Thursday, March 26, 2015

Sometimes It Is Best To Do Nothing!

I never buy at the bottom and I always sell too soon. -Baron Rothchild

I am well aware that many, including myself, have been a little confused and daunted by the markets action of late. During these times we need to avoid the big pipe dream, the pure hope, the thinking we have to make money today. Many if not all of you have a plan, a goal in mind on where you wish your trading to take you. Be careful how you define your goal. Perhaps your goal is to make $100,000 per year in the markets and that's wonderful, however if you break it down into to finite a goal you will defeat yourself. Breaking down the $100,000 into roughly 250 trading days per year equals $400 per day or $2,000 per week or approximately $8,333 per month. Sounds great and easy, doesn't it? However, there is a flaw in this thinking?


Setting a goal based on earnings every day (or week or month) and you will feel compelled to trade. What if the markets do not move very much today? What if everything is quiet waiting for a piece of news? It may be best to stay out of the market completely rather than fail at what could be a low probability trade. Another problem - what if you fail to make your $400 today due to a lack of opportunity (let's not even consider a losing day). Now the next day you will feel compelled to attempt to make $800 to make up for your no profit day, then $1200 and so on. Your stress level will be elevated and you may well begin a never-ending cycle of frustration and disappointment.


Setting a more appropriate goal will probably relieve the frustration. It's useful to have a rough idea of how much money you want to make, but setting a specific dollar amount that you must achieve on any given day (week or month) is often a hindrance. If you are new to trading and the most you have made is $15,000 in a year, then setting a goal of $100,000 is probably very unrealistic. You are setting yourself up for failure. Perhaps, an increase of 20% is more appropriate. Because if you fail to reach your goal, you will feel frustration and disappointment, and may start trading based on your emotions, the death Nell of many good traders. 


Professional's know how to patiently wait for the opportunities to come to them. They do not impose their will on the market. That is what traders are doing when they set a performance goal in terms of a specific dollar value over a specific period of time. Winning traders patiently wait for market conditions where they know they can excel. They understand that the same quiet market will handsomely reward them if they are patient. It's also useful to remember that all that really matters is performance across a series of trades. Many traders can lose 60% of the time, then happen upon a winner of many thousands that offsets previous losses accrued across a series of trades. 


When you are setting goals, it is very important that you keep them in perspective. Set goals that are equal to your skill level. As your skill level improves then reset your goal. Shooting for goals that are beyond your skills will frustrate you more than motivate you. And please remember that you cannot impose your will on the market. You do not know what market conditions will be until you see what they are. If optimal conditions are not there, you cannot do much about it. You must accept what the market is willing to give you, which may mean patiently waiting for conditions to change. By doing so, you may not profit every single day, but over the long run, you will be a consistently profitable trader.


Thursday, March 19, 2015

Trading Personalities

Companies that get confused, that think their goal is revenue or stock price or something. You have to focus on the things that lead to those.
Tim Cook

Part of developing a mental edge is becoming aware of your personality and working with it, or around it, not trying to change it. Personality traits are people's tendencies to behave consistently across time and across situations. Can you identify key traits in your personality and become aware of how they may influence your trading decisions?

There are many characteristics that can be used to describe someone's personality: friendly; creative; or argumentative, are a few examples. When it comes to determining your own personality style, it's most often not a "black and white" issue; there are many shades of gray. Some people are friendly all the time, other people are unfriendly all of the time, but most are friendly some of the time, but not at other times. For some their everyday personality bleeds over into their trading life however, for some their trading personality is distinct from their everyday personality. We as traders need to decide just how much of our personality will impact our trading.


Some personality traits are especially pertinent to the profession of trading. Some are intuitive while others are more concrete and analytical. Many traders are risk averse, while others are impulsive and seek out risk. Each style has its advantages and limitations. Know which style describes you, and how accurately it describes you. Your personality style may influence your trading decisions.


Three popular trading personality types are intuitive, data crunchers, and impulsive. The data-oriented trader focuses on concrete evidence and is often very risk averse. Seeking out as much supporting data for a trading decision as possible. The trader who prefers to do extensive back-testing of a trading idea exemplifies data-cruncher type. Consider incorporating elements of data oriented trader personality into your trading style regardless of your natural inclinations. Make sure that you have adequate information (a reason) before executing a trade. Particularly important is to have and trade a detailed trading plan in which risk is minimized and entry and exit strategies are clearly specified. Most often however, the data-oriented trader may take things a little too far. Searching for "the perfect" set-up or other criteria, that just doesn't exit in the trading world. At some point, one must accept the fact that he or she is taking a chance and no amount of data analysis can change this fact.


The intuitive trader is the opposite of the data-oriented trader. Trading decisions are based upon hunches and impressions rather than on clearly defined data. There's a difference between being an intuitive trader who develops this style over time and one who is naturally intuitive. The experienced intuitive trader, bases decisions on data and specific market information. A seasoned trader, analyzes the data quickly and efficiently. It happens so quickly that it seems like it occurs intuitively, but it is actually based on solid information. Ideally, all traders should gain extensive experience to the point where sound decisions are made with an intuitive feel.


A third trader personality type is the impulsive trader (gambler). This is the most dangerous style. The impulsive trader allows his or her decisions to adversely influence trading decisions. Rather than looking at information logically and analytically, information is discounted completely. The impulsive trader seeks out risk and enjoys taking risky, exciting trades. Impulsive traders can often make huge profits one day and see large draw downs the next. Your personality can have a huge influence on your trading performance. Identify your assets and liabilities, and work around your personality when it is necessary.


Thursday, March 12, 2015

Gut Instinct

The wise are instructed by reason, average minds by experience, the stupid by necessity and the brute by instinct.
Marcus Tullius Cicero

Nobel laureate Herbert A. Simon, a professor of psychology and computer science at Carnegie Mellon University who has studied human decision making for decades, thinks that we are able to develop a "gut instinct" because experience enables us to "chunk" information so that we can store and retrieve it easily. Our brains then "cross-index" this stored information, automatically finding patterns in one area that correspond to patterns in another. 


When you look at a chart, in 10 seconds or less your brain will tell you - Yes this is worth a further look, or just hit the button and NEXT. In other words, your gut instinct tells you more than you can logically know, because it represents much, much more information than you could ever logically process.


That being said, most traders will admit that sometimes their gut instincts have been wrong. That is nothing more than the nature of the beast we love. You are going to be wrong, don't let it bother you it's a part of this business. What your instinct is telling you is simply that you have come upon a "high probability trade", not a guaranteed one. A good gut instinct in trading is developed through experience as it is in any other profession. The more experience you have the more information your mind retains, the better your gut instinct becomes.


Be careful though, not to misinterpret your experiences. We all have that capacity. If you misinterpret your experience and allow that misinterpretation to become part of your subconscious programming you will defeat yourself. Also be careful on your perspective about what has happened. If you ask four traders to interpret what just happened you are very likely to get four different interpretations.


So how do you educate your gut instinct? How do you develop a powerful intuition that is much, much better than that of the average trader? Trust more in your experience than the experience of others. Remember, the experience of others may be distorted by misperception or miscommunication. Your experience, if you are lucid, is genuine. 

Trusting in your experience doesn't mean trusting the conclusions you draw. Challenge your conclusions and interpretations by talking to others. After an important incident, one that might have suggested a lesson to you, have a conversation with other traders you know. How did they see what happened? What lessons did they draw?

Ask yourself:
  • What went right?
  • What went wrong?
  • How could it have been better?
  • How could it have been worse?

Again, ask your colleagues for their opinions. Do they agree with your views on what went right and wrong? If not why not? The conclusions you draw from your actual experiences are the most valuable resources you have. They are collectively the foundation of your future decisions, the bedrock on which your future success will be built. Make sure those conclusions are valid and your instinct for making the right decisions, in any situation, will inevitably get better. If you do this in earnest, I promise you an improvement in your trading, more and more as time goes on.
PrudentTrader Archives 2004

Thursday, March 5, 2015

The Emotional Trader

You have to be okay with wins and losses. You can't just be looking for the wins and, when the losses happen, you can't buy more and more because you're sure it's going to bounce. We call that revenge trading.
Josh Brolin

The nature of trading demands that you have an objective and logical approach. If you are experiencing extreme elation after a winning trade and likewise extreme disappointment after a losing trade, then you are riding an emotional roller coaster: Up and Down, Up and Down. Your account balance is probably doing the same thing jumping Up and then Down. Many go to the extreme of picturing and trying to become an emotionless being, such as the ultra-logical Mr. Spock from "Star Trek." That's fine just realize it is not easy. After all how can you not get at least a little excited after a win and become just a little disappointed after a loss, its human nature, it's natural to feel that way; and that's the point, it is not easy to control your emotions, it takes lots of practice, but it is possible to control your emotions in order to achieve your objective, a logical mindset that is conducive to profitable trading.


Probably the most significant way to control your emotions is to use proper risk management. If you're risking money you cannot afford to lose, or you're risking too much of it, you will feel pressure. However if you minimize the amount of money you risk on a trade (think position size for instance), you'll be able to tell yourself that the actual downside is bearable; you'll know you can easily survive the worst case scenario. It will also help a great deal if you have a detailed trading plan and keep a log of each trade with clearly spelled out strategies for how you entered and how you will exit.


Emotion control and discipline require energy, both physical and psychological. If you are under stress because of external life events such as a death in the family, a new home, problems at work, or with your spouse, that will eat up a great deal of your energy and make controlling discipline and emotions a much more difficult, if not impossible task. Don't underestimate the powerful influence stressful events can have on your life. If you are feeling extreme stress, take a break from trading until those issues are resolved. You will save yourself untold additional hours of stress from the markets and in all probability saved a good deal of money from making careless errors. 


If you feel you must perform flawlessly on every trade, you will also feel pressure. You will become easily fearful and disappointed by minor errors or routing trading losses. Accept your limitations, you are human after all, you will feel more at ease. You cannot do more than is humanly possible no matter how much you would like to. Patience and practice build the skills you will need to be a consistently profitable trader.