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Dangers Of "Jumping The Gun" In Trading (Market Psychology)

|Includes: DIA, IWM, MDY, PowerShares QQQ Trust ETF (QQQ), SPY

When I was a new stock trader many years ago, one of the most psychologically challenging aspects of swing trading was continually maintaining the discipline and patience to wait for stocks and ETFs to actually break out above their technical resistance levels before buying them. Instead, I frequently made the crucial mistake of immediately buying these stocks, right after determining the presence of a valid chart pattern, for fear of potentially missing a big rally. However, I quickly realized these carelessly timed trade entries resulted in losing trades a vast majority of the time because I was not waiting for the price action of the stock to confirm itself by actually trading through the exact resistance level. As soon as I began waiting for stocks and ETFs to move above their technical resistance levels, rather than buying in anticipation ("jumping the gun"), I quickly noticed a dramatic turnaround in my trading profits.

"Jumping the gun" is an idiom that originated from the scenario when a gun shot signals the start of a sporting event (typically a race), but one or more of the participants takes off before the actual gun shot. Participants who "jump the gun" may be disqualified from the event when this occurs. In short-term trading, buying a stock or ETF that has formed a valid chart pattern, but has not yet broken out above resistance, is akin to "jumping the gun." Doing so over and over again will certainly disqualify offenders from building a profitable trading account over the long-term.

The indecisive and choppy price action that has plagued stocks throughout most of the summer has indeed been challenging for swing traders who seek to profit from stock market trends in either direction. But even though the ETF and stock picks of The Wagner Daily newsletter have not exactly followed through in our intended direction in recent weeks, we have most importantly stayed out of harm's way by avoiding substantial losses. Losing trades are a normal part of the trading business, but it is crucial to focus on limiting losses when the stock market is devoid of a convincing trend in either direction.

We have listed numerous detailed ETF and stock trade setups in our nightly swing trading newsletter in recent weeks, but a majority of those setups failed to trade through our exact, predefined entry prices in order for a new trade to be entered (the "trigger" price). As such, the model trading portfolio of The Wagner Daily has been mostly in cash, enabling us to primarily sit on the sidelines while waiting for the stock market to make up its mind. For newer traders, having this patience and discipline to "sit on hands" in poor market conditions may indeed be psychologically challenging. But as alluded to earlier, patience and discipline are two critical skills any serious trader or investor must master if one is to profit from short-term trading over the long-term.

In the July 25 issue of The Wagner Daily and on this blog post, we illustrated that the daily chart patterns of the Nasdaq 100 ($QQQ) and benchmark S&P 500 Index ($SPY) were poised for potential breakdown below key technical levels of price support. But instead of breaking down, the major indices unexpectedly moved sharply higher, which became an excellent example of the importance of having a trading system with well-defined rules, specific trade setups, and exact, predefined trigger prices for trade entry. Before that rally occurred, for example, we had several stocks and ETF on our watchlist for potential short selling entry, but the broad market rally prevented any of the setups from breaking down. This means the stocks and ETFs on our watchlist did not trade through our "trigger" prices for valid short sale trade entry. As such, we neatly avoided getting caught on the wrong side of the market during the sudden reversal. If we had "jumped the gun" by attempting to sell short the market prior to our setups trading through their exact trigger prices, it would have resulted in substantial losses over the past few days. This is why anticipatory trading is a dangerous practice.

When working with clear, predefined technical trade setups, trades generally will not trigger for entry if one's market timing is wrong. Entry triggers and protective stops are one's protection from catastrophe if the trade doesn't move in one's favor. Overall, profitable trading systems are simply based on playing the odds. Of paramount importance, the primary goal of any trader or investor should be to always protect capital in "bad" markets, so that one is still around to participate when the trend (either up or down) turns in the favor of the technical setups following through. As a stock trader, it is important not to suffer from the illusion that trading profits can be squeezed out of every market. If we were heavily short going into the recent rally (because of playing the anticipation game), we would have been under a lot of pressure psychologically, and that's when bad decisions are made. However, it's hard to be pressured by the market and make bad decisions if one is not even in the market.

Although the price action in the latter half of last week was bullish, we had no desire to chase the move higher. For starters, leadership among individual stocks has become fragmented. There's a big difference between buying stocks and ETFs in a market that reverses when the majority of leadership stocks are showing tight price action, versus buying stocks in a sudden market reversal when a large number of former leadership stocks have already lost key support levels and/or their bullish technical patterns have broken down. When a large number of leadership stocks break down, as they recently done, it usually takes several weeks to months for the market to "repair" itself for the next potential move higher. It is also noteworthy to point out that excessive volatility is an earmark of bearish markets, and volatility is not a friend of trend-following swing traders.

I will conclude by reminding you that that we never care which direction the market moves. We have no bias to the long side or the short side (nor should you). Instead, we rely on the successful track record of our rule-based market timing system, letting it objectively determine which side of the market we are trading on at any given time, and with how much capital exposure in our model trading portfolio. We never ignore our market timing signals just because stocks make a sudden move in one direction or the other. When you follow an objective trading plan, you will find that your mind is free of fear, greed, hope and regret (four primary emotions that drive the stock market), and will be more likely to make sound trading decisions.

To learn our proven trading strategy of the past 10 years, and to receive our top nightly ETF and stock picks with exact entry and exit prices, sign up for your risk-free subscription to The Wagner Daily.