Why it’s so easy to lose money in the markets
The TAZ Trader Blog recently posted
10 rules for losing
one’s money quickly. I also responded to a recent reader’s question and
addressed the topic of why it is
so easy to lose money in the markets. Both of these posts underscore an
important point: Doing what comes naturally is not what makes you money as a
trader. “If it’s obvious,” market guru Joseph Granville used to say, “it’s
obviously wrong.”
Let’s take a simple example of this idea,
courtesy of the Barchart site. Barchart
tracks the performance of various stocks according to technical trading
systems. By using ETFs as the stocks, we can see how technical systems
performed for entire sectors and for the market as a whole. Almost all of these
systems tracked by Barchart reflect a momentum/trend based style, in which the
trader sells signs of weakness and buys signs of strength. In other words, the
trader does what comes naturally.
For instance, one system tracks the 40-day
Commodity Channel Index (CCI) and has the trader selling dips below -100 and
buying rises above +100. Exits occur on a re-crossing of those thresholds .
Since August, 2004 in the S&P 500 Index (SPY), we’ve had 49 trades with this
system, with each trade averaging a holding period of 7 days. Of these 49
trades, 8 were profitable. Yes, you got that right. The trading system was
wrong about 84% of the time.
But maybe the problem is the indicator or the
time frame, you think. Well, Barchart follows other indicators and time
frames–a total of 12 technical trading systems in all. For SPY over the past
two years, only one of the twelve made money. Seven of the systems lost more
than 15 SPY points (the equivalent of 150 points in the ES futures) during that
time: a period of rising prices.
No, the problem is not with time frame or
indicator. Quite simply, strength has led to weakness and weakness has led to
strength, making these trading systems excellent contrary indicators. In fact,
if one could simply create a filter to eliminate periods of high momentum, you
could develop a rather good trading system by fading the ones tracked by
Barchart. Which is another way of saying, you could fade human nature.
Brett N. Steenbarger, Ph.D. is
Associate Clinical Professor of Psychiatry and Behavioral Sciences at SUNY
Upstate Medical University in Syracuse, NY and author of
The Psychology of Trading (Wiley, 2003). As Director of Trader
Development for Kingstree Trading, LLC in Chicago, he has mentored numerous
professional traders and coordinated a training program for traders. An active
trader of the stock indexes, Brett utilizes statistically-based pattern
recognition for intraday trading. Brett does not offer commercial services to
traders, but maintains an archive of articles and a trading blog at
www.brettsteenbarger.com and a
blog of market analytics at
www.traderfeed.blogspot.com. His book, Enhancing Trader Performance,
is due for publication this fall (Wiley).