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Lessons from the Pros

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The Rules of the Road Apply

Thu, Mar 29 2007, 15:20 GMT
by Online Trading Academy Team

Online Trading Academy

By Gabe Velazquez

On Saturday I had the reluctant task of having to sit through eight hours of traffic school. I tried being a good sport about it and got through it fine (the instructor made it bearable). As the class progressed I began drawing strong parallels between being a safe driver and being a good trader. If you really think about it, there are many similarities.

To be a safe driver requires following the rules. The same applies for successful trading. In both endeavors transgressions carry with them a commensurate penalty. In driving we follow a set of rules imposed on us by "the powers that be". In trading we get to create our own set of rules. Can you imagine getting in our cars and driving around without any boundaries? Yet many traders enter the markets without a concrete set of rules. Driving regulations, if followed, prevent collisions. Trading rules should be designed and implemented to minimize losses and maximize profits. They must also be very personal. By this I mean the perimeters set by a trader will have to comply with each individual's style of trading, temperament for risk and size of account. This is the reason why it is so important to know yourself when you trade. Someone else's rules will not work for you. Adherence to the rules is much more important than striving to make money. Traders who undergo protracted drawdowns are usually those who have veered away from following their rules. The lesson here is: in order to take your trading to the next level you must obey "your rules" above all else.

In taking a look at the market this week we see that indeed all the indices had a successful retest of the prior lows. So much so, that we are only a few points away from the most recent highs. Wow, what a difference a week makes! What happened to all the hand- wringing about the subprime implosion? Have things really become that much better in a week? I don't think so.

The FOMC concluded their meeting last Wednesday and in doing so, made minor changes in the language from previous press releases. This minute adjustment in the statement triggered a huge short covering rally. This is another great example of the market trading on perception rather than reality. The reality now is that this week has turned out to be a consolidation week thus far, but I'm certain that this too shall change quickly.

The chart below gives us a blueprint of what transpired for the week. A couple points of interest: first, note the slow stochastic is overbought and the market has begun a corrective phase. The most important point of support, in my mind, is 800. If you recall in last week's letter I mentioned this particular number as a break-out threshold. The ER2 rallied 17 points upon breaking this level.

The second focal point is the gap. If you have read any of my previous writings, you know I pay close attention to gaps. Notice the opening down gap left from the February 27 sell-off. The line drawn at resistance (where the market had its recent peak) corresponds to the bottom of that particular gap. If ER2 can get into the gap and fill it, then the probabilities for all-time highs become much greater.

From an intermediate term perspective the trend remains up, breaking below the 800 mark will be decisively bearish. This will also put the March 19 gap in play (See chart below).

This morning, Wednesday March 28, as I put together this piece, the market is going to gap down about six points. This is being attributed to a surge in oil prices caused by the ongoing tensions with Iran. I will be looking to see if we hold the aforementioned support levels and trade accordingly. I am quite certain that the 3 day streak of tight choppy trading will be broken today and we will finally get some volatility.

So until next time, drive safely and follow your rules while trading.

Published on  Thu, Mar 29 2007, 15:26 GMT

Archive

• Trends, Gaps, and Probabilities...
  Published On Mon, Oct 6 2008, 10:10 GMT
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  Published On Thu, Oct 2 2008, 06:31 GMT
• ATR and the TED Spread
  Published On Wed, Oct 1 2008, 06:30 GMT
• Trading and Gambling
  Published On Tue, Sep 30 2008, 06:15 GMT
• Bailouts, Bankruptcies, and Bureaucrats
  Published On Thu, Sep 25 2008, 06:20 GMT

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