“Gut feeling” or intuition is important in trading and investing. Possibly every top professional trader has it. It is a kind of sixth sense that grows out of a trader’s accumulated knowledge and experience with the market. It is that sense that tells you a trade does not feel right or that shortly a particular stock will surge. As your experience grows, so will the accuracy of your “gut feeling.”
Elsewhere, we described how to make a trader’s diary. That diary has a record of the trader’s thoughts before buying and selling along with a chart of the stock with the buy and sell points marked. When a trader studies these charts and the comments he made at the time, he is teaching himself pattern recognition. After looking carefully at hundreds or thousands of charts and the decision points on those charts and reviews subsequent stock behavior for each, he will gradually become aware (at some level) that certain patterns are repeated. Some of what he learns in these reviews is not internalized at the conscious level..
Stock trading strategies or tactics picked up in this way may not be written about in any book on trading. For example, suppose the trader is analyzing the behavior of stocks as they decline to a well-defined horizontal line of support. By horizontal, I mean that it is not inclined at any angle. Let us assume that his objective is to capture a 1% to 2% gain as the stock bounces off of the line of support. Most of the time when he attempts this he gets his bounce, but sometimes he doesn’t. After a time, he becomes uneasy about certain configurations. Everything looks right but something is bothering him, and he cannot identify what it is. He has an “inner voice” or “gut feeling” that something is wrong. He does not know that he has internalized a certain pattern configuration.
Our stockdisciplines.com traders have learned to listen to this “inner voice” or “gut feeling,” and it has served them well. Now, let’s make up a pattern for our example. The configuration that he has internalized is that when the stock too quickly returns to a support line after a previous visit, the support fails. There is no rebound. More specifically, when a stock takes more than a month to return to the support line, that line tends to hold and the stock rebounds. If it returns to the support line in less than a month, it breaks right through the line and continues its descent. Eventually, he may recognize what it is that bothers him about the pattern. Then, he might include that new insight in the list of rules he is following as he implements his investment or trading strategy. He might even come up with an explanation for himself that will give him a rationale for why he should avoid stocks when they return to a horizontal line of support too soon.
He might, for example, conclude that the buyers were waiting at the support line as usual. The buyers have seen the stock rebound from that support line repeatedly and are betting that it will do so again. However, he thinks that there were many sellers at a little higher price that had not been there on previous rebounds and that for some reason they are denying the premise of the buyers and see the rebound as an opportunity to sell. He concludes that the sellers are looking at something else that had not been there before. The fact that these people are selling in the face a rally off of a well-defined support line, suggests that they have commitment and are likely to prevail in a face-off with the buyers. Essentially, these sellers are saying “that stock should not continue to rise, so I am getting out.” On the other hand, when the stock rebounds from the line of support and remains above it for a month or more, the market is confirming whatever reason there was behind the rebound. In so doing, it also strengthens that support.
Until he figures this out, he may become uneasy about the way the stock is moving when it returns to horizontal support too quickly. He may have a “gut feeling” that something is wrong.