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The Cautious and Deliberate Trader
Even when you're a short-term trader, making one
quick, astute decision after the next, it's necessary to
plan carefully, and act cautiously and deliberately.
Consider the case of Andy, a novice trader who allows
his impulses to guide him more than his logic. If he
traded more deliberately and spent a little extra time
fleshing out the rationale for his trading plan, he
would trade more profitably.
Andy has been
honing his trading skills by studying the price changes
of a particular stock. He found that the stock trades
between $20 and $25, depending on profits during a
particular quarter. There are times, though, that the
price hits $45 when a financial analyst talks it up, or
after a major product announcement. The company has been
shaky for years. The management of the company
frequently changes, with officers resigning or dismissed
when they fail to turn the company around. In addition,
sales are seasonal, with most sales during holidays and
the Fall. But the price is far from predictable.
Shortages of supplies and problems with distributors cut
into profits. It would be wise to be a little cautious
while trading this stock. It's steady most of the time,
but it is prone to extremes for unknown reasons at other
times. Despite identifying specific factors that impact
the price, though, Andy has lost over 75% of his account
in the past year. He seems to buy at a high point
believing it will go up higher because as he says, "the
stock is gaining momentum and about to reach new highs."
Andy's approach to trading is perplexing. The stock
price throughout a given year rarely hits the high of
about $45. But Andy buys at the high and ends up selling
when the price plummets. Andy has fallen prey to a
common ailment. He makes impulsive decisions without
thinking things through carefully, and in the end,
sabotages his efforts. He needs to trade more cautiously
and deliberately. Rather than vaguely work on the hunch
that the price is going to hit a new high, he should
question his reasoning. Why might the stock go to a new
high? The company has a troubled history with management
unable to change its rocky course. There's no good
reason to believe that the stock will hit a new high.
His hunch is unfounded. It isn't based on any of the
information he has gathered about the company.
In looking at the
factors that influence the stock price, it's hard to
believe that the stock would ever go past $45 to reach
new highs. It would be a smarter move to trade it at
around the $20 price range and anticipate that it would
move up when seasonal factors that influence the price
come into play, such as during the Fall or a new product
announcement. Andy has observed that the price moves in
a cycle, so why doesn't he try to trade on this
information? Andy's biggest problem is that he isn't
thinking things through. He isn't trying to make
educated guesses on the information he has gathered.
Instead, he tries to trade based on his hunches and
intuition, but he doesn't have enough experience to do
that very well. In many ways, he is sabotaging himself.
While some traders over-think a trading plan, Andy needs
to do a little more thinking. He must try to make his
trading approach more systematic. By considering the
factors that may correlate with price movements in the
stock, he can more accurately anticipate the price
movements. He may not be right all the time, but he
would be correct more times than the current approach he
has been using, which is not based on any reliable
information. Winning traders use their intuitions to
make trades, but they also think like an intuitive
scientist developing educated guesses and seeing if they
pan out. It is vital to study the markets, understand
them, and develop your own personal theories as to how
they operate. The more you can develop these theories
and use them to guide your decisions and trading plans,
the more profits you'll make.
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