Why It Is So Difficult to Trade With the Trend: Pulling the Trigger, and Riding the Winners

Many people have no problems identifying the trend with their own methods, yet they have difficulties in pulling the trigger to capitalize on that trend. Why is that? And for those with no problems in pulling the trigger, they find themselves exiting too early (too early = earlier than what their trading plan dictates). Again, why is that?

An Example

From my own trading journal, I had this case where I was hesitating too much in pulling the trigger. As a result, I was late to trends, and ended up with positions at more risky spots. I actually noted down what I was thinking:

• Downtrend: It’s not clear whether it’ll go up or down, wait till it breaks support.
• Support broken: No stop nearby, let’s wait till it pulls back.
• Pulled back: Hmm its too close to the next support, wait till it breaks that support.
• 2nd support broken: No stop nearby, wait till it pulls back again.
• Price pauses: Price is in such a narrow range of 2-3 ticks, its too risky, it can breakout either way, let’s wait and see.
• Price breaks down: The downtrend has already moved so far, it may end soon, so its too risky to enter.
• Trend changes up on 1-min: Hmm, 3-min time frame the trend is still down, better not enter.

Another example, it was an uptrend, but there was someone dumping large lots. So again my mind had this simultaneous reasons, one for going short / or not entering, and one for going long:

• Reason to go short / don’t enter – Natural resistance: There is someone dumping big lots, so it is risky to go long. Better not go long, it looks like it might turn down.
• Reason to go long – Trend: There’s a higher high, higher low, its an uptrend, should go long.

You can see how dangerous the mind is in talking yourself out of trades. Unless price is breaking new highs or new lows into clear blue skies, it is very easy to be cluttered with previous market structure (e.g. support, resistance) which makes a clear trade difficult.

Another Example

In Jake Bernstein’s The Investor’s Quotient (2nd Edition), he also gave an excellent example of how internal thought processes and hesitations resulted in missed trades. The scenario was one where a buy signal was triggered after an extended move down.

Thought processes that resulted in not taking the initial signal:

• Let’s wait for some more confirmation of the reversal.
• True, we had the reversal, but the volume wasn’t high enough. Let’s wait.
• If this was indeed a true reversal in trend, then we’ve got plenty of time to get in because trends run for a long period of time.
• The decline was so severe that I’m afraid to get in. I’d rather wait a few days to make sure the trend has changed.
• If I get in now, I might get stopped out on a test of the low.

Thought processes that resulted in not entering on a retracement:

• Let’s wait a little longer to see if we can get in cheaper.
• The price has come back too far and the low will probably be broken
• Let’s wait until it penetrates its recent high (or low) to be sure that the test was passed.
• I’ll wait for the next upside breakout, that way I’ll be certain to buy with the trend.

Thought processes for missing the breakout:

• Prices are too high.
• Now that the breakout has come and I know it’s real, I’ll wait for a pullback to the breakout area and buy in.

Price then moves up without any retracement, then finally the trader couldn’t take it anymore, buys at the top, and gets chewed up. This is one reason why traders ignore top signals when they appear, because they have already thrown their discipline out the window.

Possible Reasons

Bernstein gave 5 possible reasons underlying such behavior:

1. Unrealistic fear of losses
2. Lack of self-confidence and positive attitude
3. Inability to act as a result of negative learning
4. Lack of appropriate learning with trading system
5. Acceptance of inputs from contrary sources

Psychological Process At Work

Here’s my take on what’s happening. There are a number of psychological processes at work here. The process goes like this:

1. When faced with what the market is playing out, based on all past experiences and beliefs, your emotional mind communicates its assessment through emotions. For most people that have not been consistently profitable, what is usually some form of anxiety: the anxiety of entering a position and getting it wrong, the anxiety of open profits disappearing, etc. Translated to words, when you are thinking whether to enter, your emotional mind is saying: “Don’t enter!”; when you are thinking of what you should be doing now with your open profit, your emotional mind is saying “Get out NOW before the profit disappears!”.
2. Your logical mind is skilled at making up reasons. It looks for evidence that supports what your emotional mind wants to do. Once it finds some evidence that “makes sense”, your logical mind stops thinking (this is what Harvard psychologist David Perkins calls the “makes sense” stopping rule.)
3. You then act out what your emotional mind has decided, i.e. you fail to pull the trigger, or you exit your winning trade prematurely.
4. This leads to good trades being missed, superb winners being cut short, and finally you get into a negative self-blaming cycle.

As you can observe from the process above, there are a few problems:

1. The action you took wasn’t decided by your logical mind, it was decided by your emotional mind.
2. You would think that you are taking an action based on a logical assessment of the situation, but your logical mind has been fooled into thinking so.
   • At most points in time, there are always reasons for why the market should go up, and reasons for why the market should go down. This is the same be it fundamental or technical reasons, i.e. there are always +ve and -ve interpretations for both fundamental and technical assessments. This means that there is always ample ‘evidence’ that your mind can latch onto to support your emotional mind.
   • E.g. if your emotional mind signals to exit, you will see retracements as evidence that exiting is the right thing to do, before things get worse (extrapolation + logical mind making up “reasons”).
   • If you are bullish, a tight range will look to you like price has difficulty going down; if you are bearish, a tight range will look to you like price has difficulty going up.

Solutions

From the process flow above, we can start to think of interventions. There are a few areas of attack:

1. Awareness: You need to be aware of the psychological process at work here, especially of the fact that your logical mind wears tinted glasses when it receives a signal from the emotional mind.
2. Educating the logical mind: As much as possible, you need to remove the tools that your logical mind uses as reasons to support the emotional mind, i.e. you want to “dis-arm” your logical mind. To do that, as the market is playing out, you keep reminding yourself of what you expect to see, so that when those things come up, you already know that they are normal, and are not valid evidence to support your emotional view.
   • Exiting early: If your logical mind uses heavy selling in an uptrend as evidence that you should exit your winning long position, first you need to logically convince yourself that heavy selling, usually leading to a retracement, is extremely normal in an uptrend, that does not in and out itself, mean an end to the uptrend, the uptrend is still intact, so it is not a valid reason to exit the position. Then when you are in a long position, you keep reminding yourself that you expect to see heavy selling that will result in a retracement, so that when that heavy selling does appear, you know that it is normal, so your long position is still good.
   • Taking countertrend trades: Similarly, heavy selling in an uptrend is not a reason to take countertrend trades prior to an actual trend change. You cannot think that heavy selling means that a trade in your countertrend direction is justified.
   • Not pulling the trigger: When considering whether to enter, especially for trend change situations, your logical mind might latch on to the fact that there are forces opposing the change to say that it is too risky to enter, that it is better to wait for confirmation. However, you need to logically convince yourself that it is very normal to see forces opposing the trend change. That does not mean that the trend change is not valid. So you take the trade, knowing full well that those opposing forces will normally be there.
3. Educating the emotional mind: This attack goes to the source of the problems. To remove or dampen the anxiety generated by our emotional minds (i.e. the “negative” assessment), we need to teach our emotional minds that those types of situations are not dangerous. Two ways include:
   • Repetitions: Visualize those situations where you failed to implement your trading plan, e.g. going countertrend, exiting early, not pulling the trigger. Do it in such detail and speed that you can feel the anxiety as price plays out. Visualize yourself taking the right actions, making the right interpretations of those price movements, following your trading plan, and the trade turning out to be a successful trade. Repetitions help to train your emotional mind that the situations are harmless, there is no danger. Its just like when you sit on a roller coaster for the first time, your heart races, but after a new more consecutive rounds, those sensations would greatly dampen because you body and mind has learned that those situations are not dangerous. Another way of looking at it is that your mind has habituated to those situations such that they no longer elicit strong emotions.
   • Rewards: In those visualization exercises, visualize the trades turning out very well, imagine the pleasure pouring into you as the trades work out terrifically. You want to reward doing the right things, and associate good feelings with doing the right things. In actual trading, if you follow your trading plan and overcome your pitfalls (e.g. countertrend, exiting early, not pulling the trigger), reward ourself immediately thereafter, pat yourself on your back, feel happy for doing well.

Conclusion

In conclusion, work on the logical mind to eliminate illogical reasons that you rely on to take an incorrect action (e.g. not taking a trade, exiting early, etc.). After those are filtered, is the direction still muddy? If yes, don’t trade, else go for it. At the same time, work on the source of the issue through visualization.

To recap some of the points for the logical mind:

• In an uptrend, a good amount of selling is expected. How else can there be retracements if not for a sufficient amount of selling to turn the market down? So since you know that a good amount of selling is normal, and that it should happen, when you see it happening, it should not be used as a reason to go short (e.g. “look, heavy selling, i should go short”), or a reason to stay out / get out (e.g. “wow there is recent resistance nearby, I should stay out and watch”).
• Similarly, a good amount of fighting between the bulls and the bears is always present in any good trend. If you are conservative, you might decide to get out first, and then place a buy or sell stop just outside of the intense fighting price level. Else if you are already in a position, you can just let the fighting play out while trailing your stop. Staying in a position and tightening the stop is usually the better alternative, because any breakthrough is usually spiky. So again, such fights (which you can see very clearly in the DOM) should not be reasons that shake you out, because you knowthat you will see them, and that they are very normal.

Some points with respect to the trading plan are:

1. Trade base on the current, latest market structures that price forms as it goes about its business.
   • In intraday trading, for an uptrend, immediate supports are important, intraday resistances which are not at any significant level can virtually be ignored. For a downtrend, immediate resistances are important, intraday supports not at any significant level can virtually be ignored.
2. Intraday highs and lows are significant. Support and resistance formed intraday, that are not intraday highs and lows, are not important, except for point #1 above.
3. In an uptrend, expect resistances and heavy selling that will produce retracements. Those heavy selling are not signals to short, they are there to produce the retracements while the uptrend progresses. Similarly, in a downtrend, expect supports and heavy buying that will produce retracements. Those heavy buying are not signals to go long, they are there to produce the retracements while the downtrend progresses.

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