Option Investor
Educational Article

The Hardest Lessons

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By David Popper

"The hardest lessons to learn are the ones that I already know," said author, Pat Morley. Pat has authored a book called "The Man in the Mirror" which basically discusses men at the midpoint of their lives. Pat notes that there comes a time when men realize that they have spent the first forty or fifty years of their lives in a mad search for success, only to discover, to their surprise, that wealth and success are not nearly as satisfying as they had envisioned. Pat also mentions that we already know, intellectually, the answers to some of life's great questions. It is just that we do not live in light of the answers. We really do not believe in our hearts the truth that we have in our heads.

So too in the market, if a trader has years of experience, or has done any reading whatsoever, he/she understands much of the truth in trading. For those who cannot watch the computer on an every day basis and who have an intermediate time horizon, it makes the most sense to purchase leading stocks in leading industries when the general market is acting correctly.

Typically, during a bear market, the market will stage several rally attempts. If the rally attempts are on light volume, the rallies typically fail. We have seen several of these recently. Often traders try to recoup some of their losses and guess incorrectly that a market reached a bottom, only to suffer further losses. (It may be okay to attempt to guess if you are using only a very small portion of capital).

When a market finally reaches a bottom, it is not possible to know it exactly at the time that the bottom is formed. Typically, you have to wait for a follow-through day. Follow-through days for the intermediate trader are defined as a rise of more than one percent on the major averages (Nasdaq, Dow, etc.) on higher volume. Waiting for a follow-through day makes sense. During a bear market, institutional investors are either selling(high volume to the downside) or simply not buying(light volume). A follow-through day indicates that institutions are beginning to buy. Several follow-through days(averages moving up on higher volume) indicate that institutions are buying in earnest. A market will not go up for long without institutional support. Typically, in a new bull market, the money will rush to some fresh new names and also to the institutional "must owns" such as EMC, SUNW, CSCO, ORCL, JDSU, etc.

During a bear market, it pays to do your homework so that ou are able to get into the best stocks once the general market averages begin to act right. One way to be prepared is to begin looking at the charts of your potential stocks. Which ones appear to have been rolling over and turning lower? Which ones look like they have found support and are ready to move higher? Which ones are breaking out to new highs? Can you see profitable resistance and support levels?

Once you have identified a short list of stocks that you think have a good probability of moving higher, make a plan. At what price do you wish to purchase a stock? Where will you set your stops? How do you plan to trade the stock if it moves higher? How big will your position be? If the stock moves lower, where will you choose to sell the stock to minimize your loss? Having a predetermined plan that you stick to can make all of the difference.

Again, intellectually, we all know this information. The question is, what is our reaction when in the trenches? Do we allow the emotions of hope, fear, and greed to cloud our judgment? Do we really believe in our plan? Do we stick with our plan? Do we really have to suffer another loss to learn the lessons that we already know?

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