Recognize, Accept, and Embrace Changing Stock Market Trends

The reason to use option strategies is to maximize the profit and minimize the risk for a given market outlook. But if your outlook is wrong you'll almost certainly lose money; you'll just lose it more slowly than you would with a lesser strategy. However, in general with option trading compared to stock trading, you'll usually lose your money faster regardless of your strategy, if you are wrong in forecasting the direction of prices.

So if the key is really market timing, first and foremost, and option strategy is second, how do you time the market? Well I would suggest that you probably already know how to do that, but if you are like most traders you still don't do it, and I'm gong to explain why. I'm sure you've heard people say "I can predict the market pretty well, but I can't trade it". And I'm sure you yourself have suffered on many occasions from looking back and realizing you knew what was likely to happen but did not take the proper action to profit from it, or avoid a loss. I'm not talking about Monday morning quarterbacking or the fact that everything is easier to see and understand in hindsight. I'm talking about all those times you really did know that, almost certainly, a trend change was about to happen or had happened but you failed to take advantage of it.

Why?

Understanding why, is the key to trading success. There are two primary reasons: Our own individual trading biases, and the natural human tendency to hope.

Each of us is unique, but we act in groups. In any trend there are only two groups: those who are wrong, losing money fighting the trend, and those who are right, making money following the trend. If you don't know what your own trading biases are, you are more likely to get sucked into the losing group. Furthermore, you'll stay trapped there and suffer larger and larger losses if you fall prey to hope and cannot overcome it with trading knowledge and skill.

Solve the first problem by recognizing your biases. For example, you might have a tendency to be overly bearish. This will make you susceptible to being sucked into brief corrections, establishing a net short position on the dip, which quickly turns into a loss.

Solve the second problem by accepting your mistake and correcting it by embracing the trend about which you were wrong. Quickly join the winning group, don't hope that you will be proven right and hold on for an even bigger loss. Trading successfully is not about being right about what should happen, it's about quickly realizing what really is happening, no matter how illogical or silly or corrupt (people are all three, in case you haven't realized, especially in crowds, and the market is made up of crowds) and aggressively and confidently reversing your positions.

There is risk in following a silly trend. There is risk in any trade. But the far greater risk is to foolishly fight that silly trend. Take the smaller risk of going along with the crowd, going along with the manipulation. That type of risk is likely to pay off with big profits. Fighting it is likely to deal you big losses.

Solving the first problem is mostly about NOT doing something. Do not make the mistake of entering a trade because you think something should happen, or because you expect it will based on a few indications that jive with your own biases about what you'd like to see happen in the market. Maybe you have a tendency to buy "bargain" stocks that have fallen out of favor, only to be caught holding the bag as they continue to fall further. Maybe you'd like to see alternative energy stocks go up, or gold mining stocks go up. But if they start to go up and you jump in long thinking, yes I'm right and now it's starting, but then there is no institutional or other big money support for that move, you will lose money. If you think Dow stocks or the Russell 2000 are overpriced and you short them on the first sign of a dip, but big money uses the dip to add to their longs and run them to new highs, then you got sucked in, because of your preconceived bias. Avoid this by realizing what your biases are and not trading on them. Explicitly decide to NOT enter trades that jive with your own biases, because they are likely to suck you into the losing group.

Solving the second problem is about taking quick action, in three steps. First, recognize that you got sucked into the losing group. That's the easiest of the three because all you have to do is look at your account balance going down and the market going the wrong way. Second, accept that you were wrong, don't hope things will turn around. Sometimes they will, but most of the time they will not, and you have to trade off probabilities, not hope. So close out that losing position. Third, embrace the new stock market trend. Open a new position reversed from your original one.

Most people cannot do these three steps. So most people lose money in the market. It's not a lack of intelligence, or a lack of research. It's human emotional weakness combined with a lack of trading knowledge and skill. You have the knowledge now, the skill is simply getting better at applying that knowledge, through practice.

The quicker you accept new stock market trends the less money you'll lose. The quicker you embrace them the more money you'll make. It's that simple.