Most traders rely upon strategies first and stock chart analysis second. While strategies are an integral part of retail trading, and a good trading system is important, merely relying upon a strategy when trading stocks will result in inconsistent and often mediocre results.
Below is a chart with Bollinger Bands with arrows showing the exit for the standard Bollinger Band strategy using the upper band as an exit point when price moves out of the top band. This is a very popular strategy for many short term traders who use Bollinger Bands.
Chart 1
All retail traders are trading to either augment their regular job, as extra income in their retirement or as a full time career.
While strategies are important, a strategy is not where you should begin your stock selection.
Fact: every strategy was designed for a specific Market Condition and works ideally in that market condition.
Have you ever learned a new strategy and it worked really well for the first few months, then all of a sudden it stopped working and you had a series of losses? Ever wonder why that happens? Why would a strategy stop working all of a sudden?
Strategies stop working because the Market Conditions have changed and a strategy is designed to work in a specific type of market, where price is behaving a certain way. If price starts to move differently, the strategy will stop working.
Example: You are using Bollinger Bands compression patterns for entries. The market condition is a platform building, and your strategy works extremely well. But all of a sudden, stocks start running with velocity and price extends far beyond the Bollinger Bands. Your strategy is to exit whenever the price moves slightly beyond the bands. So you exit only to see the stock climb upward many more points in an accelerating velocity move.
Below is a prime example of this strategy for Bollinger Bands causing you to exit just before the stock surges in a velocity move over 10 points gain in one day. As a swing or momentum trader, you can't afford to miss these huge gains. The problem is NOT your trading but the strategy you are using or HOW you are using that strategy.
Chart 2As you can see the Bollinger Bands exit strategy works during a moderately trending or platform market but fails dismally when the market condition shifts to a velocity market. Then instead of making a nice profit of 10-15 points quickly you are out of the stock with a small point or two gain or possibly even a small loss.
You end up very frustrated because you have followed your strategy rules carefully and the rules of Bollinger Bands that when price moves beyond the bands, it is time to sell. The problem is that the strategy for exiting when price exceeds the Bollinger Bands is for a sideways platforming market. This kind of strategy fails during fast moving velocity markets that accelerate quickly and price moves faster and faster as volume and energy builds.
What happened is the Market Conditions changed and your sideways Bollinger Bands strategy stopped working.
Market Conditions change more often in our automated marketplace than they did even 5 years ago. The pace of trading is faster, and the trend can move further than the Bollinger Bands strategy allows for due to the wider range of market participants.
To really succeed with any strategy you need to ask yourself some basic questions:
1. Is the strategy correct for the current Market Condition?
2. What Market Condition was the strategy designed to be used in?
3. Is the strategy appropriate for your trading style and parameters?
4. What Market Conditions will cause the strategy to fail or underperform?
By asking these questions before you use a strategy you will be able to determine if this is the right time and market to use that strategy.
Most full-time traders need a group of strategies that they can choose based on market conditions to optimize their trading profits.
Market Condition will tell you:
1. What trading style will work best.
2. What entry signals you should use.
3. The risk of trading and what risk you should take.
4. The exit signals you should use.
5. What indicators you should use and their settings and periods.
6. How and when to enter the trade.
7. How long the run or trend is likely to last.
8. How support or resistance levels will behave against price action.
9. Where to place your stop losses and trailing profit stops.
10. What strategies you should use.
As you can see, a strategy is just part of trading. When you use a strategy appropriately you will be happier with the strategy and your results.
Trade wisely,
Martha Stokes, C.M.T.
Member of Market Technicians Association
Master Rated Technical Analyst: Decisions Unlimited, Inc.
Instructor and Developer of TechniTrader® Stock Market Courses
http://technitrader.com
MetaStock Partner
©2011 Decisions Unlimited, Inc.
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