It goes without saying that we've been trading a pretty tough market. I believe as well that is really a matter of perspective. Many of those trading today have been trading fewer than 5 years and have no prior experience with this kind of market. Additionally, their relative lack of experience has them running for the "Tums" at almost every negative comment out of New York or Washington! Well, justified or not, it is precisely this kind of market which drives home an important tenet of trading. You have to stay 'on top' of the market at all times if you expect to be a successful trader. I have developed a pretty simple method for doing that.

Let's take it as a given that there are bearish strategies and bullish strategies. These various strategies derive their reputations from the 'characteristic movement' responsible for profit when the strategy is traded successfully. For example, buying stock is bullish while selling calls is bearish. If you buy stock and it goes up, you're profitable. If you sell calls against that stock, you benefit most when the stock declines in value. Let's list a few more for clarity. Bullish strategies include; buying calls, selling puts, call debit and put credit spreads. Bearish strategies include; buying puts, selling calls, etc. The 'bullish' or 'bearish' character of each of these comes from the fact that profit is derived from stock price movement. Bullish strategies work best when the underlying stock moves up. Conversely, bearish strategies are most profitable when the underlying stock decreases in value. Admittedly an oversimplification, we'll accept this as true for the purpose of explanation.


As you know, I meet with other traders of varying experience levels everyday in my online trading lab. We work our way through each trading day using strategies which are working well for us. Lately, these have been pretty bearish in nature. "Lately" meaning the past 2 or 3 years! While I have profited from stock going up, my PREDOMINANT strategies have been bearish; shorting stock being among my favorites! I've recently noticed that our strategies have been becoming more difficult to trade through. I learned many years ago that one of the most reliable signs for me that we have a coming change in overall market direction is when my current trades begin to generate less and less profit! That has to assume a consistently high level of strategy execution and adherence to trading rules, of course. I also learned that a great way to give yourself a 'heads up' on this is to always have some paper trades going. That is, if you are REALLY trading to the down side, have some paper trades to the upside going as well. Pay attention to the trade results for BOTH groups. If you see your REAL trades beginning to turn against you while your paper trades are becoming more and more profitable, the be ready for a coming change in the broader markets! Arguably a crude measure of market sentiment, these paper trades can provide you with an amazingly accurate forecast of conditions to come. There are some things to keep in mind however.

First, be sure that your paper trades are not being affected by temporary, passing influences having little to do with the broader market. For example, avoid paper trading cyclical stocks which are entering (or exiting) those times when their price might be naturally or normally affected. Trading a retail stock between Thanksgiving and Christmas would probably NOT give you an accurate indication of an improving market. Likewise, trading airline stocks after an oil price hike would not be a fundamentally sound basis for predicting a falling market.

Second, keep your paper trades SIMPLE! Remember, you are here for the MONEY, not the trade. The best indicator trade (as I call them) is the most simple strategy I can use. If I'm trading in a bearish market and want to be on the alert for improving conditions, I'll simply BUY stock (on paper, of course). The fewer components to the strategy, the easier it is to interpret the results! When trading a bull market, I'll short stock on paper to stay ahead of the bears.

Finally, be sure to use indicator stock having a broad base of support. The Dow Industrials work well for me, keeping in mind that even in the DJIA, there are stocks to avoid. WalMart is not good to use during periods of anticipated peak buying. Additionally, companies facing 'unusual' conditions; lawsuits, acquisitions (buying or selling), etc would be good to avoid. It's really a matter of common sense!

Try this and see how it works for you. In any event be sure to do SOMETHING to stay on top of the market! Happy Hunting!!

Bob Eldridge

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