business news7 Deadly Trading Sins, and How to Atone
By
Schaeffer's Investment Research
Oct 31, 2012 11:00 am
Trading tips to help you beat greed, pride, and five other common investing pitfalls.
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Despite our best intentions, the inherent fallibility of our human nature means that we occasionally commit grievous transgressions in our trading. Unfortunately, all of the research and investing capital in the world won't guarantee investing profits if you're succumbing to emotional self-sabotage as you trade. Trust us -- even if you're not a fire-and-brimstone type in your personal life, it's probably safe to say that you've got a few investing sins on your conscience. To find out how to overcome the weakness of the flesh and transcend your baser trading instincts, keep reading.
Greed
Greed -- or avarice, if you're a die-hard medievalist -- is probably the easiest of the trading sins to commit. After all, the purpose of investing is to make money, right? But there's a difference between targeting reasonable profits and swinging for the fences at the expense of common sense.
To be clear, the desire to make money is not a vice in and of itself (at least, not in a capitalist society, it's not). In fact, traders are most likely to commit the sin of greed after they've already entered a position... and the profits are beginning to add up. Once the greedy trader sees his returns top 25%, all he can think about is doubling that to a 50% gain. But once the position is up 50%, why not hike the target to 100%? And so it goes on like that into perpetuity -- or until the stock becomes ferociously overbought and reverses hard, erasing those tantalizing paper profits the trader could have once collected.
Penance: You can atone for your profit-chasing ways by setting a target exit point for each trade. A target exit point is the logically based underlying stock price that would result in a substantial, yet attainable, profit. Set your profit objectives in advance, and determine the appropriate target exit point before you trade. Just as crucially, resist the temptation to raise your profit objective as the price of the stock nears your target exit point.
Gluttony
All traders are probably guilty of having a "pet" stock or sector that's their perennial favorite. This might be due to the investor's relative familiarity with the industry, a track record of wins on one particular stock or sector, or -- in some cases -- a basic gut feeling.
While there's nothing wrong with playing your favorite stocks as part of a balanced and diverse investing strategy, a trading glutton makes the mistake of overweighting his portfolio toward one small slice of the broad-market pie. The market environment is always subject to change, and the tech-heavy approach that worked so well last quarter might play havoc with your returns this quarter.
Greed
Greed -- or avarice, if you're a die-hard medievalist -- is probably the easiest of the trading sins to commit. After all, the purpose of investing is to make money, right? But there's a difference between targeting reasonable profits and swinging for the fences at the expense of common sense.
To be clear, the desire to make money is not a vice in and of itself (at least, not in a capitalist society, it's not). In fact, traders are most likely to commit the sin of greed after they've already entered a position... and the profits are beginning to add up. Once the greedy trader sees his returns top 25%, all he can think about is doubling that to a 50% gain. But once the position is up 50%, why not hike the target to 100%? And so it goes on like that into perpetuity -- or until the stock becomes ferociously overbought and reverses hard, erasing those tantalizing paper profits the trader could have once collected.
Penance: You can atone for your profit-chasing ways by setting a target exit point for each trade. A target exit point is the logically based underlying stock price that would result in a substantial, yet attainable, profit. Set your profit objectives in advance, and determine the appropriate target exit point before you trade. Just as crucially, resist the temptation to raise your profit objective as the price of the stock nears your target exit point.
Gluttony
All traders are probably guilty of having a "pet" stock or sector that's their perennial favorite. This might be due to the investor's relative familiarity with the industry, a track record of wins on one particular stock or sector, or -- in some cases -- a basic gut feeling.
While there's nothing wrong with playing your favorite stocks as part of a balanced and diverse investing strategy, a trading glutton makes the mistake of overweighting his portfolio toward one small slice of the broad-market pie. The market environment is always subject to change, and the tech-heavy approach that worked so well last quarter might play havoc with your returns this quarter.
No positions in stocks mentioned.
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