Every market produces opportunities, but these opportunities manifest themselves in different ways in different markets. Even though there may be a substantial number of new trading opportunities, inertia will often prevent us from taking advantage of them.
Traders, especially those that are highly disciplined, can have a very hard time adapting to a market that has undergone a substantial change in character such as this one has in the last few months. Rigid discipline helps us prevent mistakes in normal markets, but it tends to hold us back from being creative and finding new avenues from which to profit. In addition, traders often don’t seek to find inventive solutions to dealing with market change.
Many momentum traders and trend followers simply head to the sidelines when their style is out of favor. Rather than trying to find a new approach they move to cash and wait until conditions favor their methodology once again.
I’ve done that myself and found it to be beneficial as it gave me a breather from a difficult market and allowed me to catch up on other work. If you are going to take a break from the market, then why not do it when your style isn’t working very well?
However, most traders want to trade and they don’t like the idea of staying idle for too long. What should you do when your normal style and strategy isn’t working and the market seems much more difficult than normal?
You become creative. You look for new approaches and methods and try to find things that will work in a different kind of environment.
In his book “Trading Psychology 2.0, From Best Practices to Best Processes,” Dr. Brett N. Steenbarger outlines the steps to the creative process in trading;
- Preparation. Before we can design new approaches to the market we have to understand what has changed. We need to observe the price action and see how psychology and emotions have shifted. Has the role of fundamentals shifted? Are chart patterns working? How is news impacting the market?
- Incubation. This is an important step too often skipped by anxious traders that want to go to work. We need time for our mind to sort out and understand the observations we make when we are preparing. We will not be able to form solid insights and make judgements until we internalize the data that we have gathered.
- Insight. As we gather our facts and internalize them we can began to form insights and develop theories about what sort of trades may work. We have new information and now we need to formulate a hypothesis on how to use to generate trading profits.
- Verification. Our insights need to be tested to make sure they work. Putting theory into practice requires that we put some money on the line to make sure that our thought process is valid.
This creative process must take place quickly as market conditions can change surprisingly fast. The important thing is that we recognize that we are using a creative process to deal with the market and to be mindful of that process.
In my own trading, I have found that when the market shifts, like it has this past week, I start to focus on developing a way to play counter-trend bounces such as occurred on Thursday. These bounces are prevalent in poor markets and offer the best opportunity for some good gains, but they occur quickly and often don’t last long. To play them effectively it is necessary to actively seek out situations where they may occur and be ready to act immediately.
It is the nature of the stock market for it to go through cycles and every cycle is going to vary. The only want to deal with this and to keep on trading is to be creative and find new approaches. Opportunities will always be there, but it is up to us to find ways to exploit them.