January 20, 2011
January 05, 2011
November 07, 2010
The Psychology of Trading
Extracted from the book: The Psychology of Trading, Dr Brett Steenbarger
Most of the time the problem with traders is that the frame of mind in which they analyze markets is different from the one in which they are actually making trading decisions. When the author encountered periods of uncertainty and stress, one of his techniques for handling the novel shifts is to temporarily get away from the screen.
"Behavior patterns are anchored to one's states of mind and body." Once the traders learn the skill of shifting their emotional and physical states, they are free to create and to enact new patterns. The change of emotional and physical state is a powerful strategy for interrupting the impulsive and emotional problem patterns during the volatile periods of price action.
However, many traders are so afraid of missing a possible market move that they dare not spend time refocusing on their trading plan. They fail to realize the far greater risk of losing sight of their plans and trading haphazardly.
Your trading plan is your anchor; you most want to utilize it when seas are roiling. The psychological antidote to greed and fear is planfulness, not calm or confidence.
CONCLUSION Late in 2001, the author conducted a survey of the following traders personality traits and coping styles which known as NEO Five Factor Inventory:
1. Neuroticism ---- the tendency toward negative emotions who reported the greatest problem with their trading
2. Extraversion --- an outward orientation toward people and life.
3. Openness to experience - a desire for novelty, variety, and risk taking.
4. Agreeableness - the tendency to get along well with others.
5. Conscientiousness - the capacity to be reliable, steady, and trustworthy.
The findings were eye opening. The traders who reported the greatest success (and who were willing to have me verify their success in case studies) tended to score high in conscientiousness. They were very steady and reliable.
The traders who reported the greatest problems with their trading tended to score high in neuroticism and openness. They were experiencing many negative emotions and tended to use trading for excitement.
The conscientious traders tended to be highly rule-governed in their trading. There was little excitement in their trading. Instead, they very consistently developed their plans and followed them.
The neurotic and risk-taking traders tended to make their decisions impulsively, without prior planning. They tended to revel in telling stories of their great wins and losses.
The survey above drove home one important lesson: Success in trading is related to the ability to stay consistent and plan-driven. Traders fail not because of their emotions, but because their emotions deflect them from their purpose. In developing their rules and systems, the successful traders had found a way to immunize themselves from the emotional effects of market volatility. Indeed, in many respects, the successful traders appeared to be every bit as fearful as the unsuccessful ones. It's just that the fears of the successful traders were not those of drawdown or missing a market move. Rather, they fears deviating from their plans. Dedication to purpose was the cornerstone of their success.
Most of the time the problem with traders is that the frame of mind in which they analyze markets is different from the one in which they are actually making trading decisions. When the author encountered periods of uncertainty and stress, one of his techniques for handling the novel shifts is to temporarily get away from the screen.
"Behavior patterns are anchored to one's states of mind and body." Once the traders learn the skill of shifting their emotional and physical states, they are free to create and to enact new patterns. The change of emotional and physical state is a powerful strategy for interrupting the impulsive and emotional problem patterns during the volatile periods of price action.
However, many traders are so afraid of missing a possible market move that they dare not spend time refocusing on their trading plan. They fail to realize the far greater risk of losing sight of their plans and trading haphazardly.
Your trading plan is your anchor; you most want to utilize it when seas are roiling. The psychological antidote to greed and fear is planfulness, not calm or confidence.
CONCLUSION Late in 2001, the author conducted a survey of the following traders personality traits and coping styles which known as NEO Five Factor Inventory:
1. Neuroticism ---- the tendency toward negative emotions who reported the greatest problem with their trading
2. Extraversion --- an outward orientation toward people and life.
3. Openness to experience - a desire for novelty, variety, and risk taking.
4. Agreeableness - the tendency to get along well with others.
5. Conscientiousness - the capacity to be reliable, steady, and trustworthy.
The findings were eye opening. The traders who reported the greatest success (and who were willing to have me verify their success in case studies) tended to score high in conscientiousness. They were very steady and reliable.
The traders who reported the greatest problems with their trading tended to score high in neuroticism and openness. They were experiencing many negative emotions and tended to use trading for excitement.
The conscientious traders tended to be highly rule-governed in their trading. There was little excitement in their trading. Instead, they very consistently developed their plans and followed them.
The neurotic and risk-taking traders tended to make their decisions impulsively, without prior planning. They tended to revel in telling stories of their great wins and losses.
The survey above drove home one important lesson: Success in trading is related to the ability to stay consistent and plan-driven. Traders fail not because of their emotions, but because their emotions deflect them from their purpose. In developing their rules and systems, the successful traders had found a way to immunize themselves from the emotional effects of market volatility. Indeed, in many respects, the successful traders appeared to be every bit as fearful as the unsuccessful ones. It's just that the fears of the successful traders were not those of drawdown or missing a market move. Rather, they fears deviating from their plans. Dedication to purpose was the cornerstone of their success.
October 21, 2010
Determining General Market Direction
Extracted from the book: Trend Trading for a Living, Thomas K. Carr
Five different types of market conditions
- Bullish strongly trending
- Bullish weakly trending
- Bearish strongly trending
- Bearish weakly trending
- Range-bound (or nontrending)
BULLISH: STRONGLY TRENDING
The Focus: It should be on long setups, particularly breakout plays.
Characteristics: Everything goes up, and up a lot, nearly every day. The bulls are completely in control and win every battle with the bears. Making money is easy in a bullish strongly trending market, as long as you have the right entry system. But the drawback is that when this kind of market reaches a top, the sell-off can be quick and harsh and can wipe out months of hard-won gains in a matter of days. So in a strong bull market you must always be careful to play defensively against a possible reversal of momentum.
How to Play It: Here we can say that a bullish strongly trending market is a great market to be in if you are already long. But if you are coming late to the party (and hopefully not too late), your best play is to look for stocks that are breaking out to new highs from periods of consolidation. You must make sure these breakout plays are confirmed by the various technical indicators we use. If price is making a new high but the indicators are not making new highs, then you have bearish divergence and you should move on to another chart.
BULLISH: WEAKLY TRENDING
The Focus: It should be on long setups, particularly pullback plays.
The Focus: It should be on long setups, particularly pullback plays.
Characteristics: This is a tougher market to trade, since the pullbacks tend to be more frequent, steeper, and
longer-lived. In a weakly trending market, corrections can last a couple of weeks. This can be frustrating if you are sitting on open long positions. Ultimately, the bulls are in control, but it can seem for days on end that the bears have moved in and made themselves right at home. However, this is one of the best markets in which to find great risk/reward scenarios in our setups. Those lengthier pullbacks serve to take a lot of the risk out of a trade, so our stop-loss can be closer to entry, and our exit targets can be that much further away.
How to Play It: Here we can say that a bullish weakly trending market is an ideal market for trend trading. You should find stocks that are showing strong trending action (normally stronger than the general market itself ) but have pulled back to an area of support. This pullback should be confirmed by oversold indicators, and the current daily candlestick should put in a reversal bar of some kind before you consider an entry.
October 01, 2010
Selling Winners and Holding Losers
Extracted from the book: Quantitative Trading Strategies, Lars Kestner
Studies of human bias in economic situations shed light on how the mind affects trading
decisions. In one such study conducted in 1998, Terrance Odean, professor of finance at the University of California, examined 10,000 accounts at a large discount brokerage firm to determine if individuals’ trading styles differed between winning trades and losing trades made from 1987 and 1993. He found a significant tendency for investors to sell winning stocks too early and hold losing stocks too long. Over his test period, investors sold approximately 50 percent more of paper profits on winning trades than they sold of paper losses in losing trades.
Based on the data, Odean concluded that winning stocks were sold quicker and more frequently than losing stocks. Although the results were a bit surprising, this behavior by investors could make sense. When we buy stocks, we’re placing a bet that a company is undervalued. Stocks that increase in value are logically
becoming less undervalued as they rise, while stocks that decrease in value are logically becoming more undervalued. Winning stocks that have increased in value could be considered not as cheap as when they were purchased. Losing stocks that have declined in value could be considered cheaper than when purchased. In this case, it makes sense to sell the winning stocks that have become less cheap and
hold losing stocks that have become cheaper.
Although the logic is sound, Odean’s results show that the opposite actually occurs. Winning stocks that were sold continued to rise, while losing stocks that were held continued to fall in value. In the year following sales, stocks sold with gains by individual investors outperformed the market by an average 2.35 percent. At the same time, losing stocks that were held underperformed the market by an average of 1.06 percent. Odean discovered, on average, that investors underperform the market by selling their winners too early and holding on to their losers too long. Based on purely economic terms, it’s unclear why they behaved in this manner; psychology may provide the missing link. Clearly, the more profitable course of action suggested by the study is to buy winning stocks and sell losing ones. Two theoretical underpinnings dominate the tendency to sell winners and ride losers: prospect theory and mean reversion theory.
Studies of human bias in economic situations shed light on how the mind affects trading
decisions. In one such study conducted in 1998, Terrance Odean, professor of finance at the University of California, examined 10,000 accounts at a large discount brokerage firm to determine if individuals’ trading styles differed between winning trades and losing trades made from 1987 and 1993. He found a significant tendency for investors to sell winning stocks too early and hold losing stocks too long. Over his test period, investors sold approximately 50 percent more of paper profits on winning trades than they sold of paper losses in losing trades.
Based on the data, Odean concluded that winning stocks were sold quicker and more frequently than losing stocks. Although the results were a bit surprising, this behavior by investors could make sense. When we buy stocks, we’re placing a bet that a company is undervalued. Stocks that increase in value are logically
becoming less undervalued as they rise, while stocks that decrease in value are logically becoming more undervalued. Winning stocks that have increased in value could be considered not as cheap as when they were purchased. Losing stocks that have declined in value could be considered cheaper than when purchased. In this case, it makes sense to sell the winning stocks that have become less cheap and
hold losing stocks that have become cheaper.
Although the logic is sound, Odean’s results show that the opposite actually occurs. Winning stocks that were sold continued to rise, while losing stocks that were held continued to fall in value. In the year following sales, stocks sold with gains by individual investors outperformed the market by an average 2.35 percent. At the same time, losing stocks that were held underperformed the market by an average of 1.06 percent. Odean discovered, on average, that investors underperform the market by selling their winners too early and holding on to their losers too long. Based on purely economic terms, it’s unclear why they behaved in this manner; psychology may provide the missing link. Clearly, the more profitable course of action suggested by the study is to buy winning stocks and sell losing ones. Two theoretical underpinnings dominate the tendency to sell winners and ride losers: prospect theory and mean reversion theory.
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