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While this
rule is suitable for a physical battle, if you use it while trading,
you are at a supreme disadvantage. To apply it to trading, the rule
should read ...
Plan logically, and attack (trade) WITHOUT emotion.
A number of psychologists
have noted that normal human behavioral patterns are unsuited to trading
the markets. Normal human responses to winning and losing will cause
people to do exactly the wrong thing at the wrong time in the markets.
To
illustrate ...
1. Take
the situation where you have a long position and it immediately goes
into profit. The normal human response is to want to take the profit
quickly. This gives immediate gratification and removes any fear you
may have had of losing the profit while the trade was on. This results
in the situation called "cutting your profits short."
2. The
opposite situation is when you put on a trade (again let's say it's
a long position), and it goes against you. The normal human response
is to hang on to the losing trade and hope it comes back and gives
you a profit. But it keeps going down, so now you want it to come
back so you can at least break even.
But it still
goes down, so now you hope it will come back and give you a small
loss. Down it goes further and you now have a big loss but you don't
want to take the loss because it is emotionally painful to take losses.
So you keep delaying the pain and losing more money.
If you are trading
non-leveraged stocks, (that is, you have bought the shares outright
and have paid for them in full), by now you may rationalize the loss
by calling it a "long term investment" and just hang on to the shares.
After all, if you sold now you'd lose heaps.
If you were trading
in leveraged commodities you could be in real financial trouble at
this point. This situation is called "letting your losses run."
You'll notice
that cutting your profits short and letting your losses run is the
exact opposite of what you are supposed to do, which is cutting your
losses short and letting your profits run.
3. Now
let's go back to the first situation where you've taken your profit
quickly and you have your immediate gratification and removal of anxiety.
You have a nice little profit but now the market is still going up.
If you'd hung on you could have made even more! You get out your calculator,
work out how much money you should have made by now, and think about
what you could have done with that money. So you ring your broker
and buy in again, noting with satisfaction that the front page news
headline now reads ...
"Bulls Roar
in Market Surge"
The market messes
around for the next week or so and then starts to drift a bit lower,
but you hang on because the broker says it's just a temporary reaction
and anyhow, the media is still full of reasonably bullish news.
You hang on for
a few more days but the market just keeps going down. Now the media
has turned bearish.
What went
wrong?
A number of things. Let's list them ...
1. Greed.
You looked at all the money you thought you should have made and jumped
back in - just as the market was topping.
2. You
"spent" the money you thought you should have made. You must never
do this.
3. You
listened to the media. You used the media to back up your decision
to get back in, not realizing that the media is not a predictor, it's
a follower. It just reports what has happened, usually when it's all
over. Never trade on the news. Once the bull market hits the front
page news and you decide to buy in on the strength of this news, you
are trading with the mob - not the smart money.
4. You
listened to the broker. If you've got a properly researched and tested
trading method that you know intimately and have confidence in, you
don't need or want the broker's advice on specifically when to buy
and sell. Remember - the buck stops with you.
5. You
exited your original position based on emotion, not logic.
Let's see what
Gann says about this aspect of trading ... On page 16 of "How to Make
Profits in Commodities", Gann says ...
"WHAT TRADERS
DON'T WANT TO KNOW. With all due respect to my readers, many traders
when they are in the market don't want to know the facts and don't
want to know the truth. They hope the market will go their way. They
want it to go their way and want to be told that it will. When you
are in the market you should be unbiased and try to determine whether
you are in right or wrong. When you find you are in wrong, admit it
quickly and get out. Our old rule is, when in doubt, get out. When
you have nothing to hold on for but hope, sell out at the market quickly.
Don't look for the man who will advise you that your position is right
and that the market will soon start going your way. Look for the man
that will tell you the truth and prove it to you. Better still, learn
how to prove it to yourself whether you are right or wrong. Face the
facts. Change your position. Change your mind. Change with the trend
and you will make profits."
On page 17 of
"How to Make Profits in Commodities", Gann says . "HOPE AND
FEAR: ........ The average man or woman buys commodities because they
hope they will go up or because somebody advises them they will go
up. This is the most dangerous thing to do. Never trade on hope. Hope
wrecks more people than anything else. Study the market and determine
the trend. Face the facts, and when you trade, trade on facts, eliminate
hope."
"Fear causes many
losses. People sell out because they fear commodities are going lower,
but they often wait until the decline has run its course and they
sell near the bottom. Often when they have been out of the market
for some time, they get in because they fear it is going higher. Never
make a trade on fear. The Bible says, "Ye shall know the truth and
the truth shall make you free." Know the facts and know the truth.
When you do this, you will have no hope and no fear and you will trade
on well defined rules and go with the trend and will make profits."
That last sentence
is very important. "When you do this, you will have no hope and no
fear (trade without emotion) and you will trade on well defined rules
and go with the trend and will make profits."
Other quotes
from Gann on this subject ... "You will never succeed buying or selling
when you hope the market is going up or down. You will never succeed
by making a trade because you fear the market is going up or down.
Hope will ruin you because it is nothing more than wishful thinking
and provides no basis for action. Fear will often save you if you
act quickly when you see that you are wrong. "The fear of the market
is the beginning of wisdom". Knowledge that you can only obtain by
deep study will help you to make a success. The
more you study past records the surer you are to be able to detect
the trend in the future."
"Remember, never
buck the trend : after you detect the trend, go with it regardless
of what you think, hope or fear and you will make a success."
"People often
write me and say "You were bearish on a certain stock on such and
such a date; now .........you are bullish on it. My answer is "A wise
man changes his mind, a fool never." ............ "Go into the market
to make money and be ready to change sides when the occasion demands
it."
Copyright © 2001
Terry Ashman
HotTrader, Australia
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