My high school fencing coach was fond of telling us, "You make your habits, then your habits make or break you". Excellent advice for traders as well as for young athletes. We all fall into habits. And once we do, it's hard to break them. So let's look at what habits traders fall into that cost you money.
10. Trying to 'time the market'. Most of the time you're wrong and being wrong is far worst than the value of being right. The stock market in the USA has an inherent upward bias. Going against that bias means that the odds are against you to start.
9. Assuming you are smarter than the 'market'. You're not. The market attracts the brightest minds in the world. Like Wille Sutton, the famous bank robber replied when asked why he robbed banks, 'Because that's where the money is', the markets attract the best minds in the business for the same reason. Thinking that you're smarter than them is ALWAYS dangerous.
8. Not having a plan. I really don't care so much if it's a bad plan, so long as you believe in it (of course, a tested, proven strategy is preferable). Most traders trade without a plan, lose money and wonder why. Duh! Find a strategy that you believe works, test it to YOUR satisfaction. Then follow it.
7. Not following your plan. So let me tell you how the evolution of a trader typically occurs. You get excited by some method. Technical breakout, upward earning revisions, moon phases, whatever. You backtest your plan and discover that it returns 8,000 % a year! 'Yowiee! Why hasn't anyone discovered this gem before?' (see bad habit #9) So you start trading your plan. What happens? You get hit with 10 losing trades in a row. 'What? Even in a singles bar I have a better batting average than this! Stupid plan!' And you move onto a new plan that returns the same result. Some years later you read that your orginial plan has enjoyed ten straight years of success but of course you're now onto trading plan #10 (and about to experience another 10 losing trades in a row). Moral, find a good plan, test it, then follow it.
6. Being inflexible. That might seem like the obverse side to bad habit #7, but it's not. Bad habit #7 was directed to those who, not having done their own due diligence, have no faith in a trading plan and thus change it faster than clothes change fashion. But the markets do evolve and your trading strategy needs to as well. If your strategy underperforms the market for several years, even if it's profitable, understand why. Look for ways to modify your current strategy, not change strategies. Here's a hint. If you're changing / modifying /justifying your strategy within a year of its development, see bad habit #7 and assure yourself that you're not committing that crime.
5. Getting into a trade without a plan to get out. We all love our trades the day we put them on. We convinced ourselves that we should buy XYZ. Damn, doesn't that new product of theirs look sexy? And the back-test of this strategy looked great. Now what happens? XYZ doesn't look so great. Two weeks later, you're out 10% and falling. What to do now? I'd argue that you're now in a terrible situation to make a decision. Especially if you hear yourself uttering the Trader's prayer… "Dear Lord, if you'll just let me out of this stock at even, I'll never trade it again!" Better that you coldly and unemotionally decided on an exit plan BEFORE you get into a trade. See mine until you can develop a better one.
4. Not doing your own homework. I've said it a million times. I could develop a very successful trading strategy, and most folk would lose money following it. Why? Because they didn't do the background work to give them the confidence to follow it. And at the first sign of losses, they would quit. So take ideas, but test them yourself until you're exhausted from testing. There really is no substitute for this work. If you're going to be a successful trader, you have to do your OWN work. Not because you're better than someone else, but because the work that you do now will give you the confidence in your own strategy so that you won't commit bad habit #7.
3. Trading on tips, the wrong way. I know, I know. You never trade on tips, right? You're too sophisticated to do something so stupid. Let's see a show of hands on how many of you who have never traded on a tip in your life. Thank you. Those of you with your hands up are lying to yourself. Now that's settled, let's discuss this dirty little secret. We all do it. But there's a right way and a wrong way to trade on tips. Tips are nothing more than idea generators. And should be treated as such. Still you have to ask yourself, does this trade fit into my style? My strategy? Would it make my screens? If the answer to any of the above is no, don't take the trade, no matter how well-respected the source or how convincing the story. Oh, and by the way, in a future blog post, I'll show you a neat trick on how to profit from tips. For now, do your own due diligence.
2. Falling in love with your company. Thinking that your stock is a company. It's not. Nor is it a product. No matter how much you love the iPhone, AAPL is still just blips of light on a screen. Now you might think that you have found how to predict that those blips of light will increase and that's fine, but don't fall in love with the backstory. It's still just blips of light. If they go down, sell.
1. Which brings us to the worst bad habit of traders. Not asking yourself EVERY day, 'if I didn't already own this stock, would I buy it today?" Start every morning looking at your portfolio. Don't have an opinion (see bad habit #2). Perform whatever voodoo that you do to select stocks. If you can't convince yourself to buy again today, get rid of the stock. If you wouldn't buy a stock today, you have no reason to continue to hold it. Period.
Saturday, September 22, 2007
Improving oneself is a lifelong effort. I copy some good advice from Zacks: