Saturday, July 03, 2010

Paralysis

As I was thinking about the subject for this weekend's article I found myself a bit mentally mired searching for a topic. That happens every once in a while. I find that when I try to think of a topic rather than just letting it pop into my head from a reader's comment or something I may see or read I have a tough time coming up with something new or at least with some new twist. There is almost a little mental paralysis hindering the quest. Anyway, the thought of that paralysis made me think of how we are sometimes affected by paralysis in our trading.

One type of paralysis I've seen over the years is the paralysis of analysis where the would-be trader spends so much time and effort conducting his analysis that he may never pull the trigger and make a trade. That issue seems to be more prevalent with people in professions and vocations that require precision and perfection in their tasks. Engineers are classic (though not always fairly) examples of this type of paralysis. I apologize in advance to the engineers as I relate an observation a dentist I was coaching once made. He said engineers were his worst patients because they wanted a complete course in dentistry before they would permit him to drill a cavity. Obviously, that was hyperbole and meant in a joking manner, but it illustrates a type of trader paralysis. The person who seeks to learn every fundamental bit of information and then wants every technical to be in perfect alignment may never find a trade. He is caught in the confinement of his analysis process. Of course, I have to agree, if he does ultimately find a trade it may be a good one. It also may not be so good since the moment he enters the trade some fact about his stock or about the market in general may change and all the effort went for naught.

Another type of paralysis is the deer in the headlights phenomenon where the trader is frozen in fear or panic as a position goes the wrong way against him. Most of us have had that type of paralysis at some point in our career. It is often marked by comments like: "it'll come back." The fact seems to be that at times traders see a position go the wrong way and just can't seem to pull the trigger to take the loss and move on to the next trade. This paralysis results in a failure to cut losses and can be devastating to a portfolio.

While there may be other examples of paralysis in traders, each of the two may share a common cure in my view. The cure is to start trades with an exit strategy; one that will take the trader out of a trade before losses run too deep. If the paralysis by analysis trader is willing to look for a trade where the initial exit is nearby, he may begin to understand that the fear of loss that propels him into all the analysis in the first place may be alleviated by having an exit strategy that will cut any loss. The same, of course, is true for the deer in the headlights paralysis. If the trader has an exit strategy from the beginning all he need do is implement it.

If we are going to trade, we must understand that there will be risk and there will be losing trades. As I write at length and in detail in my first book, "Trade Your Way to Wealth," there are many ways to manage risk so that if not eliminated it can at least be reduced and managed. Paralysis in trading results from emotions. Fear of taking a loss or fear that a trade I enter might lose. Fear can be overcome by knowledge and if we learn how to reduce and manage risk there is less reason for fear and a lesser likelihood of paralysis.

by Bill Kraft, Editor
Copyright 2010, Makin' Hay, Inc.
All Rights Reserved


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6 comments:

Ron Yacopetti said...

Hey Bill,
How about the paralysis of a nation taken over by an unqualified, childish, business-hating communist inflicting catastrophic damage in every sector that he focuses his "laser-like" concentration upon. There is nothing more paralyzing to business than having no clue what will be attacked by our own gov't in the near future or what kind of overbearing burdens will be placed upon it. Everyone I know is simply trying to survive this tyrannical administration and has done nothing but batten down the hatches.
Ron Yacopetti
Lodi, CA

Bill Kraft, MarketFN.com said...

Ron, I did not intend for my article to be political and this really isn't the forum for political commentary.
Bill Kraft

Anonymous said...

HI Bill thanks for your weekly comments I really look forward to them.
In the last 18 months I have only made 14 trades 9 losers and 5 winners I realize, even at this ratio I can make money with proper management.Part of the low trading is due to other commitments,but alot is due to the fact that I more than not lose on a trade.Interesting is the fact that my paper trades this year to date are 4 to 1 with a nice paper profit. On my paper trades I move much earlier for the fact that there is no real money at stake . In real money I wait for more confirmations which, I guess is more risky. Sometimes I look at a stock and see a trade staight away but feel this was to simple , so I search for more indicators and miss the move.I have done this many times but find it a hard habit to break.

Morris

Bill Kraft, MarketFN.com said...

Thanks for writing, Morris. Your observations are very insightful and your experience valuable. Indeed, as you indicate, a trader using appropriate reward to risk, loss cuts, and money management can certainly make money even when only 35 % of trades are winners. It isn't unusual to do better paper trading since one often changes what they are doing when going from paper trading to real money. As you have seen, waiting for confirmation often results in an exit that is farther away and a trade that may very well miss the initial jump in profit. Of course, there is always a trade-off. More confirmation may yield a greater likelihood of success with less profit while an earlier unconfirmed entry may yield a lesser likelihood of success with a greater profit. In my estimation, the key lies more with exit strategy than with confirmation. I hope you have a great 4th of July.
Bill

Anonymous said...

Hi Mr. Kraft,

"Paralysis of Analysis"... Wow! That is an immensely powerful statement, and your article was exceptional. You really hit the hammer right on the nail. In fact, I happen to be an engineer and could not agree any better on the way you described trading from an engineer's perspective. I always had to research every bit of information, leaving no stone unturned, only to find myself entangled into a situation where I wanted all the stars to be aligned before I make my move. Perfection had to be the name of the game, and long hesitations before buying and selling became the rule rather than the exception. Chasing the stock became like a missed opportunity of love at first sight, and the excitement dwindled because the fear of losses became so great that it overshadowed the anticipation of profits. Although an exit strategy is not the light at the end of the tunnel, but at least it is a tunnel to the way out before total collapse.

Nadim R Kawar (Ned)
nrk0717@aol.com

Bill Kraft, MarketFN.com said...

Thanks for a great and insightful comment, Ned.