It doesn't really matter exactly how I know, as it's not particularly critical to the discussion. How it looks when the trade isn't working can be a part of your trading plan, and it will be different for different types of trades. But, we can do an example. Let's take, for example, a retracement in an uptrend. This can be a reaction to about the halfway point between the last swing low and swing high, a 38% reaction if you are a fib trader, or a pullback to some measure of central tendency such as an EMA as in Linda Raschke's "Holy Grail" trade. In this example, the trade is to enter long at a predefined retracement area.
OK, so you're long. Now, what does a bad trade look like? Well, you want to see your trade go higher in price, right? And, it should move with some upward momentum with volume expanding as price moves higher with good closes. And, we'd like to see it moving in our direction within a reasonable time. Linda Raschke says the best trades start working almost immediately. OK, that's what we want to see as confirmation that the trade is working.
What if after we enter long we get 4-5 bars that all hug the bottom of the reaction and close on their lows? The market is saying it might not be able to get lift off and move higher. That's trouble for our long position. Or, we get a bar or two of good movement up, but the market reverses on the next bar and takes out two days of decent upside progress on heavy volume and closes on its low? That's not good for our bullish position. Or another possibility might be that the market moved up to the last swing high (now a potential resistance point), has trouble getting over the resistance, and begins coming back down toward the entry area with wide price spreads, increasing volume, and poor closes.
All of these scenarios signal that supply is coming into the market and is working against the (long) trade. If I calmly and rationally see this happening with my trade, I know the trade is not working and it is best to exit with a small loss, small gain, or break-even rather than sit anxiously and hope that what I see isn't really happening and that the market will turn around and prove me right. Given these scenarios, the odds are very good that the market may break through support (where the long was initiated) and cause a significant loss.
As mentioned in the earlier post, its more of an attitude one can develop that helps a trader remain open to the unfolding market conditions and flexible in his or her behavior. When we are so concerned with being right, anything that the market does contrary to our position immediately causes anxiety. We are not open to what the market is telling us. When the market runs contrary to what we want and we are not open to what the market is saying, the typical behavioral response is to become frozen with hope and anxiety. That hasn't been a good way to trade for me.
Whit
