We all love comparing what happens in sport with what goes on in the real world. Some traders might even consider themselves as an elitist kind of sportsman, able to navigate through difficult situations just by trusting his instincts and working off his experience. For most traders, sadly, this rarely works well and being brave or ‘following your instincts’ will more than likely result in nasty losses rather than the proverbial ‘homerun’.
In the world of sports, it’s all about making that final killer shot, that last mad dash which consumes every last bit of energy in order to get that winning result that the player so desperately wants. The player’s ability, and incentive, to do something extraordinary to change the game around is what makes sport so exciting to watch. When Ronaldo put in that unbelievable header against Wales in the recent European Championships in France, he instinctively knew where the ball was going and his many years of practice allowed him to pull off that monster leap above all other players to put the ball in the net.
Mr. Market likes to make traders suffer by throwing them curveballs when they expect a straight shot and generally behaving unpredictably which means the famous ‘gut feeling’ really won’t get a trader very far. This is precisely why it is so important to have trading rules. Rules help traders from walking down the wrong path, acting on ‘instinct’ or emotion or doubling up when wrong and making other random decisions. The upside is, of course, that rules, when applied correctly, help traders make consistent profits.
Tradeworks is all about automated rule-based trading and in this blog we have dug out 10 tried and tested rules as advocated by one of the greatest market analysts of all time, Bob Farrell. As head of the Merrill Lynch research department for decades, Bob’s insights have been condensed to "10 Market Rules to Remember" and subsequently redistributed in countless articles since then. Never the less, these rules are still very much valid and, in our view, pure gold to the avid trader.
Let's take a look at these timeless rules and how they can help you achieve better returns.
1. Markets tend to return to the mean over time.
The 1998-2000 Nasdaq bubble is a great example.
2. Excesses in one direction will lead to an opposite excess in the other direction.
Recent action in Tesla is a good example.
3. There are no new eras – excesses are never permanent.
‘But this time it’s different’!! Nope…it never is.
4. Exponentially rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.
The markets have a tendency to overshoot both on the upside and downside making trading challenging as these moves can be spontaneous and very fast. Great traders will always have firm stops in place in order to avoid trading based on emotions. (Automated execution of stop loss, take profit or customized exit rules are one of the key advantages of using Tradeworks).
5. The public buys the most at a top and the least at a bottom.
It’s human nature to follow the perceived safety of the herd as we think that ‘all of them can’t be wrong at the same time’. But sadly the crowd is wrong more often than not. People inherently trust what the read in newspapers or see on television and act on the information only to find that they are buying an old story that has already unfolded leaving only room for downside. Be contrarian and dare to think independently.
6. Fear and greed are stronger than long-term resolve.
Human emotions are the number one obstacle for successful trading and the only way to avoid getting caught is by having a disciplined approach to trading. A trader must have a trading plan with every trade he/she does. Successful traders will always know their take profit and stop loss levels and stick to them. (These settings, and many more, can be found under Money Management Rules on Tradeworks).
7. Bull-markets are strongest when they are broad and weakest when they narrow to a handful of blue chip names.
Don’t get obsessed with small indices like DowJones as it rarely reflects the true state of the market. Follow broader indices like S&P500 or even Russell 3000 in order to get a more realistic view of market fundamentals.
8. Bear-markets have three stages– sharp down, reflexive rebound and a drawn-out fundamental downtrend.
Recent price of crude oil is a good example…
9. When the experts and forecasts all agree – something else is going to happen.
While there is no need to always go against the market, be aware of overcrowded trades. When the taxi-driver tells you the Dollar will go up and he just bought some – it might be time to do the opposite.
10. Bull markets are more fun than bear markets.
It’s basic human nature to trade something that is rising in value rather than something that is depreciating. It is also worth remembering that bull markets typically last much longer than bear markets and hence give many more relative opportunities for great trades.
As humans we have an almost insuppressible instinct to react certain ways in certain situations. In trading these instincts will, more often than not, prevent us from making profits in the market. Traders can, of course, try to teach themselves not to react to these instincts…or they can choose to execute their trading strategies via automation platforms like Tradeworks. The key to successful trading is consistency and harnessing the power of modern trading technology like Tradeworks, will give many traders an edge to achieve consistent and profitable trading results.
Posted by TradeworksFacebook LinkedIn Twitter Google+