Money Management, Part 1
|
There are some common mistakes I've seen traders make in the area of money management. First, let's understand what money management is all about.
Money management overlaps with risk, trade, business, and personal management, yet it has many aspects that make it unique, distinctly different from all of the other areas of management. In this chapter we want to examine some areas of money management that seem to involve mental quirks leading to costly mistakes.
LISTENING TO OPINION
Kim has entered a short position in crude oil after carefully studying as many factors as she could reasonably include while making her decision to trade. She has entered the trade because her study of the underlying fundamentals has her convinced that crude oil prices must soon begin to fall. Then Kim turns on her television set and begins to watch one of the financial news stations. An "expert" in crude oil is being interviewed. He begins to talk about how crude oil inventories are almost certain to drop this year because oil companies are not doing as much exploration as they have in previous years. Kim listens intently to what he has to say and then begins to doubt her decision about the trade she has entered. The more she thinks about it, the more panicky she becomes. She considers abandoning her position even though she will end up with a loss. The fact that an "expert" has decided something else completely shakes her confidence. She exits the trade intraday and takes a $400 loss. Prices have not come near her protective stop, which was $700 away from her entry. The market never moves sufficiently far to have taken out her stop. By the end of the day, her crude oil futures have made a new high, and in the following days explodes into a genuine bull market. Instead of a magnificent win, Kim has a loss. The loss is more than money, she has lost confidence in herself.
What should be done?
You should set your own trading guidelines and trade what you see. Forget about opinion, your own and especially that of others. Unless you are one of a very rare breed whose opinions are sufficiently good for trading, do not trade on them.
Make an evaluation based on the facts you have and then go with the trade. Just be sure you have a strategy for extricating yourself before losses become big. Had Kim stayed with her original strategy and stop placement, she would have ended up a happy winner instead of a regretful loser.
TAKING TOO BIG A BITE
Biting off more than can be chewed is a weakness of many traders. This form of over trading derives from greed and failing to have clearly defined trading objectives. Trading only to "make money" is not sufficient.
Pete has sold short T-Bonds and is now ahead by a full point. He notes that he is making money on his trade. Feeling very confident and thinking it would be smart to be diversified, he enters a long position in silver futures, and also sells short Call options of wheat which he is sure is headed down. Almost as soon he is in the market, wheat prices explode upward and his Calls are in trouble. Pete buys back the losing short Calls and sells additional Calls on a two-for-one basis at a higher strike price. At the end of the day he looks at other positions. Silver had an intraday reversal leaving a spiked bottom as they close at the high of the day. The T-Bonds have made an inside day, but to Pete they suddenly look weak, he is down a few ticks. At the end of the day, he finds that most of the money he had made on his short T-Bonds was used to buy back the short wheat Call options. He covered those and now has additional premium in his account, but he also has additional risk, and is short Calls in a rising market ? not an enviable position. Moreover, he is now worried about his long silver futures based on the fact that silver closed at its lows on what seems to be a genuine reversal. To further aggravate the situation, he has lost confidence in himself. What was once a happy, simple, winning silver long, has now become an ugly, confusing mess, and Pete has a good chance of ending up a loser on all three trades. If Pete keeps over-trading in this fashion, he could end up like the poor fellow in the picture.
What should be done?
Break every trade into definitive goals. Make sure you achieve those goals before adding other positions. Even with a single short sale of the T-Bonds, Pete could have set himself a goal for the trade. One or two full points might have been all he needed to satisfactorily retire that trade as a winner. Then he could have made his trading decision for an additional position. There are very few traders who can successfully manage multiple positions in a variety of markets.
OVERCONFIDENCE
Overconfidence is a particular kind of trap that springs shut when people have or think they have special information or personal experience, no matter how limited. That's why small traders get hurt trading on no more information than "hot-tips."
Tim is a farmer. He raises hogs and purchases huge amounts of feed to provide for his hogs. Tim has a large farming operation which is quite profitable. He takes 250 hogs a week to market. Because of a steady flow of hogs from his operation to the market, Tim has no need to hedge his hog business because he is able to dollar average the prices he gets for them. But Tim does want to indirectly reduce the cost of the feed he has to buy, so he purchases soy meal futures. Tim listens to weather and farm reports all day long. He attends meetings of other farmers, and tries to gather all the information he can that might help him be more profitable. But Tim has a major problem, called tunnel vision. When he looks out at the grain fields in the area where he lives, whatever he sees there he extrapolates to the whole world.
In other words, if Tim sees that the surrounding fields are dry, he suspects that all fields everywhere must also be dry. One year Tim witnessed a local drought. He checked with all the local farmers and they said they were truly experiencing drought conditions. He looked at the news on his data feed, and sure enough it said that there was a drought in his area. In fact, the entire state where Tim raises his hogs was undergoing drought.
Tim wasn't too concerned about his own feed bins. He had plenty of it in his silos from previous bumper crop years. Tim decided to be piggish and speculate on what he considered to be inside information. He called his broker and bought heavily into soy meal futures. Tim was confident. He was sure that soy meal prices would explode upward some time soon, and that he was going to make himself a small fortune. Tim's greed may have turned him into a hog. However, the futures he purchased started moving down and the value of his investment began to shrink markedly. What Tim failed to do was to have a broader perspective. Everywhere else that grains were grown, farmers were experiencing rain in due season. The drought was localized almost entirely within the state in which Tim did his hog raising. Tim lost because he was confident in the limited knowledge he had.
What should be done?
We all need to broaden our horizons. We need a humble attitude relative to the markets. We can never afford to wallow in overconfidence in what we perceive as special knowledge. A trader can never afford to let his guard down. Tim thought he knew something that others hadn't yet caught onto. In so doing, Tim made another mistake as well. He heard only what he wanted to hear.
HEARING WHAT YOU WANT TO HEAR ? SEEING WHAT YOU WANT TO SEE
Marketers call this preferential bias. Preferential bias exists among traders. Once they develop a preference for a trade, they often distort additional information to support their view. This is why an otherwise conscientious trader may choose to ignore what the market is really doing. We've seen traders convince themselves that a market was going up when, in fact, it was in an established downtrend. We've seen traders poll their friends and brokers until they obtained an opinion that agreed with their own, and then enter a trade based upon that opinion.
A student of ours, Fran and her husband, John, decided they wanted to go to live in the Missouri Ozarks. Everyone told them that there was no way for them to make a living there.
Everyone they asked advised them not to do it.
Finally, a minister in the Church they proposed to attend told them that they were to serve there. Out of twenty or thirty people they asked, that minister was the only one who told them to come. Of course, it was exactly what they wanted to hear. They sold their home and most of their possessions accumulated over a lifetime. They moved to the Ozarks and went broke within a year. They had to leave and begin all over again. John, who had been semi-retired, now had to find a job. So did Fran. She had to give up a promising start as a trader to go out to put food on the table.
What should be done?
Look at each trade objectively. Do not allow yourself to become married to your opinion. Learn to recognize the difference between what you see, what you feel, and what you think. Then, throw out what you think. Lock out the input of others once you have made up your mind. Don't let your broker tell you what you want to hear. Never ask your broker, your friends, or your relatives for an opinion. Turn off your TV or radio, you don't need to see or hear what they have to say. Take all indicators off your chart and just look at the price bars. If you still see a trade there, then go for it.
To be continued in Article Part 2 about Money Management!
Joe Ross
Trading Educators Inc
ABOUT JOE ROSS:
Joe Ross has been trading for more than 47 years, and is a well known Master Trader. He has survived all the up and downs of the markets because of his adaptable trading style, using a low-risk approach that produces consistent profits.
Joe is the creator of the Ross hook, and has set new standards for low-risk trading with his concept of "The Law of Charts?." Joe was a private trader for most of his life. In the mid 80's he shift his focus and decided to share his knowledge. After his recovery, he founded Trading Educators in 1988 to teach aspiring traders how to make profits using his trading approach. He has written 12 major books on trading. All of them have become classics and have been translated into many different languages.
Joe holds a Bachelor of Science degree in Business Administration from the University of California at Los Angeles. He did his Masters work in Computer Sciences at the George Washington University extension in Norfolk, VA. Joe still tutors, teaches, writes, and trades regularly. Joe is still an active and integral part of Trading Educators.
|
|
|
Forex Trading Philosophy
Keen on starting FOREX trading? Why would you not be? Many beginning FOREX traders are captivated by the allure of easy money. FOREX websites offer 'risk-free' trading, 'high returns' and 'low investment' ? these claims have a grain of truth in them, but the reality of FOREX is a bit more complex. As wit...(related: Currency Trading)
Chinas New Currency Regime
The base unit for the renminbi is the yuan, which is how the Chinese currency is most commonly referred to. The official ISO abbreviation for the yuan is CNY, but it is also commonly abbreviated in the forex industry as RMB.The yuan had been pegged at 8.28 to the dollar since 1994. While China has been openly discussing scrapping the dollar peg for several years, many traders weren't expecting a move until later in the year.The PBC declared that the new r...(related: Currency Trading)
Online Stock Trading: Freedom Of Trade
I remember the first time I started to trade online. It was just before the tech bubble of the late 1990's and the internet was still something new for most people. Purchasing the now forgotten company was easy, and I made a few dollars on that trade. It was so excitingly simple.Flash forward a couple of years and I have made and lost my share of money. While still ahead of the game, I learned a few thi...(related: Currency Trading)
Be A Smarter Forex Currency Trader: Three Basic Principles
Below I will describe three basic principles that may come in handy for currency traders. They are very easy to implement and potentially take advantage of as you will see.Principle 1Some currency traders find that it is useful to always trade a given currency pair at the very same time every day. The reasoning for this is that most of the other traders buying or s...(related: Currency Trading)
The Major Players In The Foreign Currency Exchange Market - Forex
Since the US dollar is the centerpiece of the market,it is normally considered the 'base' currency for quotes. In the "Majors", this includes USD/JPY, USD/CHF and USD/CAD. For these currencies and many others, quotes are expressed as a unit of $1 USD per the second currency quoted in the pair. For example, a quote of USD/JPY 123.50 means that one U.S. dollar is equal to 123.50 Japanese yen.When the U.S. dollar is the base ...(related: Currency Trading)
Financial Crises, Global Capital Flows And The International Financial Architecture
The recent upheavals in the world financial markets were quelled by the immediate intervention of both international financial institutions such as the IMF and of domestic ones in the developed countries, such as the Federal Reserve in the USA. The danger seems to hav...(related: Currency Trading)
The Yin And The Yang Of Markets
I am reading a fantastic book on trading, first published in 1924, by Richard D. Wyckoff, titled "How I Trade and Invest in Stocks & Bonds". Although most of the exam...(related: Currency Trading)
How To Control Fear And Greed In Trading
There is an old saying that the market is driven by fear and greed. Anyone that has placed more than a couple of trades will surely have experienced these two emotions.All traders experience emotion. The distinction between a successful trader and an unsuccessful trader comes down to how they deal with that emotion. Let's look at how these emotions affect a successful trader and an unsuccessful trader in various scenarios:1. The trader's three previous trades have been losers. The unsuccessful trader will consider this before placing his next trade and be fearful that this trade will also end up a loser. This might result in a delay in placing the trade whilst waiting for the price to confirm that they were right - thus missing a perfectly good entry. They might suddenly discover that some other factor, previously u...(related: Currency Trading)
Trade Exit - How To Cut Losses And Let Profits Run
Cut your losses short and let your profits run. This is the essence of your trade exit rules.Cutting losses shortA protective stop protects your trading capital, it is your initial trade risk. Before a trade is even entered your should know where your protective stop will be - this is your maximum loss (barring any slippage on the exit). There are many different ways to determine a protective stop on a trade:Set dollar amount - Say $500 on every tradePercentage retracement - Say 10% from the entry priceVolatil...(related: Currency Trading)
site-map - Copyright © 2007 | Contact Webmaster | All Rights Reserved | Free Articles and Information | Currency Trading