Now that we've outlined the basic strategy of timing entries we need to dig a little bit deeper. We've established that in order for our stock to make a BIG move in our direction we'd like to see all 4 of our indicators pointing in the same direction. It can make a move without all 4, but the more of the 4 we have, the higher the gains will likely be. Now the thing is we can make money waiting for all of our indicators to give us a clear bullish/bearish signal, but to make really big money we actually need to ANTICIPATE that all 4 (or most) of those indicators will turn before they actually do. Thats how the masters make their money. They ANTICIPATE the turns, they don't wait for them. Thats too easy, because once they turn, the direction is obvious to everyone, and everyone cant make money in this game. Its the ones who take the risk on betting what isnt totally clear yet that get paid the most. Being one step ahead of your opponents is the key to winning in this game. If you can analyze things literally one minute faster that most market participants out there, your gains will be augmented exponentially.
OK, so how do carry out this ANTICIPATION tactic. The answer lies in 2 a step process of calculating probabilities and "if/then" scenarios aka calculating "risk/reward." We first need to put probabilities on indicators turning, and then we need to calculate what would likely happen if these indicators turned and also if they didnt....essentially we're calculating "if we're right how much will we make, and if we're wrong how much will we lose" and also "what is the probability of being right and wrong. The element of calculating risk/reward specifically is something that a lot of traders fail to master or fail to grasp along the way. MANY MANY traders out there will focus on how much they could make if theyre right, but will just completely ignore how much they might lose if theyre wrong. Ironically its this aspect of recognizing that you could be wrong that separates the Masters from the Avg. Trader. Masters recognize the possible outcome of being wrong as a valid scenario and are very much prepared to react and adjust positions if they see that that outcome is coming to fruition. Avg Traders on the other hand will simply refuse to accept the fact they might have made a mistake and ride stocks down to major losses. You wont see that with Masters.
OK so the first part of the process is putting probabilities on the only two outcomes possible...being right and being wrong. When I say right, I mean if we're long, what is the probability that the stock will go up, and when I say wrong I mean the stock drops when we're long. Its more of a qualitative outcome at this point. Now these probabilities are based on our the 4 criteria we mentioned in the previous post:
1) Fundamental Analysis
2) Technical Analysis
3) Overall Sector Conditions
4) Overall Market Conditions
We again go thru our 4 criteria and from that we should be able to determine a rough probability of the stock going up within our own trading time frame. For scalpers this time frame could be minutes to an hour, for momo traders maybe a day, and for others maybe a week. Its again all relative to your trading strategy but the calulation can be done nonetheless.
Now once we have a decent idea of the probabilities of being right and wrong we need to quantify the different outcomes. How much will we make if we're right? How much would we lose if we're wrong? And this is where Masters really excel. This is what differentiates traders. Masters can quantify the results before they even get into the stock, so when the stock starts moving after theyve entered the position, they're already prepared for the conclusions and can get a really good idea if the stock is playing out according to plan. If not, they can quickly adjust because they already know the outcome, if it moves in their direction they have a good idea of the upside and are ready to close out positions when targets are reached. Avg traders on the other hand, havent already thought of the outcomes...theyre basically running around chasing stocks and listening to outlandish targets and all kinds of outcomes. They get confused very easily and are ill prepared to react to dynamic changes in stock prices. The Master trader on the other hand has already thought of the different scenarios possible and quickly adapt to changing situations. This is the key, Master traders are prepared well before they enter a stock, and Avg Traders are not.
Now quantifying different outcomes takes a lot of experience and skill. It is essentially determined by observing a stock and analyzing the stocks prior movements to determine what positions have already been taken in the stock, and what positions can be taken if/when one of our outcomes comes to fruition. This is extremely important and will take some time to master. But this is the way you need to think. In order for you to truly understand how a stock will react in the future we need to get an idea of what positions are in the stock now and need to unwind in the future. If we a stock has popped and for a relatively long period of time, we can assume that there are a lot of people already long the stock. The pool of potential buyers is declines as a stock rises, and we need additional buyers for a stock to keep rising. This also tells us that if the stock were to begin losing momentum we could see a lot of sellers due to the fact that buyers will without doubt eventually become sellers. The more buyers we have long the stock, the more sellers we will have when a stock drops. We saw a this scenario play out in mass over the past several months as all those high flying commodity stocks which were heavily owned by hedge funds and the avg american cratered extremely quickly as they were severely over owned, and once the momentum started fading all those buyers became sellers all at the same time. This is also the basis for contrarian trading...when you see everyone bullish on a stock its a signal that everyone is long and its a huge red flag given that 1) everyone is piled on one side of the trade 2) the pool of potential buyers to drive the stock higher and absorb any selling from longs is waning and 3) we know all those buyers will have to sell at some point.
The same is also true for stocks that have declined significantly and rapidly for long periods of times, we can assume that there are huge short positions in the stock and we know that someone who is short will without doubt need to cover at some point (unless the stock is headed for BK).
Other scenarios to look out for our stocks who have based for long periods of time on low volume. We can assume that people have forgotten about the stock, and any bit of buying pressure could bring in a slew of new buyers which could drive the stock much higher. Remember we need a lot of buyers to drive stocks higher, so our goal is to get in as early as possible before those new buyers enter rather than later. The later the enter, the more we'll have to deal with overhead supply hitting us on the way up from older buyers.
There are a host of other scenarios but this should give you a good idea of how to think about positions that have already been taken and what hasnt been taken. And once you've determined how many people are already in and how many people could still come in, it helps tremendously to quantify how high a stock can move if it reverses, or how low a stock can go if it continues going lower. And once you couple this with the probabilities youve determined earlier you have a really good idea of all the outomces before youve even entered the stock. This is the key, prepare for the trade before you enter it!!!!
(Again sorry if the points are not totally clear or flowing, but I write these on the fly very quickly, but the point is to hopefully give you a slightly clearer picture of how Master traders think....it will take time to solidify these points, but the more you try to think along these lines, the more it will make sense i think, and over time it sort of becomes second nature....actually when i describe the process of how i learned everything to people, i use the analogy that when i first started out i felt like i was in a giant room with 100s of people having conversations with each other, and i was standing in the middle of the room and at first it all sounded like noise to me....but now i can stand in the middle of that same room and listen to all kinds of conversations and pick out tidbits of information selectively and from all over the place....its no longer noise but real information.)
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"I recognize that I may be wrong. This makes me insecure. My sense of insecurity keeps me alert, always ready to correct my errors."
"The prevailing wisdom is that markets are always right, I take the opposite position. I assume that markets are always wrong."
George Soros |
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