Quick Comment on Less Successful Traders
While thousands of posts and articles have been written on why traders are not achieving the success they desire (or worse, are failing), I wanted to point out three quick ideas that summarize behaviors that lead to failure in the market by newer traders.
- Traders play for large targets and “swing for the fences” and take on too much risk with too little information or knowledge
- Traders play for small targets when they should be playing for large targets and take on too little risk when odds are on their side and opportunities arise
- (New) Traders are more likely to be distracted by others’ opinions or their own emotions (overreactions) that occur when taking risk, or just pass on the trade
In a shorter summary:
- New traders take on excessive risk when they shouldn’t
- New traders don’t take enough risk when good opportunities arise
- New traders let their responses to their emotions keep them on the sideline altogether.
Also, newer traders tend to be REACTIVE to market action when they should be PROACTIVE.
They often wait for confirmation of a move before entering, while professional traders – knowing odds are in their favor – enter moves before they begin. New traders are more likely to enter their trades at the end of a move. Watch yourself and try to attempt to move like a professional would, which often is the opposite of what your feelings are telling you to do.
Trading is a game of balance – in this example, between taking on too much risk and leading to failure (through excessive losses) and too little risk (leading to breaking even at best) where your time and risk do not result in profit. There is an optimal point in each individual trader regarding their risk tolerance level and maximum reward point. Success requires finding balance between excessive risk and excessive concern for loss. Only through constant monitoring and good record keeping – including personal observations of your emotions – can we find this balance point.
Sidepoint: I have experienced each of these extremes, as I’m sure nearly all traders have. My fault exists in not taking on enough risk, or staying on the sidelines when I should be in. It was taking on excessive risk (overleveraged) with overconfidence that developed my fear bias through a particularly bloody trade. Fear can develop like a food poisoning experience, where it can be very difficult to get back to where you were before the incident.
Many traders experience initial success, get burned a few times, then come back to the market in a fear mentality. Afterwards, they learn from others, then overcome the fear through small victories, and then the balance is achieved through repeated experience of actually trading the market. It is a difficult process with many pitfalls, but – as anyone can tell you – the rewards are well worth the journey!
Nice post. I tend to err on the not taking enough risk / staying on the sidelines as well. I guess for me it comes from lack of confidence and caring too much about whether any single trade is going to be a winner or a loser.
I like the insights you share. Keep up the good work.
Eyal:
Thank you for your comment and observation. I must admit, I am surprised you are like me in the risk-avoidance issue! It helps to hear that successful traders like yourself still battle with fear but that it can be overcome. It’s very difficult sometimes to enter that trade when you know you should, and even if you enter, it’s so much harder to use the proper position size. Fear and uncertainly keep breathing down your neck and it seems you must resist them each time you trade – it’s rough. We just have to keep pressing on! It’s worth it!
Great post. It is insightful.
btw,thanks for adding me into your blogroll. But I guess you have linked my name to wrong address. 😉
Gav, Thank you for the comment. I’m so sorry about the link error – it has been corrected. Thank you so much for letting me know! I do enjoy your site and insights as well.
Corey
Yeah, I’ve been struggling with risk aversion, especially since October…. I KNEW we were nearing a top, so I was afraid to hold anything that dipped into the red more than a hair. I also struggled with indecision…. maybe 90% of my trades were exited at +-1%. On the other hand, things that I held after a 3-5% gain always came back to zero. Compounding it, I mostly buy large caps, many of which have been on the decline since December, as the indices rallied to new highs.
The real stunner was when I realized that a small IRA account that I have was outperforming me badly. And all it has is one index fund. But since it’s a small secondary account, I’m able to ignore it and take the gains and losses. Then I went on vacation in Feb, and found that my main account was suddenly outperforming the S&P, even though I was 40% cash…. just because I had reduced my trading to near zero.
What I’m doing now is stepping back and looking at the 10-years charts, trying to get some big picture perspective. And trying to get in the habit of buying at the START of a run rather than the end. I’m currently building positions in JNJ, which is down a lot and only $1 above a long-term trend line; and MO, which looks like it just started the third leg of a measured move pattern.
Anyway, you’re right on the mark about new traders tending to chase momentum and wait too long for confirmation; the result being that I was always buying right near the top. On the bright side, I’ve become really, really good at recognizing tops, so that aspect hasn’t been so bad. But I bought into an embarrassing number of failed breakouts before learning not to.
Dan Fitz over at Real Money called it “Large Mouth Bass investing”, whereby you snap at anything shiny. Hoo, boy, did that ever describe my first months in the market. It still does, in weaker moments.
Bob: Thank you so much for the post and for sharing some of your personal experiences – they are helpful to me and others in the trading community.
I had many of the same feelings and trade outcomes as you did at that time – I also compounded it with my analysis of the economic cycle and believed we would be in a recession within a year and so I tried to “read” my interpretation into the market action and would try to short and would almost always gain a very small profit or get stopped out. Around November I threw in the towel and started going long with some conservative swing trades that were profitable but cut that out mid-December due to massive divergences forming. I have only been day-trading and scalping since then in anticipation of a nasty correction (but I never knew when). My profits have been diminished because of this anticipation and bias, yet I am glad I was out of the market (in terms of longer term trades).
IF we are headed towards a recession – as Greenspan hints – then JNJ would be a wise play because consumer non-cyclical stocks tend to remain steady or outperform the market as mutual funds rotate money into more ‘defensive’ sectors and companies. The theory is, no matter what the economy is doing, people have to buy shampoo and bathroom products (sold by JNJ) and so economic downturns shouldn’t hurt these companies as much as – say – homebuilders, electronics, or luxury goods sectors.
Concerning the start of a run, it generally is not a good long term practice to try to call a bottom, yet the ‘sweet spot’ occurs at the true trend confirmation zone. Identify zones in the market where – after a sustained downtrend – price makes a higher high, turns down to make a lower low (don’t buy yet), and then returns upward to TAKE OUT the most recent ‘higher high’. Playing for trend birth is difficult, but entering in this sweet spot zone might just put the longer-term odds in your favor, provided you hold for a large target and not get shaken out. Your stop would be below the most recent “higher low” swing. I’ll be posting more and providing more chart examples later, but check out my post on this issue.
I look forward to hearing more from you and wish you the best. Feel free to email me anytime.
One thing that a lot of people have missed in this recent economic down turn is the fact that in-game money for all of the massive mutliplayer online role playing games has not been effected. I guess it just shows how strong and stable the computer game industry really is.
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