Market Insight and Psychology

Here is the perfect quote from John Carters book, Mastering the Trade that perfectly describes Options-Intelligence:

It is also important to remember that there is no need to spend wasted years looking for complicated setups or the next Holy Grail. There are very simple setups out there to use. Some of the best traders I know have been trading the same setup, on the same time frame, on the same market for 20 years. They don't care about anything else, and they don't want to learn anything else. This works for them, and they are the masters of this setup. They have nothing else coming in to interfere with their focus. If a setup doesn't happen that day, then they don't take a trade.

Overtrading

One of the biggest factors in traders washing out is over trading. Always having to play even when the deck is stacked against you is a losing game. Markets are very fickle, they have no emotion, and they know that most traders will wash out. It's you against everyone else. You don't have to be better than everyone, you just have to be better than the losers who continue to make the same mistakes over and over again until they are washed out. Traders believe there is some magical tool out there that will propel them to the top when in fact traders already have that tool inside their heads. Traders have to look at many, many, many charts until those patterns are ingrained on their brain and learn what the bars and candles are telling them. Two good books I recommend, Trading for a Living, by Dr Alexander Elder (a bit dated but chart patterns are highly relevant) and Mastering the Trade by John Carter.

Reading the charts

There are specific patterns out there on different time frames that give us clues as to future movement. Once a stock has risen to heights that we believe cannot be sustained we begin looking for the classic signs of a reversal. First you will get a larger run-up on higher volume, then you get the final spurt higher on lesser volume. This is where you should be shifting your charts down to 2 day 10 minute charts to see the final ending of the run. Once you get that ending, switch to a 15 minute chart and finally to a 10 day hourly. If you get the confirmation on the hourly you can almost rest assured you will see it next on the daily 3 month chart. No need to use anything fancy here. I use a 10, 20, 50, and 200 period EMA, a DMI (14) with ADX and volume. This works on the downside as well. Remember stocks fall using an elevator and rise using the stairs. If you can catch the top, ride it.

Not always is the stock done on the initial fall. Many times it will regain footing (typically around the 20 period) and try to make a new high, sometimes just slightly beating the prior high or low to then turn vigorously in the opposite direction (this is highly frustrating as most set stops and limits based on the prior highs or lows as an exit if the trade goes against their thinking). You want to figure at least .20-.25 higher or lower than the previous high or low.

Paralysis by analysis

Probably the biggest secret in the market is never get locked into one directional thinking. You may swear there is no way in the world this market can go up, you fight it the whole way saying it has to come down, you washout and the market turns around and goes down just like you thought. I can't tell you how many times my mind has been biased in one direction or the other only to see the stock market do just the opposite.

Case in point: Option Expiration week. I look at the charts, they may look terrible but I know that Oct has always been a good month for me. I do my research on the performance calculator and find that 75% of the time my choices will gain at least 25%. Three choices, AAPL, GOOG, and the Q's have an average 70% chance to gain at least 50% in Oct. Do I go with the chart that looks terrible or go with my data that says no matter what I will most likely (75% chance) gain at least 25% over all the plays. This is a very hard choice. I put the plays out, that is exactly what I do. Why does it work? I have no clue, but who cares. We all make money and wait for the next cycle. Point is, don't over guesstimate the game (and that is exactly what the market is). Option Expiration week is by far the most consistent game in town.