Why Your Stock and Crypto Picks Drop Every Time You Buy — And What To Do About It
As a new stock or crypto trader, you might have experienced the frustrating phenomenon of continually seeing the price drop shortly after entering your positions. It’s a common situation that often leads to doubt and disappointment.
However, take solace in the fact that you are not alone; all inexperienced traders face the same challenge.
Technical and Psychological Reasons For Failed Trades
Understanding the reasons why traders often fail can empower you to develop a winning strategy for buying low and selling high.
The simple explanation for why price often falls just after you take a position is that prices do two things: They go up, and they go down. At any moment, a price is about as likely to drop as it is to rise.
During accumulation periods or downtrends, the odds are 50/50 or worse that the price will drop. In an uptrend, there’s a slightly better chance of a price continuing up rather than dropping.
Psychologically speaking, the reason most people see their trades fail is due to FOMO — the fear of missing out. They see the price going up fast and don’t want to miss out on the profits, so they buy. But the higher the price goes, the more chance that it will turn around and go back down.
It’s hard to train yourself to buy when the price is down rather than up, but it’s an essential mindset. Set your feelings aside and rely on technical indicators like moving averages, RSI, and Bollinger bands to make sound entry and exit decisions.
One of the main reasons traders fall into the trap of buying high is the Fear of Missing Out (FOMO). When the price of a stock or cryptocurrency rises rapidly, traders often succumb to the pressure of not wanting to miss out on potential profits. This emotional response can lead to impulsive buying decisions, often when the price is already stretched far above its moving average.
A Simple Strategy for Swing Traders
To avoid the common pitfalls of buying high and selling low, swing traders can adopt a straightforward strategy based on moving averages.
Identifying Support and Resistance Using Moving Averages
Moving averages play a crucial role in understanding the trends and price movements of assets. They are technical indicators that provide traders with valuable insights into an asset’s average price over specific periods of time. When the price of an asset significantly deviates from its moving average, the chances of a change in momentum become higher.
While using subjective support and resistance lines is popular, they are static oversimplifications. Moving averages act as dynamic support and resistance.
When the price is above the moving average and ramping up, it tends to act as support if the price comes back down. Conversely, when the price is below the moving average, the curve acts as resistance.
Any time a price deviates substantially, the moving average can act as an attractor, pulling the price back toward equilibrium.
It’s best to set moving averages to values most commonly used by other traders to trigger buys and sells. Personally, I use 10, 20, 50, 90, 120, and 200 exponential moving averages (EMAs). (I also use Bollinger Bands, RSI, MACD, and sometimes Heikenashi Candles to help confirm trends.)
Here’s an example with EMA10 in red, 20 in orange, 50 in yellow, 90 in green, 120 in blue, and 200 in violet.
As you can see on this weekly $MSTR chart, these EMAs clearly act as resistance and support. And the further the price deviates from the long-term moving averages, the more volatile the price gets.
Entering a Position
Look for opportunities to buy when the price bounces off a rising moving average, signaling a potential continuation of the uptrend. A double or triple bottom pattern, where the price touches a specific support level a few times without breaking below, can offer an especially good buy-in opportunity. This pattern indicates buyers are stepping in at that level, creating a solid support zone.
- Never buy when an asset is overbought (hanging around over 70 and turning back down on the RSI), especially if it’s hot.
- Go find an oversold asset that’s gone cold (RSI bouncing around below 30).
That might sound oversimplified, but those are rules one and two of trading in my book. Even then, a good portion of trades fail.
Exiting a Position
When the price hits resistance at an EMA and begins to fall, it’s a sure sign to consider selling. Exiting a position near resistance can help lock in profits or avoid potential losses if the price retraces.
For example, if a price starts rising away from the EMA 20 on the daily chart, look for the next potential resistance level at EMA 50. If the price is on a bull run and above all of the EMAs, go to the weekly chart to look for potential resistance levels.
Don’t worry that the price of an asset might continue to climb after you sell it. Just go find another asset for which the price is almost certain to climb.
It’s imperative to implement proper risk management techniques, such as setting stop-loss and limit orders. This ensures your losses are limited if the trade doesn’t go as expected and you book a profit if it does.
Moving averages can be invaluable in determining where to place stops to mitigate risk. If you see a 10% gap down to the next lower moving average and a 20% gap to the higher moving average, this is 2-to-1 — a good bet. Conversely, if there’s only 10% headroom but 20% down to the next support, it’s probably a bad bet.
If you stick with this formula, you only need to profit on a little more than half of your positions—a 1-to-1 ratio of wins to losses — to not lose money. Once you get good enough to hit a 2-to-1 ratio of wins to losses, you’ll be making good money.
As frustrating as it may be to see your stock picks drop right after you buy, understanding the psychological factors and technical indicators can empower you to make better trading decisions.
By adopting a simple swing trading strategy based on moving averages and recognizing support and resistance levels, you can increase your chances of buying low and selling high.
Remember, successful trading requires discipline, patience, and a solid risk management approach. So, the next time you’re tempted to chase a fast-rising stock, take a step back, analyze the charts, and look for those resistance levels and promising buy-in opportunities.