Innerworth - Mind over markets newsletters

[nithin]

April 18, 2006

Still achieving, still pursuing, Learn to labour and to wait.

• Henry Wadsworth Longfellow -

Contagious Behavior of the Mass

People have a natural affinity to follow others. It can be very adaptive at times. If you see someone slip on an icy sidewalk, for example, it would be wise of you to start walking slowly and carefully to protect yourself from getting hurt. People are so attuned to others that they mimic their behaviors without knowing it. Psychologists call this phenomenon contagious behavior. Contagious behavior is the unconscious transmission of actions or emotions from one person to another. When trading the markets, we often fall prey to contagious behavior when we react to the opinion of the masses.

There are both social and biological bases for contagious behavior. It’s a pervasive phenomenon. From a social standpoint, researchers have shown that people react automatically to well learned scripts. When we see a set of behaviors happen over and over, we react to this pattern without thinking. Consider a common example while trading the markets: An analyst talks up a stock spurring a few online traders to buy. Next, a few other traders see the initial buying spree, and decide to follow. Soon many people are following the crowd. Research has shown that people can follow the crowd without knowing it. Negative emotions, such as fear and panic, are especially contagious. When people are studied in groups in a laboratory setting, they tend to “catch” unpleasant emotions from others more than pleasant emotions. When you see the masses sell, for example, you are naturally bound to become afraid yourself and start selling. Your natural human affinity to follow others can work against you, though. You may sell on an irrational, unconscious gut instinct, even when it is not in your best interests.

There are also biological reasons that we follow each other. Humans are built to follow others. Research studies have shown that neurons in the brain fire merely by watching someone perform an action. We laugh when others laugh, and we run from a threat when we see others reacting in a panic. Humans are biological, social beings and these social and biological bases of contagious behavior may it difficult to beat at times.

Contagious behavior may be difficult to fight, but it is vital to find a way to break away from the crowd. Winning traders often need to go their own way. It is often useful to be a rebel, when necessary. The winning trader steps back from the crowd and tries to identify the optimal point to buy and sell. It is necessary to build up immunity to contagious market behavior. How can you do it? First, anticipate the strong tendency to follow the crowd. If you are aware of the powerful influence of the crowd, you can go against them when you need to. Second, know your personality. Some people are more prone to “catch” contagious behavior than others. Emotions are especially catchy. If you are easily discouraged, you may be prone to catch other people’s panic and fear. Third, try not to pay attention to the crowd. Obviously, you can’t follow the crowd if you are oblivious to what they are doing. If you make a conscious attempt to try to look at circumstances from an objective, third eye, you can remove yourself from the situation and react more independently.

It may be difficult to build up immunity to contagious market behavior, but if you increase your awareness of the potential problem, you learn to look inward and go your own way. The more you can think independently, the more you will be inoculated from the contagious opinions and emotions of the crowd.

[nithin]

April 19, 2006

Man is a goal seeking animal. His life only has meaning if he is reaching out and striving for his goals.

• Aristotle -

Winning Traders Are Flexible

How flexible are you in your everyday life? When you are in a new city, do you worry about getting lost or do you just go your own way and assume that somehow and someway you’ll eventually get back to your hotel? Do you get upset when you are told you are wrong, or do you welcome criticism or an opposing opinion? The ability to be open and flexible often makes the difference between winning and losing in the trading business.

Trading is a scary business. When your money is on the line, you naturally feel defensive. The more uncertain you are, the more rigid and defensive you become. It’s a natural, biological response. When humans are threatened, it is often in their best interests to choose a specific course of action and stick with it. Imagine that you are changing lanes in rush hour traffic. If you commit to a lane change, it’s essential to stick with your course of action. If you waver, you’ll confuse other drivers and may end up causing an accident. When we are in potential danger, our mind focuses on executing a specific course of action; other alternatives are completely ignored. At times, this can be a good strategy when trading the markets. If you are executing a scalp trade, for example, you must commit to a specific course of action, get in and get out, and make a profit. It would do you little good to waver at a critical moment when you should take decisive action. That said, when it comes to longer term trading, it’s vital to be open-minded and flexible.

When making long term trades, market conditions can change, and you may need to make midcourse corrections. You have to look at a trade from different angles and willingly explore every possibility. Many traders are stubborn, however. They have their money on the line, and they are afraid their trading strategy may not pan out. Unfortunately, their stubbornness restricts them from freely examining their options. Eventually, they end up losing money when they miss a critical market change.

How can you increase the odds of becoming flexible? First, don’t imbue a trading plan with extreme psychological significance. A trade is just a trade. It reveals nothing about your intelligence, talent, or true inner-worth. It’s merely a business transaction, so treat it as nothing more. Second, minimize risk. Again, when you feel that your well being is at risk, you feel threatened and defend your ego by acting inflexibly. If you limit the amount you risk on a trade, you will feel naturally relaxed, and thus, more open and flexible to possibilities. If you feel extreme stress, you might even want to close out a position and reevaluate it. If it is a longer term trade, you have the luxury of exiting and reevaluating your trading plan while feeling safe, and thus, relaxed. Third, you can ask a trusted friend or coach to play devil’s advocate and help you see alternative perspectives.

Don’t be afraid to admit that you may be wrong. The willingness to admit you are wrong gives you power and freedom. When you are willing to admit you are wrong, you won’t be defensive, but you’ll feel so free that you will trade creatively and profitably.

[nithin]

April 20, 2006

You don’t have to be a fantastic hero. You can be just an ordinary chap, sufficiently motivated to reach challenging goals.

• Edmund Hillary -

The Psychology of Stops

Would you ever think of jumping out of an airplane without a parachute? Of course not, but that’s what some people do when they trade the markets. They are very willing to put their money on the line, but they don’t have much to protect them from a major disaster. Placing a stop, for example, can prevent you from allowing a small loss to turn into a big one, but many traders avoid placing stops. Why do some traders take risks by not placing stops? It can be difficult to know where to place a stop. If you fail to account for volatility, you will get stopped out too soon. Other people are afraid to place stops. Placing a stop requires you to consider the worst-case scenario, and to many, it’s difficult to consider failure. It’s easier to deny the potential problem, and to pretend it will not possibly happen. Many experts, however, suggest placing stops. They know that nothing is certain when trading the markets. They view protective stops as a kind of insurance policy that prevents them from losing money.

David, a seasoned trader interviewed by our staff, says “I never take a trade without knowing my stop. When I take a trade, I’m pretty convinced it’s something worthwhile. I’ve already figured out my stop. I’ve accepted the (potential) loss before I ever clicked the button or made the call. So if it starts going against me, I don’t feel a flood of emotions.” For David, stops not only protect him from losses, but they help him control his emotions. Stops give him a feeling of security, and allow him to feel calm and relaxed.

Seasoned traders may use stops all the time, but even the most seasoned traders have difficulty following them. Shawn, for example, admits, “I’ve blown stops and it’s painful. The weird thing is that money does not seem to be driving it. Afterwards, I sit and try to analyze the incident. I certainly knew better. I believe trading is something of a self-journey. It involves learning about your character, your self-control, and your ego.” Dan also admits he blows his stops: “Sure. That happens all the time. There’s nothing I can do about it. That’s one of challenges that continue to engross me. Do you hold them or do you fold them? If you fold them and the stock price goes up, you get angry because you made a mistake. If you hold them and they go down, you become angry again. Nevertheless, you have to stay focused on what’s going on and learn from the experience and try to apply it to the future. You’re going to take your lumps in the market.”

Even though stops are difficult to set and difficult to keep at times, they are an essential component of risk management. Losses are commonplace in trading. As hard as it is to focus on losses, they are impossible to avoid. Rather than avoid thinking of the worst-case scenario, face it head on. Figure out what could go wrong and where you can place a stop to protect you from a huge financial loss. In the long run, you’ll find you will limit losses and trade more profitably.

[goldb]

grt.

[nithin]

April 21, 2006

Change is inevitable - except from a vending machine.

• Robert C. Gallagher

Setting the Right Goals: It Makes All the Difference

If we had a choice, we would all want to become an overnight success. But unless you win the lottery, it is unlikely that you will become wealthy that quickly. If you are like most traders, it will take much longer, and psychologically, you should be ready to put in the effort. Don’t get your hopes up. Many traders set themselves up for disappointment by setting unrealistic goals. They assume they can trade profitably in a matter of months, but seasoned traders emphasize that mastering the markets may take several years. If you are realistic about what you can actually achieve, you’ll stay optimistic and persist in a field where less than 5% survive the learning curve.

Success requires that you set specific goals. Many people make the mistake of setting vague, non-specific goals. It is useful to set modest and specific goals and reward yourself as you make progress. Goals don’t necessarily need to focus on profits. It may be more useful to set goals regarding the development of skills. For example, break down the larger goal into specific steps, or sub-goals, that are within your ability to achieve. For example, a learning goal may be stating, “I’m going to study for 30 hours a week to learn a new trading technique.” You may also decide to study charts for three hours a day, or read one new trading book a week. The specific goal will not immediately lead to the larger goal of meeting a specific profit objective per month, but it is easy to achieve. As you complete each sub-goal, you’ll naturally feel a sense of satisfaction after jumping each small hurdle. As you develop your skills, you can gradually reach for higher and higher goals. Your progress may be slow at first, but over time, you’ll make significant progress. The key is to avoid trying to do too much. Take it slow. Work at your own speed and according to your own timeline. Don’t make it a race. The only person you need to please is you. If you set goals realistically and strive to achieve them with resolution, you’ll master the markets, and achieve enduring financial success.

To many, this approach may seem counterintuitive. Don’t successful people think big? Big dreams can be a powerful motivator, but there’s a huge difference between lofty unrealistic dreams and specific ambitious goals that one strives to achieve with a methodical and detailed plan. Big dreams are not always the best goals to set. Here’s why. You may not have the experience or skills to reach a goal that exceeds your abilities. For example, would you try to run a 20-mile marathon if you could not even run a mile? Of course not. So why make such high and lofty trading goals until you have the requisite knowledge and skills? Psychological studies show that it is the way one goes about achieving a high level goal that matters.

When you set high goals that exceed your skills, you usually fail, feel discouraged, and feel like giving up. It’s useful to distinguish performance goals from learning goals. Setting realistic goals can make all the difference. When you set goals that are within your grasp, you’ll achieve them, feel good about your progress, and keep building up your trading skills. If you keep working, slowly but surely, you’ll be one of the few who eventually become a master trader.

[nithin]

April 24, 2006

It is not enough to reach for the brass ring. You must also enjoy the merry go round.

• Julie Andrews -

Discipline Takes Practice

Trading is a profession where you must make a plan and stick with it, but even seasoned professionals find it difficult to maintain discipline. They sell earlier than they had planned, ignore stop-loss points, or abandon risk limits. As much as many traders try, they have difficulty maintaining discipline, and they pay the price in the long run.

Some people are highly disciplined and very self-controlled. They scrupulously follow rules and are careful to control their impulses, even if it means they are a little rigid at times. Other traders take a more carefree approach to trading. They are usually very creative and profitable, but may have trouble with discipline at critical moments of trading. Every trader has an issue with discipline to some extent, whether it is a lack of discipline or too much of it. The markets are chaotic and unpredictable, and thus, it is understandable to feel unsure and unsettled at times. After a trade is executed, what happens next is anyone’s guess, and this state of uncertainty can cause uneasiness, which may in turn, lead to impulsive decisions.

How can you increase your ability to maintain discipline? First, it’s important to view your ability to maintain discipline as similar to a muscle. Like an actual muscle, it’s necessary to build up stamina. Maintaining control takes psychological energy, and humans have a limited amount of psychological energy. When the limits are reached, maintaining discipline is a challenge. The best solution is to build up as much psychological energy as possible, which will allow you to maintain discipline. Second, it is vital to get plenty of rest and relaxation. When you’re tired, the available psychological energy that you can devote to trading is restricted. You will have great difficulty controlling impulses to stray from trading plan. By getting the proper amount of rest, though, you’ll have enough energy stored up to stay focused and maintain discipline. Don’t underestimate the stamina you need to maintain discipline. If you have over-taxed your ability to maintain discipline, or if you are too tired, you will act impulsively. Third, control your emotions. When you are feeling stressed out or upset, you will be unable to maintain discipline. Fourth, it’s vital to have a clearly defined trading plan. Not only should you map it out, but you should also write it down and put it up next to your screen. If it is clearly outlined, it will be easier to follow, and if it is right in front of you as you trade, you will be able to remind yourself to follow it. Fifth, outline the reasons you want to stick with your plan, and write these reasons down. By writing them down, you can read them over when you are tempted to abandon your plan. You might write down, “If I keep abandoning my plan, I’ll regret it later. I can stick with this plan if I try hard enough. Right now, my only goal is going to be sticking to my plan. That’s it.” When you feel like abandoning your plan, you may want to read these statements over and over again. Don’t think about the consequences of losing or closing out the trade. Focus on the present. Concentrate on completing the next steps, not on the future. If you concentrate hard enough, you will be able to stick with your plan.

Many traders have difficulty trading with discipline. It’s tempting to trade by the seat of your pants and just live with the consequences, no matter what they are. But the winning trader is the disciplined trader, and if you can maintain discipline, you will profit handsomely.

[nithin]

April 25, 2006

Ask five economists and you’ll get five different answers (six if one went to Harvard).

• Edgar R. Fiedler

Self-Statements to Combat Envy

Yesterday, Jack went over to his best friend Tom’s house to look at his new Porsche Turbo. Jack has wanted a Porsche since he was a teenager but could never afford one. Four years ago he taught Tom how to trade. Tom’s been doing great ever since. Each year he has made greater and greater profits, even during bear markets. Jack can’t help but envy Tom’s success, yet at the same time, he berates himself for failing to do as well. He thinks, “What am I doing wrong? I taught this guy how to trade. How can he be doing so much better than I am? It just isn’t fair. I should just give up.” Have you ever felt like Jack? You look at your friends and can’t believe how much better they are doing. Soon, you’re so upset that you can’t face another trading day. You may make a solid $200 on a trade, but think, “I’ll never reach my financial goals at this rate.” When you are so consumed with envy that you’re beating yourself up for failing to meet your performance standards, it’s time to take action. Rather than wallow in self-pity, it’s vital to combat envy and regain your optimistic mental edge.

The reactions to certain events can seem to come out of nowhere We can be happy and content one minute, and suddenly disappointed when faced with a setback. It can happen quickly, instantly without thinking. It’s important to get back on track when this happens, however. Although it may seem that our emotions happen automatically, they don’t. We quickly think things through, and it’s our thoughts that lie behind our emotions. For example, when we are envious of what others have, and feel disappointed with our lives, it is all because we believe that we should succeed. We believe that we should be doing as well as others. We believe that it is our right to do well. We feel entitled and shafted by life when we discover that we are not living up to our expectations. It’s natural to feel this way. In today’s culture, the virtues of ambition and success are touted with almost every commercial, every movie, and page after page of print ads. If you work hard, you deserve wealth, fame, and respect.

It would be nice if life always worked that way, but it does not. In the trading realm especially, sometimes our hard work pays off, but many times it does not. When you feel envy, or disappointment, it’s useful to pull out a list of sayings that changes your perspective and restores your enthusiasm and mental edge. What are some of these statements? Consider some of our favorites: “Run your own race. Don’t let your net worth determine your self-worth. Focus on the process, not the prize.” We’ve written columns on each of these slogans. In summary, “run your own race,” refers to the idea that comparisons to others are unproductive. Everyone has his or her own resources and talents. Some people start out ahead in ways that you are unaware of, so if they do better than you, there is no reason to think that you are doing poorly; they are merely doing better than you because they have more resources. You don’t have to compete with others. All you have to do is run your own race. And no matter how well you do, you always have inherent self-worth. Don’t let your profits, or performance, determine how you feel about yourself. Look inward for validation. Appreciate the talents you have and appreciate what you can do. Finally, it’s useful to focus on the inherent intellectual rewards trading has to offer. When you focus on profits, you put pressure on yourself to do well, and when you put too much pressure on yourself, you tend to choke under the strain. Stay modest, accept your limitations, and enjoy yourself. If you can remember these truths when you feel envious of others, disappointed, and beaten, you’ll regain your mental edge, and make the profits you’re seeking.

[goldb]

grt.

[nithin]

April 26, 2006

…it is always advisable to perceive clearly our ignorance.

• Charles Darwin -

Stressed, Tired, and Ready to Lose

Imagine what you would do in the following scenario. You have been looking at a position for a week. You had a clear and simple trading plan: Just wait for a product announcement at the end of the week, watch the stock jump $2, and sell. As might be expected, things aren’t working as you had planned. First, no clear trend has emerged; prices are moving chaotically up and down. Second, it’s been two days since the announcement and the price has barely moved. You decide to wait for two days to see if your original plan will come to fruition, but a small voice inside you is telling you to sell. You’ve been stressed out and you’re tired. It’s been a tough week. Part of you wants to listen to the little voice, and just close out the position, but the logical part of your mind is telling you to wait patiently and see what happens. Although you know what you want to do, you have a powerful urge to sabotage your efforts, and just walk away. What can you do to combat this feeling?

Trading often comes down to maintaining a peak performance state at a few critical moments of trading. To take advantage of these key moments, you must be relaxed, full of energy, and ready to take decisive action. But your mind can grow weary, just like how a muscle can become weak and ready to fail at the slightest strain. When you go on a long run, for example, you soon run out of energy. You can’t go any farther. Your muscles begin to ache and you need to take a rest and recuperate before you start moving again. It’s the same when it comes to trying to maintain your mental edge. It’s vital that you consider that the mind has limited energy, and that after putting in a hard and tedious effort, you must take a rest and rejuvenate, so you can face the market action with a renewed sense of vigor. If you have strained your mental “muscles,” you’ll have trouble maintaining control. Your mind will be elsewhere or you’ll be too tired to act decisively. When you’re tired, you will want to act on impulse. You will find it difficult to concentrate, stay focused, and stick with your trading plan. The only way to deal with these feelings is to restore your mental edge.

Don’t underestimate your need for psychological energy. When you are tired, you will have a strong urge to give up at a critical point during a trade when you should enthusiastically watch the market action and be ready to face a challenge with a peak mental state. The winning trader is always ready and willing to take action. To be a winning trader, you must be rested and ready, so get plenty of rest, make sure you are well nourished and physically up to the stresses and strains of trading. By taking these precautions, you’ll trade the markets with a winning mental edge and easily fight the urge to sabotage your efforts.

[nithin]

May 1st 2006

There is more to life than increasing its speed.

• Mahatma Gandhi -

The Dynamics of Greed

In the movie “Wall Street,” Gordon Geckko argues, “Greed is good.” Greed can motivate you to strive for perfection and keep you persisting in the face of adversity, but greed has its downside. It is often said that the markets are driven by fear and greed. The masses have a natural desire for wealth and all the advantages that money can buy. In their zeal, the masses invest in stocks and believe that their investments will allow them to achieve their financial goals. When the price starts going down, though, they fear losing their investment and they sell, often too prematurely and at a loss. The dynamics of greed drive the dynamics of the market.

As an individual trader greed may drive you. Trading is a challenging profession. Not everyone makes it. You have to study the markets and learn how to take out profits from the market action. How to do this is not obvious. Finding profitable trading strategies is an unending search. You may find a strategy that works for a while, but market conditions change and the strategy no longer works. The challenge is to make profits in market after market. Why bother? If you aren’t driven to achieve success, you won’t make it. You won’t persist. You won’t try to overcome setback after setback. Greed is a powerful motivator. It is natural to seek out happiness. If you are similar to most people, you dream of eternal bliss. For centuries people have fantasized that if they had immense wealth, they could solve all their problems, but this fantasy is often unrealistic. The human mind is capable of fooling itself into falsely believing that unrealistic fantasies can come true. It may be nice to have enough wealth to make your life more pleasant, but money does not buy happiness. Nonetheless, dreaming of wealth and how we can achieve great wealth through trading is a powerful motivator. Sometimes it is useful to indulge in fantasy and enjoy feeling the passion for success. It keeps us going when we are beaten down. It gives us something to strive for. That said, greed does have its downside.

Money is a powerful motivator, but many people know deep down that money can’t solve all our problems. And those thoughts and feelings that lie deep down in our psyche can often influence us when we don’t want them to. Since we know that money isn’t going to solve our problems, we can lose hope when everything seems to be going against us. It’s vital that we acknowledge how greed can be a motivator but also a barrier. It can distract us from focusing on our trading plan. We can become so consumed with the pursuit of money that we fail to appreciate the inherent rewards of trading. Trading offers an intellectual challenge. You can build up your trading skills through practice and experience and feel good knowing that you have mastered a skill that few have developed. Don’t focus all your energy on money and the accumulation of it. Instead, focus on developing your skills and enjoying the process of trading. In the long run, you’ll find that you will enjoy the game, and ironically, when you don’t worry about the profits, you will actually trade more profitably in the long run.

[goldb]

grt.

[nithin]

Perfect freedom is reserved for the man who lives by his own work and in that work does what he wants to do.

• Samuel Taylor Coleridge -

Trading Offers Freedom

When trading the markets, there’s a constant need to make profits. You can easily start feeling that there’s too much to do and not enough time to do it. If you’re like most traders, you’re afraid of missing out on opportunities. You know that it’s hard to take money out of the markets, and you know that to stay on top, you have to keep working on it. Why do people work so hard in such a profession? Most people would say it’s for the money. It is for the money, isn’t it? Many traders say that there are other reasons. One of the main reasons is feeling that you have mastered a career in which few survive. But perhaps the best reason to stay in the trading profession is the freedom traders have. Traders work for themselves and on their own terms.

A sense of freedom can be a powerful motivator. In an interview with Innerworth staff, for example, Don said, “When I made the decision to trade full time, I did so for a couple of reasons. One was for the freedom and independence…trading offered some financial upside, but I didn’t go in to trading for the money. I did it for the freedom.”

Many traders take the freedom trading offers for granted. In a competitive world where most people define their self-worth based on how they compare to others, there’s a powerful need to keep up with the guy next door. Out of sheer habit, one incessantly asks, “How well am I doing?” and that question usually leads to asking, “How well ‘should’ I be doing?” It’s hard to escape the need to succeed. The media provides a continuous barrage of images of success: “Buy a sleek, new sports car and impress the neighbors. Wear the latest designer fashions and watch heads turn as you walk by.” Implicit in all these messages is the idea that in order to have value as a person, you must have more, or do more, than your friends and neighbors. The need to succeed can make you feel trapped, however. If you feel the pressure to make huge profits, you’ll feel the strain and it may undermine the freedom you could be experiencing. Instead, it’s much more useful to strive for modest goals. It helps you cope with the stresses and stains of trading.

We asked Don how he copes with the pressure to succeed: “I think that doing some simple math helps. Let’s say you want to earn a certain amount over the course of a month. If you divide that amount (monthly financial goals) by the number of trading days, it doesn’t come to a whole lot. Suppose somebody wants to make $60,000 a year. If you divide that by 12 months, it is $5,000 a month. If you divide that by the number of days in a month, let’s say 20 trading days, that’s $250 a day. That’s not a whole lot of money, if one is skilled in this business. Looking at it like that, by the simple fact that you recognize that you don’t need to make it all in one day or in one trade, really put things in perspective.” When you break down what you need to do on any given day, it will seem reasonable and you will feel free. So don’t stress yourself out by trying to achieve goals that seem impossible. By thinking modestly, you will be able to make realistic plans for achieving them, and in the end, you’ll see that you can trade profitably and enjoy the freedom trading offers.

[nithin]

May 3, 2006

One important key to success is self-confidence. An important key to self-confidence is preparation.

• Arthur Ashe -

Confident But Not Over-Confident

When it comes to trading the markets, nothing is certain. How do you cope with uncertainty? Many traders are overconfident. Rather than face the possibility of losses due to market uncertainty, they fool themselves into thinking they are omnipotent. Behavioral economists Brad Barber and Terrance Odean illustrated how novice traders are especially overconfident. They analyzed account records from a large sample of online investors. Overconfident investors showed this ailment after a large windfall. They put on substantially more trades than other investors, yet achieved few rewards for their efforts. By putting on significantly more trades, they paid more in commissions, which in turn resulted in overall lower account balances. Clearly, overconfidence has a price. Are you willing to pay it?

Tom a seasoned trader told Innerworth staff, “Every time I have issues with confidence, I become overconfident. I try to be very humble when I trade. You’re only as good as your last trade. It doesn’t matter what you did last month, last year, or the last ten years, it’s what are you doing today.” But Tom does not lack confidence. He may get beaten down, but he doesn’t stay down for very long: “I get worried or depressed for a very short period of time. Rather than dwell on it, I immediately shift my focus and think, ‘Okay, fine, let’s see how we can get out of this?’ What’s done is done.”

Although overconfidence can lead to risky trades that may produce losses occasionally, a lack of confidence can be even more detrimental. It’s probably not a good idea to be optimistic to the point of putting on trades without carefully managing risk, such as limiting the size of a position or using protective stops, but a moderate amount of optimism and confidence is useful. Dr. James Felton of Central Michigan University, and colleagues (2003), point out that pessimists often panic, become fearful, and tenaciously deny they are in a losing trade. A moderate amount of optimism keeps a trader calm and inquisitive. Even in the midst of a losing trade, an optimist may be more likely to seek out information and make an informed decision. Finding the proper level of confidence is key. It is a little like walking a tightrope between extreme unrealistic optimism and extreme debilitating pessimism. Finding the right balance will allow you to pick yourself up when you are beaten down, but stay grounded in reality even after a huge win.

The winning trader is both confident and realistic. If you want to trade like a winner, it’s vital that you develop a true sense of self-confidence. By gaining a wealth of experience, your confidence will be based on your actual trading skills. When you know what you can do and what you can’t, you’ll feel calm and self-assured. You’ll know what you can handle, and you will be able to trade with solid, realistic confidence.

[goldb]

grt…

[incognito_man]

Thanks Nitin for these.

[nithin]

May 4, 2006

In life, as in football, you won’t go far unless you know where the goalposts are.

• Arnold H. Glasgow -

Your Favorite Stocks May Not Be the Best Investments

Decisions about which stocks to purchase should be objective, but many times our emotions and personal “attachments” to stocks play a more significant role than they should. Research studies by behavioral economists have shown that social psychological factors, such as the public image of a company, play a significant role in the way a stock moves. For example, consider the media coverage of oil companies right now. With all the profits we’ve been hearing about, how can you resist not trading these stocks? It may be difficult to stay away.

In choosing a stock to trade, many traders try to identify a “great buy” or “sure winner,” but what factors should traders actually consider when making this decision? Should it merely be based on an “image” or something more tangible? Are you actually considering a factor that has a direct bearing on whether the stock in the company is worth an investment? A common mistake among traders is to base trading decisions on hype and image, rather than on factors that will actually produce trading profits, such as current price patterns, volume, or momentum indicators.

Think of all the companies in recent history that were supposed to be up and coming? Tyco and Enron seemed like sure win companies with huge potential. They were viewed as great companies for long-term investments. What about General Motors? At one time, it was one of the largest companies in the world, but what about today? In recent times, you may have seen the hype about Apple Computer raise its stock price, but the high of a few months ago has yet to be seen again. If you are a short-term trader, minor fluctuations in price can pay off big, but ideally, a stock purchase should be based on more fundamental factors in addition to the more immediate factors that move the price. In other words, if the price is purely based on hype, it is easy to watch it plummet. It’s common to see a thinly traded stock surge in price due to media coverage, for example, but it may fall just as fast if the price is purely based on hype. When the masses sell, they all sell, and there are no “serious” investors left to buy the stock.

Media coverage can have a powerful impact on the behavior of the masses. But as a trader, you have to make more logical decisions than the masses. Don’t be a victim of biased analysts’ predictions, media hype and the unrealistic exuberance that seems to creep up at times. In this era of trading, the “true value” of a company is a matter of debate. And despite analysts’ predictions, no one can know with certainty the actual future stock price for any company, since the stock price is largely a function of the perception of the masses. Media hype, image, or shareholders’ sentimental attachment to their stocks may influence prices, but as traders, it’s essential to put these factors in perspective. The masses may be easily swayed by these opinions and beliefs, but you must base your trading decisions on current signals and indicators in the short-term time frame you have chosen to trade, whether intraday or intraweek. What is the basic price pattern, and how has it changed in subtle ways by media news? The price pattern, and factors such as volume and momentum are primary; the media news is secondary. Don’t make the mistake of using image, sentimentality, and public opinion as primary information for making trading decisions. By all means, consider these factors, but base you primary trading strategy on more fundamental short-term indicators of momentum and trend.

[nithin]

May 5, 2006

If you are not living on the edge, you are taking up too much room.

• Jayne Howard -
  Featured Article

Taking Risks In Uncertain Times

How much money are you going to risk next week? It’s hard to know what will happen next week, so do you really know what to do right now, over the weekend, or Monday morning? The markets are often chaotic and uncertain. It is hard to know what will happen next. The astute trader is aware of this uncertainty and takes steps to prevent it from adversely influencing trading decisions.

Consider what Don, one of the traders interviewed by our Innerworth staff, has to say: “Even though setups are skewed toward moving in a given direction more times than not, there are certainly going to be times when they’re not going to move. I view this business as similar to flipping a coin that’s been purposely weighted to lean towards heads. Whether we flip it 100 times a day, or whether we flip it once or twice a week, we’re still flipping a coin that’s been rigged. We also know that when we flip that coin, even though the probability is that it’s going to land on heads, we also know it could come up tails. It may come up tails once, twice, three, or four times in a row, depending on what the market is doing at a given point in time. There is an inherent uncertainty in trading. You must be able to close out a trade quickly when it’s not going in the right direction.” In some ways, Don’s an optimist. If we are fortunate, our trading methods give us a casino-like edge, but other times we’re on the other side of a trade. In the end, we are trading in uncertain times.

How do you cope with this uncertainty? The best way to handle uncertainty is to manage your risk. The most successful traders tend to risk relatively small amounts of capital on any single trade. They also use protective stops and have clearly defined exit strategies. Putting less money on the line with each trade is an effective way to decrease fear of losing money, and increase a sense of mastery and control while coping with uncertainty. It is also important to trade with money you can afford to lose. If you trade with money that you badly need to pay basic living expenses, you will naturally feel worried and uneasy. It can be difficult to fool yourself. So don’t bother trying. If you can’t afford to lose your stake, stand aside, moonlight, and build up your capital until you can calmly put a bet down without concerning yourself with the adverse consequences of a possible loss.

In the end, it’s necessary to accept the risky nature of trading. Anything can happen, but it doesn’t need to be a source of worry. Through careful risk management, you can protect your capital. Worry can be the doom of many traders, but if you accept the fact that uncertainty and chaos are part of the inherent nature of the markets, you can account for it in your trading plan, and neutralize its potentially negative impact.

[nithin]

Discipline is the bridge between goals and accomplishment.

• Jim Rohn -

May 8th,2006

Paying Your Dues

The great trader Jesse Livermore blew out his account more than once in his illustrious career. It’s scary to think about, but if you want to become one of the few who reach the top in this business, it’s necessary to face the possibility that you may blow out your account. Many seasoned traders have had to start over more than once. You may not be immune to this ailment. Just like all top-notch traders, you may need to pay your dues and learn what it’s like to lose and come back.

In an interview with Innerworth, Tom, a long time market observer noted, “I have yet to meet a successful trader who hasn’t paid his dues.” Tom observed that every successful trader has blown out his account and learned how to recover from it. “Take the best traders in the world…they’ve blown out. If trading was easy, everyone would be trading and everyone would be making money. You have to pay your dues. Some people are lucky and only pay those dues for a very short period of time, and others are going to pay their dues for a very long time.”

Another seasoned trader, Dan, described how he lost big before making a comeback: “One time I lost virtually everything in one or two days, and a good friend of mine came over to make sure that I wasn’t going to do something stupid. … I told him, 'It’s only cash. It’s not my life that I lost. I can get it back. It’s not the end of the world. I’m not losing my house, my car, my credit cards, or my friends. I made a mistake. I’m angry that I made a mistake, but the cash has nothing to do with it.”

The trading lore is replete with similar stories. One young, promising trader, for example, lost so much money that his brokerage decided to fund him to make back what he had lost. Even the best traders blow out. Why? For some it is merely mathematics. They are under-capitalized and end up spending what little earnings they make on a few wrong trades and on commissions. They never had a chance. Other traders are overly impulsive. In a sense, the old adage, “you have to risk money to make money,” is true. To make big profits and turn a small account into a large one, it is necessary to take big risks when a once-in-a-lifetime trade comes along. That said, you may also be taking a big risk that has dire financial consequences. There’s no one right way to trade. If you want to make it big in the trading business, you may need to take risks. But you should be ready to deal with the consequences. Other traders may want to play it safe by trading small and building up their trading skills and trading capital before scaling up to make those bigger, riskier trades. Whatever you decide, it’s necessary to keep up your spirits on the one hand but be ready to pay your dues on the other. You can make it if you stick with it, but everyone has to put in the required time and effort, and learn to pick yourself up after a setback.

[nithin]

May 10th, 2006

Efficiency is doing better what is already being done.

• Peter F. Drucker -

The Efficient and Successful Trader

How much time do you spend preparing for the trading day. Do you spend hours scouring the markets for a winning trading opportunity? Do you watch hours of commentary or read all the major financial newspapers? You don’t need to spend hours and hours reading about the markets if it doesn’t directly lead to a profit. For example, most media coverage of the markets is for entertainment value, so spending hours reading or viewing it is a waste of valuable time. You need to work efficiently and make sure that the time you spend learning about trading and the markets does indeed pay off.

Consider how Mark, a seasoned hedge fund manager, prepares. He shared his morning routine with our Innerworth staff: “I look at about 300 charts every day. That gives me a good feel for what the markets are doing overall. I try to see whether a lot of different markets are signaling the same thing and breaking out at approximately at the same time. I wait for that to happen before I take a position. When it happens, it’s fairly clear, and I really don’t have any problem with courage at that point.” The seasoned trader doesn’t spend hours the night before preparing. Instead, the seasoned, winning trader can prepare right before the trading day begins. Rather than wasting time on tasks that don’t pay off, the winning trader works efficiently.

Seasoned traders may work efficiently, but novice traders may need to spend a little extra time preparing. It’s difficult to become a skilled and consistently profitable trader. Only an individual with rare talents can rise to the top 2% who make it as a top-notch trader. It does indeed take dedication and hard work. However, some make the mistake of thinking that trading is like a regular 40-hour a week job. The idea that an hour of work directly produces an hour of pay is not pertinent to trading. Trading is more about accomplishing a specific target, and making a profitable trade, rather than putting in a specific number of hours. For instance, if it takes only 15 minutes for a skilled trader to make enough profit to have a year’s worth of living expenses, then so be it. Seasoned traders don’t have to spend 40 hours a week to make a living, if they have the requisite skills (and novice traders may need to put in more time building up these requisite skills).

The point is that if you’re a novice trader, you can’t work under the belief that everything you do will have a payoff. You must also consider that there are a fixed number of hours in the day that you can work, so you must spend that time efficiently. Trading is a challenging profession, and you need to focus your psychological energy on what matters most. For example, don’t be distracted by learning additional trading strategies that you will never use, or new indicators that are redundant with basic indicators of trend. And don’t believe you must keep up with all the media hype. Focus, work efficiently, and in time you will build the skills you need to become a consistently profitable trader.

[nithin]

The real test in golf and in life is not in keeping out of the rough, but in getting out after you are in.

• Zig Ziglar -

Is Risk Management Really Important?

Many traders view risk management as critical to long-term success. Consider what a couple seasoned traders told our Innerworth staff about risk management. Mark said, “You can have a crummy trading strategy, but if you have good money management, you can make money. If you have poor money management, it doesn’t matter how good the trading strategy is. You’re going to lose in the end.” Similarly, Chris observes, “You must have a survivability element so that if you literally wished to select stocks by throwing darts at a board, you would continue to survive market to market.”

Risk management is viewed by many as important, but what’s the best way to manage risk? Some traders use very specific rules for managing risk, such as risking a small percentage of capital on each trade. Other traders don’t seem to have any specific rules, but may look at past performance as a key. (What is the volatility? What was the previous day’s low?)

As important as risk management is, not all successful traders always manage risk. Some successful traders put on big positions when they believe they see a chance to make a huge, substantial win. When they believe they are right, they just take a chance. Doing so may lead to big losses when they are wrong, but they do it when they need to.

Is taking big risks a good idea? When it comes to trading, there is no one “right” way to trade. All you can do is consider the advantages and disadvantages of each approach and decide which approach you want to take. Whether you want to take big risks may depend on your experience and trading skills. If you are a novice trader, you have not yet learned how to use a set of methods consistently to make a profit in the long term. For novice traders, it is often vital that they control their risk (for example, risking a small percentage on each trade) so that they could survive long enough to gain mastery as a trader. One reason trading coaches preach the virtues of careful risk management is that a common mistake among novice traders is wanting to “get rich quick” and putting on big trades to make big wins. The methods and skills of a novice trader, however, do not warrant taking such huge risks. What often happens is that they lose all of their capital on a few big trades and need to rebuild their capital before trading again. Rather than gaining mastery as a trader, they fruitlessly go through cycles of risking a lot, losing it all, quitting trading to rebuild capital, and so on. These novice traders never give themselves a realistic chance of learning how to trade consistently. In contrast, the novice traders who manage their risk can trade longer, and hopefully learn how to trade consistently before their capital runs out.

Once a trader becomes seasoned, he or she may want to “reach the next level” and make a lot more profit. Seasoned traders often reach an asymptote, at which point a self-imposed cap limits their profits. It’s hard to break through this barrier, and no one really seems to know why. Very experienced traders who want to make greater profits need to start bending or breaking the rules a little to see if they can make greater profits and break through the barrier. This is risky, but some seasoned traders are willing to take the risk in order to make huge yearly profits. That said, they also can afford to take more risks. As seasoned traders, they have the methods and experience to take risks, but a novice trader does not. So even though there is no right or wrong way to trade, if you are new to the trading field, risk management has the advantage of allowing you to “survive the learning curve” until you find the once-in-a-lifetime opportunities to make you wealthy beyond your wildest dreams.