Tuesday, March 30, 2010

Preparing for False Breakout Moves in the Stock Market

Note how often in recent market action we've seen prices move above or below a recent high or low, only to snap back into the prior trading range. These false breakouts can be challenging for traders, as they assume that we'll see range extension and the beginning of a trending market. Instead, the market simply sustains a longer-term trading range.

By the time the market does experience a catalyst to move it outside the extended range, many traders are so beaten up by getting chopped up on false breakouts that they can't participate in the directional move.

What I find among short-term traders is that they often will presume that breakouts will continue in their direction without actively planning for the possibility of retracement. When we see that stocks have broken to new highs (as we did this morning), but that other asset classes aren't participating significantly and that the number of stocks making new highs has been waning, we want to actively build a scenario for a possible reversion trade. Once the correlated asset classes begin to retreat, stock prices stall out, and we see NYSE TICK pulling back, we're then prepared to act on the scenario we've built.

It is much easier to act on market action if you've visualized and planned for it in advance.


Bruce Berger said...

Bret I have been a log time follower of your blog. I am a value investor that actively uses technicals and am continually working on my mental state. I am looking to form a mastermind group of other investors that read your blog and wish to communicate once a week for support so to speak via a teleconference for say one hour. Each person can talk about whats on their mind with trading and can clarify goals and be held accountable. I wanted to model it on Ed seykota trading tribe format but its on the phone. I am also up to forming a group I live in ct if others may want to get together. Thanks

Bruce Berger said...

A follow up to my last post for mastermind group please see my blog at http://theturnaroundcontrarian.blogspot.com/

Vernon said...

Brett, I love the site, especially the trader psychology articles. I figured this article is probably the best fit to leave this comment about my own personal trading issues. I am what you would call "rangebound" in my trading reactions,i.e., I rarely believe an upside breakout will last, so I am always in search of the quick momentum scalp to the short side. This does a lot to defeat my results, in that I am quite often correct about the market wanting to "revert" back to the mean, or better yet the VWAP, but I completely lack the patience to wait for targets to be hit, especially on the long side, and I am always taking the counter trend trade. When I see SPY plodding along higher very slowly like it has for the past month or so, I keep waiting for that sizeable downturn which never happens. What can you say to someone like me who fights the market(especially when it is going up) and who is stuck in a rangebound mindset?