Saturday, April 11, 2009

An Impediment to Profitable Trading

When we trade the markets, we have many hurdles to overcome if we are ultimately to be successful. Underlying all trades, for example, is the necessity to have knowledge. We need to know what we are doing and we need to know the specific risk(s) we are assuming. We need to understand the strategy we are employing and we should have an exit strategy. We are well served when we have a plan for our trade and utilize a money management system. All those factors can help us achieve an edge in our trading that can lead us where we want to go.

One of the most critical elements, however, is one that traders often ignore and that is our own psychological trading profile. I am convinced that certain of our individual psychological traits are the greatest impediments to success that we face. Long ago, a trader came to me seeking help. He had lost a great deal of money when the tech bubble burst and the market turned over in the early part of this decade. He had a fair amount of money and no job and wanted to get back to trading for his living. When I met with him, I learned that he had no specific business or trading plan so I began to go through the elements of a basic trading plan as I later set them out in "Trade Your Way to Wealth".

When we came to the section where he would set his trading hours, he absolutely refused to set hours. I prodded him by suggesting that if he were to open any other business he would likely have hours, but he persistently refused, creating one excuse after another as to why he could not set the hours he would devote. I reminded him that his plan is always a work in progress so once set he could always make a change. Even that didn't help convince him to include hours in his plan. His resistance was adamant and seemed irrational to me. Suddenly it occurred to me that refusal to complete the plan may be a way for him to avoid trading altogether so I changed gears.

I asked this fellow whether buying stock was a strategy he believed he understood well and he agreed it was. At the time of our meeting, the market was bullish so I suggested we find a stock that looked ripe for an entry and that had a nearby exit in the event it turned down. In a short time we found a candidate that we both agreed looked bullish and that might afford a good entry. I asked the student how much money he had in his account and learned it was in the mid six figures. The stock we found was trading for around $30 a share. I suggested he buy one (1) share. Immediately he refused, he literally began to shake and offered many reasons why he needed to do further research before committing. I pointed out that even if we were wrong on direction and the company immediately announced a bankruptcy after he bought the share he would lose only $30 and the commission. Tears filled his eyes as he claimed a need to do more research, gain more knowledge about the fundamentals, and await confirmation.

He never made the trade. Undoubtedly this situation illustrates an extreme case, but it does illustrate a psychological barrier that absolutely prevented this fellow from becoming a successful trader. He is a poster-child example of how perfectionism (in his case resulting from fear) can stifle good trading. Perfectionism in trading can lead to paralysis of analysis. The perfectionist seeks every bit of information he can possibly find and then seeks confirmation of the information. Meanwhile, he is likely to miss the trade. He is so interested in being right that he fails to pull the trigger until after the target is gone.

One of the problems with the perfectionist approach is that it fails to recognize that even once as much information is gathered as is humanly possible there is still no guarantee that it will remain the same the moment after the trade is entered. Perfectionism does not guarantee the trade even though the perfectionist may, indeed, be seeking the perfect trade. A perfectionist generally does what he does to insure complete safety, but in reality there is no such thing.

Many years have passed and the fellow about whom I wrote in the anecdote above continues to try to create a perfect algorithm to find the perfect trade. Unless we can perfectly predict the future there can be no such algorithm. Unexpected attacks occur; cataclysmic natural events occur; fundamentals can turn on a dime -- any of those kinds of things can and do alter predicted outcomes.

Those who are perfectionists can help themselves in their trading, I believe, if they are aware of the trait and temper it with the knowledge that no matter how hard they try, complete safety cannot be achieved. Learn to make reasonable efforts, understand that all cannot be known and even if all current facts are known it does not guarantee the next moment. Try not to let the trade get away, but realize that it will have risk. Work to manage the risk.

by Bill Kraft, Editor
Copyright 2009, Makin' Hay, Inc.
All Rights Reserved

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H... said...

There is a long time since I start receiving and reading your weekly newsletter. Although I'm not tradings stocks very often, always found your words very interesting. But wen it comes to this article, it represents something which I am experiencing on my own skin since I lost about 75% of my trading account. Since then its almost impossible for me to pull the trigger and after that I get even more frustrated because the trade went on the right direction. I'm still looking for help in order to overcome this handicap, but I don't know what to do anymore....

Bill Kraft, said...

Thanks for writing Henrique. It sounds like your problem is basically one of lost confidence. You indicate that you are making good picks, but just can't make yourself make the trade. There are a couple of things you might consider. First, you might just do some practice trading without real money to see how you are performing. While paper trading is definitely different from trading real money in that much of the emotion is missing, you can see for yourself whether you are making good trades or not. Secondly, you may begin to enter small real money positions making sure you have an exit strategy in place before entering the trade. It also may be a good idea to find a coach who trades himself and work with him a bit. As you probably know, I do offer coaching sessions, but I don't know where in the world you might be and whether I might or might not be someone who could help you.
Bill Kraft

H... said...

Hi Bill

Thanks for your answer. Actually I'm living in Portugal at the moment and I don't know any coach working around in my country. I'm trading mainly index cfd's and forex at the moment and using only technical analysis for my trading decisions keeping an eye on news releases at the same time in order to be aware of sharp movements in the markets. I know you are coaching people working with stocks and I learned a lot from you about money management and trading psychology, but I would like to get a closest approach to the markets I trade. Thank you very much for your answer, it is always very important to have a motivating word from a professional trader. I will follow your advise during the next trading week.


tony and stacy said...

Trading is not that hard. But BELIEVING that you can do it is difficult sometimes. Fear of success, for whatever reason, is the barrier for some people into making a lot of money in trading.

Bill Kraft, said...

Henrique, you're welcome. I wish you great success.
Bill Kraft

Bill Kraft, said...

Thanks for your comments Tony and Stacey. Interesting, but true, fear of success as well as of failure can impede good trading.
Bill Kraft