Avoid this Common Stock Trading Mistake

by Darrin Donnelly on March 2, 2011

Click on chart to enlarge.

Click on chart to enlarge.

When the stock market begins a downtrend, the most important thing a Darvas trader must do is keep the downtrend in proper perspective.

Whenever a new downtrend begins, there is no shortage of panicked doomsayers and catastrophic predictions.  But the fact is that the majority of downtrends decline about 15% from peak to valley and they usually last about 6-12 weeks (we’re currently two weeks off the peak in this pullback). 

These typical downtrends are perfect base-building opportunities for top stocks that need to consolidate before the next big move.  In that sense, not only are these downtrends normal, they’re also constructive.  We actually LIKE to see them. 

Novice traders often have a hard time understanding this and are more prone to panic at the first signs of a break in the uptrend.

ALL bull markets take rests along the way.  Some are more severe than others, but most are simply due to cautious profit-taking after a strong run-up, as opposed to widespread panic about the future of the economy. 

It’s important to remember this, especially when the brutal bear market of 2008-2009 is still such a fresh memory.  Bear markets like the one that began in 2008 are the extreme exceptions and far from the norm.  (It’s worth noting that trend traders, as a group, actually made huge profits during that bear market.  This is because it doesn’t matter which way the trend is going, either up or down, a strong trend can be ridden to profits.)

We have entered into a downtrend that, to me, looks like fairly typical profit-taking.  This downtrend could be over within the month or it could drag on longer.  The point is that now is not the time to start shorting individual stocks. 

It’s also not the time to sell completely out of the stocks that are holding up constructively in this pullback.  It’s not a bad idea to scale back and sell a portion of your winners to book some profits, but it’s not uncommon for some market leaders to withstand a normal downtrend without ever needing to be sold.

In consideration of short trades, you usually want to wait at least eight weeks or more from the stock’s peak before you consider shorting it.  Why eight weeks?  Because if most market downtrends only last 6-12 weeks, you don’t want to dive in too early only to be whipsawed out of your short position as the market reenters an uptrend. 

The market is currently two weeks off its peak and most leading stocks are about three weeks into a pullback.  This downtrend looks like it will be a fairly typical correction that will allow leading stocks to form solid new bases. 

Just be ready.  Stay tuned to the action of the market.  Downtrends can end in a flash and you don’t want to be shorting top stocks or waiting on the sidelines when the uptrend resumes.

Having said all that, there is a simple trading technique that DOES allow you to start profiting from the very beginning of a new downtrend – regardless of whether that trend ends up being mild or severe – and this method is fully explained in the latest issue of Darvas Trader PROYou can start a 30-day trial of Darvas Trader PRO right here.

{ 1 comment… read it below or add one }

Mika June 25, 2012 at 9:55 am

In my small unique book “The small stock trader” I also had more detailed overview of tens of stock trading mistakes (http://thesmallstocktrader.wordpress.com/2012/06/25/stock-day-trading-mistakessinceserrors-that-cause-90-of-stock-traders-lose-money/):

• EGO (thinking you are a walking think tank, not accepting and learning from you mistakes, etc.)
• Lack of passion and entering into stock trading with unrealistic expectations about the learning time and performance, without realizing that it often takes 4-5 years to learn how it works and that even +50% annual performance in the long run is very good
• Poor self-esteem/self-knowledge
• Lack of focus
• Not working ward enough and treating your stock trading as a hobby instead of a small business
• Lack of knowledge and experience
• Trying to imitate others instead of developing your unique stock trading philosophy that suits best to your personality
• Listening to others instead of doing your own research
• Lack of recordkeeping
• Overanalyzing and overcomplicating things (Zen-like simplicity is the key)
• Lack of flexibility to adapt to the always/quick-changing stock market
• Lack of patience to learn stock trading properly, wait to enter into the positions and let the winners run (inpatience results in overtrading, which in turn results in high transaction costs)
• Lack of stock trading plan that defines your goals, entry/exit points, etc.
• Lack of risk management rules on stop losses, position sizing, leverage, diversification, etc.
• Lack of discipline to stick to your stock trading plan and risk management rules
• Getting emotional (fear, greed, hope, revenge, regret, bragging, getting overconfident after big wins, sheep-like crowd-following behavior, etc.)
• Not knowing and understanding the competition
• Not knowing the catalysts that trigger stock price changes
• Averaging down (adding to losers instead of adding to winners)
• Putting your stock trading capital in 1-2 or more than 6-7 stocks instead of diversifying into about 5 stocks
• Bottom/top fishing
• Not understanding the specifics of short selling
• Missing this market/industry/stock connection, the big picture, and only focusing on the specific stocks
• Trying to predict the market/economy instead of just listening to it and going against the trend instead of following it

Mika (author of “The small stock trader”)

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