Additional knowledge is not always advantageous when trading financial markets since certain information might make us more fervent in our beliefs and ideas, causing us to make bold forecasts that turn out to be incorrect. When actual money is on the line, incorrect forecasts may be expensive, particularly when we take positions against the current market movement in expectation of a sudden and dramatic shift in price direction, but the reversal never occurs.
Investors, particularly short-term traders, are typically better off waiting for price action to confirm a trend or reversal than than attempting to forecast what will happen next. Let’s start with the reasons why anticipating might be difficult, and then look at several methods we can rethink our thinking to achieve a competitive advantage.
- Market forecasting is difficult since the future is fundamentally uncertain.
- Short-term traders are usually better served by waiting for confirmation of a reversal rather than attempting to forecast a reversal in the future.
- Price action may be seen as a sequence of waves as an alternative to forecasting future price movements.
- Setting key buy and sell points should be based on what the price is doing rather than what we anticipate it to do.
The Problems with Prediction
Why is forecasting difficult? There are many causes for this.
The Future Is Uncertain
No matter how effective our analysis is, it is only as good as the data that is now accessible. We can’t predict what will happen tomorrow. Analysis of future movement is done with the assumption that “everything else is equal.” This suggests that we expect a stock will rise based on a trend if things continue as they are.
We Can’t Predict All Contingencies
While everything remains equal on some (many) days, there are always days, weeks, months, or even years that defy the odds. Predicting may be particularly risky at these times if assumptions are wrong. For example, anticipating that something would rise while prices are decreasing might ruin a trader’s money, particularly because we don’t know how the market will respond to fresh news or information. When prices are dropping, even good news may not cause them to rise much, and when prices are increasing, even terrible news may not have a long-term negative influence on prices.
Individual Stocks Don’t Necessarily Follow the Overall Market
Individual security analysis is often reliant on general market sentiment. This might imply that a trader anticipates one stock to grow while the market rises, or vice versa. This does not always happen, particularly in shorter time spans. Unfortunately, another situation happens when a trader anticipates one company to thrive while the rest of the market falls.
Traders must be aware of both market and individual stock trends. In any case, whether in the general market or individual stocks, we want to trade in the direction of current cash flows, not against them.
Predictions Can Be Vague
Predicting that a certain stock will rise in value is speculative, and the investing choice will almost never contain a profit or stop-loss exit point. While this is not always the case, novice traders anticipate that their stock holdings will climb and believe that if they are accurate, they will be able to exit near the peak. In practice, such a hazy strategy seldom works out. As a consequence, whether the transaction results in a profit or a loss, all traders must have a strategy for how they will enter and exit a trade.
The Holding Time for Stocks Has Decreased
The volatility of the stock market has grown throughout time, while the holding duration for assets has decreased. Buying and holding is still a feasible strategy if the approach is well-designed (as with any trading method), but because of restricted money, buy-and-hold investors must be aware that volatility may reach very high levels and be prepared to wait out such times.
Given the heightened volatility, active traders operating on shorter time frames should trade in the direction of price movements, and even short-term swings may maintain overbought or oversold levels for lengthy periods of time.
Prices Rarely Move in Straight Lines for Long
Predictions are often based on strong emotional feelings—the greater the sentiment, the bigger the trader may anticipate a price response to be. As a result, the trader expects the stock will advance in the expected direction in a straight line, resulting in significant winnings. When we consider all of the securities in the world and then consider temporal factors, owning a position immediately before a large move is statistically exceedingly rare.
Traders are significantly better off trading the averages and trading in the direction of price movements to profit than waiting for a single transaction or stock that climbs dramatically in their favor in a short period of time.
Even for the most seasoned trader, producing consistent gains from short-term trading is incredibly tough, whether trying to anticipate the market or not.
Alternatives to Prediction
Given that attempting to foresee a market turning moment may be quite expensive, one would wonder, “If I can’t predict, how can I earn money?”
The solution is to follow the price, which we can achieve by memorizing a few mantras. They are not a full list of market dynamics, but they are significant.
- Prices change in waves. After comprehending the issues raised above, all traders must grasp that prices move in waves on all time periods. This indicates that, even if prices fall, traders should not panic and exit positions as long as the longer trend is up. They should, however, have an exit strategy in place in case prices do not continue to rise in their time period. Short-term traders may trade in each of these waves, but they must stay fluid and not be bound to one way. Predicting that prices will move in just one way ignores the reality that prices fluctuate in waves.
- Don’t count on either support or opposition to last. A widespread misunderstanding is that support or resistance will hold, or that a breach of these levels would result in a significant breakout. What traders anticipate frequently depends on the position they have. Traders must understand that support and resistance levels are merely crucial price regions. Making assumptions about whether a breakout will occur or if a level would prevent a further move is an effort to forecast the market.
Rather, traders should observe what happens around these levels and then enter when momentum shifts in either direction. If resistance persists and prices fall, a short position, for example, might be taken. If a breakthrough happens, then trade in the breakout direction. Remember that false breakouts occur and that prices fluctuate in waves. Don’t become too attached to a position just because it made money for a while.
It is best to conceive of support and resistance as price pivot points and regions to seek for entry and exit points. We are not projecting anything or going against the current price trend by doing so. We instead input the current price flow. This makes trading a “matter of fact” rather than an emotive one. We have identified critical levels that will assist us in isolating the price waves that a market is experiencing. Then, when prices react at these levels, we may take a comparable position.
The Bottom Line
Traders gain from being flexible in their positions and not being wedded to a certain direction due to a projection. Predicting the markets may be risky, and in the end, forecasts aren’t required to earn money investing.
We may join trades at crucial points by understanding that prices fluctuate in waves and that we should never assume that important levels will hold or break—but only in response to what price is really doing, not what we anticipate it to do. Understanding this should put traders on the right side of the transaction rather than the incorrect side.
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