Wednesday, June 5, 2013

Don't try to catch a falling knife

Don't try to catch a falling knife!
The person that came up with that saying was obviously not a ninja.  Speaking of things falling the market was taken to the woodshed today (don't you love these English idioms),  I'm sure there are a lot of bears out there pounding their chests tell you they saw it coming and I'm sure some did but I'm sure  the rest 'saw it coming' since going short in late November 2012.  So how could someone, if they were so inclined, have seen this drop coming.  The reality is most retail traders believe they know exactly where the market is heading and lose money and I believe its that conviction (a synonym for stubborn) that is their trading downfall.  They anticipate when they should react.  Let me explain what I mean for the less gifted (intelligent).  The definition for anticipating and react is as follows:

Anticipating:  Guess or be aware of (what will happen) and take action in order to be prepared.

React:  Respond or behave in a particular way in response to something:

Trying to anticipate tops and bottoms is synonymous with guessing and usually traders find themselves jumping the gun on a trade. There must be some type of innate need or maybe something programmed by the society we live in that we have to be first in everything in order to prove ourselves better than the next person.  It is the only rationale I can think of that would make one so anxious to get into a trade in hopes of an imminent reversal of a prevailing trend.  Unfortunately, far too often the rationale for the trades come only after the trade is executed and is backed up with sound analysis such as '...the price fell  so much it has to bounce!'  or '.....I bought at double the price let me average down!'.  All solid reasons in there own right and I'm sure their trade account balances reflect the merits of that analysis.  

Reacting in the context of trading, means to respond in a particular way to a market move. Anticipating a move is a precursor to reacting to the expected move.  Reacting requires patience, a control of emotions and to be devoid of pride and ego understanding that its okay to not pick the exact top or bottom and that waiting for the move to transpire and get on early enough results in a trade with a higher probability of success. 

So with that in mind lets look at today's SP500 action and see what so many already knew what was coming! 

First you will notice that I had predefined levels of support and resistance taking from a 30 minute PnF chart from June 4th.  On an intraday basis 165.00 and 162.80 are support and resistance areas.  This is key because knowing these levels ahead of time will help eliminate the need to anticipate a move.  I always tell people that I don't have to make a decision until price reaches a predefined level of support and resistance.  

So as you can see on the 5 min SPY chart below we plotted those predefined levels of support and resistance.  Here is where the concept of reacting vs anticipating is important.  In the morning, at approximately 10:10AM the market quickly fell to $162.80.   If I had anticipated a bounce from that support level I would have simply bought at this level.   Instead I opted to wait to see how the next bar closed to confirm my expectations of a bounce.  The next 5 min bar broke and closed below support ending on the low with the highest volume bar at that point.  To me that signaled supply entering the market. Again, I could have anticipated now a move lower and entered a short and as you can see that would have been profitable trade.  Instead, I always tend to wait for broken support (especially on high volume) to be tested and confirmed as resistance.  (Remember my definitions of Support and Resistance).    That is exactly what happened at 10:30AM.  After a weak bounce back into what was now resistance on lower volume it was at that point that a short trade had a high probability of success.   See how easy that was in hindsight! :)  'Brilliant!' you are thinking.  So where do we go from here?  I anticipate a move lower to either the 50 daily moving average at $160.48 and if that doesn't hold then $159.50 (hint: check the PnF above).   Thanks for your reading!

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