The foundation post: fooled by the market … and your brain!

Previous title: Markets are correcting, aren’t they?

Sorry I have not written for a while. Thank you very much for your encouraging comments. Yes it is true, luck is an important factor in trading and it needs to be factored in when working on any trading strategy. The question is always the same: how do you manage the unknown? The fact is that when the brain has seen something, which we may call a pattern, it is looking for evidence that it is there and reveal something. We are not accustomed at at all to challenge the existence of pattern.

Let’s take an example. Here is a list of numbers: 2 , 4, 6. What is coming next?

Most likely you are going to say 8, right?

In fact, had you answered 25 it would have been an ok answer because I only about 3 consecutive higher numbers. No other rules.

When you see a pattern next time on a chart, take time to challenge it!

Now let’s look at S&P500 and recent price action.

You do not need 20 indicators. A ROC-L (created by Alexander Elder – it is a ROC 21 days applied to 13 days exponential moving average) is good enough, quite smooth. There was a divergence on the top and signal to sell was there (red color)

That’s it. I am not looking for any other confirmation. Market has been on a long streak of winning weeks. Whatever the reason (Fed printing money by billions, or chinese virus, …), the market was bound for some other direction.

I explained previously (did I?) that the market is statistically NOT a normal distribution so don’t rely on Bollinger bands to anticipate. We are much better off with action-reactions lines (the big idea behind Andrew Pitchfork) because if prices have gone away from center line in one direction, then it is likely they will do so on the other side. Concept is simple, the secret is where to draw the center line. I need to write a book about this, since Andrew never went to such details.

So finance suddenly realizing impact of Covid-19, prices have dropped in 2 days to their second reaction line. The 2 lines below close to each other should prove a better support.

Let’s be clear, we are bearish now, with something that looks like the beginning of a bearish short term trend. I can change my mind above 3300, this number will of course go down in coming days. On a longer term basis, the bullish trend is of course still valid as long as above 3100 on weekly chart, and 2840 on monthly chart.

Due to the weight of index based ETF’s, it does not make too much sense to look for opportunities on major stock. But volume might be small on small caps making trading also risky.

Until next time, trade safely.

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