7 Variable Risk Factors Traders Need To Avoid

Variable risk factors are discoveries found within all markets on all charts that we can identify. They put undue risk on a trade, so let’s know what they are and steer clear…

It’s a morning business

Let’s start with a concept discussed InsideTheNumbers LIVE. Think of the market like a big box store such as Walmart or Target. These places are open from morning until night.

They have countless items you can brows, touch and feel… The stores are designed meticulously with “floorplan” in mind so you bump into things you didn’t intend to buy, but find a quick reason to justify the purchase.

The more time you spend perusing the store, the more likely you are to fill up the cart with items that are nice to have, but not needed.

We’ve all done it, waited on line at the checkout and watched the cashier ring up item after item totaling more than we expected to spend.

Now think about the typical [inexperienced] trader named Joe who shows up each day bright eye and bushy tail, with the expectation of making money.

Joe makes a couple of quality trades early in the session while the volume and participation are flowing… After about an hour, Joe’s up $1250 and feeling great!

Joe decides to take a break, get something to eat and check some message.

The biggest decision every day comes next…

Does Joe pack it in for the day, satisfied with what opportunities Mrs. Market provided, or do the demons creep in…

What demons? The ones that lure Joe right back to the computer to begin looking for “The Next Trade.” The ones that convince Joe that he’s playing with the houses money and can easily double the morning profits…

What most traders don’t realize is the tale of two tapes. Tape number one is the market that exists between the opening bell for around ninety minutes. The other tape is the market that exits the rest of the day.

The participation and volume begin to wane as the morning session winds down. The professional traders in the biz go to lunch, attend meetings, work out or do whatever they can to get away from the market because they know what’s coming…

It generally starts with a period of consolidation and eating time off the clock in a chop shop formation.

Because Joe has already decided that he’s going to try and double the days gains, he begins looking for “the next trade.”

Emotions and alter ego take over and team justification shows up. Their job is to help Joe find another stock or index to buy. The search begins and within a minute or two, there it is…

They start talking about the next hot thing on Tout TV (CNBC), he looks at the chart and sees the thing starting to move. Joe doesn’t want to “miss the trade” so a quick decision is made to “jump in.”

Right out of the gate, Joe’s up around $250 on the trade and already begins calculating how much "[more] money he’s going to make if this thing can go up just another dollar or so, it looks good.

About 25 seconds later, the trade is now back to even and begins to fall into the red. A couple of minutes later the paper loss is approaching around $300 and Joe does the right thing and cuts his losses, preserving the remainder of his profit on the day.

We all know what happens next…

Upon selling at a loss, the stock begins moving right back up and here come the demons again. Should I get back in Joe asks… “Now I have to get back the $300.”

We all know the rest, whether it’s multiple trades in the same stock, or a few others, by the time 3:30 rolls around, Joe has given back all the profits, has been “revenge trading” for two hours and says, “I can’t believe I did it again…”

The market is open all day just like Walmart and Target. We don’t need to shop there all day. We go in, get what we need and get out, on to the next thing.

We take what Mrs. Market is willing to provide during the “Best” part of the trading day when the institutional traders and professional traders are providing plenty of liquidity which is when the technicals work the best.

Most importantly, keep the money in your pocket and go about your business, then come back tomorrow fresh, off a positive day and ready to go...

Never short a dull tape

Traders need volume and participation in order to have a successful trading opportunity.

One example is the where the market is very very quiet. It just went up most of the morning session…

You short the tape at what you think is resistance only to watch Mrs. Market eat time off the clock in what we call a chop shop formation…

Every time she begins to move down, there’s a mysterious buyer that shows up, pushing price right back up.

This price action is designed to frustrate traders to the point where they give up on the trade, even taking a small loss because it’s just not moving…

You run short of patience…

Of course, right after you close the position the market begins to move in the direction you thought.

The Trick, Trap, Fool and Frustrate crew brings you to the brink every time, regardless of the type of trade. Their job is get you off the train before heading to the next destination…

Being a “One Trick Pony” is a hard job

It’s like getting up to bat with just one swing rather than the three. Your chances of success are cut by two thirds…

Even traders who consider themselves professionals or astute chartists and technicians have a hard time picking one price to buy or sell in a fast moving tape.

However, having two prices opens a whole new world called a “Trading Zone.”

The second price that creates a “Zone” increases your chance of success by 50%, allowing traders to enter a trade at two or even three prices within the zone…

This allows Mrs. Market a little rope to run some additional tests a little deeper than one purchase price would generally allow.

Statistics play a role…

Consider a trader who is correct the majority of time on where the trade exists. Fully aware that we can’t be right all the time, we’re in a probability business. What are the odds we’re going to be wrong twice in a row?

It certainly happens, but the probabilities are not the same as trying to pick one price, you’ve increased your odds by having two prices…

Of course, you have to “Know Your Numbers” first!

Shorting “In the hole”

We’ve all been there, picture this…

The market is falling, the news is bad and the talking heads on Tout TV (CNBC) are getting more and more bearish…

The next thought is “I don’t want to miss this one.”

You immediately buy some short dated puts and strap in for the ride. Right after the purchase you start calculating the amount of money you’re going to bank on the trade. This is going to be a Whopper…

The trade gets off to a fast start, you’re up four figures right away…

About five to ten minutes later price begins to rise, you’re back to even and the bad thoughts are front and center.

Did I make a mistake? What are they saying on TV? Should I go long?

Before you know it, you’re now losing money by the minute as more buyers show up. Buying begets buying, momentum traders hop on, shorts have to cover and the squeeze is on…

We all know the rest of the story and you’re now trading on hopium watching the premium in the puts disappear faster than an ice cube in boiling water…

The market was already down to much, emotions dictated the trade and the snap backs after finding a low are sharp and fast.

Now you’re the guy on the don’t pass line at the craps table watching everyone else go on a run. They’re on the right side having a blast while the traders who “shorted the final move down” have been issued another Pie in the Face…

Happens all the time.

Short term charts give false sense of security

Traders that use very short term charts always seem to have that look of disbelief. “That trade should have worked,” they proclaim…

Followed by coming up with a solid reason price moved in an “unexpected” way, having nothing to do with their analysis. After all, “it couldn’t be my fault.”

Little do they know the larger time frames are always the dominatrix..

Use common sense. Let’s say an hourly chart is making a bullish flagish pattern setting up for a move higher. You’re squarely focused on the one minute chart that is moving lower at the time…

The hourly chart is eating time off the clock, simply going back and forth while the price action on the one minute chart looks like an old fashioned Texas Rodeo…

Somehow every time price moves down a little, the rescue crew rolls in to prop it back up.

You must look at a wide variety of charts to understand what the big picture is. It’s how we reduce “variable risk” of the short term moves that are simply “eating time off the clock” before the bigger move.

The [larger] trend is your friend, until it’s not…

Looking at short term charts is like driving your car looking through a periscope rather than having a full compliment of windows…

Buying a stock with relative weakness after the morning rush

Let’s say it’s one of those days where the market sells a little in the morning and right before lunch decides to turn around and starts moving higher.

It happens all the time…

Joe Trader is looking for a stock to buy. “Let’s see what’s down big for the day, maybe a bit oversold and due for a bounce…”

Sounds like a legit and reasonable thing to do, until the odds of a bounce start deteriorating…

Why would that happen?

If the major indices like the S&P, DOW and Nasdaq are bouncing, normally most everything follows suit, even a little…

Not all to the same magnitude or at the same exact time, but by in large, it’s all the same market, with minor exception…

The stock with relative weakness is the one that can’t seem to “catch a bid” with Mrs. Market, there’s too much selling pressure.

This is known as relative weakness against the market and a warning sign that it can go lower…

These are the candidates for the “kill em’ into the close” with relentless sell side action…

Just because something is down doesn’t mean it has to bounce back on a schedule. She could be in search of a destination to be named later…

First time best time

Like a first kiss, the first day of school or the first smoke of the day.

First time best time applies to markets and prices. We’ve seen it in the live trading room countless times where price will come close to a number, bounce away and come for another visit later…

Sometimes the trade will work the second time and sometimes they’ve come back not for a visit, but to go on to another destination.

When price is heading for a destination, the first time it gets there is the best time for the type of reaction in the other direction that scalps with potential are made out of.

Imagine banging your shoulder into a [thin] door. The more times you hit the door, the closer you get to busting through.

Same thing for Mrs. Market. The more times she bangs into a price, the more opportunities she has to move through to her next stop…

Each time after number one has diminishing returns, so limiting to “first time best time” eliminates variable risk you don’t need…