September 26, 2008 at 10:43 am | | Comments 0

What Makes a Good Trading Market?

The market has been all over the map lately… huge selloffs, sharp rallies, and just a lot of uncertainty in general. The government intervention has also made the landscape an unfamiliar one, as bailouts of individual companies have occurred, along with the introduction of a bailout plan for the economy as a whole.

Further, we’ve seen things which used to happen only on occasion become the recent norm… major intraday reversals, tremendous gaps to both the upside and downside (which are frequently filling), and a significant expansion in the average true range of the overall market. Needless to say, as traders we have had numerous additional reasons to stay on our toes!

Pros and Cons

There has been no shortage of excitement and movement for day trading, which is great for those of us who are able to monitor the action throughout the day. However, anyone with a longer timeframe has no doubt found it to be a mess with limited opportunities and sizeable risk.

With all the wild price action, my personal tendency has been to lighten up. I’ve not held an overnight position since late-August, instead opting to stay in cash and focus more on day trading in order to more closely manage my risk. Being one who typically does a lot of swing trading, that’s a big shift.

I’ve encountered many other traders, both in and out of the limelight, who are taking the same approach. The consensus has been that recent conditions fail to inspire much lasting confidence on either side (long/short), and therefore the better approach is to lighten up temporarily or stay sidelined until the technicals improve and things can smooth out.

And this market will smooth out.

But in the interim, all this discussion begs the question, “what makes a good trading market?”

Textbook vs. Practical

In a textbook sense, the ‘right’ answer to what makes a good trading market might be that it’s a trending market, perhaps even one which moves steadily higher. That’s nice and it might leave you feeling warm and fuzzy to know at some point that will happen again, but it might not help us right now. So instead, let’s get a little more real and explore some practical ways in which this market might improve in the near term for those of us who are traders.

Removal of ‘some’ uncertainty.
By starting here, I have to emphasize the word ‘some.’ There is never a complete lack of uncertainty in the market, which is exactly why there is risk and reward present. That’s good and we need it! However, market participants have had to fret continually over what will happen next, to a degree not typically seen. Instability is running high in many areas right now, as industries such as banking face unprecedented times and some have gone completely out of biz. Once we get back to an environment in which stocks are able to move more routinely (based on underlying supply and demand, rather than primarily in response to the daily despair or elation of the general market), there will be many more opportunities for taking trades with defined risk. At the moment, ‘defined risk’ is very difficult to find on a multi-day basis.

Lack of intervention.
I’ve only been a trader for a decade, but I have not ever seen such frequent government intervention as we’ve seen this year. I have no desire to discuss politics, the success of the interventions themselves or debate whether or not they were warranted/needed/wise, so I’m avoiding that here. The point is that when the market begins to fixate on how the government might inject liquidity or bolster confidence or disappoint and deny hopes for help, it’s an unusual environment for trading. Prior to recent months, about the only times we’d see that occur would be on FOMC days when interest rates might change and the policy statement is released on the economy. Aside from those times, the market has generally been able to focus on economic and company-specific data to make its decisions on, and lately those have been placed very much on the back burner. Once a return to that routine is seen, we should be able to expect more typical price action than what we’ve been seeing.

TA back in the saddle.
When the market is seeing so much violent price action in both directions and the news flow is causing extreme reactions on a day to day basis, technical analysis takes a back seat. Not only is it more difficult for bases to be constructed and well-defined patterns to emerge, but even when they do it’s more difficult to trust them to act like they ‘normally’ would. Consolidations are extremely rare to find when the market is whipping back and forth to the degree we’ve been seeing, which prevents a lot of reliable patterns from ever maturing to begin with. Further, when a bull flag or channeling stock is finally found, one has to wonder why the stock in question hasn’t been participating in the large market moves. As the market begins to settle down a bit and traditional chart patterns once again come into focus, we’ll see many more trading opportunities begin to surface.

More psychology, less knee-jerk reaction to news flow.
One of the primary reasons why I avoid trading earnings announcements or get extra-cautious on FOMC days is that the market gets fixated on the news. The nimble trader can capture some quick moves once the news is out, but the anticipation prior to the actual news release is what tends to alter the price action away from the norm. Any factor which interferes with the usual forces of greed, fear, confidence, or uncertainty is going to make the trading environment a little more tricky because the psychological aspects will play less of a role. Understanding the battle which ‘normally’ takes place within the minds of traders on each side of the market offers an edge, so whenever conditions shift in such a way that the importance of psychology is diminished, that edge disappears with it. We’re used to seeing emotions get paired together such as greed and fear, so when we recognize them both at work there is some natural opportunity which emerges. But when the primary emotion is uncertainty (like it is now), it’s extra difficult to determine who is poorly-positioned. As a result, new trades with good risk/reward profiles become harder to locate. Once the everyday focus moves beyond ‘bailout,’ it’s going to quickly become a smoother market for trading timeframes longer than a couple hours.

Looking Ahead

Of course there are additional factors which are impacting the trading environment right now, but I wanted to run through a few of the ones I’ve noticed of late which are combining to make the current environment a little harder to navigate than normal. If I’ve left out some others which stand out to you, please feel free to post them as comments below.

The good news right now is that we could start to see some of these things improve in the coming days. In the market, even a few days can make a tremendous change in the landscape, so don’t count out the possibility that the dust might begin to settle soon.

It has been a bizarre couple of weeks on the Street, but it certainly won’t always be that way. So start watching for some of these shifts to come along, because they could be here before you know it. And won’t that be a welcomed sight!

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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