“Trade what you see” is a common mantra among short-term traders who formulate their trade ideas from charts. But do we process information from charts in accurate and non-biased ways?
An interesting set of studies reported in the 2003 Journal of Behavioral Finance suggest that perceptual biases in what we see can skew our trading and investment decisions.
Specifically, when investors see a chart that has a salient high point, they are more likely to want to buy that stock. When the chart depicts a salient low point, they are more apt to sell. In the words of the authors, “expectations about future prices assimilated to extreme past prices.”
The authors found that, when a chart contained a highly noticeable high point, traders listed more favorable features of the stock; when the chart depicted a salient low, more negative aspects of the stock were emphasized. Their analyses suggest that charts affect investors by providing them with enhanced access to either positive or negative information about the stock. In other words, our processing of the chart creates a selective bias in retrieval, leading us to view shares in artificially positive or negative ways.
It isn’t too far from the authors’ finding to a broader psychological hypothesis that *any* highly salient feature of a trading situation may skew information retrieval, perception, and action. For instance, the salient information may be a recent large gain or loss; a dramatic market move; or a piece of news. Trading what we see might be dangerous for the same reason that it is dangerous to trade what we hear or what we feel.
When one facet of a situation becomes highly salient to us, we overweight it in our perception and information processing. Our ability to view the entire situation in perspective is compromised. What is most obvious in a chart–or in our minds–may not be an accurate reflection of underlying supply and demand in a marketplace.
Archives of “term traders” tag
rssTop 3 Trading Strategies
1. High probability setups with short profit targets
If you are not winning more than 75% of the time you’ll never make it as a professional trader. Whilst there are other components to success, he does make a very good point. The most common trading strategy employed by successful trader is to identify a high probability set up and couple that with an aggressive profit exit strategy that captures short term gains. For example, you might have a entry criteria that easily captures 15 points on average but you set your profit target at 6 points.
2. Adding to winning positions
Many people think all trades should lead to profit but you’ll find the most successful medium term traders on win 40-55% of the time. The difference between an amateur and a professional, when trading short to medium term trading systems, is their ability to maximum their cash on a trade when it’s winning. The Turtles, under the watchful eye o f Richard Dennis and Bill Eckardt, had a way to add to their huge winners up to 4 times. Very powerful. In order to maximize this strategy you will need to identify your R multiples which will be saved for another article.
3. Mechanical trailing profit stops
Knowing when to take profits can be the most mentally draining part of any trading system. Its not unusual to start trying to let profits run that the markets starts retracing and wiping out all your open profits. The way to overcome this emotional rollercoaster is to build mechanical trailing stops that maximize your profits on winning trades whilst minimizing giving back to much in open profits. (more…)
11 Rules for Chart Watchers
Rule 1 – If you cannot see trends and patterns almost instantly when you look at a chart then they are not there. The longer you stare, the more your brain will try to apply order where there is none.
If you have to justify exceptions, stray data points and conflicting evidence then it is safe to say the market is not showing you what you think it is.
Rule 2 – If you cannot figure out if something is bullish or bearish after three indicators then move on. The more studies you apply to any chart the more likely one of them will say “something.” That something is probably not correct.
When I look at a chart and cannot form an opinion after applying three or four different types of indicators – volume, momentum, trend, even Fibonacci – I must conclude that the market has not decided what it wants to do at that time. Who am I to tell it what it thinks?
Rule 3 – You can torture a chart to say anything you want. Don’t do it.
This is very similar to Rule 2 but it there is an important point to drive home. You can cherry pick indicators to justify whatever biases you bring to the table and that attempts to impose your will on the market. You cannot tell the market what to do – ever.
Rule 4 – Be sure you check out one time frame larger than the one in which you are operating (a weekly chart for a swing trader, a monthly chart for a position trader).
It is very easy to get caught up in your own world and miss the bigger picture getting ready to smack you. It can mean the difference between buying the dip in a rising trend and selling a breakdown in a falling trend.
Rule 5 – Look at both bars (or candles) and close-only line charts to see if they agree. And look at both linear and semi-logarithmic scaled charts when price movements are large. (more…)
You Are Having Trading Skill or You are Lucky ?
Traders with skill have large gains after 100 trades and are relatively quiet, traders that were lucky have huge gains after a few trades and are very loud, then very quiet for the next few trades that usually bring their account to zero.
Traders with skill risk 1% to 2% of their trading capital per trade and win in the long term, traders that are just lucky risk the majority of their account for a few big wins in the short term but lose in the long term when their luck runs out.
Traders with skill use a successful method with many stocks in different markets, traders with just luck are only successful with one stock and when its up trend ends their winning streak ends.
Traders with skill have winning track records over many years, traders with only luck only have winning track records measured in months.
Traders with skill have risk management as a top priority, traders with only luck do not understand why risk management is important, yet.
Traders with skill are trading like it is a business, traders operating with luck are trading like they are a gambler in a casino.
Traders with skill use a trading plan and back tested method, traders with luck make guesses and are sometimes right.
Traders with skill have done their homework, traders with luck think they are naturally smarter than the market.
Traders with skill are disciplined and stick to their system, traders with luck make bets based on opinions.
Would you rather be lucky for a few trades or skillful for a few years? Lucky traders give back their profits when their luck runs out. Skillful traders are eventually financially interdependent due to their long term capital growth.
Technical Confirmations Explained
Confirmation is necessary to validate a break of important support and resistance levels such as price patterns, moving averages and trend lines. Technicians and traders define Confirmation in various ways. While market situations vary, below is a guideline of three forms of Confirmation:
- Percentage Confirmation: Confirmation is present when there is a 3% or greater break of a support or resistance level. Volume attached to the break, while not necessary, lends confidence to the confirmation. The 3% rule is commonly used by long term traders and investors. Short term traders use a lesser requirement to complement trading objectives, keeping risk/reward in line.
- Time Confirmation: If there are at least three closes above or below a resistance or support level, then confirmation exists. A close varies based on ones trading time frame. Again, volume attached to the break adds significance to the confirmation. (We always write Three Consecutive close +Weekly close must for major upmove or down move )
- Heavy Volume Confirmation: Volume confirmation presents when there is a substantial surge in volume relative to recent volume, combined with one close above or below a resistance or support level.
- Combination: If percentage and time confirmations fall short of the minimum requirement, yet are accompanied by substantial volume (e.g. 1.5% close above resistance with substantial volume), that could be accepted as confirmation.
Traders can use this guideline to develop their own requirements for confirmation as individual investment objectives and time frames vary.