Monday, October 10, 2016

SPX Update -- and One Rarely-Discussed Aspect of Trading Rules That Will Make or Break You

Since the market is still stuck in the trading range, we're going to talk about trading psychology.  I'm going to cover three interrelated topics, which connect in a subtle way that isn't often discussed.  Since we're still in a trading range, and that can lead to a less-than-exciting trading day, let's start there...

One of the biggest enemies of the trader is boredom.  Contrary to popular belief (especially among teens), boredom does not come about from having a lack of “fun” things to do.  It comes about from a lack of productive things to do.  In my opinion, boredom is simply one of several symptoms that can develop from a feeling of general emptiness.  And while that emptiness can be glossed over and temporarily hidden with frenzied “fun,” it cannot be truly filled by vacuous activity.
That’s why we quickly grow bored again as soon as the fun stops:  It doesn’t nourish us in any lasting manner; and certainly not in the way that truly productive accomplishments do.  After a meaningful accomplishment, we can sit and rest for a while, and we feel satisfied from a job well done.  We can be doing “nothing,” but we are not bored... because the emptiness has been filled (at least partially), or our self-esteem has grown, or our character has been enhanced, or some necessary task has been accomplished -- or all of the above.   

This is why “fun” works as a reward for productivity (after we're in the fulfilling mindset that accomplishment brings), but it does not support being chased endlessly for its own sake.  When fun is treated as an end in itself, the emptiness may retreat into the background momentarily, but it never goes away.

Anyway, my point is that many traders understand this, at least instinctively (whether or not they’ve ever put it into words).  The problem isn’t that they’re too lazy, the problem is that they can become hooked on trying too hard to accomplish something productive.  

And that leads to overtrading.   It leads to forcing trades.  It leads to bad decisions, and, sometimes, to acts of outright desperation.  Is there a solution?

Well, the solution may be to redefine our individual views of “productive” action.  I’ve often preached that non-action can be just as important as action.  If a trader has clear rules, then they can derive a sense of accomplishment from NOT taking entries that violate their rules. This is easier said than done, because the market is virtually always going to do something in the way of movement.  So when one resists, say, a buy entry because it violates their rules… and then the (untaken) trade goes on to develop into what would have been a 1000% gain, it can feel like you did the wrong thing. 
Which leads us to the area I don’t hear talked about regarding rules:  The psychological importance.  Everyone talks about how you need rules to maintain discipline, and that’s true – but you also need rules to defend yourself psychologically against the one (potential) enemy who knows your every weakness:  Yourself.  That may, in fact, be the most important aspect of trading rules. 

With clear rules, you have an emotional fallback when that trade you never took goes on to become the greatest winner in history.  You can chalk it up to luck, or blind chance, or whatever (because it probably was), and say to yourself, “Hey, good for the people that took that trade.  I didn’t take that trade because MY system didn’t give me any reason to.”  And you can get on with your life.  And your next trade.
But without clear rules, you will beat yourself up endlessly for not taking that big-winner trade -- because without rules, you don’t really know WHY you didn’t take the trade.  How can you defend yourself if you don’t know why you didn’t take the trade, you just know it was a huge winner?  Just like in life, without clear guiding principles, your entire position is psychologically untenable over the long haul. 
So my point is this:  Without a well-defined trading system, you walk an endless edge where you are always one trade away from total destruction.  The amazing thing is, this one single trade can destroy you even if you never took the trade! Because the repercussions of one “incredible missed trade” will put you in the absolute wrong mindset to make your next trades successful.  You’ll be operating under a psychological gun of regret, and in a “not gonna miss the next one!” mentality -- and you’ll be tempted to jump into every long-shot, high-risk trade you can lay your hands on.  And (unless you get really lucky and hit a big winner), as the money dwindles, your mindset will rapidly spiral out of control.

So do yourself a favor, if you haven’t already:  Before you enter another trade, sit down and figure out exactly what your rules are.  Then agree to support yourself emotionally for honoring those rules.  Period.  Honoring your rules is your “win” -- that’s your productive activity.  No matter what happens to the trade (or non-trade!) afterwards.  As you go along, of course, periodically review and adjust your rules if you see areas that need improvement.   But stick to your rules, and never beat yourself up for maintaining discipline.  No matter how it ends up.

You now have a psychologically-tenable position from which to advance or retreat as you see fit.  You have the emotional foundation needed to support yourself through the inevitable ups and downs.  And you are no longer one bad trade, or one missed trade, away from going on tilt and wiping yourself out. 

Chart-wise, there's nothing to update but the near-term chart, so I've done so below.  For the larger bull/bear options, please refer back to the prior update:

In conclusion, the short-term pattern suggests that Friday's high was a b-wave, thus likely destined to be broken (although all that's technically required is a break of the red a wave high).  As I discussed in depth last update, I continue to feel bears should be cautious here, and only short the upper edges of this range, if they short at all.  Trade safe.

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