The stock dips to $50 where you have a buy order waiting. You then confirm that you bought the stock. A few hours later, you notice that the stock has not yet begun to rebound. It is still lingering at $50. You also note that its trading volume has increased. You conclude that the increased volume is normal because new buyers are entering the market and they will eventually force the stock to higher levels. However, after two more hours you observe that the stock is selling for $49.50. What do you do? Do you hold because you know there is a lot of buying demand at about $50 and figure that the buyers will eventually win in this tug of war just as they have every other time?
The fact is that the stock has never behaved that way before. It has never dropped below that line of support. That means the stock has just invalidated your reason for buying. It is not following the same pattern it followed before. Holding on to the same reasoning you had before your purchase is evidence of mental rigidity. Instead, you should be considering the fact that your premise was wrong, that you made a mistake, or at least that there is new information that does not fit your previous conclusions.
The flexible trader will perhaps conclude in a flash of insight that each time the stock declined to $50 a number of potential buyers became owners. Perhaps after five times, all the potential buyers at that price have committed themselves and there are few remaining potential buyers left to counter the selling pressure. In fact, some of those new owners have now become sellers.
Not long ago, one of our stockdisciplines.com traders was playing with a very young cat. He had a small piece of paper on a string and he was making the cat leap into the air to chase the paper. While the cat was still in the air, the trader jerked the cat's target so that it changed direction in mid-flight. The cat twisted while it was in mid-flight in order to catch the piece of paper. No matter how he changed the direction of the paper, the cat responded. Traders need the mental flexibility of that cat. The cat's mind was constantly adapting to whatever the paper did. As either a trader or investor, when new data is evident that does not fit the previous pattern, you must be flexible enough to adjust.
The market is like a river with lots of little eddy currents and mini-whirlpools. Parts of the river are moving one way while other parts are moving another way. The water is constantly and simultaneously churning, swirling, flowing, and changing. The trader's mind must be flexible enough to adapt to a world in which nothing is fixed. Accordingly, the trader's mind, notions, and perceptions must be open to re-evaluation. The trader must learn to recognize the truth of something that is very hard to accept emotionally. If he has a losing streak, he must learn to recognize and admit that he is out of sync with the market and perhaps take a break. If the trend of his equity is down, it is time for him to re-evaluate what he is doing. Flexibility is one of the habits of mind that characterize an expert trader or investor.
Dr. Winton Felt maintains a variety of free tutorials, stock alerts, and scanner results at www.stockdisciplines.com has a market review page at www.stockdisciplines.com/market-review has information and illustrations pertaining to pre-surge "setups" at www.stockdisciplines.com/stock-alerts and information and videos about volatility-adjusted stop losses at www.stockdisciplines.com/stop-losses