Monday, August 24, 2009

One question test

As it often happens during the most uncertain times - at what potentially is a trend reversal point - I get a lot of questions about signs of such reversal, in this case top. As it often happens, a lot of those questions are asked in order to confirm author's belief - and if no such confirmation is obtained, back and forth arguments ensue. Over the last week or two, I expressed my point of view that we were not ready for full blown reversal yet, and more upward action was likely to come.

One theme that constantly popped up in such exchanges (not a first time mind you, it's rather typical way of thinking) was this: "but there is no job creation, commercial real estate is imploding, A is weak, B is wrong (long list of what is wrong with economy)... this market must drop, I am shorting it!"

Notice one thing that all those reasons have in common? Well, aside of them being probably right. They all have no ties with market timing. Here is what I mean by this: if you employ some idea for trading related decision-making, you have two major questions to answer. One is the direction of your planned trade. Another is timing of the trade initiation. All the ideas listed above have to do with direction... do they have anything to do with timing? How do we distinguish which ones help us pick the right entry moment and which do not, leaving us to seek more indications to time our trade right?

Easy. There is a one question test that does just that. As you evaluate your trading idea, ask yourself: IS IT A NEW TURN OF EVENTS OR WAS IT SO A DAY, A WEEK OR A MONTH AGO?
Because if jobs creation wasn't there a month ago either yet market went up during this month, how does this fact enable you to enter short now? It does not. Any economy related, company related, sector related idea can be verified by this question in order to find out whether it should be used in timing your trade or you need to keep it as purely directional idea and look for something else to help you with timing.

You would think this is something that concerns mostly position or swing traders... but I get this from day traders too. 'I am shorting RIMM, I just analyzed their this and that, and it's very weak". RIMM is up 2 and half points for the day, so I ask: Why here? Is there any short setup, sign of reversal? What is it that makes you think short right here and right now? The answer is: Well, I just finished reading that report... Pause, then we both laugh as my counterpart realizes that his timing of finishing the report is fairly dubious as a market timing event. OK, I start laughing just a tad sooner as I am not polite enough...

Anyway, once again. Your one question test concept is, could this have been said a week or a month ago just as well and did not impact market during this time? If so, what makes me think it will do so now?

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