Wednesday, December 26, 2018

The Psychology of Trading a Crazy Market

It's been a while since we've seen a VIX greater than 30.  It's also been a while since we've seen three consecutive days where there have been fewer than 100 stocks across all exchanges registering new monthly highs and well over 2500 making fresh monthly lows.  And it's been a while since we've seen fewer than 10% of all SPX stocks trading above their 3, 5, 10, 20, 50, 100, and 200-day moving averages.  I recently wrote a Forbes article on what market history tells us about the paths of bear markets.  Over this holiday period alone it has generated well over 40,000 hits.  That tells us something about market psychology.

I recently participating in a podcast with J.C. Parets of All Star Trading.  If you haven't checked out his series, I suggest you do so.  You'll find a wealth of trading perspectives.  In my session with J.C., we discussed how the volatility of markets can induce our own emotional and behavioral volatility.  An important priority in trading crazy markets is doubling down on our own sanity.  That means mentally--and emotionally--rehearsing being wrong on trades so that we are prepared to take the right actions if the stuff hits the fan.  As a rule, the more we face the heat of battle, the more we want to keep a cool head.  When we *anticipate* the losing trade, we allow ourselves to normalize it emotionally--and that helps us keep the cool head.

Indeed, it's not at all unusual that I will structure a trade that looks like it has momentum in its favor.  I put on a price stop in case of reversal, but I also put on a time stop.  If the move cannot materialize in a relatively short period of time, momentum on that time is not what I had expected.  That itself may disconfirm my idea.  Exiting the position for a modest loss can set up a trade the other way.  In such cases the loss is a tuition we pay for valuable market education; a fee we fork over for useful information.

When we take the threat out of losing, we open the door to using losses as learning lessons that make us better.  That's a great psychology for a crazy market!