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TheRumpledOne
6,358 posts
msg #59319
Ignore TheRumpledOne
1/27/2008 4:27:19 PM

7 Trading Sins
Stockscores.com Perspectives for the week ending January 27, 2008

I was in an art gallery the other day and came across a painting depicting a tree being cut down by two men. What was peculiar about the painting was that the men were using a leaf from the tree to do the cutting. The message was obvious and fitting for those trading the stock market.

We are our own worst enemy.

Making money in the stock market would be a lot easier if we did not succumb to the whim of our emotions. If 2008 is to be a year where you beat the stock market, you must overcome these emotional traps:

Fear - fear debilitates our ability to make decisions. Fear in all its forms; fear of loss, fear of ruin, fear of being wrong, fear of uncertainty and fear of what others may think causes us to break our rules. Fear causes us to avoid taking good trades, avoid selling our losers, fail to hold our winners or simply not take action when we need to. It is an irrational response to the market's message.

Greed - if you want something too much, greed can take over your rational mind. You may establish that you want to make $10,000 today trading but, if the market does not provide the opportunities for you, greed may make you force the trade. You may hold a stock longer than you should because you have not met your goal or you may take a trade that is not good enough. The desire to make money may make you irrational in your pursuit of that desire.

Perfectionism - many traders try very hard to always be right. If the market shows that they are wrong with a loss, they work very hard to turn that loss in to a profit. They may average down on a losing position or just hold the stock after their stop price has been exceeded with the hope that the market will turn around and turn their loser in to a winner. It is the pursuit of perfectionism that causes us to ignore that trading stocks is a matter of probability. Trying to always be right leads to failure, for eventually, one of those losers fails to turn around and gives the trader a portfolio crushing loss.

Pride - it is important to realize that the stock market does not care about you, that in the grand scheme, you don't matter. I say this because some traders attach their self esteem to their success in the market. They may avoid making the right decision because of the effect that the decision will have on how they feel. Simply put, you can not take your performance in the stock market personally because your feelings have no effect on the stock market.

Anger - I have seen traders react to a loss with anger. They may be angry with the decision they made or they may be angry with how the market responded to some information. This anger leads them to make an irrational decision or blame others for their loss. What happens to you in the market is not anyone's fault but your own and anger will only cloud your judgment for what to do next.

Impatience - trading stocks is a waiting game. You take a trade with an expectation for what will happen in the future but how long it may take is not in your control. More than once I have taken a good trade but exited because I was bored. Many of those trades led to a profit that I missed out on because of my impatience.

Recklessness - the feeling of losing is not a good one and can lead to a laissez faire attitude about the next trading decision. With the hope of taking away the bad feeling, the trader ignores risk management and rational decisions and simply takes any trade that might stop the negative feeling.

These are cited as the 7 Deadly Sins of Trading by Ruth Barrons Roosevelt in her book of the same name. As someone who has traded long enough to be an expert on all of these mistakes, let me assure you that overcoming these emotional breakdowns is more important that understanding any technical indicator, fundamental ratio, news release or trading strategy. Overcoming emotion is the most difficult part of trading and will separate those who succeed from the majority who fail.

Simply saying that you will avoid making these mistakes is easy but doing so when under the pressure that the market inflicts is much more difficult. Every trader needs to go through the list of emotional breakdowns above and think about how they react to these emotions. Write down the mistakes you make because of fear or greed. Think about times when you have been reckless in your trading and write down a plan to overcome them.

Before you make another trade, create a plan to overcome the seven deadly sins of trading. Doing so will do more to your profit than anything else you can do.


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