Tuesday, October 9, 2007

The Psychology Of Market Timing

The biggest enemy, when market timing the stock market via mutual funds, ETF's, even individual stocks (or in any trading for that matter), is within ourselves. Success is possible only when we learn to control our emotions.

Edwin Lefevre's "Reminiscences of a Stock Operator" (1923) offers advice that still applies today:

Caution Excitement (and fear of missing an opportunity) often persuades us to enter the market before it is safe to do so. After a down trend a number of rallies may fail before one eventually carries through. Likewise, the emotional high of a profitable trade may blind us to signs that the trend is reversing.

It is important to follow a tried and true timing strategy that puts you in the right position for established trends, and also gets you out of failed trends quickly to protect capital. Excitement results in losses more often than not.

Patience Wait for the right market conditions. There are times when it is wise to stay out of the market and observe from the sidelines.

Depending on your emotional ability to handle extreme volatility, that patience may result in a cash position or in bearish positions, which will trade that volatility. Do not underestimate the value of being in cash!

Conviction Have the courage of your convictions: Take steps to protect your profits when you see that a trend is weakening, but sit tight and don't let fear of losing part of your profit cloud your judgment.

When trading a timing strategy, do NOT abandon the strategy. Emotions are the most common reason for abandoning a strategy and when emotions rule your decisions, they WILL result in losses.

Detachment Concentrate on the (trading plan) rather than on the money. If your trades are technically correct, the profits will follow.

Many traders have had the experience of being profitable on paper, but losing money when they execute the trades real time. If the trading strategy is not followed absolutely, it will fail. Again, emotions dictate losses.

Stay emotionally detached from the market. Avoid getting caught up in the short-term excitement. Screen watching is a tell-tale sign: if you continually check prices or stare at charts for hours it is a sign that you are unsure of your strategy and are likely to suffer losses.

Focus on the longer time frames and do not try to catch every short-term fluctuation. The most profitable trades are in catching the large trends.

Subscribers to Fibtimer know our position on this. We are trend traders pure and simple and our strategies identify and trade trends. If a trend fails our strategies quickly exit.

Expect the unexpected Investing involves dealing with probabilities not certainties. No one can predict the market correctly every time. Avoid gamblers logic.

Many consider market timing as a fool's attempt to forecast the market. We agree with the their logic when the word "forecast" is used. NO ONE can accurately forecast (predict) the future direction of the stock market over and over. At Fibtimer we are trend traders. We do NOT forecast. We identify trends and when they are confirmed we trade them. Trend trading is ALWAYS a winner over time.

Limit your losses Use stop losses to protect your funds. When the stop loss is triggered, act immediately - don't hesitate.

The use of strict money management is the key to limiting losses. Fibtimer's strategies never allow losses to accumulate. When the strategy says sell, we do so without emotion.

The biggest mistake you can make is to hold on to losing positions, hoping for a recovery. Falling stocks have a habit of declining way below what you expected them to. Eventually you are forced to sell, decimating your capital. Human nature being what it is, most traders and investors ignore these rules when they first start out.

It can be an expensive lesson.

Control your emotions and avoid being swept along with the crowd. Make consistent decisions based on sound timing strategy and you will be profitable. Do not expect overnight profits. The stock market is where the profits are, but it is not a grocery store. You do not pick the profits off the shelves.

Profits will come if you follow the plan without deviation and do not make emotional decisions to jump ship based on news events, short term losing trades, or especially because the market is rallying today and you are in cash or bearish.

The strategy will win out over time. It will get you out of losing trades and keep you in the long-term profitable trends. Stay the course and win.