Many traders are extremely proud of themselves when they catch the market’s exact tops and bottoms. I’m not. Traders should focus on MAXIMIZING their profits. Trying to catch the exact tops and bottoms actually decreases performance. This is especially true when trying to catch the exact bottom in a bull market and the exact top in a bear market. Here’s why.
Fear of missing out
Trading and investing is all about probability. There is no holy grail indicator. E.g. some traders will say “I’ll only buy XYZ if its RSI falls to 25”. They are essentially trying to catch the market’s exact bottom. This is dangerous and can result in the trader missing out on a hugely profitable trade.
Indicators can only be used to approximate the market’s turning point. They are not absolutes. The market doesn’t HAVE to do XYZ before it can bottom. The market doesn’t HAVE to do ABC before it can top.
You will miss out on a lot of profitable trades if you try to catch the exact bottom and tops in markets. E.g. let’s assume that you want to buy when the market’s RSI falls to 25. What if RSI falls to 26 and that’s the market’s exact bottom? You would have missed out on a hugely profitable trade just because you wanted to wait for RSI to fall just 1 more point.
Some seasoned traders will tell you that there’s nothing wrong with missing out on a trade. This is true, but to a limited extent. Missing out on a few trades is ok. But if you consistently miss out on profitable trades because you want to catch exact tops/bottoms, then that is a problem. You are leaving a lot of money on the table.
Don’t wait for the best trading setup. Enter into a position with a good trading setup because rarely will a setup be EXTREMELY bullish or EXTREMELY bearish.
This reminds me of the line “if you try to achieve Great, you might not even achieve Good.”
Don’t try to catch the exact bottom in a bull market
This is especially true for traders who try to catch the exact bottom of corrections in bull markets.
You should care more about missing out on a long trade than getting caught in a bull market. You can just wait until the bull market makes your position profitable again if you are caught on the long side. But if you miss out on a long position, you will have to wait a LONG TIME for the next correction to re-enter.
E.g. You expected the market to fall -10% in a correction. The market might fall -9% and then bottom. If that happens and you stubbornly stick to a -10% target, you will miss out on the whole lon trade.
This case is especially prevalent in a bull market because bull markets have a natural bullish bias. The natural bullish bias might stop the correction sooner than you expected.
So if you expected the market to fall e.g. -10%, just buy when the market falls -8%. Give your minimum target some leeway.
I focus on the medium-long term instead of the short term.
Don’t try to catch the exact top in a bear market
Don’t try to catch the exact tops for rallies within bear markets. Let’s assume that you want to sell into a bear market rally. You expect the market to rally +10% before making new lows.
The market might only rise +9% before topping. If you stubbornly stick to a +10% target, you will lose miss out on a very profitable short position.
The market has a natural bearish bias in a bear market. The bearish bias might cause the rally to stop sooner than you expected.
Give your indicators some room
It’s a good idea to give your indicators some room. Doing so will prevent you from missing a lot of profitable trades.
Let’s assume that historically, the market’s bottom always occurred when is RSI (momentum indicator) was less than 22.
- Instead of trading by the rule “buy only when RSI falls below 22”, give that indicator some leeway.
- Trade by the rule “buy only when RSI falls below 25”.
- That way you won’t miss the trade if the market bottoms when RSI is 23 next time.