7 Sins of Trading
Stockscores.com Perspectives for the week ending January 8, 2006
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In this week's issue:
I was in an art gallery the other day and came across a painting depicting a tree being cut down by two men. What was peculiar about the painting was that the men were using a leaf from the tree to do the cutting. The message was obvious and fitting for those trading the stock market.
We are our own worst enemy.
Making money in the stock market would be a lot easier if we did not succumb to the whim of our emotions. If 2006 is to be a year where you beat the stock market, you must overcome these emotional traps:
Fear - fear debilitates our ability to make decisions. Fear in all its forms; fear of loss, fear of ruin, fear of being wrong, fear of uncertainty and fear of what others may think causes us to break our rules. Fear causes us to avoid taking good trades, avoid selling our losers, fail to hold our winners or simply not take action when we need to. It is an irrational response to the market's message.
Greed - if you want something too much, greed can take over your rational mind. You may establish that you want to make $10,000 today trading but, if the market does not provide the opportunities for you, greed may make you force the trade. You may hold a stock longer than you should because you have not met your goal or you may take a trade that is not good enough. The desire to make money may make you irrational in your pursuit of that desire.
Perfectionism - many traders try very hard to always be right. If the market shows that they are wrong with a loss, they work very hard to turn that loss in to a profit. They may average down on a losing position or just hold the stock after their stop price has been exceeded with the hope that the market will turn around and turn their loser in to a winner. It is the pursuit of perfectionism that causes us to ignore that trading stocks is a matter of probability. Trying to always be right leads to failure, for eventually, one of those losers fails to turn around and gives the trader a portfolio crushing loss.
Pride - it is important to realize that the stock market does not care about you, that in the grand scheme, you don't matter. I say this because some traders attach their self esteem to their success in the market. They may avoid making the right decision because of the effect that the decision will have on how they feel. Simply put, you can not take your performance in the stock market personally because your feelings have no effect on the stock market.
Anger - I have seen traders react to a loss with anger. They may be angry with the decision they made or they may be angry with how the market responded to some information. This anger leads them to make an irrational decision or blame others for their loss. What happens to you in the market is not anyone's fault but your own and anger will only cloud your judgment for what to do next.
Impatience - trading stocks is a waiting game. You take a trade with an expectation for what will happen in the future but how long it may take is not in your control. More than once I have taken a good trade but exited because I was bored. Many of those trades led to a profit that I missed out on because of my impatience.
Recklessness - the feeling of losing is not a good one and can lead to a laissez faire attitude about the next trading decision. With the hope of taking away the bad feeling, the trader ignores risk management and rational decisions and simply takes any trade that might stop the negative feeling.
These are cited as the 7 Deadly Sins of Trading by Ruth Barrons Roosevelt in her book of the same name. As someone who has traded long enough to be an expert on all of these mistakes, let me assure you that overcoming these emotional breakdowns is more important that understanding any technical indicator, fundamental ratio, news release or trading strategy. Overcoming emotion is the most difficult part of trading and will separate those who succeed from the majority who fail.
Simply saying that you will avoid making these mistakes is easy but doing so when under the pressure that the market inflicts is much more difficult. Every trader needs to go through the list of emotional breakdowns above and think about how they react to these emotions. Write down the mistakes you make because of fear or greed. Think about times when you have been reckless in your trading and write down a plan to overcome them.
Before you make another trade, create a plan to overcome the seven deadly sins of trading. Doing so will do more to your profit than anything else you can do.Back To Top
I have been working on a new strategy for longer term traders that seems to have good potential. This strategy looks for stocks that have made both abnormal price changes and traded abnormal volumes for the week. Instead of the usual inspection of a daily stock chart, I look to the longer term weekly chart for an abnormal break from low volatility early in a trend.
Identifying stocks that have caught the market's attention with significant change to their fundamentals is what is behind this strategy. A strong trend from a change in psychology is often motivated by significant fundamental change, and that change in fundamentals when the market does not expect it is often the first of many changes that motivate the trend.
I applied this strategy to the 1500 most active stocks on the Nasdaq stock market. I focused on this market because I feel that it will lead North American stocks in 2006. Of this group, 14 stocks showed statistically significant price change (up or down) and statistically significant volume. Of the 14, here are some charts that I think are worth considering for longer term position trades.Back To Top
1. NUVO
The daily chart is not that impressive, but the huge jump in volume and price on news late in the week indicates to me that the stock may be under accumulation. Support is at $8, a close below that would be a negative signal for the stock.
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2. ALKS
This entire week was strong for ALKS and serious volume traded as the stock broke out of an ascending triangle pattern. If support at $17.50 is penetrated then investors have lost favor for this stock, but right now it looks like it wants to cruise higher. Don't be surprised if there is a short term pull back on profit taking, the positive outlook is longer term.
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3. BEAS
Big breakout late this week on BEAS, it looks like the stock wants to go to the $13 resistance level in the months to come. The stock has been building an ascending triangle pattern for about two years, so this break is significant. Technical support is at $8.25.
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4. ITMN
ITMN breaks through two year resistance this week as it moves out of a period of optimism signaled by rising bottoms. A penetration of support at $16.50 would be a bad thing for the stock.
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References
Get the Stockscore on any of over 20,000 North American stocks.
Background on the theories used by Stockscores.
Strategies that can help you find new opportunities.
Scan the market using extensive filter criteria.
Build a portfolio of stocks and view a slide show of their charts.
See which sectors are leading the market, and their components.
Disclaimer
This is not an investment advisory, and should not be used to make
investment decisions. Information in Stockscores Perspectives is often
opinionated and should be considered for information purposes only. No
stock exchange anywhere has approved or disapproved of the information
contained herein. There is no express or implied solicitation to buy or
sell securities. The writers and editors of Perspectives may have positions
in the stocks discussed above and may trade in the stocks mentioned. Don't
consider buying or selling any stock without conducting your own due diligence.
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