Avoiding the Whipsaw Trap

November 7th, 2012
in contributors, syndication

Written by , Zentrader

To give you an idea of what a challenging market we've had, starting mid-September, I had conflicting long-term and short-term timing signals.  Then October 19th all of my timing signal time frames went bearish.  As of that time it's not prudent to open new longs - the market's bias is down and you are swimming against the current.  You should use any strength to unload any longs (which I did last Thursday).  I currently only have a short in EWC, which I opened on Thursday.

Follow up:

I should have sent an email out when my major trend changed, but what I was waiting for was a bounce to initiate a fresh short position on whichever ETF I wanted at the time.  These timing points are generally by an arrow on the charts. In the past this has avoided whipsaws because if you get short the moment the signal switches it would often result in a bad trade. I've gone and wiped the slate clean for now and I'm going to try representing the data a little differently to see if this helps traders create a better trading plan.

The green box represents when the major trend aspect of my timing signal switched bullish and the red when it went bearish. Right now we haven't had a decent opportunity to get short but we still have time. I see two scenarios playing out over the next couple of weeks.

1. (20% chance of happening) We rally back to 3075-3100 which would be the bottom trendline of the previous uptrend and the upper trendline of the newly formed bearish downtrend. Maybe whichever president is elected it triggers a relief rally and this takes us to those levels.

2. (80% chance of happening) We break below last weeks levels and continue down while eventually capitulating and forming a decent trading bottom. If this happens then I'll likely sit out of shorting this downtrend and continue to build my watchlist of stocks that have responded well to recent earnings.

Those are the two things I'm watching for because elections week can be very volatile, so it's best to be very liquid right now and let the speculators duke it out. Preserving your mental capital is very important - remember our actions are largely a product of our last 3 trades. If we have 3 really great trades then we start to feel invincible and 3 poor trades can make us question our trading plan. Both of these can work against traders so it's important to have faith in your plan, trade light, and use a stop, whether it's a hard or mental one.

About the Author

Jeff Pierce is a momentum trader who specializes in market timing. He offers a twitter based trading service where he helps traders develop a focus list of stocks that have responded well to recent earnings and are likely to outperform based on a very specific technical pattern.  His blog is Zentrader.

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