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The Trading Doctor - Why Can't You Execute The Trade?

InvestorEducation / Learn to Trade Apr 22, 2007 - 04:26 PM GMT

By: Dr_Janice_Dorn

InvestorEducation

The mail I am receiving indicates that many of you are having real challenges with execution of trades. In the next week or so, I will go over some critical elements of trade execution, particularly the setting of stops.

However, today is about just taking the trade and why you can't do it.
We live in a culture of instant gratification. We thrive on everything from microwave ovens, fast foods, instant replay, mastery in a minute, one-night stands, a pill to "fix" what ails you, and just about everything else that you see around you which just "lights up" the brain dopamine systems. It's a "faster and faster forward" world in which we all live. Naturally, there is carryover into our trading. Why wouldn't there be?


Part of the attraction to leveraged financial instruments, such as futures, options, double ETF's and single stock futures is their ability to feed our greed and impatience to get rich quickly. I cannot tell you how treacherous this type of thinking is, especially for the novice trader or the individual who is in the first two of the five stages of trading competence that I have written about extensively.

All you have to do is to compare the rate of return on leveraged vehicles to those of other more conventional investing or trading options, and you see what I mean. The theoretical rate of return is significantly greater and so is the risk of ruin!

Trading is the buying and selling of risk. All other things being equal, the amount of risk that we are willing to assume is the only real aspect of trading over which each of us has control. Once your money enters the markets, you are in the realm of risk and you are the only one who has power over how you embrace and manage that risk. Of course, there are other things which we must consider such as diversification, power failure with no backup system, etc., so this is a caveat statement, but I think you get the point. If not, please let me know!

Why do successful hedge funds show consistent year over year annualized returns of 20%? After all, they are the "big money" so they could go for the big percentage returns like 50% or 75%; right? Absolutely correct. However, to "go for broke" in this manner translates literally into going broke. Just look at what has happened over the past few years with those hedge funds that took on more and more risk. Think Amaranth blow- up where they lost nearly $5 billion US in one weekend earlier this year due to wild and uncontrolled speculation in natural gas futures. (Ask me about what the trader who orchestrated this blow-up is doing now if you want a real eye-opener!)

One of the most common reasons that retail and institutional traders fail is that they do not adhere to comprehensive, controlled, systematized methods for risk management. This, almost always, manifests as overleveraging of assets, i.e. really bad risk and money management.

With that background, let's go back to our main topic, i.e. "Why Can't You Pull The Trigger?" There are a number of psychological factors involved here. The most important factor, however, appears to be that you are risking too high of a percentage of your total equity per position. If you are doing this, you are risking wipe-out of your account or excessive drawdown. If you feel anxious, upset, worried, frightened and overwhelmed before you take a trade, you will not be able to pull the trigger. In a way, then, this is a kind of self-preservation. You know that something is wrong, but maybe you don't know what is wrong.

So, what happens? You have fear, so you don't pull the trigger, therefore, you don't take the trade. You have the risk of not taking the trade as well as the risk that you would have if you actually took the trade. Thus, in a way, you are damned if you do and damned if you don't. Although it is clearly preferable to not take the trade in this instance, you may find yourself in the most uncomfortable situation of regretting that you did not take it (if it was a good trade) or cursing yourself for taking it (if it turned out badly). That said, the better part of valor in this case is to not take the trade. It is better to sit on the sidelines rather than lose money, although it feels pretty horrible when it happens, especially if the trade would have worked out.

So, what can you do to put yourself in a situation where you see the signal, recognize it as familiar, and execute without hesitation? The answer is simple, but not always easy. The answer is that you manage your risk by managing your position size. This means that you trade small enough so that a loss will not wipe you out. It is much easier to deal with the psychological components of trading if you are not trading scared, i.e., if you are not emotionally or psychologically "attached" to one particular position.

Here are some questions to ask yourself before you put monies at risk in the markets:

  • What percent of my total portfolio am I willing to risk on any one position?
  • What does my back-tested system tell me about the worst case scenario for any given position?
  • Have I accounted for slippage or commissions (the vigorish, aka the vig) in these calculations?
  • Have I prepared myself psychologically, physically and financially for this potential drawdown?
Once you answer these questions, get right with yourself and take the appropriate steps to control and manage your risk, you are on the path to steady and consistent profits. Getting rich slowly and in a safe manner beats the gunslinger approach hands down!

 

By Dr. Janice Dorn, MD, PhD
Prescriptions for Profits
www.thetradingdoctor.com

Signup for your risk-free subscription to the Trading Doctor Newsletter. If you are not completely satisfied that our newsletter is for you just let us know, via email, within 7 days of your subscription date and we'll immediatly refund your money.

© Copyright 2006-07 -- Janice Dorn, M.D., Ph.D. -- Ocean Ivory LLC

Dr. Janice Dorn is a graduate of the Albert Einstein College of Medicine, where she received her Ph.D. in Neuroanatomy. She did her postdoctoral work in Neurophysiology at the New York Medical College. She received her M.D. from La Universidad Autonoma de Ciudad Juarez, did one year of clinical clerkships in Phoenix, Arizona. and then completed a Neurology Internship at The University of New Mexico in Albuquerque. For the past twelve years, Dr. Dorn has focused her attention on trading, mentoring and commentary in the financial markets, with emphasis on Behavioral NeuroFinance, Mass NeuroPsychology, Trading NeuroPsychology, Futurism and Life Extension. A graduate of Coach University, she is a full time futures trader and trading coach.  Dr. Dorn is the author of over 300 publications, relating to Trading and Investing Neurouropsychology, Market Mass Neuropsychology, Behavioral Neurofinance, and Holistic Wellness and Longevity. 


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