Are You a Weatherman Trader?

What’s the difference between a Weatherman and a Trader? I asked this question at our forum a little while ago and stumped quite a few people. Do you know the difference?

On the surface they seem the same, but there is a very importance difference between the two. The main difference between a Weatherman and a Trader is that the Weatherman tries to predict what will happen next, whereas the Trader reacts to what IS happening. A subtle difference, but understanding that difference can make, or cost you, a lot of money.

Too many traders get caught up in trying to predict what the market will do next. I have friends pushing stock charts in front of me all the time asking “where’s it going from here?” The truth is I don’t know, no one does (and if they tell you differently they’re lying) but what I do know is IF the market does THIS, then THAT should happen – that’s reactionary. That’s reacting to what the market is doing, not trying to predict what it WILL do.

Case in point: the morning of October 4th, 2012 the December mini-Dow (YM) made a very aggressive run up. The advance was so quick that most traders didn’t have a chance to get into the trade until it was over – most traders but not all traders. Traders who are used to reacting to the market saw the advance building nearly 30 minutes before the breakout came! So while all the Weatherman traders were busy trying to short the market, reaction Traders were becoming suspicious of their short positions and maybe even cautiously bullish.

Take a look at this chart.

See how the Dow continues to push lower just after the open? But did you also notice that during one of these moves lower the market made a new short term swing high? This should not happen in a reasonably strong bear move and upon seeing the new swing high, reaction Traders start to question whether or not the Bears are still in control of the market?

Notice too, how the next move lower, after that new swing high, also made a higher swing low! Even novice traders know that markets make higher lows in uptrends not downtrends. At this point reaction Traders implement a plan to BUY the market IF the last swing high fails, because they know THAT IF the trend is truly changing THEN the lows will hold and the highs will yield.

The ensuing breakout above the swing high was textbook and the Dow quickly rallied to 13500 where Weatherman traders once again attempted to SELL, only to be overrun by the bulls in a similar sequence to the one that started the move up (which can be seen on a shorter time frame).

So how do you become a Trader who reacts to what the market is doing instead of a Weatherman who tries to predict what the market will do next? The key to reaction trading is to have a plan that hinges on the market doing something. The reaction Trader’s mantra is: IF the market does.

THIS, THEN I’ll do THAT. One of the best pieces of trading advice I ever got was: make the market prove you right before you get in. This advice is the core of reaction trading.

The easiest way to make the market “prove you right” is to use Stop-Market orders to enter a trade. Stop-Market orders only trigger IF/WHEN a specific price is hit. IF the price is not hit THEN the trade is never filled. Weatherman traders, on the other hand, love limit orders as they try to pick where the market will turn. The problem with entering trades with limit orders like this is that the market hasn’t shown you what it wants to do yet and as a result you could end up taking loss after loss after loss before you finally get it right.

Instead, forget trying to second guess what the market will do next; rather concentrate on what the market is doing now and formulate a strategy from there. You’ll know you’re on the right track when you start thinking in terms of “IF the market does this THEN I’ll do THAT”. IF you learn to do THIS, THEN you can leave the prediction business to the Weatherman and THAT will put more money in your account.

For more from Erich, visit the Indicator Warehouse for additional futures resources and NinjaTrader Indicators.