How to Play a Slow, Choppy Market

So once you recognize a potentially narrow, choppy day, what do you do? When I suspect a narrow day lies ahead, there are three things that I need to remind myself to do.

1. Be patient.

   Being patient means refusing to trade all but the highest-quality setups, even if that means you wind up doing nothing that day. It's easy to "let the trade come to you" when there are trades coming at you left and right. It is much harder to be patient when good setups are few and far between. But that is what separates the pros from the amateurs. Many times the difference between success and failure isn't in the trades you make but in the trades you don't make.

2. Lower your expectations.

   If I suspect the day will be narrow, then I need to set my targets lower. That sounds logical and obvious, but once we are in a trade, it's amazing how easy it is to fall into the traps of hope and greed. Who doesn't secretly hope against hope that your next trade will exceed all expectations? So it's a constant battle with yourself not to fall prey to emotion but to follow discipline and to exit conservatively on narrow days.

3. Go where the action is, but play it safe.

   There are a few stocks we have been trading lately that have wider ranges, larger swings and more potential for daytrades, particularly on narrow days when other stocks are not offering us much momentum. Among them are Baidu(BIDU Quote), Google(GOOG Quote), First Solar(FSLR Quote), SunPower(SPWR Quote) and DryShips(DRYS Quote).

   These stocks are very fast traders, though, so I would not encourage anyone to trade them unless they are very good at controlling their trades and their emotions. One moment of hesitation on these can skin you alive, so you must be able to keep your stops.

Let me give you an example of a morning trade from yesterday that combined all these narrow-day rules.

DRYS has been a hot stock in a hot sector since posting stellar earnings last week, and it has been a great stock for momentum trades. Yesterday it gapped down from Friday's [Feb. 1] closing price of $74.29, to open at $73.75. With a 54-cent gap down, the rubber band starts to stretch. My job is to figure out when that rubber band will predictably snap back. When will short-term buyers step in? How far down would it need to drop, in a choppy and narrow market, to entice me into a trade?

The market bias is going to influence where that rubber band snaps. Let's rate the market from -10 to +10, where -10 is very bearish and +10 very bullish . If the market were at -10, I would not play DRYS until it dropped from $74.29 to about $65. I would wait until I saw that large of a drop, because it will take a lot more temptation before greed "predictably" begins to overcome the fear, in a negative market. If the market were at +10, though, I would target around $73.80 to $74 for a long entry, because it won't take much temptation for buyers to jump into a hot stock in a strong market.

In a choppy, narrower, mixed market, I need to look for something in the middle. From tracking the recent action of that stock, I would be willing to buy DRYS after about a $2 selloff. So from $74.29, I would start to be interested around $72. Yesterday morning, as it started selling from the open price of $73.75, I watched as it moved down to $73 ... $72.50 ... $72 ... where I started getting interested, and began looking more closely for a bottom. Once it got to $71.50 and below, that exceeded my target for an entry, and that to me is a high-quality setup.

The risk was lower, because I had waited for my criteria to be met, the rubber band was stretched to a predictable level, and the trade was developing some excellent momentum. I waited for a high-quality setup, and let the trade come to me. I could control the trade and keep a reasonable stop . And I didn't expect the world. The trade moved up from $71.20 to $73.92. I can't reasonably expect more than a move back up to the open price in a narrow market, so I need to take whatever I can get and exit conservatively.

Those are the types of setups I look for, and if I don't see them in a narrow and choppy market, I would rather do nothing at all.

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