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The stock market is nothing if not a place of pure deception. Just when you think you have the market figured out it changes course leaving you scratching your head in frustration. Or even worse, just when the market seems to be making logical sense it makes no sense whatsoever, which seems to be the case most of the time anyway.
LOGICAL DECEPTION
Think about the following: all you hear in the news media is how the consumer is not spending any money; how the Christmas season will be dismal; how continued unemployment will stifle any improvement in consumer sentiment, etc. etc. yet have you taken a look at the retail sector in the last few months? The RTH (Retail Holders Trust) broke out yesterday to a high it has not seen since the summer of 2008. Where is the “logic” in that?
How about economic reports? You will be hard pressed to find any logic here either. Take, for instance, the last jobs report as unemployment has shot up to above 10%. Sounds horrible does it not? It is horrible. That is logical. In spite of the report, however, the market has put in its best three day performance in months to log six consecutive days of gains. Bottom line: if you are going to trade logic-other than the logic of the market-you better have a really good handle on money management or you are going to get slaughtered. Your win/loss ratio will have to be managed with heat seeking missile accuracy.
How about earnings? If a company beats the street the stock should go up right? Makes logical sense right? Wrong. No matter how you slice it there is no logic in the reaction to earnings reports. Sure, you will have the media, analysts, and the CNBC anchors discuss the reason behind the reaction as if there is A reason. They are just trying to make logical sense of it all. If there is a great report and the stock falls it is because “the street wanted better guidance.” If it rises, it is because it is a great report. No explanation needed. Or, if the company guides lower the stock surges because “the street was expecting worse” or the CEO says the “future is bright.” If it falls as a result of guiding lower, the reason, well, is logical: it was a bad report. Just look at some of the reports this past earnings season and try to make logical sense of the stock’s reaction. If you can’t, I am sure someone else will be happy to give you a logical reason.
TECHNICAL DECEPTION
If you are not very careful the market will chew up your technical analysis and spit it out all over the streets of probability and historical pattern “has to beisms.” In other words, just because a pattern or technical benchmark has been proven to work in the past does not necessarily mean it will work in the future. Just in the last few days and months we have seen this play out over and over again. Let’s look at a few examples.
Here is the S&P 500 chart from July of this year (2009) when the market decided that a bearish head and shoulders pattern, along with a break through major moving averages (200 and 50 TANKS) was going to take the market down to who knows where.
The result (which, by the way, I discussed previously): a huge rally in the opposite direction. Deception at its best. Did you learn anything from it? We are seeing it again. Here is the current S&P chart:
The stock market may have short term memory loss but so do technical traders. Some of the best rallies are a result of the HAS TO BEISMs turning into NOT SO FASTISMs.
THE ART OF TRADING
So what is a trader to do? Throw darts? Pull a stock from a hat? Listen to Jim Cramer? I have a few ideas, and for active readers of my blog, none of the following will come as a surprise. I believe good trading is an art. The best definition of art, as it relates to trading, is “a superior skill that you can learn by study, patience, practice, and observation.” It is completely up to you to decide how to apply these disciplines to your trading methodology but let’s consider each one anyway.
1. STUDY: If you really believe you can begin trading without disciplined study you are either going to be torn apart by the bears or run over by the bulls. Professional traders make money off those who have false expectations about the riches to be made in the market. If you have been trading for any length of time you know there is no such thing as getting rich quick on Wall Street. There is a reason we call it WALL Street you know: because there is a huge wall that must be climbed before good trading skills can be properly developed. You will never know everything there is to know about the market, so pick one technique, study it, and become very good at it. That is all you really need. “
2. PATIENCE: This one is really hard to master because, as the word itself implies, it takes time to become a good trader. If you lack patience, someone who has mastered it will take all your money. While you look for a trade, the patient will be waiting for a trade to come to them. While you impatiently interpret the news, the patient will look to trade the reaction to the news. While you try to predict the market’s direction, the patient will anticipate its next move. While you become a slave to every move in the market as a result of your impatient need to participate, the patient will master a battle strategy and enter when given an opportunity.
3. PRACTICE: I am a strong advocate of practicing a strategy before entering the market with real money, with the emphasis on a strategy. An education can get really expensive and really quick without practice. Practice will allow you to become intimate with your strategy, with the market you are trading, and with your psychology. Practicing a swing trading strategy is not the same as practicing a day trading strategy and if you try to mix the two watch out! Remember the words of Ed Macauley: “When you are not practicing, remember, someone somewhere is practicing, and when you meet him he will win.” Practice, and let others who have not, meet you on the battlefield. The odds are you will win.
4. OBSERVATION: Learn to observe the markets and yourself. SUN TZU said it best 2000 years ago when he wrote: “Know yourself and know your enemy and you will be safe in every battle.” (ART OF WAR) I believe it is best to observe trading from “outside the charts” as a disinterested third party. I do not listen to CNBC; I do not have a live news feed to keep me glued to every bit of noise in the markets; I do not trade based on what someone else is doing. I trade based on the way I perceive the market via pure technical analysis and nothing more. Either there is or is not a trade. In fact, there are more ANDs and BUTs in my trading style than CALLS and PUTS. This condition must be present AND…this rule has been met, BUT this one has not. Get it? Always keep an open mind and you will not be surprised by the market. Observe your trading and make sure that your swing trading does not turn into day trading and vice versa; that your rules based trading does not turn into emotions based trading; and that your recent trades (profitable or not) do not influence your next one(s).
By combining study, patience, practice, and observation you can turn the art of deception into the art of trading. The result: a work of art worth investing in.
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