8 Trading Mistakes You Must Avoid
Stockscores.com Perspectives for the week ending May 7, 2013
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Buying stocks with strong momentum have a higher probability of success but also more risk. This week, Tyler looks at how to balance probability and risk when trading stocks. Watch it on YouTube by clicking here.
This Week's Trading Lesson
Here is a list of eight mistakes that most of us do as we work our way through the learning process it takes to be a successful stock trader. Avoid these and you will be well on your way.
1. Fail to Limit Losses
I have not yet met someone who is always right in the stock market. That means you and I are going to be wrong some of the time. What is important is what we do when we are wrong. When the stock market shows that your analysis was incorrect, sell! Move on, get out, forget about it. Small losses won't hurt you, using hope to justify holding a loser will.
2. Averaging Down
Averaging down on a loser is buying more at a lower price, expecting the inevitable bounce that gets you out without a loss. This strategy will actually work a lot of the time, you just keep averaging down until the market reverses. However, when it fails to work, and you keep buying in to a stock's bungee jump that fails to bounce, you can lose everything. Without capital preservation, you are just a spectator.
3. Buying in to Emotion
It is tempting to buy more of a stock that is moving quickly higher. It is important to remember that when everyone is doing this, investors will inevitably pay too much. A simple rule is to not buy stocks that have run away from their trend line. You can buy stocks that have momentum, just wait for them to pull back to the trend line and buy them on short term weakness. Never chase.
4. Believing in Public Information
The stock market is efficient, it prices in all available information. That means the news release that you are reading has no value. The annual report has no value. So long as the general public has the same information as you, your decisions based on that information will provide random results.
5. Selling on Pull Backs
It is easy to be nervous with our winners because the feeling of having a winner turn in to a loser is not a nice one. So, we tend to sell our winners too early, getting out at the first sign of weakness to lock in the profit and give ourselves the congratulatory "you never go broke making a profit" speech. You have to maximize gains and learn to distinguish between the minor pull backs that are part of long term, money making trends and actual trend reversals. A trade is not successful until you have doubled your risk.
6. Taking Too Much Risk
Emotion is the enemy of the trader. Cold hearted people, or at least those who do not care about the risk of the trade, are the best traders. To make sound decisions, you can not risk more on a trade than you are willing to lose. If you do, you will break your trading discipline and avoid selling losers when you are wrong or sell your winners too early.
7. Going Against the Mood of the Market
It is not easy to paddle a canoe up a river, against the current. It is also not easy making money on a stock when the mood of the market is against you. When considering a stock, I always first assess who is in control of the stock, buyers or sellers. To make money, you either have to trade with the group that is in control or pick the point where control changes from one group to another. Don't go against the mood of the market.
8. Trade Possibility, not Probability
I remember an advertisement for a lottery, it said, "Think of the Possibilities!." What if the lottery company suggested we think of the probabilities? We have all heard that we have a better chance of getting struck by lightning than picking the right numbers to win the lottery, but because we think of the possibilities, we continue to buy tickets. A lot of people approach the market the same way. They may look at a stock and describe all of the things that could happen, how the company could find gold on a long shot mining exploration and how the stock could go rocketing higher. However, when you trade against probability, you are on the path to poverty.
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Investors want safety and substance; the stocks that are performing the best right now are those with real businesses showing real cash flow and earnings. After flash crashes and sharp corrections, investors are looking for stocks that they can believe in to ride out the occasional round of volatility.
The problem is that most of these stocks have been going up for a long while; it is getting hard to find stocks that are starting upward trends that are not speculative stocks. Speculative stocks that show strength are fizzling out because the dominant player in this market, institutional investors, are not buying them. They will jump on some speculation from retail investors but there are not enough retail investors in this market to sustain the trend.
That means we have to trade the market like an institution. Take a long term view of the charts and be patient with the trend. If a stock is showing optimism and a good pattern on the weekly chart, it is worth considering.
To find these, I run the Stockscores Simple Market Scan and view the weekly charts of the stocks that are found. I did that today and found a couple of charts that I think have good potential for longer term trades.
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1. TK
The shipping companies are catching some bids today, TK is breaking through long term resistance at $36 which has held up for two years. Long term support at $32.50 or $35 if you want to be more aggressive.
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2. ANF
ANF is breaking out of a cup and handle pattern on the weekly chart right now. A favorable ranking among retailers by Wells Fargo has helped the stock today, but the pattern of optimism has been building for a while. Support at $45.
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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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