How to Avoid Going Down the Rabbit Hole

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While Harje is off jet-setting around the world I will be taking over at Money Morning. I run the Alpha Wave Trader service here at Port Phillip Publishing and spend my time scouring the markets for trading opportunities in stocks and indices using my proprietary technical analysis model.

I am currently focusing on the smaller end of the market because I’m finding some great opportunities in that space. I am still a bit sceptical that the overall market can continue racing higher at its current rate, so I am avoiding the large-caps for now.

The best way I can add some value to your day is to showcase a few different stocks that I think are worth keeping your eye on while also teaching you a bit about my way of analysing price action.

But before I dive down into the nitty gritty, I reckon it makes sense to give you a big picture overview of how I view markets.

At the very top of the totem pole for me is the statement: No one knows the future. Myself included.

Free report: Aussie stock picker, Sam Volkering (with gains as high as 1,431% in the last 18 months) reveals what he believes are his next four big potential winners.

When you accept that statement without reservation your whole approach to the very big problem of navigating the markets changes drastically. You don’t need to work out what the future is. You need to manage your risk effectively in an uncertain environment.

The question is no longer ‘How much can I make?’, but ‘Where am I proven wrong?’

If you start to delve into the question ‘Where am I proven wrong?’, you soon go down a rabbit hole. That’s where technical analysis comes in. To make a clear set of rules about where you are proven wrong you must reference the past, otherwise your rules are arbitrary.

For example, if you say that you will only risk 20% of the price of a stock before getting out, but that stock moves 50% on a regular basis, you are in for a world of pain.

You can have the most fabulous fundamental research and feel certain the stock is undervalued, but I assure you it can go down for another three years before turning around. Standing in front of it and then holding on for dear life will just tie up your capital in a dud that I could have told you was trending down. It will also chew up your mental energy and stop you from behaving in a proactive manner. Odds are that you will dump the stock in disgust at some point and then look back six months later and kick yourself because it has rallied 100%.

That brings me to my next key insight…

Prices constantly revisit old ground shaking out weak hands

I hate to break it to you, but I’m guessing you already know this. The retail punter is cannon fodder for professional traders. The patterns that keep occurring again and again are just traders being shaken out of their positions whether they are long or short.

To find a viable trading strategy you have to understand what these mistakes are, and you must enter trades that take advantage of these mistakes.

Whether a market is trending or range bound you constantly see prices gravitating back to where they have been before. This price action wrong-foots market players by making it extremely difficult to hold onto a position without wearing pain at some point.

Traders are an optimistic bunch. Despite being told ad infinitum that only a small fraction of traders actually make any money they continue to dip their toe into shark infested waters and soon enough lose a foot.

When their positions race into the money the dollar signs start flashing and the initial trading plan to take part profit quickly goes out the window. Then prices reverse course and race back to the entry price. The memory of all those shiny dollars flash before their eyes and they refuse to get out because taking a $1,000 profit seems so pitiful after being up $5,000.

So, they hold on and watch the position go to negative $5,000.

If the market oscillates enough it might make their position go into and out of the money a number of times. Each time the trader will cycle through multiple emotions. From elation to despair, relief to horror.

In my experience it takes about three cycles of elation to despair before a trader finally throws in the towel and dumps the position. Often at a loss.

Then the usual round of mental anguish and what ifs occur as the trader relives all the moments when they could have made the right decision and they tell themselves next time they will follow the rules.

There are two things involved in this dance: the market and the trader. Therefore, the trader must understand two things. They must understand the market beyond what they believe to be true and they must understand how they behave in high pressure situations (i.e. they need to understand themselves).

I would say most traders don’t have a clue about the underlying mechanics of price action (even if they call themselves technical analysts), and most of us have little understanding of why we behave the way we do in high pressure situations.

For most people, the chance of surviving long-term in the market as a trader is near zero. Anyone can invest in the large-caps and hold on forever and make some money. Depending on when you invest, you will either make a little or a lot, if you hold on for long enough. I am not talking about investing. I’m talking about trading.

So how can we move beyond this pessimistic outlook?

That’s what I hope to show you over the next few weeks while Harje is away. I will continue to reveal the key insights I have made over nearly three decades of observing and trading markets. I will reveal different aspects of my technical analysis theory which has been built from the ground up as a result of those observations and I will give you real-time trading examples. It should be fun.

If you are interested in a more hands on approach to technical analysis, I shoot a video each Monday for Money Morning subscribers. You can find all the past videos here.


Murray Dawes,
Editor, Alpha Wave Trader

PS: Download your free report and learn our three favourite small-cap stocks right now. Click here to find out more.

About Murray Dawes

Murray Dawes is the Editor of Pivot Trader and contributing Editor at Money Morning. He was one of five, from 5,000 applicants, chosen for a graduate position with the Swiss Banking Corporation — now part of banking giant UBS. The bosses quickly cottoned on to his potential and pushed him…

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