CMU: How savvy traders look at the market

Cracked.Market University: 

All too often people think of trading in binary terms. They are bullish or they are bearish. The market is going up or it is going down. I need to be all-in or I need to be all-out. This stock is either racing to the moon or it is in a bubble and on the verge of collapse.

What these people fail to grasp is trading successfully is far easier when we approach the market in shades of gray. We don’t have to be all-in the same way we don’t have to be all-out. Sometimes a trade looks promising but it isn’t fully developed. That’s a great opportunity to test it with a smaller position and see what happens. When the trade starts working, we add more. If it fizzles because we got in too early, no big deal, pull the plug and try again next time. These aggressive trades are not unreasonably risky when our risk is reduced by starting with smaller position sizes.

On the other end of the spectrum, maybe we have a big winner we love, but the recent price-action is throwing off some warning flags. Not enough to abandon ship, but if we lock-in some profits, it becomes far easier to confidently hold the remainder of our position.

Shades of gray is how I felt about today’s price action in the S&P 500. As I wrote previously, I liked Friday’s late resilience after violating the weekly lows and bouncing back. The market confirmed that optimistic sentiment Monday morning when it poped at the open. I started buying partial positions early in this rebound because I could manage my risk by starting small, getting in early, keeping a nearby stop, and only adding to what was working.

Following that simple recipe, I ended up with a full position in a 3x index ETF. Tuesday started well with another opening gap higher and everything looked great. Unfortunately, the market’s midday second-thoughts gave back a big portion of those early gains. That fizzle was enough to give me pause. I still liked the way the market was trading and it is unreasonable to expect stocks to go up every single day. My inclination was to continue giving the rebound the benefit of doubt, but taking some of my position off midday made it a lot easier to confidently stick with my trade.

With one foot in the market and one foot out, no matter what happens Wednesday, I will be in good shape. If the rebound continues, I still have a lot of long exposure. If the market tumbles back to 3,300 support, I reduced my risk and it won’t sting nearly as much because I scaled back.

After the market reveals its intentions Wednesday morning, I will either buy back in or pull the plug and wait for the next opportunity. While other people are stressing over the overnight futures, I will be sleeping like a baby because I know I’m in good shape no matter what happens tomorrow.

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