11 Fatal Mistakes That Most Traders (Can’t Help But) Make And What You Can Do About It

11FatalRandom Thoughts

I have some bad news. We’re not made to trade. The same mechanisms that are keeping you alive and allowing you to function as a normal human being are the exact same mechanisms that come between you and your success. This is on a psychological and even physiological level.

But, First,  I Digress

beansI hate accounting. I’d much rather study markets, trade, write, do webinars, and travel the world speaking the good gospel of trend following—anything but accounting. However, if my educational business is to remain a business then it’s a necessary evil. And, I really enjoy it-the business that is, not the accounting. Yes, it makes money and gets me out of the office. There’s more to it than that though. It serves as a constant reminder of what not to do. It also inspires me to be become better. “You make me want to be a better trader.” You do!

On The Go? Listen To This Column

On The Go? Listen To This Column

Anyway, in getting around to finishing up my 2015 accounting (thanks to a nudge from my hot bookkeeper, who I happen to be sleeping with), I’m contacting clients to see if they’re ready for another year of me providing market color commentary, teachable moment “walk throughs,” pointing out potential opportunities, and when necessary, suggesting that we just wait until conditions improve. Through this process I’m getting a lot of confessions: “I held on to longs too long.” “I over leveraged.” “I over traded.” “I sought action over opportunity.” “I confused the need to be right vs. making money.” “I day traded when I should have just stuck to position trading.” The list goes on and on. Some are willing to turn over a new leaf. And, unfortunately, others are done, realizing that they’re not made to trade. Well, the bad news is, none of us are. We all have to overcome this human flaw. Okay, let’s break it down.

 1. Letting The Little Brain Control The Big Brain

Our decisions are often made by a very small part of our anatomy. I know there’s a joke in there somewhere but I’m actually referring to the Amygdala-the tiny almond shaped part of our brain lizardsgettingitdone1that controls our emotional responses. I wrote extensively about it here. In a nutshell, it’s the emotional part of our brains that makes snap decisions. Decisions that we often need to survive. And, we can’t make decisions without emotions (Damasio, Shull). So, we have to recognize and embrace but not try to eliminate emotions from our trading. As I wrote in the aforementioned article, sometimes, all we need is a few seconds to get past the little so called lizard brain to use the rest of what’s sloshing around up there. For more on you and your amygdala, see this Week In Charts that I did last summer:

2. Confusing The Issue With Facts

In life, logic applies. And, as a general statement, you better follow this logic if you are to function as a normal human being. Yet in trading, there often is none. As Marian McClellan (the late mother of Tom McClellan) once said, “People buy and sell stocks for a variety of reasons. Some people buy when they have money. Some people sell when they need money. And, others use far more sophisticated methods.” You’re dealing with the emotions of the participants. Their reasoning, which often has no logic, is what makes the markets-markets that go up and markets that go down.

The media would leave you to believe that you can connect the dots by using news. You can’t. Markets sometimes go up on bad news and down on good news. Wasn’t high oil prices bad for ???????????????????????????????????????????????????????????????????????????????????????????????????????markets and low oil prices good? Just a few days ago the headlines read “Market Goes Down On Low Oil Prices.” Huh? I can go on and on. Again, since you are dealing with the emotional nature of the participants, logic doesn’t often apply.

3. Trying To Control The Situation

womanmegaphoneIn life, controlling the situation as much as possible is what made you successful. Yet in markets, you have no control. You can only control you. As the late and great Mark Douglas once said, “All it takes is one a-hole to screw up a perfectly good trade.” And, guess what, you have absolutely no control over him. Giving up control isn’t easy but it’s necessary.

4. Being Under Capitalized

Source: Bizjournal.com

If you’re trading a million dollar account and lose $10,000, provided you followed your plan, then it’s no big deal. If you’re trading a $20,000 account and lose $10,000 then you feel like you’ve been wiped out. So how did it go from 20k to 10k in the first place? What about money management? Well, the money management is a little tougher with a small account. The frictional costs (e.g. slippage, commissions) are relatively higher. And, from a psychological standpoint, it’s harder to follow the plan once the account begins to erode, thereby often creating a downward spiral.

I quickly learned about the psychology of stock trading during my first foray into the markets. I sold a boat that I wasn’t using for $1,000. I bought 100 shares of my first stock with that. Within days, the stock was down 1 ½ points. I was only down $150 but I felt like I was wiped out, even though I was making more than that per day in my day job.

http://www.dreamstime.com/royalty-free-stock-images-expensive-tag-education-image10092389“I’ve never met an unsuccessful paper trader.” (Layman’s) When real money is on the line, things change. And, unless you view a small account as “tuition,” then it’s not going to be easy.

Unfortunately, even if you do hit it right with a small account, you might still put psychological pressures on yourself because it’s not enough. I made this point in Dave Landry’s The Week In Charts on Thursday, re-telling a story from Nick Radge (www.thechartist.com.au) about a friend of his (warning, it doesn’t end well).

5. Looking For Action And Entertainment

????????????????????????????????????????????????????????????????????????????????If you’re looking for action, the markets are a very expensive place to look. It’s far more cheaper to go to Vegas. At least there, a pretty girl will bring you a drink while you lose your money. As I often preach, trading, done properly, can be quite boring. A lot of times, we’re more “wait-ers,”-waiting for opportunities than traders.

It’s not your fault. We’re wired to take action. We have to in order to survive. Unless you’re a toll taker, clients aren’t going to pay you to just sit on your ass. Yet, in trading, that’s often exactly what you should do.

Speaking of doing nothing, I lose clients when I suggest that they sit on their hands. That’s okay. I can sleep at night knowing that sometimes return of capital is more important than seeking return on capital. First, do no harm. And, I’m in for the long haul. The lost clients go off to trade anyway or grail hunt, and, provided they don’t blow up in the process, will eventually “get it” and return. They then become my favorite clients. They learn that simple is better, there’s no secret sauce, and sometimes, you just have to wait for your pitch.

Speaking of the Holy Grail, this brings us to number 6, Holy Grail hunting.

6. Holy Grail Hunting

tauntingTrading with charts is the art of reading the emotions of others while embracing your own. No one knows what the other participants will do. Will Joe stick something somewhere he shouldn’t and loose half of his stuff thereby being forced to sell his stocks? (reminds me of the “pickle slicer” joke, yeah, she got fired too) My apologies for being crude but you get the idea. Selling often occurs for no logical reason. So, can there be some magical indicator, numerology, or arcane system that predicts what the “Joes” (or pickle slicers) will do next? Of course not!pickleslicer

Let’s assume that you have a simple, viable system and happen to hit conditions just right. You’re trend following and the market is trending. Permanent income hypothesis (read further) creeps into your head. Now let’s assume that conditions began to change and you’re money machine grinds to a halt—or worse, you begin losing money. What do you do now? Do you tweak your system? Add a layer of complexity? Or, go off to find the next thing that works?

I see quite a few people have some initial success with my simplified trading ™ techniques but then go off to chase rainbows as soon as the markets get a little choppy. Many end up perpetually out of phase.

7. Fear Of Being Wrong Or Looking Stupid

Markets go up and markets go down. I know, duh, huh? Yet, when a position is going sharply against you, you reason why it should not be doing that. And, you might be right, it should not be going against you but it is. And, unless you’re Bill Clinton, “What is, is.” Don’t worry about being wrong or looking stupid (see last DL’s WIC YouTube). Sometimes, you just have to get out of the way…here it comes: “He who fights and runs away lives to fight another day.”

8. Attempting To “Transfer” Success

????????????????????????????????????????????????????????????????????????????????The same people—motivated people–who are mostly attracted to the markets make the absolute worst traders. You weren’t born with a scalpel in your hand. You had to learn and earn it. Unfortunately though, those who are or have been successful in their other life automatically think that transfers to trading. It doesn’t. It appears much easier on the surface that it really is. Like anything, you have to work at it. It’s really not hard but it’s far from easy. You become successful the same way you did in your career-lots of hard work combined with experience. Trading is no different.

Source: Nature.com,  G. Renee Guzlas, artist

Source: Nature.com,  G. Renee Guzlas, artist

9.  Convincing Yourself That What You See Is All There Is (WYSIATI)

In Thinking Fast And Slow, the author writes about how people draw conclusions based on a very limited set of data. They make assumptions that what they see is all there is. So, if you’ve only been long since 2009, then you’ve done quite well up until now. If you fancy yourself as more of a trader type and implemented a choppy market systems in 2015 then that worked quite well until the crash late last summer. And, if that didn’t wipe you out, maybe the January side did.

GURUThere are a lot of things that “work until they don’t” when it comes to markets (trust me, I have a few T-shirts). If you do hit upon something that’s working quite well, congratulations! Just, don’t let it go to your head. Avoid getting sucked into a so called permanent income hypothesis. Play devil’s advocate. What could go wrong? Did I happen to just hit it just right?

The market can occasionally give us the feeling that it’s a permanent income producing machine. Unfortunately, it isn’t. They’ll be good times and even great times. Unfortunately, they’ll also be bad times. If you haven’t traded a system long enough to recognize changing conditions in the charts, your equity curve will soon let you know.

10. Winging It/Lack Of Planning

Source: Wikipedia

Source: Wikipedia

In the beautiful design which keeps us alive, chemicals are dumped into our system to give us the boost we need in “flight or fight” situations. When faced with danger, we don’t want to sit around contemplating our navel. The adrenal glands dumping the steroid cortisol into our blood stream can keep us alive-to run away from the bear, to jump out of the way of a speeding car. Yet, this same hormone (reminds me of the how do you make a hormone joke?–“don’t pay her”) is also triggered under stress. And, when does stress occur? According to Montier, stress occurs when information is unknown and/or changing. This sounds like the exact moment you enter a trade, stepping from the known into the unknown.

A trade will be stressful. That’s one of the few things that I can actually guarantee. Sooner-or-later it will go against you. This goes for every trade. You’ll have to either give up some open profits or worse have it turn into a loss. Like buying a pet, “It’s going to end badly.” (Carlin) Knowing that it’s going to end badly ahead of time is a wonderful thing. Plan for when, not if, the trade will go against you.

11.  You Do It Anyway

You know what you’re doing wrong? Well, provided you have a little experience, you KNOW what you’re doing wrong. Livermore once said that people make mistakes and know that they are making them. We know we shouldn’t be firing off day trades if we are position traders. We know we shouldn’t be buying because a market is “low enough” or selling because it is “too high.” We know that we shouldn’t “invent trades” (Mauthe) when there are none. We know that we should honor our stops vs. hoping the market will come back. As I preach, whenever I work with someone and wonder how I’m going to figure out what they’re doing wrong, I just ask. 99% of the time the tell me. On the other 1%, when I identify the questionable trading practices a confession follows dreamstime_xs_31842997shortly thereafter.

Great Big Dave, You’re Did A Great Job Telling Me About My Problems. Now, How Do I Fix Them?

Assuming you’ve done your homework and have some experience, then the solution is simple. Notice that I used the word “simple” and not “easy.” Just like the old “Doctor, doctor, it hurts when I do this” joke, quite often the answer is “Don’t do that.” If you are a position trader, then resist the Siren call of daytrading. If there’s nothing to do, then do nothing. When you do think you really have the mother of all setups, then plan your trade while things are static. Plan before going into the trade when all information is known. Then, trade your plan. Have a stop in place because guess what, you will be wrong sometimes. That goes for you, me, and that guy who screams on T.V. And, if you’re right over the short-term, take partial profits just in case you cease being right and then, trail a stop higher on the remainder so hopefully, you ride out the trend for a long long time. Simple huh? Simple yes, but I never said it was easy. To learn more including “3 steps to success” watch the latest episode of Dave Landry’s The Week In Charts. It’s free and must be good because people often say “Dave’s good for nothing!”

SO Big Dave, Are You Holier- Than-Thou?

Thegoodpastor1Hell no. The name Israel literally means “struggles with God.” I’m the Israel of markets. When I’m hot, I feel like God. When I’m cold, I wonder if flipping burgers is above my pay grade. When there’s nothing to do, I think there has to be something that I can do. When positions go against me I reason why the market is wrong and I’m right. I cuss and I fuss. I’m emotional, probably too emotional—I cry like a school girl when forced to watch a Nicholas Sparks’ movie. I’m not perfect but through my own mistakes and constantly watching those of others, I know that I must put metrics in place. Like So-Crates, “I know that I do not know.” And, neither do you. So we follow along.

Good Lord Chief Orman!

Source: YouTube-Honeymoon In Vegas

Source: YouTube-Honeymoon In Vegas

You’re really wound up today. Can we talk about the markets?

Oh Yeah, The Markets

It’s pretty ugly. How’s that for an oxymoron from a trend following moron?

The Ps (S&P) 500 have pulled back a bit lately but unfortunately, it’s just that a pullback.

Ditto for the Quack (Nasdaq).

Again, the Rusty (IWM) remains a poster child for what’s really been happening to this market for a long time. It’s down over 20% from the peak (which the media defines as a bear market, btw) and based on the trend, it doesn’t look like the fat lady will be singing anytime soon here. I don’t think she’s even getting dressed yet. Never forget, it’s always darkest right before it gets more dark.

In the sectors, the Energies are waking up. I wouldn’t rush out and buy just yet. Wait for setups.

Gold the commodity and Gold stocks are really beginning to wake up.

So, in general, commodities are rallying from lows. Unfortunately, they’ve got their work cut out for them. There’s lots of overhead supply. You know the routine though. Take things one day at a time and one setup at a time.

Utilities have also woken up but I’m not seeing anything here worthwhile just yet.

In light of the overall market (and most sectors), I’m really taking a “show me,” no, “REALLY show me” approach on the long side.
Most other sectors remain in bona fide downtrends. And, some, like Retail appear to be in the early phases of rolling over. Amazon here, the biggest of them all, appears to have topped. And, as goes AMZN and other big cap stocks, so will the market.

So What Do We Do?
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