Falling Markets, Trade it as Part of the strategy
One of the most important aspects of trading is managing the risk on your positions. If the market doesn’t go anywhere when you are in a position, you cannot gain from it. So depending on volatility, you really have no control over your gains. You can, however, manage your losses to some degree with good risk management techniques.
Industry professionals always talk about how they buy into strength. While this may be great in a bull market, it is a recipe for disaster in today’s uncertain markets. Instead, simply do the opposite of what you feel when entering a trade. So buy when the markets are falling and sell when it is rising. This principle, while simple in theory, is really hard to execute and even harder to master. Please note that the examples below will be based on a long trade. Simply use the opposite for shorts.
Let’s take a look at the logic behind this concept. The stock market spends a good portion of its time alternating up and down without making any ground. This is true on just about any time frame. Research actually shows that this is true around 66% of the time. That means you have a significant edge over random entry using this concept of trade entry alone. Further, it tells us that as the market moves higher (on a buy), based on historical evidence, it can only continue in that direction for so long before it turns around and continues back down again. As a result, it might be less risky to actually enter a buy when the market is declining (to some measure of its alternating range) because the amount you stand to lose can be lessened.
So even though it might be very uncomfortable to buy while the market is declining, it can potentially reduce the amount of risk you are taking on the trade at the same time. Let’s also consider the psychological factors involved here as well. If you are feeling really anxious about putting on a long trade while the market is falling, we know most other market participants are probably feeling the same way. This assures us that the fear to buy is really an indicator that measures current market sentiment. If sentiment is really that low, then we reason that we must be running out of sellers to drive the market lower. Now let’s consider, from a numerical standpoint, where you might place a stop loss order in such a situation. If the recent previous low on the S&P is at 1820 and the market is declining into that area, you are thinking the market will most likely reach that level again. So if you buy near that level, you can place a stop right beneath it (say 1810 for a decent margin) and have that be a reasonable measure of whether you were wrong if it gets hit. So as the market declines to that level, your mind is oscillating between the greed of buying the absolute low versus the fear of it continuing to fall. But, for every point it falls, it is one more point reduced from your risk.
Stop-Loss Disclaimer: The placement of contingent orders by you or broker, or trading advisor, such as a “stop-loss” or “stop-limit” order, will not necessarily limit your losses to the intended amounts, since market conditions may make it impossible to execute such orders.
At some point in this equation and mental oscillation, you should pull the trigger and buy. Using this mental exercise to enter a trade can teach you quite a lot. Go ahead and try it in a demo mode on a trading platform.
So what does all this mean in the big picture? By keeping losses reasonably small and going against the majority, you will not get demoralized by trading. That might keep you in good spirits while the market is beating people up (which is just about the time it will take off for a really good move). So the famous wisdom of Rudyard Kipling stands; it is important to keep your head about you when everyone around you are losing theirs. The market has a way of demoralizing its participants just before the very best moves. By keeping your risk managed, and your spirits high while trading, you will always be there when the market decides to deliver you a really big trade (the one thing you cannot control). Make sure you are there to benefit from the spoils of the trading battle.
Having said all that, you’t can not just randomly decide to buy into a market that is falling. You need to choose your levels carefully. Just randomly deciding that the market has stopped dropping or rallying can be quite expansive. Remember, your goal is to to take the randomness out of the market and trade ONLY when you get the methodology in order.
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Commodity Futures and Options trading has large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in the futures and options markets. Don’t trade with money you can’t afford to lose. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed on this web site. The past performance of any trading system or methodology is not necessarily indicative of future results.
