TRAPS OF OBVIOUSNESS
Part 2
Next adage I want to discuss, and negate, if you will is that "You can't go broke taking your profits."
We heard it zillion of times. Well, it's wrong! Of course you can go broke if you take losses bigger than profits. There is no trading without losses.
They are a natural part of trading and if you allow those losses to be bigger than your profits, you sure can go broke taking your profits.
Considering that this adage is usually used to justify "selling too soon", I do consider it to be wrong.
The next one is even better. A loss is not a loss until you sell.
This one has taken more traders out of the game than any other. If a trader keeps his losing trade, he loses in more ways than just money on this particular trade. He loses focus, ability to pick other trades, he is nervous, often angry and this losing trade just sucks all his energy out of
him. Not all gaps are filled (one more wrong assumption). Any particular trade is not guaranteed to be the one that will come back sooner or later. For instance, all my three hardest losses (I mean, real hard) would have taken me out of the game should I have held them. I owned ESOL at 15 and sold around 7. Try to find it on NASDAQ map today :) I owned TTG at 20 and sold at 12. Where is TTG today? I was short KTEL at 22, covered around 29 and it went to 80. So much for that theory that one will hold a losing trade until the gap is filled.
One more idea that can be heard frequently among traders is that shorting makes stocks go down. It's shorters that kill our excellent picks. This is not true. If a stock is really strong and has more demand than it has supply, it will overcome the selling pressure and shorts will only add fuel
to the run-up as they try to cover. If a stock is not strong enough and shorts were right, they will provide support for the stock on the way down while buying to cover in order to realize their profits. In my strong opinion, shorting is an absolutely necessary part of the game as it provides more liquidity, somewhat limits volatility and provides a cushion as stocks reverse.
Last one I want to discuss today, and probably the toughest to negate, is that selling attracts buyers and buying attracts sellers.
It seems SO obvious that it was always bothering me, even on early stages when I didn't really have arguments against it. Let's think of it this way.
If it was the case, would we see anything but the same trading range on all stocks. Stock drops from 20 to 15, happy buyers nail it. It goes back to 20 and sellers hit it. We see every day that stocks just continue to go up
or just drop and drop, making new lows. So, let's better put it this way.
It's just one particular case of a more general law. There are several cases, and those are:
1. Buying attracts more buyers.
2. Selling attracts more sellers (or, if you wish, scares more traders into
selling)
3. The case we started with.
The first two are called THE TREND. If the third case was the only one, we would never see any trends. The third case calls the range and it works ONLY for stocks that trade in a range. The problem is, failing to realize it leads to all those disasters when traders try to short every top or buy every bottom. I can tell you that during the huge market run-up last fall, there were plenty of killed traders that could not believe the market still had the courage to go up. They were shorting and shorting. Some just got burned holding their shorts and some were covering and shorting again, mistakenly thinking that this is a normal trading process. They try every next top to short or try every next bottom to buy.
In doing so, a trader tries to pick the point of a trend reversal. There is only one of these points. Doing this, a trader tries to find that one going against the trend on all others. It just doesn't make sense. It's quite clear when you think of it in these terms, you are better off going with trend at each of interim points. You find yourself wrong once at the reversal point, and then reversing the direction of your trades to be in accordance with the new trend again. An example of this you could see
yesterday on a stock that we shorted three times and then it reversed and went up strongly.
<RT Member> I was wondering if you agree with value trading..meaning do you think the lower a stock falls, the
more value is created that attracts buyers. I see you mention it a bit already but wondering if you agree with trading on value of stocks.
<Threei>Not really in a sense that low prices create value. If it was so, we would see huge buying on stocks that went down from their sky high prices to under 10. Look at VNTR annual range,or PSIX, OMKT, CDRS,or...or...or... That drop from the NASDAQ highs created so much value that we should be in the middle of our way back if it was the case. Just how many traders were killed trying to go with this theory when QCOM dropped from above $600? Conversely, how could it go THAT high if buying were to create selling pressure? In fact, we saw just the opposite. Let me talk about the
general market, not particular stocks. Wasn't the NASDAQ run-up fuelling more and more buying? Wasn't its drop (and still is) leading to more and more selling? Trends go in cycles they are followed by reversals or by trading in a range. The key to successful trading is to identify the trend or range and act accordingly.
Thank you for this question, as it allowed me to go into deeper details on this extremely important topic.
<RT Member> Threei, thank you so much. I was told a phrase that sounded so reasonable...buying attracts profit taking and selling attracts value and I've been hammered lately for it. Obviously this is clearly not the case.
<Threei> This is why we called this topic as we did, TRAPS of obviousness. |
