The violent moves we have seen in the markets in the last few days are a keen reminder that timing can be everything when it comes to trading, especially if you are a retail trader. The market sell-off on 22and 23rd May was hard to predict and difficult to manage as the moves were extremely quick and volatile.
But don’t despair. The unexpected is part and parcel of trading, sometimes the unexpected works in your favour, sometimes it doesn’t. The best way to survive in the markets is to understand market timing. This has two parts: firstly your own time frame, and secondly how to time your entry and exit levels.
Firstly, managing your own time frame. Decide what type of trader you are. Are you someone who wants to be in and out over the course of the day? Do you want to accept the risk that comes with holding a position overnight? To answer these questions it will depend on the product you are trading and the size of your capital base. For example, if you are trading individual stocks it may be worth holding the position for a longer period – say a number of days – to take advantage of any news flow or corporate data that might work in your favour. However, if you trade FX then a shorter term strategy might be more expedient as this is a $4 trillion a day market, and can move extremely quickly. The good news about FX trading is that sometimes a simple, momentum/ trend following strategy works well.
Ultimately your capital base will determine your time frame. If you have a small capital base and you trade forex then it can be difficult to hold positions for a long time as the market can move so quickly and take you out of your trade very easily. Larger capital bases tend to benefit the longer term trader, especially in the FX market. For stock pickers, the size of the capital base has less of an impact, however the larger your base the larger your potential profits.
Secondly, market timing. This will be dependent on the strategy you are following. If you are following an Expert Advisor (EA) or another algorhythmic based trading strategy your choices of entry and exit are taken out of your hands. But, by far the largest group of traders are discretionary traders, who make their own decisions. You could fill hundreds of books with various trading strategies and rules about entry and exit levels, but the rule of thumb should always be: buy low and sell high.
Some trend-following strategies suggest waiting for a break out to the upside before taking a long position, or vice versa for a short position. This strategy is one of my bug-bears as it can lead you to buy at a high (if you want to go long). The best piece of advice for any trader is that trends do not go up (or down) in a straight line. Using the current market example, any strategy that required someone taking a long position once the S&P 500 broke through record highs would have led to some traders getting burned. A better strategy would be to look for support levels that he market could pull back to. For example, if you expect a shallow pullback, you may look for an entry level after a 100-150 pip pullback. This doesn’t mean you think the trend is over; on the contrary, you want to get in at a better level to ride the trend higher and boost your profits.
The best traders are always those who are students of the markets. Doing your homework on market timing can pay dividends and should be lesson number one.
Kathleen Brooks is author of Kathleen Brooks on Forex: A simple approach to trading foreign exchange using fundamental and technical analysis.