The Real World
Nothing obviates risk like informed common sense. — Michael Burry
People who are new to trading often make the same mistakes and they usually make them for the same reasons. Novices have lots of ideas about what trading is. Unfortunately, most of these ideas are wrong and beginners spend a lot of time paying attention to the wrong things. We will explore these errors and discuss the real keys to trading successfully.
Hollywood depicts trading as exciting. In the movies, professional traders are charismatic men with nerves of steel and carefully honed instincts. On a regular basis, they bet their entire bankroll on a single trade. Nothing could be further from the truth. Trading is not glamorous. It is detail-oriented work. Getting started requires both training and practice, and succeeding takes discipline.
Common Errors
The first step toward becoming a successful trader is finding out what the pitfalls are. Knowing about them makes it a lot easier to avoid them.
Mistake 1 – The Chart Trap
It is natural to look at a stock chart and think, "If I had bought it at A and sold it at B, I could have doubled my money. And if I bought it at C and sold it at D, I could have doubled it again!" The problem with this line of reasoning is that in the real world, you can't. There is no way to know that A is a low point until some time after it has passed. And there is no way to know that B is really a high point until days or weeks after it has happened.
Nobody rings a bell or raises a flag at the end of November to tell you that RMCM has reached a low point. It is not possible to recognize those critical turning points as they are happening, even though we see them so clearly in hindsight. To add to our problems, our own instincts often spur us to action at the worst possible times.
Mistake 2 – Buying stocks that have gone up and selling stocks that have gone down
Rather than buying at the bottom in December, we tend to watch until we think the danger is passed. Once the stock has shown us it is safe by rising significantly, then we finally give in, buying somewhere near the new point A. As the market continues up during March, we are happy that we were smart enough not to miss this great opportunity. But by May 18th we are down $20 a share, and we are busy trying to convince ourselves that this is just a temporary setback.
As the market spikes up on the 1st of June we are relieved. "See? It's coming back!" Each tiny rally spurs our hope. We can't sell now. We've lost too much money. But as the rally in early July collapses and prices tumble to the $60 level, fear overcomes denial and we realize we have to salvage whatever we can so we sell at B.
As we continue to watch the stock, at first it bounces along near $60, but then it starts to climb. When it crosses $75 we think, "Wish I could have sold it there instead of at $60." Then it passes $100, then $110 and we think, "Wow, it's really going for it." As it rises above $110, we reach the point where we just can't stand it anymore and we buy back in, just as it crosses the high it set back in April...