How to Trade a Changing Market

This column was originally published on RealMoney on June 12, 2007 at 2:07 p.m. ET. It's being republished as a bonus for TheStreet.com University readers. For more information about subscribing to RealMoney, please click here.

Last week I heard a newer trader airing some frustration. He said that over the last several months he has been trading very well. He had a routine down, his averages were consistent, and he was feeling confident. But since last week, he has been taking one stop after another. The market changed, and he lost his bearings. It is important not only to recognize that change but to have familiar strategies to use after the change has taken place.

The truth is that it's relatively easy to trade in a bullish market . Any reason to go long is usually a good one. But a changing market is where most traders run into problems.

Trading a Negative Market

The tide floats all boats, even those with powerful motors. So when you are trading news stocks, you have to adjust your targets according to the type of market. Since June 1, we have been trading in a weakening market. On June 1, 4 and 5, we had a fairly flat, slightly downtrending market, and on June 5 and 6, the downtrend picked up some steam.

Even in a negative market, if a stock has positive news, a strong premarket gap and active premarket volume, I will still be looking for a long position off the first bottom. To adjust for the downtrending market, however, I will look for deeper pullbacks before entering, and my upside target will be reduced. I will then want to turn around and short the first top.

I will also be aggressively looking to short any overbought situations. If a news stock gaps up a large percentage and then climbs from the open, for example, in a downtrending market, I am much more willing to short that first top. If I saw that same situation in a strong market, I might pass on the short and look for a long position on the first pullback instead.

Trading a Flat Market

Flat markets are the most difficult to trade. When the market is not really showing a strong bias in any direction, I won't be aggressive with either longs or shorts, but I will be more selective. Instead, I move into what I call "scalping mode," where all of my trades have conservative, reduced targets.