People who invest in the stock market often make a series of mistakes that are emotional and irrational.
The shorter the time frame the more emotional stock market investing can be, so for instance, a day trader is far more likely to get confused and make mistakes, than a swing trader or long term investor.
It’s the notion that ‘I am running out of time and I have to act to limit my losses’. Every emotion is triggered on the individual by price action, sudden, volatile price moves and news releases and breaches of support and resistance.
Here are some common myths that play a part in investor psychology when stock market trading…
Never Allow A Profit To Turn Into A Loss – Myth
All positions start out as losing positions, believing this rule is a sign that you are an emotional trader who cannot stand to see an open losing position.
Have A Strict Trading Plan And Be Disciplined – Myth
Money management rules should apply, but you should trade the markets and not money. Instead of having a fixed stop loss size you should pay attention to resistance and support levels, one day you need to risk $100, and on another you need to risk $500 on these stop loss orders.
If you are too disciplined, you will self sabotage yourself as the markets will often make confusing moves that will go against your strict rules. Instead you should identify the uniqueness of each trading day, and the unique support resistance levels that apply to it.
Place Your Stop Below Yesterday’s Low – Myth
Floor traders intentionally drive the market lower to shake out these stops, once shaken out, the market skyrockets! And of course it applies to both sides of the market. So you should never watch yesterday’s high and low as potential levels to place your stops, you must place them further out!
The above apply more to day traders and swing traders, but even longer term investors who buy CFDs and stocks on margin, need to know where to place their stops and not be panicked when important levels are breached.
A breach of resistance or support may set off panic on that day, but you have to bear in mind that one trading day alone, cannot change the overall trend by any means! You have to pay attention to the stock’s daily and weekly chart, look out for divergence patterns on the indicators and check with the direction of the overall market.
Valid breaches of support and resistance require that the market or stock in question settles on the other side of this support / resistance line for at least 2 days. Also you have to look what other stocks in the same sector are doing, if your long stock has breached a support level (i.e. the 200 day moving average) but the majority of the sector’s stocks still look strong, then there’s a good chance that the breach will be a false one. As you can see it gets very complicated, and a simple disciplined trading system that sees things as ‘black and white’ will simply require selling this stock, without doing further research.
Consider the stock chart below, the weekly chart shows a bearish trend below the weekly 200 day average, and this daily chart shows a brief breach of the daily 200 day average. You would almost qualify it as a buy signal, as the stock did spend 2 days above the average. The stock however failed to make a higher high on the second day of the breach, and this should get you concerned, it later drops back down below the average and the CCI also confirms it:
You cannot develop exact, strict trading rules to invest in these stocks or any stocks. The best thing you can do as an investor or trader, is to have a more flexible approach, one that allows you to bend your own rules and use an element of personal judgement! You need to check how the whole sector is doing as well as the whole stock market.
Stock Market Investing Strategies and Stock Market Speculation by..
Scott Smith
Investing The Stock Market © 2008 – 2010
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