This Market Is Hard but Not Impossible - TheStreet

Editor's Note: Alan Farley's column runs exclusively on RealMoney.com; this is a special free look at his column. For a free trial subscription to RealMoney.com, click here. This article was published May 30 on RealMoney.

Baby, it's getting cold out there. I've been getting a lot of emails from experienced traders ready to hang up their gloves. It's been so brutal, the setups these pros rely on to pay the bills have stopped working completely. Keep in mind that these aren't your typical buy-'n-pray momentum-heads. They are the genuine artists, craftsmen and keepers of the market flame.

Just how tough is it right now, and what is it that's giving so many traders a case of the fits? Let's start by recognizing that not everyone is having a tough time. In fact, a cadre of players are headed for the best year in their trading history. Somehow they've tuned themselves to the market in a way they can take to the bank.

First, the Bad News

What are the real obstacles in today's trading environment? First, there's no upside momentum. This is a big deal, even in a bear market, because so many traders rely on it. The damage done by this missing link is subtler than you might think. Many stocks are still in active uptrends and hitting new breakouts. But entry signals for these stocks are triggering right where they cause the most pain.

This is the one-hit-wonder syndrome. You see a breakout, it sets off a buy signal, and you jump in. But the stock just sits there and goes nowhere while its newfound strength slowly ebbs away. After a while, it rolls over from its own weight and triggers your stop loss. To add insult to injury, the stock then magically recovers without you and moves higher.

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The market suffers from illiquidity not evident in the daily volume. Scalpers now make up a fair share of all trading activity. Subtract their frantic activity, and the rest of us have to work in an odd, disconnected environment. Look closely and you'll see a strange oscillation in which buyers or sellers are active, but not both at the same time. Conflict is a good thing for market health, because it breeds resolution and sustainable trends. When the tape just flips from one side to the other, it lowers predictability and muddies the landscape.

No doubt this should be a short-seller's dream market. But many traders are finding it just as hard to turn profits by short-selling as by going long. How can this happen in an obvious downtrend? The answer lies in timing and liquidity. Short squeezes are following many natural entry triggers. And when a good selloff does start, it frequently has a stealth quality that makes it hard to recognize in the early stages. This invites a late entry that also faces a high short-squeeze risk.

The Good News

I'm having a good year and often wonder what lets me prosper in these adverse conditions. I know part of it is due to the natural power of swing trading and how it enables you to adapt to changing markets. But it goes deeper than that. I prefer sloppy markets, and I enjoy the twists and turns overlooked by other traders. I'm also a natural-born coward. This underappreciated trait has been saving my neck, as well as other body parts.

My pattern-reading skills are more attuned to seeing danger than to seeing opportunity much of the time. This raises constant red flags on positions that are already in the money. I find myself with an itchy trigger finger when it comes to jumping ship. This isn't how I like to trade, but it's been a lifesaver this year. My average profit has gone down, but I've retained a high win-loss ratio for my trades. This convergence keeps me in the game but also requires more work than usual. No one said this would be easy.

"Collaring" is one of the more subtle aspects of position strategy. A trade collar is just like the one you put on Fido to keep him in check. The markets cycle through many phases of danger or opportunity. Common sense can tell you the nature of the current phase most of the time. Use what you see, and apply the right collar for that particular market. Simply stated, be aggressive in times of greatest opportunity, and be defensive in times of greatest danger.

Collars signal when to let profits run and when it's the worst thing you can do. They also define the right stock to trade at any point in time. For example, go after volatile

Nasdaq

stocks when the collar is loose and the market is printing money. But stick with lower-beta

NYSE

stocks when opportunity is low and hidden danger lies around the corner.

Alan Farley is a professional trader and author of

The Master Swing Trader

. Farley also runs a Web site called

HardRightEdge.com, an online resource for trading education, technical analysis and short-term investment strategies. At the time of publication, Farley did not have any positions in any of the stocks mentioned in this article, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback and invites you to send it to

Alan.Farley@TheStreet.com.

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