Glenn Stok writes about investment and risk-control strategies he perfected in 45 years trading stocks, options, and futures contracts.
How often do you find yourself becoming subject to erroneous assumptions and unrealistic expectations of market conditions after you enter a stock or options trade?
You might be subject to the whims of the market and let emotions get in the way. Emotions negatively affect trading decisions. You need to remain objective. You do that by sticking with a planned strategy.
I’ll explain the difference between objective and subjective trading and how you can improve profitability by using the right strategy.
Objective vs. Subjective Trading
I find it’s always best to create a plan of action for entering and exiting any stock position and stick to that procedure. That helps you stay objective, and it's a more mechanical method because you don't have to rethink your strategy when market conditions change.
In addition, it eliminates the emotional feelings of fear and greed that occur if you allow yourself to become subject to biased thinking. You need an impartial and neutral view at all times.
While you are involved with an active trade, it's challenging to have a clear head because you're watching the fluctuations of your account, and you try to rationalize your next move without realizing that fear and greed are actually guiding you. It's not good to be subject to these conditions.
On the other hand, when you trade objectively, you can maintain a clear head, remain impartial to market conditions, and make changes to trades as per practical, unbiased rules that you plan ahead of time.
|Objective Trading||Subjective Trading|
What Happens When You're Subject to Fear?
An intelligent analysis of the market is done better without being invested in the outcome.
As long as there is no fear of losing, you can analyze the data and determine what to expect the market to do. That means you can consider what may happen based on current market conditions.
When you're already involved in a trade, you're doomed to being subjective, hoping for the market to do what you want it to do, rather than doing what analysis and due diligence would lead you to expect.
What Happens When You're Subject to Greed?
How often have you had a stock position go against you, and you think to yourself that it will turn around, so you wait? That’s not being objective at all. Rather, you’re letting your emotions control the situation.
Your decision to do anything is subject to your greedy feelings. You can’t admit that you may have been wrong, and you let a losing position get even worse.
Another time greed can cause you problems is when you have a nice profit and refuse to take it. Instead, you leave the trade going, hoping for more. You think to yourself that if it’s doing so well, it will continue. That’s greed!
Stocks always have only a 50% chance of going higher. That never changes. Just like when you flip a coin, it has a 50/50 chance of being heads or tails. If the coin comes up heads five times in a row, it’s still only a 50% chance that it will come up either heads or tails the next time.
It’s the same with any investment. If a stock continues to climb, it still only has a 50% chance to move another tick higher. Your greed keeps you from selling and taking a nice profit, and you end up giving some of it back.
You need to remain objective at all times when involved in a trade.
How to Maintain an Objective View of Your Investments
If we have a strict strategy and follow that method without letting our emotions, greed or fear, change our plan, then we can remain objective, and we won’t allow the market to affect how we handle our trades.
That is being mechanical. It follows a specific procedure for managing an active trade to completion, either with a gain or a loss.
Trading mechanically helps avoid being subject to emotions. It means to have a strict method to follow, no matter what happens.
Mechanical trading requires strict adherence to these rules:
- Plan your entry price and wait for it.
- Plan your exit strategy and obey it.
- Plan any other triggers that will dictate reasons to get in or out of a trade. And stick to it when it happens.
- Decide what risk/reward you want and structure your portfolio accordingly.
- Use stop losses to control your mechanical behavior.
- Admit when you’re wrong and get out. This one is hard to do persistently. I still fail at it from time to time.
Additional Rules for Trading Success
In addition to maintaining an objective view of your trades, the following list of rules will help produce better returns on your investments.
- Patience: If a trade doesn’t look good, don’t do it just because you hope it will work. Be patient and wait for a more reliable position to be available. Be selective.
- Avoid Hoping and Wishing: Don’t enter or stay in a position just because you hope it will work out. Do your homework; analyze the company and trade based on performance.
- Loyalty: Don't be loyal to a stock position. When you think you’re wrong, get out! Don’t let a lousy position get worse. It may turn around, but that’s just wishing and hoping.
- Size: Keep your trades small enough so that significant market moves don’t force you out with a substantial loss.
- Frequency: Don't trade merely to be active or to get another small gain. Remember the rule about patience.
Remember, you can become subject to assumptions and unrealistic expectations when you're involved in a trade. So make sure to avoid that condition.
The only way to have a consistent and objective strategy is to create your entry and exit rules ahead of time and stay with the plan by managing it mechanically. As a result, you'll improve your results and have a better chance of being profitable.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
© 2017 Glenn Stok