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Strategies & Market Trends : Strictly Buy and Sell Set Ups -- Ignore unavailable to you. Want to Upgrade?

To: chowder who wrote (7589)	1/31/2006 6:27:00 PM
From: chowder	Respond to of 13449

Don't Let Overconfidence Undo Your Winning Streak ............. Skip has been successful in everything he has tried: sports, academics, and business. He recently started trading to prepare for his retirement. He's done well, and last week made huge profits after a long winning streak. He is psyched up and optimistic. At this point, there are two ways Skip can go. He can either stand aside, and let his optimism wane, or he can jump back in the markets, and potentially give back his profits. A study by behavioral economists Brad Barber and Terrance Odean showed that young traders like Skip tend to take unnecessary risks after a huge windfall. They overtrade and tend to end up with lower account balances than traders who did not have a windfall. Trading expert Martin Pring in "Investment Psychology Explained" notes, "after a long winning streak, almost every investor and trader falls into the trap of thinking that he is infallible." If you want to stay profitable, it is vital that you control your optimism. Everyone wants to be good at trading. Not only will you have more money and status, but you can have pride in knowing that you've developed a skill that few possess. You are one of the elite who mastered the markets. Rewards usually go to the humble, though. The markets have a way of exposing the arrogant trader who feels omnipotent. Martin Pring offers a few guidelines for how to control your optimism and stay profitable. The first step is recognizing that you may have a problem with pride and overconfidence. Admit that you are human, fallible, and can make mistakes. Once you admit that you are human, you will feel free and be willing to look at past trades more objectively. If you think, "I'm the greatest trader in a decade," you won't be willing to look for faults in your trading plans. But if you think, "I'm human; I'm fallible, and of course I make mistakes," you will look at your past trading plans with a critical eye and you'll surely find ways to improve. Second, focus on potential risks before potential profits. Traders who are overly optimistic tend to focus on the positive aspects of a trade, specifically how much money they will make. It's more important to focus on how much money you may lose, however. If you focus on what you can lose, you'll avoid risky, low probability setups. You'll search for less risky trades that have a better chance of making a profit. Third, develop a clearly defined trading plan with a clear exit strategy. Determine either a point where you decide the market has moved against you or a profit objective where you take profits and close the position. Committing to a specific trading plan will help curb your over-enthusiasm. Finally, it's useful to move profits out of your account occasionally. For example, once you reach a 20% profit objective, take the money out so you will have a feeling that you have to start over again. You may also want to take a break from trading to feel that you have to "start over," sort of like summer vacation at the end of the school year. When you come back, it will feel like starting a new school year with new challenges. This strategy will help you control feelings of overconfidence after a big win. Many traders allow overconfidence to wipe out the profits they have just made. Don't give profits back. If you stay humble, you'll increase your chances of staying profitable. Innerworth.com (This message is linked to previous articles.)

To: chowder who wrote (7589)	2/3/2006 6:40:17 PM
From: chowder	Read Replies (1) \| Respond to of 13449

False Hope ................................................. In "The Disciplined Trader," Mark Douglas suggests, "Execute your losing trades immediately upon perception that they exist. When losses are predefined and executed without hesitation, there is nothing to consider, weigh, or judge and consequently nothing to tempt yourself with. There will be no threat of allowing yourself the possibility of ultimate disaster." This is sound advice, but studies by behavioral economists suggest that many traders have difficulty following it. When they find themselves in the midst of a losing trade, they persist with a losing course of action, rather than cut their losses. Why do traders falsely hope that a losing trade can turn around? There are many possible reasons. Research studies have shown that investors tend to believe a loss is merely temporary and that if they wait it out, a losing trade will turn around. In the markets trading outcomes are often uncertain, and this uncertainty allows people to hope for the best. Holding losing trades may also reflect what behavioral economists call the sunk cost effect. Sunk costs refer to the original amount that is paid to acquire a stock. Sunk costs increase when the losing position decreases in value. During a losing trade, some traders talk themselves into believing that the "true" value is higher than the market suggests. They convince themselves that the "true" value is closer to their initial cost, or entry point, rather than its current value, and can't see why they should sell at a loss. Denial and unrealistic optimism may be another plausible explanation. Humans are naturally risk averse; they are afraid to gamble with their wins, but are very willing to gamble with their losses. While in a losing trade, traders are willing to believe that by taking a chance, and holding on to a losing trade, the odds will work in their favor and the loser will turn into a winner. Other traders believe they are special and that their special talents or good fortune will turn a losing trade into a winner. Many traders, though, are afraid to admit they are wrong. They have a natural human tendency to believe that they made the right choice. After people make a decision, they tend to search for evidence to support their choice. All of these explanations are viable, but we propose a few other possibilities. At Innerworth, we have conducted our own analysis of the situation. We asked a sample of traders if they tended to hold losing trades and falsely hope that the trade would turn around. About 50% of our sample admitted they suffered from this ailment. What were these traders like? They tended to show less discipline and self-control in their personal and trading life than traders who readily closed losing positions. In addition, they tended to base their trading decisions on their intuitions rather than specific facts, and they tended to experience unpleasant emotions, such as anger, fear, and disappointment more frequently. If you show these personality characteristics, you may be prone to hold on to a losing trade, but you can overcome this tendency if you try. First, accept the fact that losses are commonplace. You should expect to lose. Don't take losses personally. Losses do not reflect on you or your personal worth. They are routine in the trading business and should be put in the proper perspective. If you take losses in stride, you'll feel better. Second, define your potential losses before you execute a trade. Third, practice exiting your losing trades with precision and accuracy. Visualize encountering a losing trade and exiting promptly. There's no point in falsely believing that a losing trade will turn around. Take losses in stride and move on. Innerworth.com (This message is linked to previous articles.)