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Three Lessons For Trading In The New Bull Market

05/14/13 03:47:42 PM
by Billy Williams

It has been 14 years since we've had a full-fledged bull market and to maximize your opportunity there are three lessons to keep in mind.

Security:   AAPL
Position:   Sell

Where the market is going to end up a year or two from now, no one can say with any certainty. What you can say is that all indications seem to point upwards as bulls have pushed the market to new all-time price highs and have momentum on their side. But, now that the market has transitioned from a 14 year trading range, how do the rules change now that the bulls appear to have control of the trend for the time being? How do you adapt to the current market-type and what strategies do you use to maximize the opportunity that the current market offers?

At first, it seems a little silly to ask how you would take advantage of the current market with all its potential after having broken free from a decade-plus trading range, but that is precisely why you should have a strategy in going forward. There are potentially millions of investors and traders who have been introduced to the market without ever having experienced a secular bull market and have only known the stagnant back and forth trading that has marked the beginning of the 21st century.

Now is more important than ever to review the key success factors in trading this bull market to maximize the opportunity that it presents and all the promise that it holds for outsized gains.

The most important is to interpret price action, not predict.

Figure 1. From 2011 to 2012, Apple Computer was experiencing a big bullish run. It was a major stock leader at the time even though the market was a little week due to the European debt crisis and more. The strength it displayed made it an obvious choice for traders and investors alike and many were rewarded handsomely for staying on the right side of strength in the market.
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Price action is dynamic and changes depending on a number of factors such as forward-looking prospects, buying/selling volume, competitive advantages, etc. That said, there is no way to know for certain where a stock's price will be in a year or more.

Gurus that try to predict prices in stocks or the indices are often wrong and investors/traders who follow their predictions usually end up in a worse position.

The worst trade to make is to enter a position based on your belief that price will hit a certain level. What makes it worse is that if the trade goes against you and you refuse to exit because you know your prediction will come true. This is tragic folly and will break you as a speculator.

The cornerstone to success in the markets is to be an interpreter of price action, not a predictor. Interpreters of price action read price as it unfolds in the present and take entries and exits based on that, not what they believe that price will do at some predetermined price level or time.

Second, to achieve the highest level of performance, invest/trade in strength. Even when the bears were in control, there were bullish trends somewhere in the stock market and it was your job to find them.

Figure 2. Later, AAPL lost its luster as price began to break down but many investors/traders hung on predicting that the stock would rebound but were later disappointed. There folly stands as a lesson for every market participant to respect risk and plan accordingly.
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In bull markets, almost every stock goes up in price but the stocks that yield the greatest gains have the highest level of relative strength and emerge as stock leaders which lead the market to higher ground just like now.

Presently, large-cap stocks appear to be taking the market higher and, even more specifically, biotechnology and energy industries are leading the way. By profiling which segments of the market are performing with the highest level of relative strength, you can find where the leaders are and take advantage of their momentum for the highest returns available.

Lastly, you want to limit your risk as much as possible.

Remember the lesson about traders who make predictions and then hang on even after a trade is underwater? That is the hallmark indicator of an amateur.

Even the best predictors, and traders, may have an idea of where a stock or underlying security is about to end up but professionals use risk control in the event that they are wrong.

You can be right 99 times out of 100 but when that 1 trade comes along with a bullet with your name on it, you better have your stops in place and not be overexposed.

Professionals trust themselves on big trades but respect risk control even more by trading the appropriate size and with stop losses to avoid getting crushed by the market.

So, in the current bull market remember to interpret price action and don't be a predictor; look to trade/invest where strength in the market is exhibited, and always respect risk by trading the appropriate size and use stop losses.

Billy Williams

Billy Williams has been trading the markets for 27 years, specializing in momentum trading with stocks and options.

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