The Patience Principle
SmartMoney.com
Thursday June 07 07:40 PM EDT
<<FROM DRUGS TO drag racing, slot machines to Sycamore Networks (NASDAQ: SCMR - news), we are a species that loves external stimuli. And when it comes to investing, seek and ye shall find. With a casino of stocks, options, exchange-traded funds, mutual funds and futures out there, there are more than a few places to find fast action. The problem is, fast action is usually losing action.
Patience is always a virtue, but in trading it's a requirement. Despite the fact that traders are often thought to be constantly jumping in and out of stocks, the real money is made by holding on for the big moves. In trading as in life, good things come to those who wait.
So although I am a trader, I want to play the major moves. Short-term fluctuations are fodder for the talking heads, but trying to constantly scalp a half point out of a news headline is usually more trouble (read: risk) than it's worth. My own results improved substantially once I stopped making big bets on small movements and focused on the converse. Small bets on big movements make much more sense.
The point is this: You want to take chunks out of the market, not bite-sized pieces. It may feel great to grab a quick kill now and then, but the real money is made on the big moves. The weekend moves. The moves that happen when you least expect them and probably aren't even paying attention.
Take a look at some of the best-performing stocks over the past 52 weeks, and you'll find that the majority didn't generate their stellar performance overnight. It took time. When stocks move, they move in trends and it often takes traders weeks or months to build a substantial position. Despite some intermittent negative press, for instance, Abercrombie & Fitch (NYSE: ANF - news) has climbed 336% over the past 52 weeks. You could probably have done alright by jumping in and out of the specialty retailer's stock, but the big profits were made by getting in early and hanging on. Even if you had missed buying at the absolute bottom, you could have ridden at least part of the stock's rise over the past year and done very well.
I'm certainly not espousing a strategy of buy and hope. If you're long and wrong XYZ, cutting your losses is just part of the game. But just like children who need their space, you've got to let a winner be a winner. As long as a stock is acting right...it stays. Most of the trades I make involve taking losses, not cashing in winners. With the exception of a few well-placed buys, a winning position doesn't need that much encouragement.
Indeed, 95% of trading is watching. So if you buy XYZ at 50 and it goes to 55, hold on! The big money is made while you sit on your hands and wait, not by popping Xanax while glued to the screen frantically hoping Cisco Systems (NASDAQ: CSCO - news) ticks a quarter point higher.
The problem with traditional day trading (that is, entering and exiting a position during the same trading session), isn't that the market is so impossible to predict over the short term. It's that it is very difficult to make any real money over the short term unless you are trading inordinately large positions. And we know how well that turns out.
Positions grow large, they don't start out that way. And even if you are extremely well-capitalized or are using leverage, the risk of making large short-term bets just isn't worth it.
Additionally, it messes with your mind. No matter how good your analysis, every day can't be a winning day. Irregular income is part of dealing with the markets — its one of the reasons we trade noncorrelated asset classes. Yet most people trading short term take huge risks just because they feel compelled to have a winning trade — at all costs. Either I win on this trade, or I'm taking the whole ship down with me. Egos like this will risk $10,000 to make $100, and you don't need a Harvard MBA to know that over a long period of time, the math just doesn't add up.
The last thing I'll say about short-term trading is that it involves too many decisions. Let's say you buy XYZ at $50 and it goes to $55. Now you've got a winner, so you sell out for a quick profit only to see the stock spike to $60. Yikes! Not wanting to miss any more of the move, you buy it back at $60, double down at $55, and puke the positions entirely when it again touches $50. You aren't playing the market, the market is playing you.
If you like XYZ at $50, buy it at $50. But buy it because you think it's going to $100, not $55. Rome wasn't built in a day, and neither are profitable core positions. Taxes, commissions and the bid-ask spread are often cited as the reasons so many individuals lose money trying to trade short term. But the real reason is that the big money is made on the big moves, and big moves take time.
There is one good reason to trade short term and that's to hedge an existing position. What the heck is hedging? We'll discuss some basics to get you started, one week from today...>> |
