The Best 50 Trading Tips: Lesson 5
Section Eight – Psychology in the market
No book would be complete without mention of the psychology involved in trading or investing. Much is made of the two major emotions of fear and greed.
Fear of missing out, fear of loss, fear of being overexposed and fear of a market crash are all genuine concerns. Interestingly it is usually greed that gets us into the situation of feeling real fear. Greed leads to being overexposed and greed leads to buying a stock based on some ill-informed tip.
The best method of overcoming these two very powerful emotions is to have a robust trading plan. Never buy a stock without assessing the amount that you are prepared to risk on each trade.
I am not a psychologist; I have no training whatsoever in this field. I am totally unqualified to make any judgement or assessment relating to “psychology in the market”. If the psychology of the market is of interest or concern to you, I very strongly recommend that you read “The Investors Quotient”, a book written by Mr. Jake Bernstein. In fact, I recommend that every trader or investor read this book before you trade, and then again after several months trading.
What I do have is 30 years involvement with private retail clients, male and female, commodity traders, option traders, warrant traders, currency traders, stock traders and both short and long-term traders/investors. I have seen every mistake possible, every trading method, every search for the holy grail, some very complicated trading methods and at the end of the day, the simpler the plan the better.
Tip 1 – Can you sleep at night?
Every trader will at some stage have a terrible trade, or a run of losses, or perhaps the market will become a savage bear market causing varying degrees of angst. Most traders understand these events and cope with them one way or another, through a well-developed trading plan.
If thinking about the market or your portfolio keeps you awake at night you are probably over committed or have too much at risk. Back off!
Tip 2 – Joint trading
Very few relationships are truly equal. Never is this more apparent than when a couple open a joint trading account. Invariably one partner will want to buy a particular stock and the other partner will be opposed to the purchase. Two people can read the same company report or research document and come to different conclusion. By all means have a joint account but if you have any doubts about “Who is the boss” then open an individual account as well, just for those occasions when you disagree.
For most couples it can be extremely difficult to make joint trading decisions. It is better to open separate accounts and make your own decisions.
Tip 3 – Don’t get married
A classic example of investors falling in love with the stock is those investors who bought the second tranche of Telstra shares, paying close to 8 dollars for a blue chip long-term investment. Telstra rose to 9 dollars shortly after but then spent the next seven or eight years slowly falling to a level of around $2.60. Most people who purchased Telstra during the second tranche still own them today and constantly say what a great dividend they pay. No amount of dividend payments make up for the 60 percent capital loss. In other words don’t fall in love with any particular company.
I do not consider that purchasing shares is an investment. My interpretation is that I lend a company some money in expectation of a good return in a short period of time. If I don’t get what I expect then I will withdraw my funds.
Tip 4 – Never turn a short-term trade into a long-term trade/investment
Too often people will purchase a stock on the basis of a story told by a friend, a taxi driver or a newsletter tip. Maybe the tip was good and the stock rose or maybe the stock fell in price straight after the purchase. Regardless of which way the price moves most newcomers have no concept of when to exit or when to take profits, so they hold the stock as the price falls, often turning a short term speculative trade into a long-term losing investment.
The best time to calculate your potential loss is prior to your purchase; once you own a stock it is far more difficult to make a rational decision.
Tip 5 – Male and Female
The biggest issue that men have is their ego! Men find it very difficult to believe that they have made a mistake and bought a stock that is losing value.
Losing trades can also lead men to seek revenge, often overtrading in an effort to regain losses. Like golf, trading can be a great leveller. Gentlemen – there is no room for a big ego in this business.
The major problem woman have is a lack of confidence. This is not a bad attribute. Women tend to be more cautious than men and this is a good thing. The issue for woman is “Where do I start?” and “Who can I trust?” All I can suggest is that you talk to people and you will get a feeling about who to trust. When you do start, start very slowly and gently with small trades.
Women tend to seek advice and are willing to discuss problems. They are generally more patient.
Research has been conducted in the past, suggesting that woman are better traders/ investors than men.
Tip 6 – Volume
The market gives you five important pieces of information each day; the opening price, the high and low price for the day and the closing price. These prices are important bits of information with the closing price being the most important. Prices measure the value of each share in a company.
The fifth and most important information is the volume traded. This can tell you as much if not more than the price because volume is a measure of the emotion behind the price movement and I feel that understanding the emotion of shareholders is more important than the price. High volume on an up day is usually a bullish sign. High volume on a down day is bearish.
Price is a measure of value whereas volume is a measure of emotion.
Tip 7 – Classic signs of a market peak
- The “Hot Tip” syndrome – At the barbeque, in the taxi, in the local hotel, suddenly everyone is an expert and are happily giving all and sundry the latest “tip”.
- Float Frenzy – Money is easy to raise, so everyone is floating a new Company
- The Media – The media feed the frenzy with statements about how much longer the boom can last.
- Politicians – Pollies start to pat themselves on the back for the great job they are doing in creating a bull market due to their wonderful economic management. (Cynical but true)
Section Nine – Summary
Trading is an eleven step repetitive process
In summarizing I have listed below what I believe are the eleven simple steps to trading success. These eleven points all require thought, planning and a degree of trial and error that will ultimately lead to a plan that suits your budget and your psychology. As previously mentioned, the details for formulating your trading plan following the process outlined below are contained in my book “Exploding the Myths”.
- Global Rules: These are rules you need before entering the market. i.e. “I will not purchase an airline stock”
- The set-up: What price action on a chart are you looking for? Get to recognize how a chart should look.
- Finding a stock: How do you find “the right” stock? I use Pro Trader, an end of- day software tool that scans all stocks for the various characteristics that I need to see before I purchase a stock.
- Entry signals: Breakouts, higher highs higher lows. The timeless classic book “Technical Analysis of Stock Trends” by Edwards and Magee is a must read for all serious traders.
- Confirmation signals: On-balance-volume
- Fine tuning your entry: Market depth – One of the great aspects of the internet and the market data that is available on a trading platform is market depth.
- Risk Management: Assess how much you need to risk on each trade.
- Money Management: Never plunge, consider position sizing
- Order placement: be precise and get it right.
- Managing the trade: Buying a stock is only the beginning, you need to manage the trade as each day progresses.
- Exit the trade: In today’s volatile markets you cannot sit and wait. You need to exit at some point.