Saturday, November 14, 2009

What's Your Trading Personality?

In my most recent book, "Smart Investors Money Machine," I discuss a variety of ways people can add streams of income to their lives. I use examples of a single unattached male, a family with children, and a couple at retirement to show how various strategies might be employed by them at differing life stages with differing needs and varying time constraints to add what can be important streams of income in each situation.

One of the important considerations for any of us is to arrive at an understanding of our own trading personality. As I have emphasized so many times both in these articles and in "Trade Your Way to Wealth," a critical need is a trading business plan and as or even before such a plan is developed, the trader would be well advised to do a little self-analysis to determine his or her trading personality characteristics. Obvious factors such as how much time one is willing and able to make available for study and trading are critical, but, in my view, one needs to take a deeper look in order to increase the favorable odds or gain an edge.

Since this subject can be both broad and deep, I'll just try to give a few examples of trading personalities I have seen along with some suggestions as to how the trader with such traits may help himself improve in the trading arena. One of the more common traits seems to be an effort at achieving trading perfection. Classically, people who have been trained as engineers tend toward this approach. Through training and experience they seem to tend to seek every last piece of information before entering a trade. Obviously, if one could actually gather and process all information relative to a trade before making an entry, an edge would likely exist. Clearly if one were designing a bridge or the structure of a building he would need and want every available piece of knowledge and information in order to insure the integrity of the structure. However, in trading, it is rarely, if ever, possible to know all relevant facts.

Suppose one were to undertake a relatively complete fundamental analysis of a company in order to decide upon a trade. Even if literally every available fact were gathered and incorporated into the decision, that would not preclude a new fact from changing the whole picture just as the buy order were placed. The CEO, for example, could be indicted or new onerous law passed, or a competitor could announce a fantastic new product that would be an overwhelming advancement (remember what the auto did to the horse and buggy or vacuum cleaners to rug beaters or computers to typewriters?). A new news item can literally wipe away attempts at perfectionism in investment analysis.

In addition, those whose trading personalities tend toward perfectionism are frequently plagued by paralysis of analysis. There are just so many pieces of information to try to gather and analyze, one may never get to a level of comfort that permits entry into a trade.

For folks with this element of perfectionism in their trading personality, I would suggest a bit of change in focus. Instead of looking for the perfect trade, look instead to trades that offer a strong reward to risk potential, perhaps on the order of 2.5 to 1 or better. Look for trades that offer a close and convenient exit just in case you are wrong on direction (as you inevitably will be on occasion). Understand that there really is not perfection in trading and that it is a different animal than designing a bridge. Trading involves infinite variables.

Not far from the perfectionist is the trader who seeks ever greater confirmation before entering a trade. He may see an entry, but then awaits confirmation of the entry and then looks for confirmation of the confirmation. Believe me, I am not against confirmation, but, like anything, if taken to extremes it can be harmful. The problem with confirmation is that the longer one waits, the farther the trade has moved and the more of the trade the trader often misses. In addition, the exit in the event the trade goes the wrong way gets farther and farther away before entry is made thus increasing losses in losing trades and reducing gains in winning trades. My suggestion for these folks is to concentrate on having a disciplined close exit at the time of entry. If that method is employed and the trade goes south, the loss will be small and contained and the trader can move to the next trade. Again, reward to risk potential should be a major consideration in my view.

Lastly, for this week, at least, is the ready, fire, aim trader. This personality is almost diametrically opposed to the perfectionist trader and jumps on a trade with little basis, technical or fundamental, and no plan other than some unsubstantiated hope he will make money. Often this person buys because a friend owns a stock that has done well or because it has been touted by a broker. The trader has neither an entry nor an exit strategy and just jumps on board, all too often as the stock is about to turn the other way. Here, I believe the trader needs to learn and exercise discipline. He needs to have an exit plan in place before entry and he needs an overall plan for his trading. Without those in place, he is quite likely to wind up without trading money quite quickly.

Obviously, these examples are relatively extreme, but they are also relatively prevalent to one degree or another. The key is to understand yourself and your own foibles. We all have them and they can definitely impede good trading. I think it was Pogo who said something like: "We have met the enemy and they are us." It is so true that we are most often our own worst enemy in trading and the first step is to discover what we are doing to undermine our own success. Once found, we can take steps to improve.

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

P.S. Save $50 PER MONTH on my subscription trading newsletters!
SAVE on my Under $10 Stock Trader Service!
SAVE on my Option Trader Service!
SAVE on my Trend Trader Service!

Technorati tags:

To comment on Bill's article click on the "comments" link below.


Bill Robbins said...

Could you give your opinion on the proposed Trader's Tax, House Bill H.R. 1068? It looks like it would put most traders out of business.

Anonymous said...

Your analysis of trader characteristics is right on the dime.
Of all your suggestions, I think that pre-trade planning is most important.
Either with covered call or put, or at least a plan for entry and exit prices. When prices go south, you have to know ahead of time where your quitting level is. Still, trading is more of a game than a business: and since it's a game, you want to be a good loser.

Anonymous said...

Hi Bill,
Well written article and it is all about trading for a know yourself first.
What do you think for those who would like to subscribe your services (like Under $ 10 trader) and learn from there as a beginner of trading and aim to be a trader for a living.
Your advise/comments is much appreciated.
Thank you.

Bill Kraft, said...

Bill, House Bill H.R. 1068, if it gets through committee, is passed by the House and by the Senate and signed by the President, would create an onerous burden on the smaller trader as well as active traders in my view. The bill as it currently stands has been referred to committee and would impose up to a 0.25% tax on transactions. In other words, a $10,000 trade would generate a tax of up to $50 ($25 on entry and another $25 on exit). While it might not put traders out of business, it would constitute a significant added cost to trades and I certainly oppose it. It is one of those insidious taxes that doesn't seem to affect many and seems small, but adds mightily to the weight on the camel's back. One likely effect, it seems to me is that it would stifle a lot of trading and thereby fail to raise the revenue it shortsightedly anticipates.
Thanks for writing.
Bill Kraft

Bill Kraft, said...

Anonymous, the only thing with which I disagree is your statement that trading is more of a game than a business. Throughout history trading has been an important business (think of the Hudson Bay Company or the China tea trade or trading commodities like food for money). Yes, of course, anyone engaged in trading can lose whether it be a single trade or overall. The chances of losing are much greater, in my view, when trading is treated as a game rather than as a business.
Bill Kraft

Bill Kraft, said...

Thanks for writing, Anonymous. Regarding your question about subscribing to the $10 Trader, I think it could definitely be helpful if used carefully. I would suggest it be used to see what I am doing and how I am doing it rather than blindly following trades by putting your own money at risk right away. Hopefully, it's worth the price (free the first month) to begin to educate yourself to see where entries are made and how exits are set. Look for the ways losses are cut and see methods to let profits run.
Bill Kraft