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behaviour that works against trading

  1. I have identified common human behavioural probems that work against my ability to be a good trader, I believe they are fairly common. If you would like to see some others e-mail me and I will send them to you when I have finished detailing them for e-mail or wait for the next post in the next fortnight or so.

    Psychology of trading, attitudinal change and discipline

    After doing review and evaluation of my trading I realised that although I had sell stops and trailing sell stops in place, I often ignored them. I would consistently write down the same faults in my “faults and solutions” columns at the end of each month, and that would be “didn’t follow my initial sell stop”, or “didn’t follow my trailing sell stop”.

    Certain situations that arise when you trade shares means some of your decisions are based on your emotions, and not on your logic and knowledge. This could have a long term detrimental effect on your ability to trade profitably. Having a good trading plan in place to follow means you will know what to do as each trading situation arises, and helps you to avoid the emotional and impulsive decision making that exacerbates the common human behavioural problems that work against your ability to be a good trader. You should keep a written record as to the possible behavioural problems you identify in the situations that arise during your trading, so you can develop an early awareness to the problem, and put a plan in place to solve the problem.

    It’s more beneficial to develop your own trading plan because following somebody else’s will mean you are following rules that you are not comfortable with. Developing your own trading rules gives you rules that are more suited to your personality, and gives you a better understanding as to why they are important. You may never be totally comfortable with every trading decision you make, but having an awareness to possible behavioural problems that effect you will help.

    How you control your emotions and attitude would be the biggest contributing factor to how successful you are as a trader, more so than any other part of the trading plan. Most of us will just concentrate on stock selection methods if we are not doing to well, but concentrating on our own behaviour could be the answer.

    The common human behavioural traits that I have experienced that work against trading are:



    COMMON HUMAN BEHAVIOUR THAT WORKS AGAINST TRADING NO.1


    PEOPLE TAKE PROFITS TOO EARLY.

    People tend to do what’s comfortable, and what’s easy, rather than what’s right.

    They take the money and run, rather than have an open position and risk the paper profits, because it’s the more comfortable position to take (it makes us feel good in the short term). People are too risk averse when it comes to profits.

    When a stock’s price goes up 15% or 20% in a week for example, I would be so tempted to just take my money and run, even though the stocks price was still heading up and my trailing sell stop wasn’t hit, and I know I should never sell an advancing stock.

    The market must be the one to tell us to get out of a position, via a trailing sell stop. If we always took the 15% or 20% or whatever profit we would never hang on to a stock long enough to double, or triple our money. Needless to say the price of the stock continued to rise in most cases after I sold, and in some cases, a lot. I would continually write in my faults column “took profits too early”, and as a solution would write, “just follow my trailing sell stop plan”. It was as simple as that.



    SOLUTION:

    My solution was to have and use a sell stop plan and stop watching live prices all day. An initial sell stop is the price you will sell the stock based on the purchase price, it’s the first sell stop. The initial sell stop price is an intra day price, which means if the stock hits the price during the day the stock is sold, so I need to watch the price of the stock immediately after the buy to make sure it doesn’t head down to hit the initial sell stop. If it rises immediately after I buy I will only check the price once every 2 or 3 hours on the first day. An initial sell stop becomes a trailing sell stop when the closing price of the stock rises, and I recalculate the initial sell stop and move it up. Once this happens I don’t watch the price of the stock as much, as my potential loss diminishes. I would check the price once or twice during the day at this stage, a bit more if the price started to fall. The trailing sell stop remains intra day until the trailing sell stop is halfway between the initial sell stop price and the cost of the stock. Once this happens the trailing sell stop is watched on closing prices only, not intra day. Not watching live prices all day helps me follow my sell stop rules better, and prevents the unnecessary selling of a stock to take a quick, short term profit.

    I would only look at the price of the stock the following morning when I updated the charts. Because to watch a live price go up suddenly I would think too short term and believe that was a good enough rise and believe I should lock in the profits by selling. But of course it wasn’t the end of the rise, normally the rise would continue.

    Watching live prices is a waste of time, and encourages clouded emotional and impulse decision making, although it used to be exciting watching a price move higher every time you click the update button. I will wait for the following morning to open the chart of that particular stock to see what happened, if it rised in price a new trailing sell stop needs to be calculated. If it fell in price but was still above the trailing sell stop price I would do nothing, just look at it again the next day. If it fell in price and hit, or fell below the trailing sell stop price I would watch the stocks price on opening and sell if it continued to fall, or hold it if it rised again, but keep an eye on it to make sure it didn’t start falling again.

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