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Trading 101

Trading 101: How to Trade using Momentum

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Momentum is an interesting concept.  When you relate it to people and those who trade the markets, momentum reflects the change in sentiment and the inertia of the price movements. When things are going well, the good times are rolling and when bad things start to appear, the sky can be falling.  People use the saying, “when it rains it pours” which means that when negative momentum accelerates, things can turn awful quickly.

Since human emotion is an important part of determining future price movements, measuring momentum is a tool that should be part of your trading arsenal. There are a number of good indicators that you can use to measure momentum and one of the best is the Moving Average Convergence Divergence Index (MACD).

The Development of the MACD Indicator

The MACD was developed by Gerald Appel in the late 1970’s. The initial MACD only included a portion of the index and histogram that is used by investors today.  Gerald’s goal was to determine momentum by evaluating the difference in two different moving averages.  By analyzing the difference in specific moving averages, you can visually see that when the difference is expanding, momentum is accelerating and when the difference is contracting momentum is decelerating.

What Does the MACD Calculate?

The formula that is used to calculate the MACD subtracts the 26-day exponential moving average from the 12-day exponential moving average, which is called the MACD index.  An exponential moving average differs from a standard moving average as it puts more weight on current prices and less weight on differed prices.

The second piece of the MACD is the signal line.  This is calculated by generating a 9-day exponential moving average of the MACD index

During the last 4-decades, analysts and traders have altered the index and signal line to fit their needs.  For example, if you wanted to capture short term momentum, you could change the index to the difference between the 5-day exponential moving average and the 13-day exponential moving average, and alter the signal line to be the 12-day moving average of the index.

Using the MACD

The chart above shows an MACD index as well as signal line, which is in the section below the price of WTI crude oil. Additionally, it shows the MACD histogram which was created nearly a decade after Appel initially introduced the MACD index by Thomas Aspray.  The MACD histogram measures the distance between the MACD Index and the MACD signal line and displays this number on a histogram.  The benefit of seeing this difference on a chart is that you can tell when the histogram is beginning to shift its trajectory.

There are a few ways that you can use the MACD to enhance your trading by evaluating momentum.  The most common way to use the MACD is finding crossover signals.  When the MACD index crosses above the MACD signal line, a buy momentum signal is generated. When the MACD index crosses below the MACD signal line, a sell momentum signal is generated.

In the chart of crude oil, the green arrow shows you an MACD crossover buy signal. It tells you when positive momentum is accelerating and prices are likely to continue to move higher. The red arrow in the chart describes a spot where negative momentum is accelerating and prices are likely to continue to move lower.

Since the histogram is the difference between the signal line and the index, the MACD histogram should move from negative to positive territory when a buy signal is generated (which occurred at the green arrow), and the MACD histogram should move from positive to negative territory when a sell signal is generated (which occurred at the red arrow).

One of the benefits of using the histogram is you can analyze the trajectory of momentum. Prior to the buy and sell signal, the MACD histogram started to show that momentum was accelerating.  In the case of the buy signal, positive momentum was beginning to accelerate and in the case of the sell signal, negative momentum started to accelerate.

Since there are no hard and fast rules on how you should use the MACD histogram in conjunction with the crossover signals, many use the histogram to anticipate a crossover, by analyzing its trajectory.

MACD Divergences

Another way you can measure momentum with the MACD is to determine divergences.  The term describes a scenario where prices and momentum are moving in the opposite direction.  An example can be seen in the same crude oil chart.

In the example above, the price crude oil is moving lower in May shown near the red arrow.  As prices continue to decline below the March lows, momentum begins to decelerate and does not hit a new lower low in tandem with prices.  You can see that the trend of the MACD histogram is moving upward (green arrow). When prices are moving lower, and momentum begins to decelerate, you have a situation where divergence is occurring.  This usually signifies that an asset price is ready to reverse course.

Summary

  • The Moving average convergence divergence (MACD) is a momentum index that is used to determine changes in momentum. The MACD index was introduced in the 1970’s and is calculated by subtracting the 26-day exponential moving average from the 12-day exponential moving average.
  • The MACD signal line is the 9-day exponential moving average of the MACD index.
  • Gerald Appel used exponential moving averages in the MACD calculation to weight current prices more than differed prices when determining current momentum.
  • One of the most popular ways to use the MACD is to evaluate crossover buy and crossover sell signals. When the MACD index crosses above the MACD signal line a buy signal is generated. When the MACD index crosses below the MACD signal line as sell signal is created.
  • In 1986 the MACD histogram was introduced by Thomas Aspray. The histogram reflects the difference between the MACD Index and the MACD signal line and displays this difference in a histogram format.
  • The histogram can be very helpful in confirming and anticipating an MACD crossover buy or sell signal.
  • The MACD crossover buy and sell signals are the most common way the MACD is used. An alternative method of judging momentum is to use the MACD to evaluate divergences. When prices are moving in the opposite direction of momentum, and momentum is decelerating, a reversal in price action is imminent.
Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.5 stars on average, based on 1 rated postsDavid Becker is a New York-based finance writer and capital markets analysis. With more than 25 years of experience in derivatives trading and risk analysis, David runs a consulting business that focuses on investment evaluation and personal finance. David has been published on high profile online and print media. He holds a B.A. in economics.




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2 Comments

2 Comments

  1. tuth

    June 27, 2017 at 5:06 pm

    which indicator works fine with macd? i think psar is a good partner for it. what do you think? and how much do you wait for confirmation? 2 candle is ok?

  2. embersburnbrightly

    June 27, 2017 at 9:26 pm

    Great article, very helpful to me, as someone still learning the ropes. Thank you!

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Trading 101

Trading 101 and Beyond: The Head and Shoulders Pattern and Why You Should Never Ignore it

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The “Head and Shoulders” pattern (H&S henceforth) is perhaps one of the most widely used and misused technical patterns out there. Figure 1 depicts an example of a H&S pattern (tops – white ellipses; neckline – bright blue trendline).

Figure 1. REGN Daily Chart

It is without a doubt the pattern’s name that makes people smirk when they hear market commentators referring to it. After all, why would anyone invest/trade their hard-earned money using a pattern that has the same name as the most popular anti-dandruff shampoo? I am personally never thrilled to discuss the pattern. Imagine advising a portfolio manager, who relies entirely on fundamental analysis, that they should immediately sell one of their favourite names because the stock has broken its “neckline”… Patterns such as the double/triple top seem to be never questioned, whereas the H&S pattern gets ridiculed left, right and center, even though their implications are not that much different.

The former takes into consideration that the same level has served as resistance on more than one occasion (i.e. market participants realize that a security is too “expensive” at a certain price and a horizontal resistance is formed). Double/triple tops have an implied target of the distance between the “resistance” level (marked by the double or triple top) and the interim low (the lowest level within the pattern) projected down from the interim low (see Figure 2; double top – violet horizontal trendline; interim low – bright blue horizontal trendline; target – yellow vertical line).

Figure 2. MRK Daily Chart.

Hypothetically, if the stock had bounced up one more time before moving lower, a H&S would have been observed (tops – white ellipses; neckline – bright blue trendline; target – yellow vertical line in Figure 3). The only difference between the two is the slight change in the implied target, which is simply dictated by the slope of the neckline. That is, had the neckline been flat, the target from the H&S would have been identical to the one obtained from the double top.

Figure 3. MRK Hypothetical Daily Chart

While double/triple tops seem to be understood by most market participants, the H&S pattern is often disregarded. In the next section, I discuss why, on the contrary, the pattern should never be ignored.

The H&S Pattern

A textbook H&S pattern occurs in an uptrend and has three peaks, with the middle one being the highest. The neckline connects the two interim lows (i.e. the lows on each side of the “head”) and is used as the trigger to sell. Similarly, an inverse H&S transpires in a downtrend and has three troughs, with the middle one being the lowest. The neckline connects the interim highs and is used as the trigger to initiate long positions. So what makes this pattern so important? Two things.

Note, at a first glance the two don’t have much to do with the pattern so just bear with me.

  1. Prices tend to trend, and the trend should be considered active until there have been definite signals that a reversal has occurred. Yes, this is one of the six tenets of Dow Theory. A quick glance at S&P 500’s monthly chart reveals that the tenet could very well hold true (Figure 4). With the exception of 2016, the index always appeared to trend for extended periods. That is, the index was either posting higher highs and higher lows (uptrend) or lower highs and lower lows (downtrend) until eventually reversing. So how is this related to the H&S pattern? Let’s recall that a H&S pattern occurs in an uptrend and, by definition, includes one lower high – the right “shoulder”. So unless the neckline has a very steep slope, a break below it, in most cases, would lead to a lower low. A lower high (the right “shoulder”) and a lower low (the subsequent move below the neckline) implies a downtrend. But as the chart depicts, there were a total of only three periods where the index posted lower highs and lower lows (i.e. the dot-com bust, the “Great Recession”, and the sideways move in 2016). Therefore, the H&S pattern should not occur frequently on charts of “trending” securities, similar to that of S&P 500. Of course, unless prices are indeed reversing. We will return to this chart shortly to examine the pattern’s track record.

Figure 4. S&P 500 Monthly Chart

  1. Stock prices are significantly more volatile than their underlying drivers. This proposition has been a topic of discussion for many years, with Robert Schiller pointing out to this phenomenon in his papers “Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends” in 1980 and “The Volatility of Stock Market Prices” 7 years later. He concludes that stock prices deviate significantly more than the expected changes in real dividends. For more details on the subject, you can refer to Shiller’s texts. Market volatility, particularly since the “Great Recession”, is indicative of markets exhibiting bouts of extreme volatility, which cannot be explained by fundamental drivers. The “Flash Crashes” of 2010 and 2015, and the several late-day selloffs during the February and mid-March corrections in 2018 are only some of the examples of such volatility. In the context of H&S patterns, as market volatility exacerbates each move during a trend, a change in trend (i.e. a completed H&S pattern) should be followed by a swift move in the direction of the new trend.

All in all, the combined implication from the above two points is that market participants can profit tremendously by initiating positions at the onset of a new trend (i.e. when a trend reversal occurs) because 1) markets will move in the direction of the new trend for a prolonged period (as markets tend to trend), and 2) each move during the new trend will be of large magnitude (as markets are significantly more volatile than their underlying drivers).

Going back to the monthly S&P 500’s chart, it is evident that nearly all major trends had terminated with a H&S pattern (tops and bottoms – white ellipses; necklines – bright blue trendlines in Figure 5).

Figure 5. S&P 500 Monthly Chart

Of course, the pattern has also given false signals. Zooming in (Figure 6 –S&P 500 weekly chart), two such occasions catch the eye – the 2016 consolidation (already visible on the monthly chart, Figure 5) and earlier in 2010. On both occasions, the index broke below the neckline of a H&S pattern (neckline – yellow trendlines, break below necklines – yellow arrows) but did not subsequently trend in the opposite direction (i.e. a trend reversal did not lead to a prolonged movement in the opposite direction).

Figure 6. S&P 500 Weekly Chart

However, had one gone short upon both signals, they would have had an opportunity to reverse and go back long shortly after. Not surprisingly, it was inverse H&S patterns that gave clues that the topping patterns in Figure 6 are giving false signals (lows – bright blue ellipses; necklines – bright blue trendlines in Figure 7).

Figure 7. S&P 500 Weekly Chart (same period as in Figure 6 – 2009 to May 22, 2018)

Overall, using the pattern would have led to catching practically all major tops and bottoms over the last 20 years, and being whipsawed on two occasions. Not a bad track record given how quickly one could have been able to close and reverse in both 2010 and 2016.

Formation of the Pattern

So how exactly does a H&S pattern form? Imagine a prolonged uptrend where each subsequent rally takes prices to a new high and each subsequent pullback terminates at a higher level. As prices tend to trend (point #1 above), prices are expected to move way past fundamental values before they reverse. Market volatility (point #2) only exacerbates the extent of each move. It is only after prices have reached extreme levels, in relation to their true drivers, that they are unable to make a new high (yellow trendline in Figure 8).

Figure 8. Hypothetical Uptrend with One Lower High 

This is not a reversal as of yet. A reversal of a trend requires not only a lower high but also a lower low. For example, if the subsequent low terminates at a higher level, followed by a new high, the uptrend will be considered intact (Figure 9).

Figure 9. Hypothetical Uptrend Continuation

However, had the subsequent down-move terminated at a lower level, the security would be considered in a downtrend (Figure 10).

Figure 10. Hypothetical Uptrend Reversal

As seen in Figure 5, in most cases, once markets eventually reverse, they start trending in the opposite direction. That is, markets trend higher to reach extreme “expensive” readings before they reverse and trend downwards until they become extremely “cheap”.

Unfortunately, most of the technical analysis literature on the subject describes the pattern with a very stringent set of rules. Those rules, while aiming to make interpretation of the pattern objective, may lead to untimely entry & exit, and ultimately to unprofitable trading.

Traditional & Alternative Interpretations of the H&S Pattern

Traditional Interpretation #1: The H&S pattern is a reversal pattern (i.e. H&S can only point to falling prices and inverse H&S – to rising prices). This is perhaps one of the two greatest myths about the pattern. Most traditional texts discuss the action of prices breaking through the “head” of the pattern as simply one of the three ways to negate the pattern’s original reversal signal (the other two being -1) breaking back above the neckline, and 2) breaking above the right shoulder). This completely ignores the fact that a “failed” H&S pattern may often give a continuation signal that is more potent than a reversal signal generated by a “completed” H&S pattern. Given that markets trend for extended periods, there are various examples of “failed” H&S patterns pointing to a continuation of the ongoing trend before the eventual reversal takes place. Let’s look at a few examples. First, Figure 11 depicts Aphria’s (APH.TO) price action since mid- 2016. The stock formed a “tentative” H&S pattern from November 2016 to August 2017 (tops – white ellipses, neckline – green trendline). APH never broke below the neckline, and instead broke through the head in late 2017, giving one of its most potent buy signals, with the stock tripling over the next few months.

Figure 11. APH.TO Daily Chart

More recently, a client of mine requested a technical overview of New Flyer Industries (NFI.TO). Over the last 3 years, the stock had formed several tentative H&S patterns (tops – white ellipses; necklines – green trendlines in Figure 12). Similar to Aphria, the necklines were never broken, and the subsequent breaks above the “heads” of the pattern resulted in major buy signals.

Figure 12. NFI.TO 2-Day Chart

Going back to the S&P 500’s weekly chart, the index formed a tentative H&S pattern in 2012 (tops – white ellipses, neckline – green trendline in Figure 13), but instead of breaking the neckline, it broke the head and continued its advance.

Figure 13. S&P 500 Weekly Chart

Credit for this alternative interpretation goes to Fregal Walsh, who had published a paper on the subject in the 2015 IFTA Annual Journal.

Traditional Interpretation #2:  The first counter move after the pattern is completed should terminate at the neckline. In other words, after the break of the neckline and the initial move in the opposite direction of the prior trend, prices are expected to reverse and halt at the neckline before reversing again in the direction of the breakout (first counter move after pattern completion terminates at the neckline – yellow trendline in Figure 14).

Figure 14. Traditional Theory for First Counter-move after a H&S Completion

While this certainly is the case for most broken trendlines (i.e. support turns into resistance and vice versa), this is yet another stringent guideline in the context of the H&S pattern , which can certainly lead to missed opportunities. On one hand, prices may never retrace back to the neckline, meaning one may never enter in the direction of the breakout if they were to wait for a retest. On the other hand, prices would often not only retrace back to the neckline, but would also move back above/below it before eventually reversing in the direction of the breakout. Using the same monthly chart of S&P 500, it is evident that out of the 5 major H&S patterns, on 4 occasions (patterns 1, 2, 3 & 4 in Figure 15), the index never retested the neckline after breaking it. Notice that this was the case irrespective of the direction or the slope of the neckline.

Figure 15. S&P 500 Monthly Chart

In the last inverse H&S pattern (#5), the index reached the neckline but before bouncing higher it broke below it (Figure 16).

Figure 16. S&P 500 2-day Chart

I am certainly not implying that subsequent retests of the neckline are insignificant. Often enough, if the specific technical backdrop of a security warrants it, I use the neckline as either a potential entry or a negation level. Rather, I am suggesting that if one is certain of a trend reversal, they should not religiously wait for a retest of the neckline. Also, sometimes, the neckline could be broken back (i.e. the security moves back within the pattern) but this not necessarily mean that one should close all positions. Figure 17 shows one of many such examples, where a stock (ATD.B.TO) moved back above the neckline of the H&S pattern (green trendline) for a week before plummeting over the next few months.

Figure 17. ATD.B.TO Daily Chart

Entry

Traditional technical analysis theory suggests that one should wait for the neckline to be broken before initiating a trade. To a large degree, entering upon a close below/above the neckline is a reasonable entry strategy. After all, as we saw in Figures 11, 12 & 13, the pattern could very well be consolidating before breaking the “head” of the pattern and continuing its prior trend. In that case, a premature entry in the expectation that the neckline will be broken will result in an unprofitable trade. Thus, on a systematic basis (and without considering any other technical developments), waiting for a close beyond the neckline is advised (H&S tops – white ellipses;  neckline – blue trendline; target – vertical blue line; entry – blue arrow in Figure 18).

Figure 18. WMT Daily Chart

Unfortunately, this entry often leads to trades with a very unfavourable risk-reward profile, as by the time the neckline is broken on a closing basis the stock may have already moved significantly away from the top of the pattern (i.e. from the negation level which determines the risk of the trade). One way to tackle this is to wait for a corrective move in the opposite direction of the breakout before initiating a trade. This scenario was already covered in the previous section, where it was shown that the first corrective move after the break of the neckline may terminate 1) prior to retesting the neckline, 2) at the neckline, or 3) beyond the neckline (yellow lines in Figure 19 indicating possible scenarios for the first counter-move after the neckline is broken; eventual move in the direction of the breakdown – red line).

Figure 19. Possible Scenarios for First Counter-move after a H&S Completion

Having done extensive work on “price gaps”, I had found that if a gap transpires during the formation of the head or the right shoulder, or upon breaking out of the pattern (i.e. breaking the neckline), a probable scenario is that price will pull back to pre-gap levels, giving a K-Divergence signal. See my primer on gaps for more details on how to trade the gap phenomenon and my “K-Divergence” paper in the 2018 IFTA Annual Journal for details on the specific H&S trading application.

Exit

Naturally, one exit strategy is to close positions once the pattern reaches its implied target (i.e. the distance from the head to the neckline projected from the neckline break – see Figures 3 & 18 for examples). It is noteworthy that the suggested target is considered to be a “minimum” projection from the point of pattern completion. Simply looking at S&P 500’s monthly chart, it is evident that the minimum target was exceeded on every occasion (target – purple vertical lines in Figure 20).

Figure 20. S&P 500 Monthly Chart

Not surprisingly, as index’s constituents are more volatile than the index itself, they form the pattern much more frequently. When it comes to individual stocks, the minimum target can be used to close at least half of the position. WMT’s chart (Figure 18 above) shows just that – an S&P 500 constituent completing a H&S pattern (and meeting its minimum downside target in May) without the index completing a topping pattern during the same period.

Conclusion 

Hopefully, the above discussion has at the very least made you just a little bit less skeptical about the infamous Head and Shoulders pattern. If you have any questions or if you would like to see a more thorough description/explanation for any of the sections in this article, feel free to do so in the comment section below.

Featured image courtesy of Shutterstock.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.5 stars on average, based on 14 rated postsPublished author of technical research. In his work on price “gaps”, published in the 2018 International Federation of Technical Analysts’ Annual Journal, he developed a new technical tool for analyzing and trading the “gap” phenomenon – the “K-Divergence” (http://ifta.org/public/files/journal/d_ifta_journal_18). Besides obtaining a Master in Financial Technical Analysis, he has completed a BBA and an MBA from the Schulich School of Business in Toronto and has completed all exams for the CFA, CMT and CFTe designations. Currently, providing research to investment management and financial advisory firms. http://www.linkedin.com/in/konstantindimov




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Trading 101

Managing the Safety of Your Cryptocurrency

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The fact that Coinbase and other companies have made it possible for nearly anyone to invest in cryptocurrencies is almost unilaterally a good thing, but it has led to many people buying cryptocurrencies without understanding the ecosystem. Bitcoin and other cryptocurrencies are only seen as risky investments because of their future worth, when there is also the risk of theft in the present.

Many investors focus their time on the idea of maximizing the returns on their investments, but protection against downside is equally important. We’ve all heard the oft-cited thought experiment where when you lose 50% of your investment, you now need 100% returns to get back to even. Avoiding negative returns is an equal priority to achieving high ones.

There are some steps a newbie cryptocurrency investor can take to make sure they are as protected as they can be. From wallets to basic security and diversification, the points below are a few quick changes you can make that will maximize your security.

The Basics

The two most basic steps are not keeping your money in an exchange wallet, and using a 2-factor authentication application. Many people new to the ecosystem will go with the path of least resistance, and that results in only having a password protecting their assets.

Exchanges are considered to be secure, but there have been many breaches in the past, so it is not impossible your funds could be compromised in the future. In the case of a hack, hopefully your exchange would cover you, but the best thing you can do is move your funds into an offline wallet (e.g. desktop, mobile, or hardware). By splitting your money off from the giant “honeypot” that exchanges serve as, the incentive for hackers is greatly reduced.

Additionally, by enabling 2-factor authentication and using an application, you mitigate for the risk that your password or phone number are compromised. This may sound crazy, but it is possible for a SIM card to get hijacked and a hacker to use your phone number to gain access to your funds. Authly and Google Authenticator make it possible to prevent that from happening.

Wallet Management

Once you have made sure your money is on a wallet, there are still risks you need to understand. At this point, the biggest risk is that you might forget the passcode or PIN to your wallet. Or you could lose the device with the private keys on it. Both of these situations can be handled easily by taking careful note of your memetic passcode and backing up your wallets onto a second device.

It might help to back up a bit for a second. Your private key is what verifies your ownership of a public key, which can be thought of as being similar to a bank account. When you moved your coins into an offline wallet, you “took ownership” of your private keys. This is an essential part of forming a decentralized network, because if you hadn’t done that, all the keys would still be managed by a centralized source. Another way to look at it as if you are making sure no one else knows your ATM code.

Something fewer people in the ecosystem realize is they are not assigned a single set of keys, but actually many pairs. These pairs of keys are generated from a “seed root”, which is a 16 word sequence of seemingly random words (see this list for more about this). By having this seed root, you are can prove you are the rightful owner of the cryptocurrency in question. It is considered to be the password of passwords, and should be guarded as such.

Knowing all of this, the best way for you to carry on with your security is to write down your 16-word seed root, file it away in a separate area from your wallet, and then back up the data onto an offline hard drive that can be recovered in the case of emergency. All of this may sound like a paranoid hassle now, but the small time investment will make the difference.

Protect Your Crypto

By learning to manage your money well, you will be able to increase the protection of your cryptocurrency. The final thing you should consider is spreading out your funds between several different wallets. There is always the risk that a company gets compromised, and by diversifying where you hold your securities, you can reduce the effect this may have.

Featured image courtesy of Shutterstock.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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Trading 101

Trading 101: Managing Trading Emotions And The Fear of Missing Out (FOMO)

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Fear of missing out

At any given moment of the day, there are thousands of markets waiting for you. All those charts are moving 24 hours a day, 5 days a week, and every tick means that you could make money.

Dealing with missed trades can be a major challenge for traders. Thinking of all of the money that never made its way to your trading account is tough, and it often leads traders to make some of the worst mistakes in the market.

Things FOMO traders say…

“I knew it!” – This usually comes from a trader who were following his planned set-up but ended up not taking the trade

“I could have made so much money today.” – Everyone would be a millionaire in hindsight.

“I waited so long for this trade.” – A trader with a trigger-happy finger who is stalking a market as it is setting up for a good trade.

“It still has room to go…” – A trader who gets in late after first being too scared to enter.

“I have a feeling…” – A trader who is not following a plan with strict rules and criteria for entry.

“I’ll just enter with a small position.” – A trader who is justifying breaking his rules.

Reasons for FOMO trading

The problem with trading is that it can often be perceived as an activity with no clear beginning or end. Basically, a trader is always in the middle of his game – a game that never stops. And when there is no beginning or end to it, you could – in theory – always enter a new trade that has the potential to make you money.

We could for example compare this to gambling at a casino. When people sit down to play blackjack, everyone understands when the game begins and when it ends. After the game is over, you can’t change anything anymore. You have either lost or you have won.

In trading, however, the game never really ends. Even after you have closed a trade, you can always get back in. Every tick in the market is a potential opportunity for you to make more profit. When we are thinking like this, missing a trade feels like leaving money on the table!

Entering early in fear of missing out

This is one of the most common situations among FOMO traders. They see a set-up falling into place in front of them, and then decide to enter their order early since the price is already moving with such strong momentum. They get worried that the price will continue to surge without them.

The problem with this is that you enter your order before the set-up satisfies all your trading rules, meaning your risk management and your planned risk:reward ratio will be completely off. What often happens later is that the price turns before it reaches your planned entry point, and you end up sitting in a losing trade that never even met your entry criteria in the first place.

Price moved too fast and you missed your entry

It happens that you have a near-perfect set-up with only one minor criteria on your trading plan not being satisfied. You then see price move strongly in the direction that you expected, while you are still sitting on the sidelines.

This is obviously painful, and it is exactly in situations like this that traders tend to commit FOMO trading like chasing the price or enter their next trade too early as in the previous example.

Instead, be patient and move when the time is right

This is the correct way to approach trading and the only way to fight FOMO. In order to do this successfully, you must have a trading plan and a checklist with all your entry criteria written down. Many active traders like to have this physically printed out on a piece of paper so that they always see it before entering a new trade.

When you have your trading rules written down, experience shows that violating them becomes much more difficult, and you will end up as a much happier and more successful trader!

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Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.3 stars on average, based on 34 rated postsFredrik Vold is an entrepreneur, financial writer, and technical analysis enthusiast. He has been working and traveling in Asia for several years, and is currently based out of Beijing, China. He closely follows stocks, forex and cryptocurrencies, and is always looking for the next great alternative investment opportunity.




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