June 18, 2009 - Tricks of the Trade! - part 1

This post is dedicated to a trick you may not find in any trading book. It applies to all trading but it is especially meaningful when day-trading.

It's a common saying that you should "put emotions aside" when trading. Well if it was that easy to turn off your emotions then everyone would be making millions. With experience it becomes a little easier to "see through" your emotions to what your ultimate goal is, but you will never be able to trade without those feelings of fear and greed sneaking back into your mind and affecting your trade. What we can do is not put ourselves in situations when strong emotions can be formed.

Don't Consecutively Trade Anything
Let me explain by way of an example. A new trader, let's call him John, will find what he thinks is a good trading setup and puts in the trade. Shortly after the trade goes against him and he is stopped out at a small loss. At this point in time, feelings are created in John. Feelings of loss and disappointment! He will feel especially attached to this stock so he continues to watch it even after he is stopped out.

John believes that the setup was right for the trade and he must have put his stop-loss in the wrong spot. At this point something interesting happens - the stock goes back up as if to continue the trend that John had predicted. Fear of missing the trade is now strong. John is convinced he was right and gets back in the trade, in hopes of making back the money he just lost and then some. He may even increase the size of the trade to get his money back faster - big mistake!

Unfortunately, the markets punish traders the harshest when they are desperate. John watches the trade turn against him again as if there was someone on the other side manipulating the price against his trade. Fearing bigger losses and doubting the trade ever worked, he gets out - now with a loss wider than the original. This creates even deeper feelings which resemble the feeling of trying recklessly to get your money back at the casino table. Nothing can be more dangerous to a trader's account!

It is human nature to feel greed, fear, and hope. We cannot control them, but we can avoid situations where strong emotions cloud our judgment.

I can say that I've been burned many times trading a losing position in hopes of turning it back into profits. As a result, this is now one of my trading rules: Do not consecutively trade any stock. Once you're out of a trade, do not put in a second trade, unless this was exactly part of your original trading plan. Let yourself cool down and the feels to dissipate before you trade that stock again. This often means not trading that stock again for the day.

Happy trading!