Friday, March 06, 2009

Tightened Profit Targets: Adapting to Changing Market Conditions

It was pure coincidence that I posted on the topic regarding the need to tighten profit targets on a day when such tightening was the difference between profit and loss. If you follow the Twitter comments intraday, you know that I reconfigured the S1 and R1 profit targets to factor in the volatility patterns that we've been seeing thus far in 2009. Sure enough, given the weak TICK distribution and solid relative volume noted in the Twitter posts, we hit the revised S1 target but never hit the standard S1 level. Instead, we had a violent end of day rally that would have erased all profit from a patient market seller who was waiting for the trending move to hit its first support level.

I'm finding that the altered pattern of volatility is affecting daytraders as well as those holding positions over swing time frames. The market has been behaving in unusually noisy ways, moving a good deal intraday, but achieving relatively little directional change relative to the total distance traveled. That noise is enough to stop traders out of good ideas, and the reversals are enough to frustrate traders who are holding positions for larger directional moves.

The problem becomes psychological when this frustration affects subsequent decision making, leading to undue risk aversion or impulsive attempts to recoup lost profits. The traders who are particularly hurt by these market developments are those that traditionally profit from momentum: just when they are ready to add to positions, the market reverses--quickly eroding any profits they might have had.

I am going to stick with the reconfigured profit targets until I have definite indications that market conditions have changed. Those targets will be posted to Twitter prior to the start of each market day (free RSS subscription). While psychological exercises can aid with frustration, the real answer to this problem is to adapt to market conditions and become a little quicker to take profits. Under the recent volatility conditions, the market will hit either the revised R1 or S1 level over 70% of the time. I'll be reworking the other levels as well and will post these via Twitter prior to Monday's open.