Stock Trading 101 – Markets Overshoot

Every trader wants to buy at the bottom and sell at the top. However, to sell at the top will most of the time be pure luck because no one knows how far prices want to move because of their tendency to overreact. Being somewhat close to the top is what one should aim for. Let’s take a look at the recent volatility in the Swiss franc that forced the Swiss Central Bank to peg the franc to the euro in an attempt to curb speculation.

Look at August 9^th 2012 when the trading range of the franc for that day was 1.3182-1.4167. This is a 7.5% potential price change and this type of action is completely off the charts and defies standard statistical modelling. This is a complete outlier that should never occur because the probability of such a move taking place is extremely low to non-existent. Yet we see such events in the markets all the time and when they take place the volatility dramatically increases and standard deviation principles go out the window.

 So be aware when aiming to close a position at the top or trying to predict it in order to enter a short trade. Chances are you might manage to correctly calculate it, but remember that when this happens it might be pure luck and don’t get too overconfident in your ability. The markets are the most uncompromising force that can quickly humble your ego down if you are not careful.