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Ten Principles of Short-Term Trading

1) Strength Begets Strength – A market rise that expands the number of stocks making new highs and that finds more stocks trading with strong upside momentum tends to persist in the short run.

2) Weak Rises Tend to Reverse – When markets move higher with fewer stocks making new highs and with fewer stocks showing strong momentum, the rise tends to reverse in the short run, often entering a trading range prior to making an extended decline.

3) Broadly Weak Markets Tend to Reverse – When the market is very weak (many stocks making new lows and many stocks displaying strong downside momentum), it is common to see the market make marginal new lows in the short run, but reverse after that.
4) Weak Tests of Prior Market Highs or Lows Tend to Reverse – When we get a market trading above or below its value area on low volume, few stocks making fresh new highs/lows, and weak momentum, we tend to get a “mean reversion”–a trade back into the value area. That’s basically what this week’s action has been about.

5) Strong Tests of Prior Market Highs or Lows Tend to Persist – When we see expanding volume and expanding new highs or lows on a move above or below the value area, such a breakout move tends to becoming a short-term trend. The longer the prior consolidation period (the heavier the volume within the value area), the more extended the subsequent trend tends to be.

6) Weak Pullbacks Following a Strong Move Will Reverse – When we have a strong market move that expands new highs/lows and momentum, a pullback on weak volume and with relatively few stocks participating will lead to at least a test of the impulse highs or lows and often to a resumption of the strong move.
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How would you classify trading errors?

TRADINGERROR

  • Improper analysis, categorized as inadequate preparation or incorrect interpretation
  • Improper entry (early or out of sync with market and sector action)
  • Improper execution (inappropriate position size, failure to adhere to proper trading principles, e.g. momentum resumption)
  • Failed exit, e.g. profit turns into a loss, failure to recognize ‘windfalls’, etc.

So what ‘rules’ must we have.

  1. Identify your edge (specific market, specific techniques)…if making money on the short (long) side isn’t working, why persist at that which isn’t making it happen? Strive to do more of what is working and less of what is not.
  2. Trade with the market. Intraday ‘tells’ are huge. If breadth is negative and the dollar is positive, going long equities is going to be tough sledding.
  3. See the market as it is. If we’re wrong, having missed the exit ramp, are we going to stay on the highway into the next state, or get off?
  4. Understand the market structure. Is the market trending, detrending, breaking out of consolidation, bouncing off support or resistance, consolidating?
  5. Know how volatility is behaving…rising, falling, at extremes.
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