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Have you ever felt like you need to rush and really get into the moves in the market quickly so you don’t miss out? I’m here in Yosemite National Park today and this morning we got up ultra early and we rushed into the park because we’re in a big RV, it’s 30-foot long, there’s very little parking down on the floor of the national park, and we had to make sure that we rushed in early before the crowds, so that we could get parking and enjoy our day in the park. And I know that a lot of traders feel this way when there’s a trend. When something really starts moving, there’s this temptation, this urge to get in quickly, to get in early, so you don’t miss the move, so you don’t miss the trend. And sometimes that is valid and helpful, and sometimes it’s really not. Sorry, there’s a little bit of river noise in the background, so I hope you can still hear me.
Because what happens is, when a lot of traders are watching a particular stock or a particular instrument and it starts moving, it starts moving up, people want to try and pile in. And what I’ve noticed over the years with all of my backtesting and systems that I’ve tested and looked at, and even with the traders that I’ve coached, a lot of people try to get into new trends very early so that you don’t miss out in profit. Have you ever done that? One of the challenges is there’s a trade-off here in trading, and I like to say to my mentoring students that everything in trading is a trade-off, right? And the trade off with trend trading… Hey, there’s Quinn in the background. He’s wandering around waiting for me to finish my video.
The trade-off with trend trading is that the earlier you get into the trend, the more of that trend you can catch. But, and it’s a big but, more of the moves that you get into will be false. That means they won’t actually go anywhere. They won’t turn into major trends. And so, the opposite approach is to wait for more confirmation, to wait to see that the trend is actually moving before you get in. And the trade-off there is you catch less of the move, but you’re more certain that it’s a big solid trend. And so, in your backtesting, if you’re finding that you’re getting a lot of false moves or your system is not generating the sort of returns that you want, one of the things that you can try if you’re trend trading is making your entry criteria a little more strict.
So, if you were using a breakout entry like a 20-day or a 40-day or a 50-day breakout for your entry, that’s really early in the context of a major trend in the stock market. And so, maybe what you could do is try a 100-day, 200-day, 300-day breakout. Even an all-time high, like a highest high ever breakout, can actually work really well in certain circumstances. So, by adjusting where you sit in that trade-off between getting in early and catching more of the trend versus getting in late and catching less of the trend, getting in late is psychologically a little harder because there’s more concern, more worry that you’re going to miss out. There’s also more concern that the trend is going to be finished before you get in, you’re going to miss the bulk of the move. But that psychological difficulty is what actually gives you the profit. Now, if you’ve seen some of my videos before, I’ve talked a lot about how in trading we get paid to do the psychologically hard things, the things that others won’t do, and one of those things is waiting for confirmation in a new trend.
So, when I look at my entries and exits of trades I’ve taken in the past, even my best trades included, a lot of them wait for a fair while before getting in. My trend filters, my trend criteria are really, really strict. And my entries, I use a very longterm breakout for my trend trading system. So, consider that when you’re trying to improve your longterm trading systems, and if you’re feeling like you’re trying to get in early so you don’t miss out on too much of the move.
Now, that’s trend trading but it doesn’t actually apply in the same way for other sorts of trading. Now, think about mean reversion trading. In mean reversion trading, it’s quite different because when you get the signal, you’ve got to take that as soon as you possibly can. With mean reversion, what you’re doing is you’re capitalizing on market panic. Now, market panic, for instance, in a bull market, some bad news comes out or something happens, a president tweets something, and the market broadly or the market for that stock panics and the price dips. Now, in a bull market, those dips are almost always very short-lived, and so that’s a situation where you do need to rush into the market. In mean reversion, you don’t want to wait for confirmation before taking your trade. So, if you’re trying to develop a mean reversion system and you want to improve the profitability, the key there is actually the opposite to trend trading. You want to try and find a way to get in more quickly.
Now, what’s interesting again, is we’re going to get paid here for the psychological difficulty of the situation, because getting in early in mean reversion means getting in in the middle of the panic. And, again, that’s psychologically really hard, pardon me, because you want to buy when everyone else is selling, when the bad news is coming out, when other traders are panicking. And you buy then, earlier in the dip, because if you wait for any sort of confirmation in mean reversion, the move is pretty much going to be over before you get in, the reversion back to the mean. And so, you’re going to miss out on the profit potential of that trade.
So, again, this recurring theme comes up that as traders, we get paid to do the psychologically difficult thing. So, in trend trading it means waiting for more confirmation, not having as many false breakouts because we’re waiting for a longer term entry signal. And in mean reversion, it means getting in more quickly in the middle of the panic, when everyone else is doing the opposite. Mean reversion is much more like trying to get a park in a parking space in Yosemite National Park, you’ve got to get in really early. But trend trading, totally the opposite. You want to wait and see that the trend is continuing and see that the trend is solid and stable before you get in.
So, I hope that helps. My name’s Adrian Reid. This is Enlightened Stock Trading, and if you need to improve your systems, then have a think about how and where you could do the psychologically difficult thing. And if you test that, you’ll probably find that the profitability of your systems and the reliability of your signals improves dramatically. So, if you want to learn more about how to improve your trading systems, how to build rock solid confidence in your trading systems so that you can follow them day after day and make money consistently, click the link below and download my Trading System Confidence cheat sheet, and I’ll see you in the next video. Bye for now.