There is nothing more frustrating than finding a good candidate for a trade, making an excellent entry, and then watching the profits disappear when the market turns around and moves against our position. This kind of experience can place an extraordinary amount of psychological pressure on someone trying to trade for a living. Learning to deal with this situation before it becomes frustrating is crucial to your development as a full-time trader.
I learned a piece of wisdom from a master trader one time, when he observed that stocks will often climb up the steps and then jump out the window. He was describing a common situation in which stocks climb a wall of worry and then make a dramatic selloff which makes your profits disappear. This occurs in many stocks that have found a base at a lower price and buyers are slowly being tempted to enter new positions but without full conviction.
You know this is happening when you see price move up in short small steps which looks like a staircase. What will often happen then is last-minute buyers climbing on board the momentum and suddenly pushing price up in a hurry. Professional traders call this a parabolic top.
If you see this formation after a long slow period of price improvement it is a clear sign that something dramatic is about to happen. This drama is normally a rapid selloff which captures all the profits of the last several days and traps the late comers to the party who are then eager to exit their positions to prevent disaster. This pattern happens so often that you can almost rely on it to make a living.
To be an effective trader you must not let your profits disappear. You need to have a discipline of harvesting your gains and protecting your open profits in every position. The easiest way to do this is to have a trailing stop of a certain percentage that is keyed on the highest high since you have been in the trade. If your broker does not offer this kind of automatically adjusted trailing stop, then you need to find a new broker. All the good ones have this feature.
In the early stages of a trade, protecting yourself and your capital against sudden reversals is important. But after you’r really excellent trades you also need to incorporate this method of protecting your profits in order to be successful in the long term.
Good luck and good trading!
here is an example of SPY marching up and down the staircase lately, from our daily Market Health Check:
