How to Identify and Avoid Traps while Day Trading - dummies

How to Identify and Avoid Traps while Day Trading

Traders can be superstitious, and that shows up in traps that affect the stock market. As a day trader, you want to be aware of them, because they can affect trading even when there is no logical reason for their existence.

A trap is a situation where the market doesn’t perform the way you expect it to given the indicators that you are looking at. You have a choice: Go with what the market is telling you or go with what your indicators are telling you.

To a long-term investor, perception is perception. When perception is different from reality, an opportunity exists to make money. To a short-term trader, perception is reality because it affects what happens before everyone figures out what’s real.

Traders talk about getting caught in traps, which neatly fits the language of bulls and bears. When they stumble into a trap, they’re stuck moving against the market, which causes them big trouble. After all, day trading is about identifying trends and moving with them. You only have a few hours to work before the time comes to close out.

The best antidote for a trap is to take your loss and move on to the next trade.

Avoid stock performance chart traps

If you look at actual price charts created in the market every day, you may notice that sometimes, it’s really hard to tell whether a breakout is false or real and whether a trend is changing or just playing out with a smaller subtrend.

A ton of subjectivity goes into reading charts, and some days you read them wrong. You think that you are ahead of the market when you’re actually just trading against it. Ouch!

Some traders try to work around these types of chart traps by automating their trading. Several different software packages are available that can scan the market and identify potential trading opportunities. But even the best software misreads the market on some occasions, which is why you need to monitor your positions and make sure you stick to your loss limits.

Recognize the contrarian trap while day trading

About 80 percent of day traders lose money. So maybe you’re thinking that the way to make money is to just do the opposite of what everyone else is doing.

But the reason that day traders lose money isn’t so much that they’re wrong about the trend; it’s because they’re sloppy in their trading and don’t limit their losses. (That’s why so much of this book is about the business of trading rather than the actual mechanics of placing buy and sell orders.)

In a contrarian trap, the trader has made the decision to trade against the market, and that’s exactly what happens: He or she loses money because the market is moving in the opposite direction.

Taking a contrary position doesn’t work too well in day trading. In most cases, you have to go with the flow, not against it, to make money in a single day’s session. The market is always right in the short term.

A lot of people make money with a contrarian strategy, but they need to pay attention to avoid the traps.