Five Ways to Stay Profitable in a Scary Market

This title assumes a great deal. It assumes that as a trader you are already profitable and that markets are not ordinarily scary. If you can identify with these assumptions, then you have come a long way in your development as a successful trader. In as much as 95% of traders fail in their attempt to become successful trader. I suggest I back up a bit and address this to those who would be amongst that 5% who are consistent winners in this zero sum game we call day trading.

Market Basics

First let us understand some market basics. Markets exist to facilitate trade. From moment to moment the market offers traders the opportunity to profit from price movement. It’s an environment where every trader has the freedom to create his own results, i.e. all the choices and the power to exercise those choices reside with the trader.

‘Scary’ implies fear, anxiety, or insecurity. In his book, The Disciplined Trader, Mark Douglas addresses these issues in a no-nonsense, no holds barred way.

Let me give you an example of his views on this subject:

“It was only the lack of trust I had in myself to do what was needed to be done that I was really afraid of.”

“The market is never wrong in what it does; it just is.”

“The market cannot take anything away from you that you don’t allow.”

“In the trading environment the outcome of your decisions is immediate, and you are powerless to change anything except your mind. You have to learn to flow with the markets; you are either in harmony with them or you are not.

It becomes self evident that your trading success will be dependent on your ability to correctly perceive opportunity, to execute a trade arising from that perception and your ability to allow your profits to accumulate.

Are You Consumed by Fear?

Markets are inherently scary. If you are a trader consumed by fear, then the market will always be scary, and the only variable is how scary it is at any given time. When consumed by fear a trader is doomed to failure. Fear will twist your perceptions and blind you to the opportunities available. Fear will almost always drive us to make the wrong action, and it will without question make us totally incapable  of accumulating profits that might be made.

However even for disciplined and proven successful traders, the markets can be scary. Objectively scary markets can be quantified by the Volatility index, the VIX - the ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking and is calculated from both calls and puts. The VIX is a widely used measure of market risk and is often referred to as the "investor fear gauge.”  Levels below twenty are associated with market complacency and over thirty with increasing market anxiety. Extremes are often excellent contrarian indicators.

Trading should be considered a business, and your rules should reflect good business practices. These would include adequate capitalization. Conservation of capital is your primary job. If you are under-capitalized, you are half way to the losers stall before you even start.

Over-Trading & You

Do not over-trade. This too will drain your energy, your attention to detail, your perception of price changes and the efficiency of your trade execution. Over-trading will inevitably drain your capital from your account to the guy on the other side of your trades, who you can be sure does not have his/her perceptions blunted. If you have this as your guiding star, chances are you will eventually succeed in this business.

Preserving capital is closely associated with risk management, and I will address this in the five things you can do (successful trader or not) to be successful even when there is evidence of market anxiety.

5 Rules to Trade By

1)      Stick to a Trading System that has proved itself over time to be profitable despite losing trades. No system is 100% correct. It only needs to be correct 50% of the time if profits are substantially greater than losses.

2)      Never Anticipate Your System. Let your system fully play out so that its various criteria are fulfilled before entering your trade. When in doubt keep out or if already in a trade, get out!

3)      Always Use Stops; NEVER Trade Without Them. Make it your practice to enter your stop loss trade before you enter your trade.

4)      Never Let a Winning Trade Become a Losing Trade; use a trailing stop once your trade is showing a profit. Once a trade is showing a two point profit consider bringing in your stop to the entry price; so should the market unexpectedly reverse, it would be a scratch trade. After that trail your stop two points for every two points prices move in your favor.

5)      Trade with the Trend. Do not attempt to pick tops and bottoms to trade against the trend.

Following these principles and spending the time necessary to create the psychological stability necessary to succeed is the most difficult part of this profession. Your goal should be to have the self knowledge and confidence that you unquestionably believe in your trades. Identify with Mark Douglas’ dictum, “markets can’t do anything to any trader who completely trusts himself to act appropriately, in his best interests, under all market conditions.”