FSO Editorials: "Right, Wrong, Poker, and Chess " by Fernando Gonzalez for OTA 09/18/2006

Right, Wrong, Poker, and Chess
Weekly Review with Fernando Gonzalez
Online Trading Academy
September 18, 2006

The markets spent most of the week preceding the Labor Day weekend hesitating right at key Short-Term resistance, as marked in our last article. This led to some pretty miserable trading conditions, as Wednesday and Thursday yielded a painfully tight 4 point range in the S&P. This is just about as tight I have seen the markets. By Friday, the market managed to break through and sustain above our 1303 mark in the S&P500, and this puts a new multi-year high into play over the short-term for the S&P500. For the DOW, a new all-time high comes into play over the Short-Term with sustained trade over the 11,465 mark, while the NASDAQ continues to fight for its life – its yearly high is not in play in this time horizon. We will take a look at the charts as we usually do, in our next issue.

In the meantime, let's take a moment to address the big question on the part of the media, market participants and investing public on whether the markets have truly entered a "bull market" mode, or whether the selling that we had seen in May is only a warm-up for more to come. The Bulls might argue that we have seen the worst in the stock market over the course of 2000 through 2003, and they have good reason to think so: the S&P500 had already been cut in half, and history suggests that this benchmark is not likely to yield such miserable performance any time in the near future. There may be a thousand other GOOD reasons to state the worst is behind us and the course of the markets is higher. They may very well be right.

On the other side, the Bears might argue that the markets are in a "secular" bear market state, which suggests that we still have a long way to go before the markets yield the type of positive performance that a true Bull Market can return. In fact some may even state that the worst is still ahead of us. There are a thousand GOOD reasons to believe this as the most probable future direction of the market. And they may very well be right.

Who should we then believe? When it comes to these things, there is a simple principle that has helped me understand the markets, and in many ways, the course of living as well, and it goes like this: We as humans are creative enough to develop persuasive lines of evidence to support just about ANY belief. This is good and this is a positive aspect of being human. The use of our creativity, visualization and imagination is a key aspect in being able to tackle the many challenges of the markets, as in other risks we take outside the markets as well.

But the markets, as is life, are perpetually in motion. It was here long before any of us, and will likely be here long after we are gone. Because of this constant motion, the markets perpetually change. We as participants who interact with this perpetually moving market must adjust to these constant changes as well.

We might develop all kinds of evidence to support our beliefs, or merely just listen to what analysts or other participants say and base our beliefs on those. In either case, we must think independently enough to set limits to our beliefs if only to anticipate the possibility of being wrong and consequentially have to deal with the monumental risk we assume by not adjusting early enough to changes.

It's an inevitable fact: we will be proven wrong many times. Our interaction with the markets is not a game of being right and wrong in one specific instance, but rather adapting to the markets in a series of connected instances. This "adaptation" to changes, the process by which we gradually give up on one belief in favor of another new one (which may be totally neutral), should filter its way into every aspect of our technical strategy. Setting reasonable limits to our beliefs, particularly when it comes to the direction of the markets is a key aspect in our interaction with this system that is perpetually in motion. These limits must consist of boundaries not just in PRICE, but in TIME as well – just to give us a chance to 'live another day,' so to speak, in the event that we are wrong. This does not just apply to the single act of setting a stop loss to an individual trade, but rather to the collective approach towards a whole set of trades throughout a period of time, each of which are connected to the other that create a string of continuous, or perpetual interaction.

The answer to the question of whether this market is in a long-term Bull or Bear Market is one that will always come to us in a gradual fashion – it will be like this perpetually. In these large time horizons, there will ALWAYS be plenty of time to capitalize either way. It is quite difficult to be pressed into one line of thinking, because of the monumental risk that is associated with such thinking. In the long-term market, the risk of being wrong extends very far and very wide, in terms of both PRICE and TIME. Because of this extensive risk, we must be all the more meticulous to make sure we have looked at all the right evidence to support our beliefs, not just from a single source, but from our very own observations. If (and that's a big IF) we have established one particular belief, we must be prepared to qualify such line of thinking with well defined limits in price and time, and be prepared to CHANGE in the event that those limits are exceeded. Losses are always attached to wins, and because it's really only a few big losses that can get us – the nature of the game is to adjust to changes, while avoiding risks of large single setbacks that prevent us from taking future risks.

Let us recognize that our small beliefs (reflected in our day-to-day actions) are attached to our big ones. This is yet another reason to remain flexible on what we believe about the markets for the long-term. This process of day to day survival is the process by which we learn to survive over the long-term, trade effectively and ultimately to build and maintain our accounts.

Some say trading is like Poker (Calculation of Risk and Decoys), while others say that it is like Chess (Forward, Strategic Thinking). While there are definitely striking similarities, I observe that the stakes, playing field, participants, and even the measures of time are more complex than each one of these. Trading is more like one long Poker and Chess game at the same time that never really has a time limit. At all times, the concepts of Right and Wrong are each a given. They are also temporary. The process by which we manage our constant exposure to the risk of being right or wrong in ONE instance, as well as in a SERIES of instances, in this monster Poker-Chess game is what will ultimately count.

Until next week: Good Luck!

Fernando Gonzalez

Fernando has over 6 years of high volume professional trading experience, with a long-term track record of profitability. He helped develop the original material and coursework for Online Trading Academy. He has designed and individually conducted courses for over 400 trading students and several hundred others in Lectures, Forums and Intraday participation within the Day Trading Education and Advisory Community. He has also co-authored a best-selling book: Strategies for the Online Day Trader (McGraw-Hill 1999), which reached overall best-seller list on Amazon.com & section bestseller list for Barnes & Noble and other notable sources.

DISCLAIMER:
This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results.

ABOUT THE WEEKLY REVIEW:
The weekly review heavily focuses on the application of Technical Analysis on the Broad Market Levels. You will rarely see individual Stock Picks on the Weekly Review! It is the author's belief that most Individual Stocks (certainly not all) will follow the overall direction of the Broad Market that surrounds them, as well as the Sectors they comprise. Discussion is focused heavily upon the Major Market & Sector price activity. Rarely also will you see discussion of the fundamental, macro-economic or political nature in the Weekly Review. By focusing only on the technical, or price & volume aspects of the major measures of the market, Fernando hopes to satisfy any equity trader's needs for a qualified discussion and forecast of the overall direction of equities, whether it be the Short, Intermediate, or Long-Term time horizons. Whether you trade the Index Futures, Index Tracking Stocks or Individual Equity Market Instruments, having an experienced eye on the conditions of the broad market that surrounds you is extremely important!