Wednesday, July 15, 2009

Matching the Time Frames of Your Analyses and Your Trading

Three common mistakes that traders make was the topic of a recent post; if I had to add a fourth, it would be letting longer-term political and economic biases interfere with a shorter-term read of market strength and weakness.

Toward the end of last week, I raised the possibility that we might ultimately hold the May/June lows, which could lead to a bounce back into that long-term trading range. When Monday's weakness could not take out the prior week's lows and we held strength after weakness in Asia, that trading range scenario gained credibility.

Interestingly, however, my conjectures were generally met with a near indignant response from traders who emailed. "How could we go higher when the economy is so weak?" was a common response. The key to the replies, however, was the emotional tone of indignation--almost as if I had insulted their family members.

Those traders had a *need* to believe in a bearish thesis; their beliefs were not grounded in how the market was actually trading. This dynamic is not unique to bears; I found similar indignation when I posted an article to a website in early 2000 comparing the stock market to the exhausted 4 AM dancers in Ibiza. I received many defensive replies, indicating that I simply did not understand the new market paradigm.

The economy may indeed be weak and stocks may ultimately reach new bear market lows. What I know is that the market is not trading that outlook right here and now. As long as more volume is being transacted at the market's offer price and more stocks are ticking up than down, I want to participate in that demand/supply imbalance.

It's vitally important that the time horizon of your analyses fit the time horizon of your trading and investing. Mismatches will take you out of good investments on short-term weakness, and they will keep you out of short-term rallies on longer-term pessimism.