Trend Technician » psychology

How Bad Trading Psychology Crushed Me In 2009

admin — Sat, 25 Jul 2009 22:31:08 +0000

I’m not perfect, but then you’ve probably already deduced that. I thought I’d share some experiences with you to show how when people abandon their plan it can be demonstrative of the worst kind of psychological trading problems. These are exactly the kind of things that kill you when you’re making a trade — You enter into your position with a plan and then you decide something has “changed things,” so you abort the plan. In the end you always pay the price for this kind of behavior.

2009 has gotten me this way a couple of times. The problem is that I genuinely believe we’re in circumstances unlike any we’ve seen before. This causes me to “rethink” things far too often for my own good. Here’s a typical example of what I’ve done a couple of times. I decided at one point to go long TLT (Long Term Treasuries) as a hedge against some other positions. I sold a call off the position as well to limit my downside. The plan was if the trade moved the other way I would double up the position to increase my exposure and even out the hedge.

So of course TLT has a huge downward move, much larger than I expected. I start thinking about the economy and I get worried and I decide just to let my current position ride instead of doubling up. Of course TLT recovers part of the way. Had I doubled up my position as I had planned when I entered the position, that trade would have become a neutral one. Instead it was quite a loser and offset the gain in the position it was hedging.

I committed similar folly with a position in energy stocks. Basically I keep convincing myself that the unprecedented market conditions overcome my plan. Don’t get me wrong, it’s fine to decide that unanticipated news has affected your plan. But when this happens, you need to close out your position, take a step back and decide what makes sense. Instead I tookthe “middle ground” and start improvising and making it up as I go. This is completely self destructive. Once you have a plan, you stick with it.

Read more about psychology in my Trading Psychology feature.

Photo Credit: George E. Norkus

Don’t Trade Without a “Stop”

admin — Thu, 16 Jul 2009 21:11:23 +0000

If you’re trading without a “stop,” you are playing Russian Roulette with your money. “Stop Loss Orders” or “stops” are orders you place with your brokers to indicate that if your position moves against you to a certain point you will exit the trade. You have a “stop price” where if the issue trades at that price or worse, the order turns into a market order to sell or buy. Many traders don’t actually place the order but have a price at which they will exit the trade, which they still call a “stop.” In fact some traders prefer not to place an actual order because they fear they will influence price execution and get “stopped out” when they wouldn’t have otherwise. Regardless of how you execute the exit, you should never enter any position without a price at which you know you’re wrong and get out of the trade.

The Psychology of the Stop

The psychology of trading is fraught with peril. In many ways once the trade is on you can become fixated on making that trade work out. The problem is, when you’re doing the research and working out your trade, you’re perfectly rational. Once you’ve placed the order however, you can start lying to yourself and costing yourself money by convincing yourself to stay with a trade that’s turned against you. By always trading with a stop, you can set the extent of your trade while you’re still acting completely rationally. This can be a huge money saver.

When you’re deciding to enter a trade, you should be deciding a priace at which you’ve been proven wrong. You have reasons why you think the market is going to move in a certain way, which is why you’re considering entering the postion. You also need to set at what price your analysis no longer holds true and it’s time to get out. By doing this while you still have all your pros and cons fresh in your mind you can make the best decision and prevent yourself from taking unnecessary chances.

Moving the Stop

SPY With Parabolic

Another key thing to remember is that once you’re in the trade you don’t just forget about your stop. By moving your stop you can also keep from giving back all your profits or making other costly mistakes. Never let a profit run into a loss. Here you can see a subsection of a chart of the S&P 500 Index [Trend Analysis]. This chart has the parabolic indicator overlaid on it which is one strategy for moving your stop while in a trade.

We’ll discuss Parabolic in another article, but it provides a useful visual of how a stop might move during a trade. It also illustrates that this also doesn’t apply only when going long but when going short as well. You should always be looking for when you’ve been proven wrong and cut your losses when you have been.

You Don’t Have To Always Be Right

No one is right all the time, and trading with stops are simply a matter of managing your money to reflect this. If you are right only one half of the time but make more when you’re right than you lose when you’re wrong, you will have success. You are trying to play the odds and you want to make sure that when you’re wrong, you minimize the damage and that when you’re right, you maximize the reward.

Ultimately the stop is your protection from catastrophe. Many people don’t want to be wrong, but I’d rather be wrong with money than right without it. One key thing that many traders forget is that being stopped out of a trade doesn’t mean you can’t retake a position, it simply means it’s time to re-evaluate and make sure your trade still makes sense or wait until it does again.

Photo Credit: Kass & Rachel

Trading Psychology

admin — Wed, 01 Jul 2009 02:27:54 +0000

Mastering psychology is easily as important as any other type of analysis involved in trading markets. There are two psychologies you need to be worried about, the markets and your own. Your own is much easier to read but can still be very hard to control.

Discipline

Trading psychology is much easier to identify than to control. Many times when we’re trading we will decide that this particular case requires a different set of rules than the usual case. This is usually the first step towards a bad trade.

Ups and Downs

One of the first issues you will have to purge from your behavior is the mood swings that can come from trading. When you win you are a genius, when you lose you are a failure. Eventually, if you are going to be successful, you must learn to simply see wins and losses as inevitable parts of the process. Wins and losses have hundreds of different sources and your primary goal should always be to put the odds in your favor. You can make the right decision and still lose money or leave money on the table. You want to be a trader, not a gambler.

Getting Your Money Back

One of the most damning reactions to losing money is to try to “get it back.” Once again you must view losses as simply parts of the process. You will have losses. There’s no way around it. If you can be right even half the time, with good money management that can be enough to make a fortune. However if you let your losses destroy you in a desperate attempt to “win” every trade, you are doomed to turn minor losses into catastrophes.

Self Destruction

Another characteristic that plagues traders is the instinct to take a success and turn it into a loss. As people decide they are brilliant and have “beaten” the market, they start to take more risks and bend their rules. This is when they turn self-destructive and bring ruin on themselves. Just as you can’t let your losses destroy you, you can’t let your wins do so either.

The Rules

The key to successful trading is to develop your rules and then stick to them. You need to develop your own system and don’t let dreams of riches or fears of doom derail you. While it’s important to always be updating and tweaking your system, you mustn’t develop them in the middle of a trade. While your psychology can be difficult to master, once you have you need only start to try to identify the market’s psychology. Thus you’ve removed dangerous variables.