Wednesday, February 18, 2009

Trading and Mental Flexibility

One of the least recognized trading strengths is mental flexibility: the ability to keep an open mind to the evidence of the evolving marketplace and revise views and strategies accordingly.

Once a view becomes ours, we are prone to confirmatory biases, seeking information that supports our preconception. If, however, we can formulate multiple "what-if" scenarios, we're no longer attached to any one outcome.

A directional move that cannot hit the R1 or S1 profit targets is not a trending move on a day time frame. Failure to reach the first of the targets is a characteristic of range days.

At some point in time, a directional move will look like an uptrend or downtrend day. Evidence will accumulate that the move is not being sustained. The market will return to its prior range. Instead of trading for price continuation, you'll want to trade for reversals back to a volume-weighted price average.

The transition from directional trade to range trade often begins when buying/selling pressure cannot generate new price highs/lows and incremental volume. Look at the ES trade around 9:55 AM CT. The 9 AM market was directional; it looked like the start of a trend day. By 10 AM, selling pressure (very negative TICK) could not generate fresh price lows; volume tailed off.

Switching in an hour's time from a trend view to a range view, a continuation strategy to a mean reversion strategy: That is the mental flexibility required of the active trader.