Every now and then during a rough patch I think to myself, “a blind monkey throwing darts could trade better than me.” On paper trading seems like a pretty simple equation — the market can either go up or it can go down. Set a 50 point profit target along with a 50 point stop and over an infinite sample you’d be even Steven. Yet if we examine traditionally accepted failure rates among traders it’s clear that the majority of traders lose more money than mere chance should statistically allow. Is it truly possible that traders as a class perform far worse than random?
Seinfeld viewers may remember an episode when after a series of poor decisions the hapless George Costanza decides he’s going to do the opposite of his every inclination. George’s results were astonishing. Instead of nervously sniveling or lying in pressure situations he became honest and bold. He even snared the dream girl and dream job. Like George many traders have certainly considered, “if I’d only made the opposite trades I’d be rich.”
By stipulating fact – the vast majority of retail traders lose, would it not be equally true that doing the opposite of retail traders would be immensely profitable? Certainly some losing traders would have made money if not for excessive churning and commission costs but the reality is most traders lose because they all think the same.
What motivates traders looking at virtually identical data to do the exact opposite of each other? Don’t both counter parties have equal knowledge of key information? We can presume other traders are aware of the same chart points or heard the same report that we’re acting on.
Consider the action after a key report. If the data is perceived as bearish the market will auction down quickly to a new value area-a price band mutually agreed upon by buyers and sellers as reflective of the new information. Traders then put their betting caps on and position themselves with the thought of either “this bear information is aberrational, dips are to be bought” or “this bearish report is a harbinger of further bad news”. Two traders, the same information, two vastly opposing viewpoints. Here’s an important philosophical rub – technical traders are positioning along with discretionary traders and making similar statements. One system is saying “breakout I’m short”, while the other system that’s buying is saying “support off a key moving average”. One system is placing greater faith in a particular set of technical data than the other. Not only do traders argue at price but so do software applications.
Now we have two competing camps. Longs and shorts. Regardless if you’re discretionary or technical it’s important to observe who is gaining and losing control. Let’s state the obvious: Future prices are dependent upon who becomes more aggressive-buyers or sellers. Who are the most aggressive traders? Those who’re taking losses. Profitable trading means you’re successfully front running orders. Comfort isn’t derived by the number of people long with you-that’s instead a warning of soon to be long liquidation. When a market makes a contract low what’s one thing we know? Every existing long is under water. If you’re long and believe your fellow longs will begin taking losses then what are you waiting for? In trading there’s zero nobility in being the last on the sinking ship. The cautious traders are scoping out the lifeboat the moment they hear a thud. You are paid for your ability to be positioned ahead of new buyers or sellers.
Here are some ways and methods to think in a manner different than the crowd.
1. Learn how to read sentiment indicators. Here’s a link to an article I wrote on the ISEE put call ratio. http://tradingmarkets.com.site/options/how_to/articles/-77152.cfm. Be aware of one way sentiment expressed by options traders, the media and financial bloggers. If too many people agree or are pumping the same view they’re probably late and out of step with evolving, contrary information. If universally disseminated news is seemingly bullish but the market breaks then take it as a sign of real weakness. Most of the hardest breaks in stocks the past year have come immediately on the heels of “good” news from the Fed, Treasury or Congress.
2. Be a cynic. Don’t argue with the tape but look at the other side of every coin. I’ve long noticed that as a group Russian and British traders are better than average. Why? Because by nature they question widely accepted beliefs. New opinions translate to revaluations. Leave your dogma at the door and be open to the unexpected and seemingly illogical. Winning traders have a reason to be in the trade. Even if based on nothing more than a vague, ethereal feel, a good discretionary trader has a profile in his mind and the moment his thesis is no longer provable or valid he is out of the position.
3. Even profitable trades can lay the groundwork for bad habits. My friend is an excellent trader who bought the S&P’s on a temporary low several weeks ago. The market rose about 20 points within a few hours of his purchase. He took the profit and the market immediately tanked and made a new low. I called and congratulated him, “Great trade. You bought the old move low and got out on the swing high.” His reply both surprised me and displayed the mind of an expert speculator. His view was “I bought the market thinking the low was in and the cover while profitable and seemingly adept was the wrong play. If the market had continued higher I would have been out with too small a profit. I don’t trade for the expectation of being paid for the ‘wrong’ trade but I do expect to maximize the ‘right’ trade.” Human nature is much easier addicted to the pleasurable than the beneficial.
4. Recognize past mistakes and eliminate them. This month’s Golf Magazine has an article analyzing each shot of Tiger Woods career. Tiger’s success is less predicated by the good things he does than by virtue of doing far fewer bad things than other PGA golfers. All of us have a particular bad habit that consistently costs us. You should get an occasional feeling of deja vu when repeating a stressful event. Embrace that personal information as a signal. Your worst habit is potentially your best fade.
Kurt J. Eckhardt began his trading career in 1982 as an active floor trader in the Treasury Bond pit at the Chicago Board of Trade. Today Kurt is president of Eckhardt Research and Trading which offers the first ever futures pool to trade live on line while educating clients. Please go to Ecktrade.com for details and contact information.