September 09, 2008 at 6:45 am | | Comments 0

Beware of Traps!

A relative of mine runs a ranch and occasionally has to capture animals which don’t belong there. So in order to rid the place of persistent pests, he sets out traps with intriguing lures. Most of the time, the offending critter simply can’t resist what appears to be a risk-free, tasty meal, and they fall for it – to their demise.

Some things just look too good to be true, and at times in the market that’s certainly the case.

Watch Where You Step

Take Monday’s huge gap higher, for example. Overnight news related to one of the biggest problems this market has faced (housing and foreclosures) produced some early fireworks as shorts ran for cover and many traders on the sidelines reacted to hopes that a significant turning point had finally arrived. However, the session highs were set in the opening minutes and before the morning was over, the bulk of those gains had been erased – trapping all who bought into the hype as prices rapidly returned to much lower levels.

Few stop to consider the psychology at work in the market, on both sides, leaving them vulnerable to become victims of such traps. The news isn’t everything, so the failure to recognize that it’s how the market responds and adjusts to that news can invite some significant pain. After all, even good news which isn’t good enough can bring about selling.

An overnight gift in the form of a gap like we saw Monday can also invite heavy selling, as can a timid breakout. Also, if you determine that the easy money has been made in the short-term, then you’re staring right in the face of a possible reversal situation.

Look At Every Angle

Remember, the market is a forward-looking mechanism, so whenever the majority has already benefited from a move, there’s not enough power to push stocks much further. As a result, stocks can easily head the other direction…usually quite fast!

Bulls and bears alike get trapped on occasion in the market, and every time it happens emotions are sure to run high. It’s obvious that pain is in store for one camp while profits are banked for the other, so in order to place yourself in the right camp you must learn to recognize situations which have potential for big short-term reversals. Developing that skill will help you avoid falling victim to these traps.

So whether you’re eyeing new entries or evaluating current positions after some big overnight news, always consider the flip side of the trade and what your opponents are thinking. If you sense their case is better than the arguments you might pose, then there’s no reason to put yourself in harm’s way for getting trapped. Back down or pass up the trade completely – that way you can still roam freely. 😉

Jeff White
President, The Stock Bandit, Inc.
Swing Trading & Day Trading Service

[tags]Stock Market, Day Trading, Stock Trading, Investing, Swing Trading[/tags]

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