One of the primary responsibilities of a trader is to forecast the future direction of a security. It's not really a difficult choice, there are only three options – Up, Down and Sideways. However, because traders are notorious for trying to make simple things complicated, let's assume we can expand our matrix to a total of five choices as follows:
Typically what occurs during a forecasting debate is a spirited conversation about why a security is believed to raise or fall. Sometimes (if the moon is in the correct phase) you might actually get two traders to agree on the same direction yet debate the actual duration and size of the move! What typically gets left out is "Sideways." It is the unwanted party guest.
The majority of analysts I know feel as though they have not completed their forecasting responsibility unless they identify a future rise or fall. That can get you in trouble. Having a strong opinion on "Up" or "Down" when in reality the market is sideways is tantamount to believing you could empty the swimming pool by using a spoon!
Sure, with enough time and patience you could probably make the pool level go "down." However, heaven forbid that it rains during your experiment and the pool level actually raises! The truth is, your arm is going to wear out long before an appreciable change is made in water depth.
So it is with a sideways market. Your personal opinion (and trading account) is going to wear out long before the security begins to move!
That is the easy part – being willing to adopt a neutral or sideways mindset when doing forecasting. The challenge is getting comfortable with forecasting a sideways move. Here are some tips.
If you have been a student of mine very long, you have likely heard me use these three letters in class: I. D. K. It stands for "I Don't Know" which is such a powerful and freeing statement! Go ahead, try saying it out loud (softly if you're at work) – "I...Don't...Know."
What I have learned about myself and my own analysis is that if I don't have a clear idea of what direction to forecast, it often means we are entering a consolidation or sideways environment. IDK often means a sideways market is ahead.
This used to bother me... especially the more public my analysis became. After all, students show up looking for my prophetic opinion, right?! That's simply not true. Students want insight into the market, and if the insight is that we simply don't have a strong bullish or bearish opinion... then that is what they wanted (needed) to hear.
Thousands of dollars have been saved because students were willing to accept a sideways analysis and had the patience to say "I'll wait until next week to review and enter that trade"
In Foundations of Stocks and Options, our students learn the importance of Back Trading to our 4-step Trader Conditioning Process. Back Trading has two forms: Documented and Non-Documented.
The whole purpose of this is to condition yourself to observe and respond to various market conditions. To improve your ability to forecast sideways markets, find a security (or an Index) that had a historically sideways move. Then, go back in time and practice analyzing, forecasting and trading that environment. We teach students to do this using Trade Navigator in the Foundations series.
If you are having trouble being an "Perpetual Bear" or "Perpetual Bull" (which I personally think are silly terms!) - force yourself to do a full analysis from the alternative perspective.
Even if you are 100% convinced of a bullish forecast... take the time to sincerely offer up a bearish counter-analysis. And no... the answer is not "well, there is none!" There are always signals you can find that would suggest a contrary perspective.
One of the most profoundly important decisions I made as a trader was to have a buddy. Jeremy Whaley is my trading buddy and to this day (almost 20 years now!) we still discuss our trades. Not every single one because I also have several thousand students as another form of accountability!
However, we'll typically put our heads together once a week and test each other's opinions (or biases) on the overall market forecast. When we first began trading however, we talked through almost every single trade! If we found one was strongly bullish and the other bearish, the temptation was to place trades and see who was "right." However, what typically happened more times than not is that the market traded sideways and we both lost on our option trades.
The danger of writing this blog is that it could become an excuse or even a tool for a trader to claim "Analysis Paralysis." It should not. If you struggle with Analysis Paralysis I encourage you to contact me, or visit www.tradesmartu.com and review our course content.
I can fix this problem easily - all that's needed is a simple paradigm shift. Analysis Paralysis is NOT an analysis problem, it is a psychology issue. However, That's a subject for another blog.