Fatal Mistakes
Stockscores.com Perspectives for the week ending March 12, 2011
In this week's issue:
Stockscores Live Classes
I am teaching two StockSchool classes in Calgary in May. The Stockschool Pro class will run May 1 and 2 and, for those experienced Stockscores traders who aspire to trade for a living, I will be doing the StockSchool Advanced class May 7, 9 and 10. Click on these links for more information.
Fatal Mistakes
If you are a normal human being, you are predisposed to fail in the stock market. To be successful as traders, we have to overcome that thing which makes us human - emotion. Decisions on trades always seem easy with the benefit of hindsight because there is no emotion; there is no consequence for the decision. When we are trading and making decisions that have an effect on our money, it is easy to let emotions affect our decisions in destructive ways.
I have traded for a long time and have become very good at picking stocks. Despite a lot of success, I still struggle with the emotional side of trading daily. Overcoming emotion is the hardest thing for a trader to do.
Here are some fatal mistakes that we traders make and some thoughts on how to overcome them:
Watching the Profit and Loss Window
Our trading platforms have that little area that shows us how much we are up or down on our positions. Paying attention to this while we are trading is a very bad idea. We have an emotional attachment to money and preconceptions about what a lot of money is. We approach trades with a subconscious idea of what is a nice profit and what is a painful loss.
By watching the profit and loss components of our performance, we initiate those preconceptions in our brain and make decisions around them. We start to exit trades because the profit is higher than we expect. We hang on to trade that was profitable and is now a loser because we long for the good feeling that came to us when the stock was up. We stick with a loser because we can't stand the feeling of locking in the loss that we see on our screen.
How much you are up or down on a trade are irrelevant to the decisions that you must make about the trade. Stocks should be entered and exited because they satisfy well tested rules for doing so.
Never count your money, when you are sitting at the table, there will be time enough for counting, when the dealing's done. Kenny Rogers knew a lot about the effect of human emotion on decisions when he sang that song.
Judging Success One Trade at a Time
Normal people tend to reference short term performance as the gauge for trading effectiveness. If you follow a set of rules and it works on one trade, it is easy to think that those set of rules is an effective strategy.
Anyone with a basic understanding of statistics will know that this is foolish. In things that are unpredictable, like the stock market, the efficacy of a strategy is based upon how well it works over a large sampling of instances. To judge the quality of a trading strategy, we must consider how well it has done over a large number of trades.
If you buy a stock because it gapped down on the open and you make money on the trade, does that mean you will make money every time you buy a stock that gaps down on the open? Does it mean that you will make money most of the time? If you are using the results from a test sample of one, it is impossible to know.
Working Hard When Things Get Hard
Anyone who has had success in some access of life has probably got there because of hard work. Trading success requires hard work as well but there are times when hard work leads to losses.
In a good market, trading profits seem to come easily. Since there are so many potential trades to take, we end up only taking the best of them. If the market loses its momentum and there are fewer good trading opportunities, we end up having to lower our standards to find stocks to trade. How can we expect to do well with lower standards?
If the market is not working in our favor, we have to increase our standards, not lower them. We have to be willing to do nothing if there is nothing good to trade. Work hard when the market is easy but get lazy when the market is tough.
Taking More Risk than You Can Tolerate
Emotion clouds our judgment and the fear of losing money brings out our emotion. If you are not comfortable with the potential for loss then you cannot make good decisions.
How much risk can you tolerate? You have to be able to answer this question and tailor your trading approach around that number. If you are willing to lose $500 on a trade and are faced with a $2000 loss, it is unlikely that you will do the right thing. Your decision will be plagued by your emotional state.
Avoiding Pain, Pursuing Pleasure
We tend to be myopic, making decisions based on the short term pleasure and pain factors. We know a donut is bad for us but right now, it tastes good and we are eager to enjoy it. Everyone has their weaknesses and they tend to revolve around avoiding pain and pursuing pleasure in the short term.
As traders, this means hanging on to losers and selling the winners. It feels good to lock in the profit, it feels bad to sell the loser. We make our decisions around those short term factors rather than a rational assessment of where the stock is likely to go.
When you are faced with a trading decision, ask yourself whether your decision is based on how it makes you feel. If so, it is best to re-evaluate that decision.
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Recently, I have focused on long term trading opportunities, stocks like T.TD which have the potential to be slow and steady winners over the next year.
Not everyone has that much patience, their interest is in shorter term swing trades that can provide smaller profits but in a hold period measured in days. This week, I set out to identify some swing trading opportunities using the Pull Back Play strategy.
First, my outlook on the market. The S&P 500 broke its upward trend line on Thursday, indicating that the market is likely to go down in the next two weeks. However, the Dow and the TSX 60 indexes bounced off of their upward trend lines on Friday. This implies that we are likely to get a few days of strength.
So, I think that next week will probably be one where prices rise but there remains a risk that we still get a continuation of the profit taking that has been the norm for the past two weeks.
I ran the Pull Back Play strategy on the Canadian market this week, seeking out some of the commodity based stocks that saw some selling pressure recently but look to be bouncing off of their upward trend lines Friday. Here are a couple of stocks for swing traders to consider:
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1. T.PD
T.PD has been in a steady upward trend since October of last year but succumbed to some profit taking last week which took it lower for three days in a row. That slide appeared to end on Friday and the stock was able to come back to close up for the day and above its open. This is a swing trade that counts on the stock continuing in its long term upward trend. Support at $10.50.
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2. T.CPG
T.CPG ran away from its upward trend line, making a pullback likely. That happened last week and the stock is now at the support of its upward trend line. It should bounce back and be good for a few dollars of upside in the short term. Support at $43.75.
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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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