We all are guilty of analyzing til the cows come home, trying desperately to cheat the future. We have all of our fancy little squiggly lines that supposedly tell us where prices are going in the future. The sobering bottom line to all of this activity, is that price rules the day. Price determines everything about our livelihoods as traders. I went on record as saying I think we are going to have a retracement before the year end rally kicks in. Guess what, who really cares about my opinion, even I don't! I never trade based on my opinion. I won't take any shorts up here even though I think we are going to retrace until price tells me it is ok.
What exactly do I mean by that? If we look at both the stock indexes and Crude Oil ( a market I said was potentially setting up a sell signal ), you will be able to see my point. I am just showing the SP 500 here but if you look at Crude on your own, the same argument holds.
Here are two scenarios marked off that should amply demonstrate what I am talking about. Prior to the July meltdown, I was very bearish, but had not shorted the market. We were kind of drifting along and although I had all sorts of fancy math telling me the plunge was coming, the price had not confirmed it. You certainly can take positions at the market when you are really convinced a move is coming, but that is a very difficult proposition. Trying to manage an entry like that, where to put your stops etc.. becomes very difficult especially if you are a short term trader. In my view you need to have some type of price movement in the direction you are looking to "pull" you into the trade. This will give you defined risk, leaving you with a stop and exit point nearby. It will also confirm that at least for the moment, price momentum is in the desired direction.
If you test systems out the one theme that constantly rings true which is in contradiction to this is that stop losses always diminish the test results. Virtually every system I ever developed or traded live, performed best with no stops when in the development stage. However, a funny thing happens when the opening tip off occurs. Many of these classroom results get completely whacked! It is one thing to look at a bunch of SP 500 trades and see that 83% of them won with an average profit of blah blah blah. It is another to be in one of them where you are long with no stop and the trade is 40 points against you and accelerating away.
This could have been the case right here for me. I had indicated that price entered my Weekly sell zone around 1200 and we are at 1228 as I type this. How would you like to be short and be that much out of the money? That is just not prudent, and if you trade like that at some point you will get wiped out. The solution is pretty simple, just wait for the price action on a short term basis to make some type of pivot, break a trend line, something basic like that. When this happens you at the very least have an indication that the freight train may be stopped for a time, and you can take a shot. What does get confirmed in testing things mechanically is usually the accuracy gets better with stops, it is just the dollars won to lost never improves. Since we know in general the real world will treat us more harshly than the same lab where we develop things, I always defer to what works in actual trading not what should.
Back in July we did get a trend line that was nothing fancy, just a very obvious one, to break. I have to admit that I had shorted a bit before that front running the trend break by a little. However, I did this with a tight stop knowing that it was possible I was early and we were not quite ready. When price broke the trend at that point I deemed it as confirmation that the trend might have changed.
Fast forward to today. I have said that I thought we were going to retrace one last time before a big rally to end the year. I am not bearish like I was in July, it is more of a cyclical timing thing. However, in either case, we are nowhere near breaking a trend line or forming a lower short term high or pivot as some would call it. As a result, no shorts yet. Today, if we were now to take out yesterday's low in the Russell, I would deem that a possible short term shift or trend break, and it is a shortable event. I probably will not take the entry if it develops, because overall I am really bullish, but it will be a game time decision.
The point of all of this is that price patterns keep you out of the trouble that the larger picture analysis can get you into when looking at setup markets. Market setups are often against the very short term trend, so you don't want to get run over. This is why I always stress setup markets are not entries. I need to have both a setup and a price confirmation to trade, even on day trades. In this case with both Crude and the Indexes, both are not there so there is no trade.
Here is another example, GOLD. I am bullish here due to the weekly setup as I have explained recently, for a rally into the end of the year/beginning of next year. However, there is nothing in the price pattern at this point that confirms this to me. There has not even been a basic trend line broken yet, and price is making lower highs and lower lows. There is no market structure in place to justify a long entry to me yet. As I have said, if the lows from last month go I could be completely wrong on this long setup. I am letting price tell me when to get in, not a bunch of fancy wiggles that tell me I can go in right at the market and hope I catch it right.
I hope I have made my point today. If you happen to be a long term investor who is really bullish on something like GOLD and want to hold it for years, this type of logic does not apply. In that instance you always want to buy on extreme weakness whenever you can find it. I think most readers realize I am a short term trader, so these discussions are along the line of how I go about doing what I do. I am not attempting to "convert" people.
Have a great weekend