Knowing When to Trade

 | May 09, 2014 | 12:48 PM EDT
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Earlier this week, I talked about the idea of whether to trade or not to trade. Today, I want to discuss a separate aspect: when to trade. Although there may be small periods in which an asset class moves within a vacuum, it is often short-lived. When you hear someone constantly talking about the yen or the transports or the high-beta momentum names or bonds, there is a reason.

Yes, we make too much of what is moving the market from day-to-day, but over stretches of time, these relationships between asset classes do matter. We often talk about correlations, which is nothing more than the measure of how these relationships impact different asset classes with one another.

So the media will get fixated on one of these assets classes or relationships and beat it to death. While it may get annoying at times, I find it helpful. At least I know what to watch. Sure, it is only perception, but if enough people perceive that it matters, then perception will become reality.

This brings up one area where some traders, especially newer traders, may want to avoid: Transition. This is when the market falls into a void in which there is no dominant headline. One headline moves the market one way, then another headline moves it another way and the correlations seem to be changing every day. This time of transition changes perception.

Unfortunately, a change in perception doesn't happen all at once, which leads us into chop. No one I know likes to trade chop slop. It is a sure way to get nickeled-and-dimed to death throughout an entire trading day, week or even month. There is nothing wrong with sitting out during choppy conditions.

Avoid give backs! I almost always use this rule on a Friday, but any day is applicable as well. If I start Friday off with a few strong trades, then I will often shut it down for the day. For instance, this morning I was able to catch a quick 2 points in Ubiquiti Networks (UBNT), then a pop in Green Mountain Coffee Roasters (GMCR). If was nice because I took a hit on a bullish UBNT play into earnings. Clearly that one was a loser; however, when I start out the day, especially a Friday and I can turn flat to green, or better, red to green, I will often shut it down for the day.

Between options expiration and generally lower-volume, thin afternoon trading, I simply do not want to give back gains at the end of the week. Giving back gains on a Friday often results in trading regret over the entire weekend. There is no after-hours trading to try and get some gains. There is no next day to get back on the horse. You have two days to stew. It can weigh on you emotionally and bring you into a new week of trading in a poor mindset.

Confidence is key so why do something to risk it? Instead, a green Friday can often lead to a green following week when it comes to trading. Head into the week with positive emotional capital.

On the flip side, if you start your day with loss after loss after loss, then shut it down. It is different for every trader, but most I know will shut it down for the day if they have three or four consecutive losses.

Some others I trade with set a dollar limit. For instance, if they lose $1,000, then they won't initiate any new trades and just manage open trades -- assuming they have some still open. If the open trades pull in some profits, then they will likely continue to trade for the day, while still holding true to the concept of not opening new positions if they are already down $1,000 on the day. 

These are more guidelines than rules and traders should tailor them to their personal situation. I'm certain an experienced trader will offer up more than these three, but if I only had to use three rules for my day when I was first getting into trading, I would use these three.

Since I fall into the "give back" rule today, I am just watching for the remainder of the day. I actually see the market falling into the chop rule as well today, so I have absolutely no issue using the remainder of the day as an information gathering session.

Good luck the rest of the day and have a great weekend!

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