Take Money Out of the Decision

Take Money Out of the Decision
Source: Stockscores.com Perspectives for the week ending December 2, 2011
What are your motivations for trading the stock market? If you a relatively normal person then it is likely that you trade to make money. However, I have found that trading to make money is dangerous because of the emotional attachment we have to our cash. The best traders have different motivations.
Consider something as simple as crossing the road. What do you think about when crossing a busy street? Are you solely motivated to achieve the obvious goal of getting to the other side? Not likely. You are probably thinking a lot about getting to the other side without getting run over.
While this seems obviously silly, the correlation that can be made to trading demonstrates an important point. When we focus on money, when we are motivated by greed, we tend to ignore the obvious. If you are trading to make money then a number of psychological problems enter the trading decision.
First, we worry about missing out on an opportunity. We may look at a trade and think that it is not ideal but still “pretty good”. We remember the last “pretty good” trade set up that came along and how it did really well. We remember the pain that we associate with missing out on that pretty good trade set up that we ignored and that motivates us to take this trade, even though it is less than ideal.
Would you cross a busy road if you had a “pretty good” chance of making it without being hit? Would you jump out of an airplane if there was a “pretty good chance” that your parachute would open?
Second, when our trading decisions are motivated solely by money, we tend to work very hard to find something to trade. While a good work ethic is important to be successful in life, working hard to identify opportunities in the stock market is not always good. Doing so means we work hard to find things that are not obvious, and therefore, may not be good enough to even be worth trading. I find that my very best trades are the ones that I don’t have to think twice about, those that jump off my trading screen when the stock is in front of me. I don’t work hard to find them, they find me.
Third, when we trade just to make money we tend to sell our winners too soon. We want to lock in that good feeling of making a profit and don’t want to ever feel the frustration of having a winner turn in to a loser. So, we exit the stock when it feels good or at the first sign that the trade might make us feel bad. This causes us to not ride out the inevitable pull backs along a longer term trend.
Finally, focusing on the money causes us to now manage risk effectively. When we think about how much we “could” make if the stock goes up then we might buy a position larger than we are willing to lose. By taking too much risk, we are more likely to not sell our losers when they reach a sell signal or exit our winners too soon because of the fear that the winner will turn in to a loser.
Rather than focus on money when you trade, I want you to focus on being right. Do your analysis on a stock and then ask, “am I right to buy this stock?” “Am I right to short sell this stock?”
Make your trading an intellectual exercise, a challenge to your brain to be right more than you are wrong. Take your focus off of the green and on to the black and white. The easiest way to do this is to only look at the charts and not look at your account’s profit and loss indicator. I strongly believe that if you focus on making the right decision instead of focusing on making money, you will end up making more of it anyway.

Do Not Think

You cannot expect to do well in the market if you look at investing in a normal way. By definition, being average is doing what most other people do and since investing is largely a psychological game, doing what other people do is only natural. Average results come from normal people acting in normal ways.
To beat the market, you have to be different.
Not necessarily in a straight jacket bouncing off padded walls different, just a little off.
Here are 10 things that may help you be a better investor, some ways to think differently from the crowd in that pursuit to achieve market dominance.
1. Do not think about making money, think about losing money – the first step toward success is accepting that losing is part of trading. You will not be right all of the time, you cannot always trade your way out of a bad situation. There will be times when you simply have to walk away with a loss. The key is to keeping the losses small and manageable. When the market proves you wrong, take the loss.
2. Do not think you can average down to win – it is a logical idea, add more to a losing position with the expectation that the market must eventually go your way. Many times this strategy will work but, when it does not work, the loss may be insurmountable. The market does not eventually have to go your way.
3. Do not think that your success is entitled – you may make a great trade, pick a really great stock and have a feeling like you really have the market figured out. Forget your gloating, no one ever has the market figured out. We must always remember that we have to work as smart for the next trade as we did for the last.
4. Do not think that talent is required – making money in any trading endeavor is a small part technical skill and a big part emotional management. Learn to limit losses, let winners run and be selective with what you trade. Emotional mastery is more important than stock picking skill.
5. Do not think that you can tell the market what to do – the market does not care about you, it does not know that you want to make a profit. You are the slave, the market is your master. Be obedient and do what the market tells you to.
6. Do not think you are competing against other traders – trading success comes to those who overcome themselves, it is you and your persistent desire to break trading rules that is the ultimate adversary. What others are doing is of little consequence, only you can react to the market and achieve your success.
7. Do not think that Fear and Greed can ever be positive – in life, fear can keep us from harm, greed can give us the motivation to work hard. In the market, these two emotional forces will lead to losses. If your decisions are governed by either or both you will most certainly find that your money escapes you.
8. Do not think you will remember everything you learn – every trade provides a lesson, some valuable education on what to do and what not to do. However, it is likely that your lessons will contradict one another and lead you to forget many of them. Write down the knowledge that you accumulate, return to this trading journal so that you can retain some value from the lessons taught by the market. Remember, the market is cruel, it gives the test first and the lesson after.
9. Do not think that being right will lead to profits – you may be exactly right about what the fundamentals are and what they are worth. However, timing is everything, if your expectations for the future are ill timed, you may find yourself losing more than you can tolerate. Remember, the market can be wrong longer than you can be liquid.
10. Do not think you can overcome the laws of probability – traders tend to be gamblers when they face a loss and risk averse when the have a potential for gain. They would rather lock in a sure profit and gamble against a probable loss even if the expected value of doing so is irrational. Trading is a probability game, each decision should be made on the basis of the best expected value and not what feels best.
Source: Stockscores.com Perspectives for the week ending August 27, 2011