Trading Psychology.
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Although developing the perfect mental condition is a topic usually reserved for day traders and professionals; their lessons can maximize the effectiveness of our trading.
Successful traders realize this fact of life: Just because you bought a hundred shares of a stock that every technical indicator screamed “buy me”, doesn’t mean the collective actions of the market will help that stock go your way. And it’s the collective actions of the market that move your stock.
Grounded traders accept the uncertainty of the market. He (or she) is not caught off guard if the stock trade fails to profit. Why? Because uncertainty is part of the game, just like any business endeavor. He is not financially devastated because an exit strategy automatically minimized his losses.
The acceptance of risk is one of the most important qualities a trader can have. Trader psychology is about keeping emotions away from your trades. However, noticing what you feel brings insight and clarity.
• Don’t blame the market or the stock for your losses. Look at the situation and figure out what you could have done different. Maybe you should've went short, maybe you should've never entered the trade. The stock market offers unlimited opportunities to make money. Take your loss (set at 8% - 10%) and move on.
• The media isn’t that smart. During the “credit crisis” of September ’07, news shows and newspapers were predicting the impending doom of any bank that held a mortgage on their balance sheet. Stocks were dropping, hedge funds were losing money and even I thought to sit on the sidelines for a few months. What happened a short time after? Several great stock market rallies.
The media will summarize the current situation as an easy to understand marketable sound bite. When the scenario changes as it will, the media is off to encapsulate the next thing. I can't imagine a team of economists feeding Maria Bartiromo the latest data feeds.
Don't let the media shape your view of the market. The only thing they are right about is today and yesterday.
• Volatile markets are easier to understand when you recognize it’s about the irrationality of the participants. Don't look for meaning where there is none.
• Stock prices are impossible to predict, but it has been shown that volatility will cluster. Big price moves seem to attract other big price moves. And small price moves attract other small price moves. Look at a chart and see what I mean.
• I’ve said this before but risk management controls are essential to making money. In other words, initiate a stop loss on every stock and you won’t have to hope your trade recovers from a 40% drop.
You may have read this before, but according to trading psychology, hope and fear screw with a trader’s logic. Hope that the stock you bought won’t go lower. And the fear if you don’t sell soon enough, you’ll lose your profits.
How do we keep level-headed?
One of the first stocks I traded was CNTY, a resorts & casino company. I forgot how many shares I bought but I made about $2,300 on my first shot. I picked the stock because I liked the chart. I didn’t do much research.
After my windfall I was convinced I could beat the market with my chart reading prowess. I bought CNTY again with my entire trading capital and watched my account shrink quicker than a cheap cotton t-shirt washed in hot water.
I learned two things. I made money based on a random event. Not because I found a stock that had probabilities in my favor. I deluded myself into thinking I could rip a hole into the stock market. My confidence was shaken and everything I thought I knew about chart reading was in question.
My "random win" had me looking for charts that matched CNTY's profile. My "random lose" had me thinking I better stick to mutual funds.
And last but not least, by going for a home run, I knocked myself financially out of the game for a couple months. My money is now made by going for singles.
Consistency does not exist in the stock market. You’ll win a few and lose a few. You can however, consistently minimize your losses. The best traders believe without a shred of doubt, that anything cam happen.
Success is determined monetarily in trading. Not by how well you play with others. Don’t freak out if you lose on several trades. It’s only the big picture that counts.
As Bernard Baruch says "If a speculator is correct half of the time, he is hitting a good average. Even being right 3 or 4 times out of 10 should yield a person a fortune if he has the sense to cut his losses quickly …"
Keep trading decisions limited to which stocks are currently trending up or down. Not to stocks you hope might trend up or down. If you can truly do this, you’ll be ahead of so many other traders.
Ok, our trading psychology therapy session has ended. I’ll see you same time, next week. Don't forget your daily affirmations.
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