Wednesday, January 20, 2010

Fade What You See

It only takes a few minutes of conversation to figure out who knows something about markets and who doesn't.

One unerring confession of cluelessness goes by the maxim, "Trade what you see."

If trading what you saw made money, you'd be a raving success buying short-term strength and selling short-term weakness. But that has consistently lost traders money over the years.

If trading what you saw made money, the field of behavioral finance would not exist. The entire thrust of years of research is that our perception is filled with cognitive biases that affect decision making.

Do traders *really* think that all the time, effort, and money that the world's leading traders and portfolio managers put into their research and generation of ideas is worthless? That all they need to do instead is put positions on based upon what they see in a trendline, a chart pattern, or an oscillator reading?

No, it's precisely because unaided perception is flawed that we need to go beyond what we see and identify the themes and intermarket patterns that lie behind price action.

Because some of the best opportunities in trading are when the herd is seeing one thing, but the markets are telling us something quite different. The great traders can trade what they see when everything lines up, but they also know how to fade what they see, when what's obvious becomes obviously wrong.