Rhythm is important. Without the rhythm of the tides and seasons, there would be no life on Earth. When the rhythmic pulse of our heartbeat, breathing, or neural activity is disrupted, we suffer greatly. Rhythm moves in us and through us, and we know it–children in Brazil beat samba rhythms at play, there is pleasing regularity in the rhythmic bounce of a ball, the guy in the suit waiting on the subway platform taps his toe to some unheard beat–even the throaty rumble of that train drives a relentless rhythm in the dark of the tunnel. The market has a rhythm, too, and one of the keys to successful trading is being in synch with the market’s beat.
Today, stocks sold off. Yes, there were several explanations and potential catalysts, but many traders had sensed a breakdown was coming. Looking objectively, momentum on shorter timeframes showed the market was “going down a lot easier than going up”, but there were also many subjective factors: Buyers seemed to be stepping away from bids. The market felt jittery, as the underlying buying conviction seemed to fade. For weeks, I had been advising my research clients to initiate hedges, put on shorts or offsets, and to have a clear plan to manage the risk in long positions–we had also entered a short in German stocks last week, and had no potential long entry in stock indexes.
Days like today (10/1/14) get a lot of attention in the media and generate social media traffic through the roof. Everyone is talking and everyone has an opinion. However, most traders find success by stepping away from that noise. You have to execute with the rhythm of the market, and to look to rush and short on a day the market is declining, well, that only works for nimble daytraders. This is very important, though it is perhaps a slight oversimplification: in general, swing traders need to be selling when everyone is talking about buying, and shorting before the move is apparent in the market. We get paid for being a little bit ahead, and it’s possible (sometimes, not always–remember, markets are very random) to feel the groove of the market.
Reading the rhythm of the market is not so difficult, but executing around that structure takes considerable skill, iron discipline, and a kind of mental flexibility that is almost unique in the human experience. Expect to be wrong often; being wrong cannot generate anger, frustration, or fear because those emotions will throw us further out of synch with the market. Being wrong is perfectly fine, but staying wrong is fatal.
So, what now for the market? In general, we should expect markets to reverse and to recover much of a drop like that. Bearish sentiment is rising, and technicians are pointing out broken trendlines, “levels”, ratios, and making dire predictions of the coming crash. The cynical trader ignores all of that, and focuses on discipline. Maybe he starts looking for certain patterns that could generate long trades, and sees how they play out. Maybe he takes some profits on shorts, tightens stops, and reduces exposure. Almost certainly, he is watching for that next bounce, knowing the character of that bounce (quick and sharp snapback? If so, look out new highs! Slow and reluctant recovery? Probably a consolidation setting up another breakdown, and could be soft into first quarter 2015…) will tell us a lot about the next steps.
If you are troubled by the market’s movements, relax. Step back, out of the noise. Focus on the message of the market, and find the rhythm. Let the market take the first steps–and maybe we can hope to dance a few steps before the tune changes.