The Distraction of Money
Stockscores.com Perspectives for the week ending August 29, 2010
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In this week's issue:
"Anything worth doing is worth doing for money." - Gordon Gecko, Wall Street
It is generally accepted that money is a motivator; if you link pay to performance, performance will improve. For that reason, many people's salaries vary with their performance. This is most prevalent on Wall Street where bankers and traders receive most of their compensation in the form of incentive based pay.
In his book, "Drive", Dan Pink considers whether pay for performance really works. Does dangling a carrot and threatening with a stick cause people to deliver better results? The research finds that this is not always the case.
For very mechanical tasks, incentive based pay does work. A brick layer who is paid by the brick will work more effectively than one who is paid by the hour. However, for tasks that require analytical thinking, performance is actually worse when it is linked to pay.
Pink cites research involving the solving of puzzles. The person who was told she would receive a financial reward if she solved the puzzle in the shortest time performed worse than a person who had no potential for financial reward if the puzzle was solved quickly. The person who was solving the puzzle for the sake of solving the puzzle did it quickest.
I have been teaching people how to trade the stock market for over ten years, teaching a lot of people from many different backgrounds. One constant that I have seen is those who perform the best as traders are those who don't care about the money. They trade with a set of rules and the discipline to follow the rules, making the money irrelevant.
The market is a puzzle that we want to solve. Why does a focus on money make us ineffective traders, or puzzle solvers?
I am not a behavioral scientist and I have not done the kind of research necessary to really answer that question. However, I do have an opinion based on what I have learned from trading.
Money causes us to focus on something that is irrelevant to the problem. In doing so, it complicates the puzzle, making it more difficult to solve.
If we aspire to make money from the market, we should change our focus to find trading opportunities with a positive expected value. Money will be the determinant of success, but it will not be something that is part of the problem to be solved.
Suppose you buy a stock and it is showing you a profit of $1000. It is near to the end of the month and you need $1000 to pay your rent. There is a good chance you will sell the stock because of your need, regardless of what your analysis would tell you about the stock's potential to move higher.
Money causes a greater problem to our trading when it comes to taking losses. A stock may remain a good hold despite the fact it is showing as a loss. The size of the loss often causes traders to exit the trade simply because the money, and the potential loss of more, causes them too much concern.
Not only can money bring an irrelevant condition in to our problem solving equation, it also tends to bring emotion which hurts our ability to make good decisions. Most people function poorly under stress and the fear of losing money brings stress. When we focus on the money, we trade with emotion and that means we make bad trades.
Every trader has to overcome their emotional attachment to money. Trades have to be based solely on the merit of the trade. Our pursuit must be on doing the right trade, doing good analysis. If we trade to make money, we will lose it! Our chances for success improve when we simply trade to solve the market's puzzle.
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The markets finished this past week with some strength although they ended the week with a loss. The late week comeback was expected since prices had fallen too quickly, motivating buyers to bargain hunt and short sellers to cover positions. The major indexes are now nearing their downward trend lines where they will most likely stall and reverse lower again. However, I estimate that there is a 35% chance that the buyers will take prices through that downward trend line and stock prices will firm up.
With that in mind, I did a Market Scan looking for stocks that broke through resistance on abnormal trading volume on Friday. When inspecting the chart, I sought out those that had been outperforming the overall market and had a decent chart set up. If the market can hold reasonably well then I think these stocks may do well.
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1. VHC
VHC breaks out from a pennant pattern that has been building since March. While the overall market has been falling, this stock has held up well and built the optimistic price pattern. Friday, the stock broke through resistance on very abnormal trading volume. It looks like the stock should move higher from here, although a short term pull back is quite possible before it tries for new highs. Support at $5.90.
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2. NNI
NNI has been stuck under $22 but has tested that price ceiling a number of times. Each time, it has pulled back but the pull backs have formed rising bottoms, a sign of investor optimism. One Friday, the stock broke through resistance with abnormal volume, closing through resistance and at its high of the day. Support at $20.30.
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References
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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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