There are lots of differences between successful and unsuccessful traders. One of those differences is anticipating where the price will be so you can make a plan, as opposed to what many want-to-be-traders do, which is come up with an idea and then expect the price to do what they want.
If you anticipate where the price is going to be before you trade, you are going to put yourself in a much better position to make high reward:risk trades.
Anticipate, Don’t Try to Impose Expectations
The highest NHL scorer of all time, Wayne Gretzky, said “A good hockey player plays where the puck is. A great hockey player plays where the puck is going to be.”
How does this relate to trading? Let me give you an example. A newer trader recently sent me an email and said “Hey, company blah-blah-blah is doing some really cool and cutting edge stuff. I think they will be a leader in this field and therefore their stock is going to go up. It’s a no-brainer. I am going to buy some, what do you think?” This person has decided to do something (buy) and is now expecting the stock to go up. They are also expecting others to agree with their assessment, which will push the price up.
First, let’s deal with a couple of problems. My friend has no plan for this trade. They assume they are right and that it is easy money. But what if everyone else already knows this could be a great company, and thus the price is sky high already? In this case, the stock may already be priced based on everything working out perfectly, so the stock could plummet on even the slightest hiccup. Also, this new trader likely has no concept of what to do if the stock does drop.
They think they are right and haven’t even considered the possibility that the price could go down instead of up; they likely aren’t using a stop loss to help control risk. They probably haven’t done any sort of analysis to determine whether the stock is fairly priced (compared to the earnings, or potential earnings) nor have they likely looked at a chart to see if now is a good time buy based on recent price action. And this brings us to the point of this article…anticipating where the price is going to before you make a play.
Anticipating Instead of Expecting
My advice to the newer trader is to look at lots of charts. What they will see is that every stock is constantly moving both up and down. It may have an overall upward (or downward) direction but it never just moves relentlessly in one direction for long. Based on this very simple premise we can anticipate that after a rally the price will fall back or retrace a portion of that up move. We can anticipate that the price will stay in a range until it breaks out. We can anticipate that a trend will continue until it doesn’t. Most people struggle with this. They fear they will miss a move so they buy a stock after they see it has been moving up for a while, or they think it will break out of a range and so they buy it. But by anticipating where the price will be, we can make much better trade.
By simply looking at a chart, and how the price moves over time, we can make a basic assessment of where that price is likely to be in the future. We can then decide where we want to place a trade based on that assessment. We want to pick the spot that gives the best opportunity for upside with limited downside. We can then place a target based on our assessment, and a stop loss in case it doesn’t work out.
After the price has run-up, we can look to buy on a retracement, instead of buying on the way up and then having to hold through a retracement which may shake our confidence causing us to dump at an inopportune time. If the price is in a range or triangle pattern we can buy near support—the bottom of the triangle—if the price is in a longer-term uptrend, or we could sell/short near the top of a range or triangle if the price is in a longer-term downtrend. I call this strategy front running. We are anticipating where the price will eventually be, which also happens to be an ideal spot for a trade. To be successful, we need to wait for the price to arrive at ideal spots. This means being patient and anticipating that the price will get there. If it doesn’t, we don’t trade.
Remember, that most people get themselves hyped up before a trade, like that new trader, expecting the price will move up as soon as they buy it. When it doesn’t work out that way, they may panic and dump it at a loss, or far worse they may hold onto it hoping that it turns around when it may not. We need a plan for every trade: how and when we will take a profit and how and when we take a loss.
One of my stock trading strategies looks for long-term uptrends, where the price is currently consolidating near prior highs. The price then needs to break above the consolidation, signaling that the price is continuing its advance. This is a very simplified version of the strategy, for a broader discussion see the CANSLIM Trading Strategy.
So if a stock is strong and trending higher, I may use another strategy to enter it, but otherwise, I wait…knowing that eventually, it will form this pattern providing me with an opportunity to get in.
MSCI (MSCI) consolidated near a prior higher, on two occasions, and then broke to the upside. The trades provided small risk because with this pattern I place my stop loss below the consolidation. Based on prior moves, 15% to 20% upside was/is anticipated from the breakout point. Both trades provided about a 5:1 reward:risk (second trade still underway). A trailing stop loss could also be used instead of a target.
This brings up another point. I look for this PATTERN in any stock. I care about the pattern, not the stock. I anticipate that the pattern will appear in many stocks, thus providing a steady stream of high-quality trade setups. I don’t expect it to occur in any single stock! New traders often get married to individual stocks; pros look for repeating patterns and are willing to trade anything providing that high-quality trade setup.
Before each trade, ask yourself:
“Am I just expecting this to do what I want?” The answer should be NO! We place trades only at good technical locations.
“Has the price arrived at a good technical location for a trade, providing favorable upside for limited downside based on my assessment of the chart?” The answer should be YES!
Anticipate where goods spots for a trade will be, and then wait for the price to go there. Don’t just buy at random spots and expect the price to move in your favor; this is a recipe for an empty trading account. Once you know where good spots are, look for those opportunities in many stocks, not just one.
By Cory Mitchell, CMT, join me on Twitter @corymitc.
Disclaimer: Nothing in this article is personal investment advice, or advice to buy or sell anything. Trading is risky and can result in substantial losses, or even more than you deposited if using leverage.