A stale trading or investment position can devastate hard-earned nest eggs or trading positions. Like eating stale food, which becomes infested with germs, stale positions are often self-inflected wounds.
Human nature and ego drive many to assume their original analysis is correct. When a market price moves contrary to expectations, ego can cause a feeling that the market price is wrong. Market prices are never wrong; they reflect the current level where buyers and sellers meet in a transparent marketplace environment. Like throwing out stale food, eliminating stale trading or investment positions will optimize results and protect capital.
How do you know a risk position is stale?
- Forgetting about investment or trade positions in portfolios for extended periods without positive performance makes them dust collectors.
- Adding to risk positions only because they are out of funds makes them stale.
- When expectations become prayers, a position is stale.
A plan can avoid stale positions
- Establish clear and concise risk-reward dynamics before executing any trade or investment position.
- Risk-reward plans require stops and profit horizons.
- If a market price moves contrary to expectations and to stops, eliminate the position and decide if the original thesis remains valid. Moving stop levels is inappropriate because the market price moves to that level.
- If a market price moves in the anticipated direction, adjusting and increasing profit horizons is appropriate. However, the quest for higher rewards requires stop adjustments to protect capital and profits.
- Remember that a risk position is long or short at the current market price, not the original execution price. The thesis for a risk position needs constant adjustment reflecting current market conditions.
Discipline is critical for success
- Stopping losing positions is necessary but difficult.
- A stop is an admission the risk position was wrong.
- Traders and investors can be wrong, but market prices are never wrong.
- Small losses are acceptable and part of any successful trading or investing program.
- Allowing losses to mount with no plan or adding to risk positions because they are out of funds is never acceptable.
- Discipline enables market participants to profit even if they are wrong on their initial ideas over 50% of the time.
The danger of giving in to the ego
- Ego is a person’s sense of self-esteem or self-importance.
- Ego creates self-indulgent results that run contrary to successful risk-reward.
- Ego drives people to believe they are correct and the market prices are wrong.
- Ego can make the market the enemy when prices move contrary to expectations. The market sentiment is a trader or investor’s best friend as it creates trends.
- Ego does not allow for learning from mistakes, which is the most valuable education.
Trading and investing are iterative processes
- Approach all markets with a philosophical and quantitative approach: How much are you willing to risk, and how much do you want to profit from that risk?
- Document a risk-reward plan before buying or selling to open a new position.
- Stick to the plan when the price moves contrary to expectations.
- Amend the plan when the price moves in the anticipated direction.
- Balance and diversify an overall portfolio to limit risks.
- Rinse and repeat for all positions in all markets.
The world’s most successful traders and investors tend to remember their significant losses instead of substantial profits as they respect the market’s harsh lessons. A humble approach that sets aside ego and concentrates on macro and micro analysis increases the odds of successful trading and investing that will build nest eggs over time. When a risk position is stale, toss it out!
Thanks for reading, and stay tuned for the next edition of the Tradier Rundown!