Absent a systematic and responsible plan, our emotions will run things. When shit hits the fan, we’ll be too scared to get in. When we hear some suited up analyst on television talking positively about the stock we own, we’ll be too hopeful to get out when the trend turns.
Systematic trend-following can help us avoid emotional biases that attend optimism and pessimism. An optimist may hold onto a losing position for too long, while a pessimist may exit a winning position too early or not get in at all. To succeed in this game, we have to stay alive and continuously take responsible risks.
Investors who have lived through a painful bear market tend to get gun-shy. They do all they can to avoid feeling the pain again. They say the markets are rigged and curse Wall Street as crooks. This isn’t going to help them win. They need to get back in the game, but in a responsible way.
I learned a lot about the human condition during the Financial Crisis of 2008. When equity prices found their footing and began going up again during the middle of 2009, many people didn’t dare buy stocks again. The pain of the Crisis was too fresh and paralyzing.
“Buy stocks again!? We’re in the midst of a financial crisis. The market was making new lows just a few months ago!”
“I think the recent rally is overdone. We’re still in a bear market. I’m going to wait for a retracement then maybe I’ll get back in.”
The chart says it all. The blue circle indicates when the S&P 500 index made a new 52-week high. A sample size of one, sure, but this happens over and over again. How many people do you know that got back in in 2009? How many waited for years before doing so? Trend-Following takes action when it’s advantageous and responsible to do so.
Situations like this is where a system comes in handy. Even when emotions run high, you know what to do — either get back in, cut the loss or hold on. The rules run the ship, not your emotions. Feeling scared? Too bad. The trend is turning up again so we’re getting back in. The stock you hold is a really good company? Tough shit. The price is declining, so we’re getting out.
Rules. Rules. Rules. This is the way.
4 thoughts on “Trend-Following Balances Optimism and Pessimism”
Yes, we have to take most of our biases out of our decision making.
But Daniel Kahneman says in Thinking, Fast & Slow, that even he, a Nobel Prize winning behavioral economist, can’t take his biases out of his analysis of research and other data. We’re all emotional and have to reckon with that when we make decisions about trades and other things.
Historical data and technicals don’t predict markets. They just give you a feel for possibilities.
There is no doubt that the SPY daily chart is mostly bullish. But it’s also flashing over bought warnings. StockChartsTechnicalRating (SCTR) is a barely bullish 44.5. At 60 or above, we would feel a lot more bullish. RSI is an over bought 70.2.
So far this year, SPY hasn’t stayed over bought for more than a couple of weeks or so. Support is at about $393. Resistance is at about $408, I think.
SPY Feb. 17 expiration $408 call options have a 49% probability of being called with the stock over $408. The options have about a 53% probability of closing out of the money, under $408.
I think we’re in a bear market rally and that the Fed will hike 1/2 point next week. While I’m bearish, I’m doing bullish puts trades assuming prices will fall and I’ll get stocks at discounts. Just sold LMT 2.17.23 $445 strike puts. I recently had LMT put to me at $360 and sold covered calls that will expire today. It’s close to be called, if it isn’t, I’ll sell calls again, which would be a hedge as well as an income trade.
This is the way! ✊🏽👍
Would love to see the systems and rules you follow.
No rule is 100% accurate, but we’re all playing odds and find the system with the most reliable signals.
Hey I do not disclose details about my trading system.