Timeless Trading Wisdom – How To Correct Common Trading Mistakes

Excellent article about common trading mistakes and solutions to these trading problems. Most often these trading errors are due to mental and emotional issues that affect our decision making process. I do agree with everything Tyler Bollhorn wrote. Do yourself a favour and read this. As he suggests at the end of the article it will help you become a better trader. Enjoy!

The article is from Tyler Bollhorn of Stockscores:

I have often said that making money trading stocks is simple, but not easy. Once you learn basic technical analysis techniques, have good tools to identify opportunities and gain some experience at identifying good trading opportunities, the actual job of picking stocks is relatively straightforward. Where most traders fail is in the application of a methodology. The simple and undeniable fact is that we are all human, and therefore, we are all blessed with emotion. When money is on the line, our emotional attachment to it can take over our decision making process. With that said, I thought it would be helpful to examine the common problem areas that are a result of mental breakdowns. By examining the emotional conduits to decision making, hopefully I can provide some solutions to correct common trading mistakes.

Trading Problem #1 – No Patience on Entry

Anticipating a signal that never comes is common for traders monitoring the market closely and eager to get some money working. For example, a good buying opportunity arises when a stock breaks from an ascending triangle. Jumping in ahead of the breakout is not an ideal situation because the probability of success buying an ascending triangle is not as good as buying a breakout from one. What causes this mistake? I think a fear of missing out on the maximum amount of profit or the fear of too much risk in buying a stock are the two most common mistakes. Essentially, the two guiding forces of the stock market are at work here; fear and greed. By buying early, we can realize a greater profit when the stock does breakout since we will have a lower average cost. Or, by buying early we can reduce risk since a breakout followed by a pull back through our stop will result in a smaller loss as we have a lower average cost. What tends to happen, however, is that the stock does not break out when expected and instead pulls back. This either leads to an unnecessary loss or an opportunity cost of the capital being tied up while other opportunities arise.

The Solution

The simple and obvious solution is to wait for the entry signal, but there are also some things you can do to help yourself stay disciplined. Rather than watch potentially good stocks tick by tick, use an alarm feature to alert you to when they actually make the break. Watching stocks constantly is somewhat hypnotic, and I think the charts can talk you in to making a trade. However, letting the computer watch the stock may help you avoid the stock’s evil trance. Another good solution is to focus on different thoughts when considering a stock. Don’t think about potential profits, don’t think about minimizing losses. Instead, focus in on the desire to execute high probability trades. It takes time to reprogram yourself, so persevere.

Trading Problem #2 – Selling Too Soon

We have all felt the disappointment of not selling a stock at the high. When a stock is marching higher, we set a point where we intend to sell so that we can lock in the gain before it goes down. The problem is that after we sell the stock, it continues to go higher leaving us with an opportunity missed. Selling too soon is a problem that I continue to wrestle with after 15 years of trading stocks. I want to lock in that good feeling of taking a profit off the table. I want to avoid the negative feeling of watching a good profit get cut in half by a rapid sell off. And so, I break my selling rules and sell the stock in anticipation of weakness, rather than when the market tells me I should. The result is that profitability over the long term is not maximized. Once in a while, I may get out of a trade at a better price than I would if I followed my rules, but over 10 or more trades, my net profitability is not as good as if I had maintained my selling rules. Keeping in mind that trading stocks is a probability game, it is important to maximize gains on the winners so that the inevitable losers can be overcome.

The Solution

There are few things that can help you avoid falling in to this trap. First, go through a number of past trades and apply your selling rules to see what your net profitability would have been if you have been disciplined, and compare those with what you actually achieved. I did this and it gave me powerful proof that maintaining discipline pays off, and is worth striving for. In fact, when I did this over one particular one week period, the difference amounted to a pretty nice new car! That gave me the leverage on my emotions I need to overcome them. Second, turn off the profit and loss indicator that most brokerages and trading platforms give you. How much you are up or down is irrelevant to the decision making process. Since we have an emotional attachment to the money, knowing that we are up a certain amount and then seeing that shrink on a normal pull back in a stock leads us to make an emotional decision. Finally, remember to sell at floors, not ceilings. Do not limit the upside movement of a stock by setting a price target, but instead, limit the downside movement by setting a price floor. Sell a stock when it pulls back to a floor, rather than selling it in anticipation of it reaching a ceiling price.

Trading Problem #3 – Letting Small Losses Turn in to Big Losses

As I just mentioned, trading stocks is a probability game. You will not be right all the time, which means that one of the most important aspects of trading stocks is to never let small losses grow in to big, portfolio debilitating losses. You have to limit losses at a risk level if you are going to be successful over the long run.

Solution

The simplest and I think most effective solution for most people is to set a stop loss point before purchasing a stock, and apply it immediately after purchasing a stock. Use basic chart analysis to determine where the market will have proven your decision to enter a trade wrong, and set your stop just below that. Automated stop losses are best because they do not require you to have the discipline to pull the exit button. Do not change your stop once you are in the trade. Making the stop loss judgement before you enter the trade is best since you will not have an emotional attachment to the stock at that point since you have not put your money on the line yet.

Trading Problem #4 – Trading Low Probability Opportunities

My dad is one of those do it yourself guys who would rather work hard than have someone else do the job for him. As a kid growing up, that meant that I helped build fences, garages, basement developments, pour concrete driveways, do yard work and generally learn that same ethic to work hard. I am thankful that I have that spirit, but in the early stages of being a trader, it was something that hurt me. The stock market can not be made to go your way by hard work. There are times when the market giveth, and there are times when the market taketh away. The legendary Vancouver stock promoter Murray Pezim once said that all abnormal profits in the stock market are just short term loans. His point is that people do not know when to leave the market alone, and when it is time to work hard Traders will tend to take low probability trading opportunities at the worst time, because it is during weak market conditions that the market only shows marginal opportunities. By working really hard, traders can find opportunities that are pretty good, but not great. By taking these lower probability trades, the trader sets him or herself up for failure, since their rate of success will not be as good.

The Solution

I have said it many times, when the going gets tough, tough traders get lazy. You must always be picky about the kind of trades you make, particularly when the market is weak. Working hard to find opportunities will not make you more money, working hard at being disciplined will. Teach yourself to look forward to the slow times. Make a list of things that you are going to do when the market slows down. Plant a tree, play golf, kill the ants that are crawling around your house. Just make the list. Perhaps most importantly, if you depend on the market for a paycheck, make sure that you bank money when the market is good so that you don’t have to trade when the market slows down. Making a trade because you need to pay some bills is not a good way to trade.

Trading Problem #5 – Overtrading

There are stock traders who make 150 or more trades in a single day. I am not sure they make a lot of money. I firmly believe that you can make more money by making fewer trades because it will make you focus on only the best of opportunities, and play them with a larger amount of capital so the pay off is better. By being patient and disciplined with the really high probability trades, you can maximize profitability.

The Solution

If you are currently making 50 trades a week, tell yourself that next week you will only be allowed to make 10. If you are making 20 a week, promise yourself that you can only make 5. Don’t just tell your self that you are going to stick to your new rule, write it down! By setting this limit, you will hopefully change your outlook and try harder to only consider very high probability trades. We want to focus on great trading opportunities, not just those that are good.

Trading Problem #6 – Hesitation

You are watching a stock that has all the signals you look for in an opportunity. The proper point to enter comes, but you wait. You second guess the opportunity and don’t buy the stock. Or, you bid for the stock at a price that is not likely to get filled if the opportunity does pan out the way you anticipate it will. As a result, you get left behind while the market pushes the stock higher. A short while after the initial entry signal, when the stock has made a decent gain, you decide to finally enter the trade. After all, the market has proven your analysis correct, so you must be smart, and right! Not long after you enter, the stock turns south and you end up with a losing trade. If only you had bought when you first thought about it.

The Solution

This is really just a confidence issue. You are either not confident in your ability to analyze stocks, or you are not confident in the methodology that you are using to pick trades. Therefore, you have to research your method so that you have the confidence that it works. Then, you have to start small, making trades that have a potential loss that you are comfortable with. As you gain confidence in your method and your ability, increase the trade size. With your new found confidence, stand in a crowded room and scream, “I am great!” Well, maybe don’t carry it that far.

Trading Problem #7 – Letting Winners Turn in to Losers

The final trading problem that I want to focus on is allowing winning trades to turn in to losers. Many of us have probably had a time when a trade was making big loot, and we started to count the profits like they were ours before we exited the trade. When the stock started to lose the ground it had gained, we avoided selling because we had built up an emotional attachment to the paper profits we had seen. Instead of selling the stock to lock in some gain, we opted to hold out for the stock to go back to where it used to be, promising to sell when it came back to the point where we felt good about the trade. The stock drifts lower, and eventually the gain turns in to a loss. We ultimately sell it at the bottom, swearing never to do it again. But without some reprogramming, we probably will.

The Solution

Like Kenny Rogers used to sing, “Don’t count your money, when you are sitting at the table, there will be time enough for counting, when the dealing’s done.” Do not calculate your profits before you lock them in. Avoiding the profit watch will help you avoid an emotional attachment to the paper profits, giving you greater clarity to take the exit door when the market tells you it is time to do so.

I hope this outline of mental problems and some solutions helps you become a better trader. The difference between those who succeed in trading and those who fail is not the system they play, but how well they play it. Your mind is a powerful thing, don’t let it beat you in the market.

Linda Bradford Raschke – 50 Time Tested Classic Stock Trading Rules

Excellent trading advice from Linda Bradford Raschke which makes for a great addition to myTrading Rules. Check them for more trading rules from great traders.

1. Plan your trades. Trade your plan.
2. Keep records of your trading results.
3. Keep a positive attitude, no matter how much you lose.
4. Don’t take the market home.
5. Continually set higher trading goals.
6. Successful traders buy into bad news and sell into good news.
7. Successful traders are not afraid to buy high and sell low.
8. Successful traders have a well-scheduled planned time for studying the markets.
9. Successful traders isolate themselves from the opinions of others.
10. Continually strive for patience, perseverance, determination, and rational action.
11. Limit your losses – use stops!
12. Never cancel a stop loss order after you have placed it!
13. Place the stop at the time you make your trade.
14. Never get into the market because you are anxious because of waiting.
15. Avoid getting in or out of the market too often.
16. Losses make the trader studious – not profits. Take advantage of every loss to improve your knowledge of market action.
17. The most difficult task in speculation is not prediction but self-control. Successful trading is difficult and frustrating. You are the most important element in the equation for success.
18. Always discipline yourself by following a pre-determined set of rules.
19. Remember that a bear market will give back in one month what a bull market has taken three months to build.
20. Don’t ever allow a big winning trade to turn into a loser. Stop yourself out if the market moves against you 20% from your peak profit point.
21. You must have a program, you must know your program, and you must follow your program.
22. Expect and accept losses gracefully. Those who brood over losses always miss the next opportunity, which more than likely will be profitable.
23. Split your profits right down the middle and never risk more than 50% of them again in the market.
24. The key to successful trading is knowing yourself and your stress point.
25. The difference between winners and losers isn’t so much native ability as it is discipline exercised in avoiding mistakes.
26. In trading as in fencing there are the quick and the dead.
27. Speech may be silver but silence is golden. Traders with the golden touch do not talk about their success.
28. Dream big dreams and think tall. Very few people set goals too high. A man becomes what he thinks about all day long.
29. Accept failure as a step towards victory.
30. Have you taken a loss? Forget it quickly. Have you taken a profit? Forget it even quicker! Don’t let ego and greed inhibit clear thinking and hard work.
31. One cannot do anything about yesterday. When one door closes, another door opens. The greater opportunity always lies through the open door.
32. The deepest secret for the trader is to subordinate his will to the will of the market. The market is truth as it reflects all forces that bear upon it. As long as he recognizes this he is safe. When he ignores this, he is lost and doomed.
33. It’s much easier to put on a trade than to take it off.
34. If a market doesn’t do what you think it should do, get out.
35. Beware of large positions that can control your emotions. Don’t be overly aggressive with the market. Treat it gently by allowing your equity to grow steadily rather than in bursts.
36. Never add to a losing position.
37. Beware of trying to pick tops or bottoms.
38. You must believe in yourself and your judgement if you expect to make a living at this game.
39. In a narrow market there is no sense in trying to anticipate what the next big movement is going to be – up or down.
40. A loss never bothers me after I take it. I forget it overnight. But being wrong and not taking the loss – that is what does the damage to the pocket book and to the soul.
41. Never volunteer advice and never brag of your winnings.
42. Of all speculative blunders, there are few greater than selling what shows a profit and keeping what shows a loss.
43. Standing aside is a position.
44. It is better to be more interested in the market’s reaction to new information than in the piece of news itself.
45. If you don’t know who you are, the markets are an expensive place to find out.
46. In the world of money, which is a world shaped by human behavior, nobody has the foggiest notion of what will happen in the future. Mark that word – Nobody! Thus the successful trader does not base moves on what supposedly will happen but reacts instead to what does happen.
47. Except in unusual circumstances, get in the habit of taking your profit too soon. Don’t torment yourself if a trade continues winning without you. Chances are it won’t continue long. If it does, console yourself by thinking of all the times when liquidating early reserved gains that you would have otherwise lost.
48. When the ship starts to sink, don’t pray – jump!
49. Lose your opinion – not your money.
50. Assimilate into your very bones a set of trading rules that works for you.

Have a great day!

Trading Rules

Small losses
Avoid big losses at all cost. The higher your percentage loss, the higher the percentage gain you need to get your money back. With a 50% loss you need a 100% gain to break even.

Control risk
Know your exit criteria before you enter a trade. As soon as the reason for your entry is not valid anymore exit the trade. I typically use hard stop losses.

Liquid stocks
Liquid stocks are easier to exit. As a matter of fact technical analysis is more reliable with highly liquid stocks. Lots of volume makes it more difficult to manipulate stocks.

Trade strong stocks
A strong stock has no overhead resistance and is trading near its 52 week high.

Just the charts
Never call a company for more details. Their job is to run a business. Trading for a living requires different skills. Everything you need to know is right there in front of you. If you can’t see it – it probably isn’t there.

Pressure
The stock needs to display some kind of basing pattern or consolidation pattern. Buy the stock near its initial breakout. Don’t chase stocks.

Market analysis
You need to know what kind of stage your stock is in. Stan Weinstein explains the different stages in his book. Trade in the direction of the primary trend.

Discipline
Stay disciplined. Keep emotions in check. Emotionally detached traders yield better results.

Cycles of Market Emotions

Here is an article about cycles of market emotions by Mike North from First Ag Capitol. I liked the article as he explains the emotional cycles of our trading decisions. Read on and then decide which state are we in at the moment?

For every market there is a chart. The chart defines that market’s price over time. However, what makes up a price? What influences its movements?

Some will say supply and demand. Others will suggest that the volatility that comes as a function of speculative money flow and the war that wages between fundamentalists and technicians have an influence. Whatever flavor you choose, one thing is certain … it moves.

What is more interesting is what happens as it moves. As prices continue to move and adjust, people will be monitoring actual value relative to their expectations of the future.

It is no wonder that when prices move lower, the world does not seem fair. Anxiety, denial and fear grip the producer as he watches opportunity pass. Desperation and panic set in as they watch their cash flows take on darker shades of red. People begin to realize that they have yet again missed an opportunity. Statements like “If only I would have …” or “I could have …” or “I knew that I should have …” are tossed around frequently. The “woulda, coulda, shoulda’s” create a sense of self-defeat that makes one feel like waving the white flag of surrender. Hopelessness and depression define the human psyche. How could it get any worse?

But, alas, it is over! The market begins to rebound. Hope bubbles until optimism boils over. This new brighter outlook breeds an excitement that grows to a stage of euphoria that people seldom experience. Producers start to feel like they can fly. Times are good. The market begins its move lower and we repeat the cycle once more.

What frustrates me is hearing of how this cycle leads to bad decision-making. Over and over, people allow the desperation of bad times to temper their activity during improving times.People spend so much time charting price that they often forget about the emotions they experienced as those prices unfolded. The chart of your emotion should be watched much closer than the price chart your eyes are often glued on. If people would write down how they felt and what decisions they made as a result of that emotional response to price, their risk management success would move to a much higher plane.

Can we agree on something? Let’s agree to not allow this emotional roller coaster to dictate our reaction to price opportunity. As you navigate your marketing plan, please do this – chart yourself.As you track your emotions, spend some time thinking of the past. What were your best years emotionally? What were your worst? It is interesting that as I ask this question in crowds, I often find that their emotions very closely follow price.

People often suggest we would be better off with more stable prices that move little and seldom change. They are not suggesting this because it would do their business better. The root of that comment comes from a desire to get off of the emotional roller coaster. I grant you that wish. However, that does not mean that something will magically appear and your life will forever change. I challenge you to understand you.

Price cycles create more emotional predictability than market certainty. If you can pattern yourself, you can corner the market of “you”. Doing so will help you more clearly see opportunity through the lens of reality. I bid you well.

THE SCOOP PATTERN

The Candlestick Scoop pattern is shown in the following figure. As one can see, it looks like an ice-cream scoop.

The Scoop pattern has two parts to it.
- The handle
- The scoop

The handle is the flat part which mostly consists of indecisive trading. One mostly finds Spinning Tops, Doji and small bodied candles in this part. It could also be a very small trading range congestion zone. The bears and the bulls are locked in a fight and this fight can go on for days, or in some cases, weeks. The congestion zone is the area where supply and demand are fairly balanced. Any disturbance on one side is immediately compensated by the other. Then one day, some bulls give up hope that the position will make money. They start selling, casuing prices to go down. However, the lower prices starts attracting new bulls who drive the prices higher. this new surge and interest in the stock, causes more bullish traders to jump in the position, thus creating a scoop type of formation. If the prices can break the congestion zone handle, they can start a new uptrend.

If one notices bearish signals forming as the price approaches the handle area, the scoop pattern might not be able to complete itself and traders need to exit at that point.

The following chart of chart of BearingPoint inc. shows a perfect Scoop pattern. The handle in this case lasted about a month. This period was obviously too long for traders to keep holding the position without any potential gain in sight. The selling was stopped by a Bullish Harami, which attracted new buyers in the stock. This should have immediately alerted a candlestick trader that the possibility exists for a Scoop pattern formation. Notice that there were no indecisive or bearish signals forming as price approached the handle area. This should give the trader the confidence that the Scoop pattern is going to breakout the price.

The J-Hook Pattern

Today I will be talking about the J-Hook Pattern. It’s a bullish continuation pattern that is pretty easily identifiable and highly reliable. This long pattern occurs during all trends (up, down, sideways), thus giving you flexibility in all market conditions. It is also considered a momentum play.

Not only that, if you miss the initial entry point, there is usually a secondary entry point. So whether you catch the pattern in the middle of the “J” or towards the top, there is always an opportunity to profit on the long side using this pattern.

Here’s a diagram that I drew up:

The J-Hook during an uptrend:

-Needs an existing uptrend on strong volume
-Needs a price correction on lower volume (*for the difference between a price & time correction, see diagram at the bottom of the post)
-Will show price bars expanding and volume expanding at pivot
-Initial Entry: a breakout on strong volume above the previous peak
-Secondary Entry: either during the formation of a bull flag/pennant, or on the breakout exiting the flag/pennant.

- – -

The J-Hook during a downtrend:

-Needs existing downtrend that is exhibiting an exhaustion in selling pressure.
-The pivot point is usually marked by multiple doji, hammers, and other reversal candles.
-Volume will generally be higher during the downtrend, but should lighten up when most of the selling is finished.
-Initial Entry: on a strong breakout above major downtrend resistance. Usually, this is marked by a strong gap up on large pre-market volume.
-Secondary Entry: either during the formation of a bull flag/pennant, or on the breakout exiting the flag/pennant.

- – -

The J-Hook within a neutral range:

-Needs existing neutral range on light volume.
-Mark a slight dip below the range with slightly increased volume. At this point, you won’t know that it will be a J-Hook.
-The pattern materializes when you see an immediate reversal as it reaches upper resistance pof the neutral range.
-Initial Entry: a breakout above the neutral range on strong volume.
-Secondary Entry: either during the formation of a bull flag/pennant, or on the breakout exiting the flag/pennant.

Here’s an example of today’s neutral range J-Hook pattern ($MBI):

*The difference between price & time corrections:

Head and Shoulder (H & S) Chart Patterns

The head and shoulders chart pattern is a pattern that falls into the class of bearish reversal chart patterns. Head and Shoulder chart patterns occurs at the top of a trend and is usually used as a determinant of a bearish reversal of the existing bullish price action.

A head and shoulders Forex chart pattern is made up of:
1. Candlesticks that form a crest (the shoulder 1)
2. Second crest which is usually higher than the first one (the head)
3. Third crest which is not as high as the second, and may or may not be as high as the first crest (shoulder 2)

Head and Shoulder chart patterns can be a bottoming formation after a downtrend or a topping formation after an uptrend. The bottoming pattern is a low price then followed by a retracement then a lower low, the head, and a retracement then a higher low which is the shoulder. On the flip side, a topping chart pattern is a high followed by retracement then a higher price high and finally a lower low. Head and shoulder chart pattern is complete when the trend line which connects the 2 highs, bottoming pattern, or 2 lows, the topping pattern, is broken.

Application of Head and Shoulders Chart Patterns

To be able to identify Head and Shoulders chart patterns, there are 3 crucial things:
1. Have an eye to see how the candlesticks line up
2. Have the ability to use the drawing tool of your Forex trading system to make the appropriate traces across the highs of the candlesticks
3. Draw a correct neckline, which is the landmark for the trade entry
You should ensure that the head and shoulder have to fully form with the 2nd shoulder being almost complete before placing a Sell stop. The Sell stop should be placed about 5 pips or ticks below the neckline. When you are using Head and Shoulders chart patterns to trade in the Forex market you should know that the extent of the bearish reversal of the price action is equidistant to the distance between the neckline and the peak of the head. This is the profit point you should be eying. It is worth mentioning that the entry signal is usually reinforced when the price action is in an overbought region or is at a resistance level. 

It is very important that traders wait for the head and shoulder chart pattern to complete before they make a move. One should not assume that a pattern will develop, or become complete in the future. You should watch partial patterns keenly but you should not make any trades until the head and shoulder pattern breaks the neckline. The neckline is the landmark for the trade entry.

On the other hand, for the inverse head and shoulder, you should wait for price movement above the neckline after the right shoulder to be formed. A trade can be initiated as the chart pattern completes. You should always plan your trade beforehand, jotting down the profit targets, variables that may change your revenue target, entry as well as stop points.
Just like there are two sides of a coin, trading using head and shoulder chart patterns has its limitations. First and foremost the chart pattern is not perfect and as such can fail at times. This chart pattern is not always tradable. For instance, in the event that there is an extensive drop of one shoulder due to unpredictable even then there is a high likelihood that the price target will not be hit. Bearing in mind that you have to wait for the pattern to develop fully, it could mean waiting for longer periods which can affect your trading. 
In conclusion, though head and shoulder patterns can be subjective at times and take long to develop, the complete chart pattern provide entries, profit targets and stops making it easier to implement a trading strategy.