensuing correction was excessive out of fear.

On a micro level, day traders have to deal with emotions of fear and greed everyday in their trading. Fears of losing and missing out are basic. The fear of losing usually leads to tight stops that may cripple the trade before it has time to develop and the fear of missing out usually comes in the form of abandoning the entry rules in order to chase stocks that are ripping.

Greed usually manifests itself by being swept away with a winning position, thinking it's going to keep ripping and turn a mediocre day into a big winner. Dreams of this nature can cloud the trader's perspective and force him (her) to throw trading rules out the window.

The most realistic approach to trading is to aspire for consistently profitable trading results by applying focused and disciplined trading rules. A disciplined approach to trading rules will help the trader manage entries and exits, thereby relieving the trader from acting purely on the emotions of fear and greed.

A 50% win/loss ratio can be a very profitable business if the trading rules are consistently adhered to. As long as winners run at least 2:1 over losers, and preferably 3:1. But every trade has to meet certain pre-defined criteria and the trading rules have to be applied in a consistent and disciplined manner. If either or both are missing from your trading plan, your trading results are likely unsatisfactory. If this rings true for you, the beginning of a new year is a good time to start elaborating the criteria and the rules.

A reader submits the following: BTU: Entry on the break of the 11:45am candle which is an inside NR7 bar. It was also basing under the round number $28.00 and it looked liked it tested the PDH a few times. Target just ~ $29.00. Action went sideways for most of the afternoon until a nice little jump at around 2:30ish. Had a decent profit but gave most of it back because it never reached my target. In retrospect I should of at least partialed after the 3 WRB.

Okay, I'm not sure why the target wasn't met, because the Esignal chart shows that it was tagged. I would just like to emphasize the need to sell into strength and you should plan the exit as price approaches the target for example exit at $28.95 as opposed to exactly $29.00.

The entry is good NRIB (NR7) at the base of PDH. The long basing period may have contributed to a sense that price could go higher than the initial target, however, we have to stick to our trading rules - 3WRBs, Fib. targets, whole $ dollar levels are all areas of profit taking and/or consolidation. Take at least a partial. If price consolidates and wants to move higher, there's nothing to prevent you from adding back.

Made a similar play in ACI and I was wondering if it is stupid to do that since they are basically in the same space as each other. They were pretty much moving in lockstep.

Not stupid at all. I often trade pairs because it's much easier to manage two positions in lockstep than not. Always good to find ways to capitalize on sector strength/weakness.

The GG trade is mine. I took a partial at $28.00 after a small profit because it was an obvious support level. In my heart, I had a good feeling that it would eventually go lower, but price is pre-disposed to consolidate at obvious support levels, whole $ levels, fib. targets, 3 consecutive red bars. I'm being repetitious on purpose. The key take away is sticking to the trading rules to protect profits. Price could have easily reversed at support and retraced.

As I said above, there's no reason not to get back in if price consolidates and wants to continue in your direction. This GG consolidation is a thing of beauty - a series of lower highs on a flat base with the 3 MAs (5, 20, 50) squeezing into a tight formation. Burn this 1 min. chart to memory.

I re-entered full size, partialed again when price stalled at the half $ and exit as price approached the whole $ level on capitulation volume.


yr said...

Hi Jamie
Happy New Year to you! Its been a while since I last commented...
XLE gapped down today from shooting star daily bar, which is very bearish. Which would have been a better short entry in your opinion:

1) break of IB low (2nd 15 min bar)
2) break of shooting star low which is unable to closed above 5EMA on 5min (9.50am ET bar)


Anonymous said...

Hi Jamie,
Two stocks that look promising for tomorrow: FLIR (resistance low 32's) and GRMN forming 2 day channel. Happened to catch MON (break of 83.54) after it came out of R-Zone around 12:10 PM. As always keep up the great work.

anarco said...

Amazing post! It really helps me in the areas I am trying to grow as a trader. Thank you!

I also would like to contribute a few thoughts.
I think this post also touches on the subject of Motivation and Success.
Why do we want to succeed as traders?

Although one cannot deny that making money is a huge motivating factor in the life of a trader, I believe that money should not be our prevailing goal. Most successful people (in any field) don’t do what they do for their own glory. They do it as a mean to grow and improve themselves and in most cases to also better the people and environment around them (a goal larger than themselves).

I believe that the road to success is not a direct one. I believe it is the wrong formulation to say: “I am going to work on becoming a successful trader.”
But if I master my emotions, master the trading skills and methodology (setups, indicators, trading rules, etc), and master my mind, success will definitely come.

For 2009, my goal is to trade well, to be disciplined, to stay focus, and to continue studying and consistently applying sound trading principles. Success will come.


PDT said...

Excellent post. Thanks!

Do you think in the case of the BTU trade one should move onto greener pastures with a small gain after the long basing period? I find that when I am in a trade like that and action goes sideways for a good amount of time I just stick with it because "hell, I'm in this already.. lets see what happens". At that point im left just hoping price will move in my direction. I guess I could move my stop up to just under the PDH but I'm still left guessing.

Jamie said...

Welcome back YR and Happy New Year!

Let's review that setup tomorrow. I'll post the charts on the blog and give you my thoughts.

Jamie said...

Hey Alex,

Thanks for the stock tips. I'm adding both of those to my focus list. I also like AMZN and PLD as they consolidate above their bases.

Jamie said...

Thanks Anarco,

Appreciate your ideas about success and motivation. I believe that organizing one's trading plan into an actionable business strategy will allow you to more easily measure your performance. Of course every business plan needs some tweaking along the way to make it more realistic.

But in the interest of full disclosure I have to admit that money is my primary motivation for trading. We can elaborate on these themes in upcoming posts.

Jamie said...


That's a very tough call. In the case of BTU, it kept making higher highs, so it was optimistic. If it had been making lower highs, you could have rationalized tightening the stop.