The Movie You've All Been (Still) Waiting For

If the performance of the Philippine Stock Exchange Index was a movie, I envision its short description to be -

Movie Title - "PSEi at 4000"

Director - D. Bears

Scheduled Release Date - December 2007

Status - Postponed Indefinitely

Genre - Action. Drama. Suspense. Horror.

******

That introduction is a perfect segue to what I want to discuss today. I want to share with you an important component of stock trading psychology and discipline that many people know but few people practice. It's called cutting losses.

As I've learned from Absolute Traders, that's what separates the men from the boys. And folks, there are only a few good men (traders).

It's a sight we often see and a story we often hear. After buying a stock, a novice trader builds an appendage linking himself to his stock. He begins to fall in love with it and before he knows it, the stock becomes a certificate waiting to be passed on as an heirloom.

That's the sad reality. And as in life, the best lessons are learned when you face defeat.

In a bull market, a regular stock trader thinks he is a genius because he is making money. What he doesn't know is that the it doesn't take a genius to make it big in a bull market. Everything is going up. Even speculative stocks.

Then when the bear comes knocking on the door, the trader gets caught with his pants down.

This is what happened to a majority of stock market traders who came in 2007. If you thought stock prices were cheap during the 2nd quarter, they're even "cheaper" now. So now people are waiting for the market turn. And they are doing that...still waiting.

Admitting Defeat: Freeing yourself from emotions

It's difficult when you have to admit defeat. After making money in a bull market, you think you can't fail. If you are a technical analyst - regardless of your expertise - 99% of the time the failure is not because the market didn't go your way. It's you.

Human emotions are as fragile as the stock prices today. That's why it's so difficult to become a very successful trader. It's not that easy to be free from emotions.

My broker has plenty of clients. He has two phones. Sometimes he'd ask me to wait on the phone while he answers his other call. I'd hear him calming the nerves of his client. It just gives you an idea as to how dynamic human emotions are.

I can still remember what Bonner Dytoc (or was it Danny Go?) said. Investors are traders who forgot to cut their losses. There are real long term investors out there, but in the Philippine market, it's quite difficult to be an investor. It requires a supreme test of patience.

Ask someone who bought certain stocks in 1997 and in 2001. I am sure this person will give you his two cents worth. Or he can just give you a stock that's worth as much. :-D

The key thing in keeping your emotions in check is to know when the chart has broke down. If you don't mitigate your losses the next to break down will be you. Apart from that, you need experience. If you've been actively trading for a good three months, I am very sure that in that span of time you will have learned the value of cutting your losses.

Obviously though, there are still many stubborn people out there. Apart from being stubborn, people like to be sentimental and being needlessly optimistic even if the signs point otherwise. As someone once said, there's no sense in holding on to a stock if you're only investing (or trading) purely on hope.

Just remember, what is the main reason you bought the stock? If that reason is not there anymore, and the chart is obviously confirming that also, then it's time to bid your stock adieu.

You as Director

I am always thinking of how to make technical analysis, trading and investing more relevant for people who have little to no knowledge about the stock market. I made a lot of errors in my short trading life, and I don't want people to have to go through the same. If you lose some, you should win some, otherwise, it's easy to feel disheartened and just classify stock market investing as pure gambling.

As I pondered on the aspect of cutting losses, it dawned upon me that as a stock trader you are actually watching a movie. The stock market is a movie composed of actors called the bear, the bull and the utterly clueless. Although you don't have control over what is going on, what you have control over is ____. This is the power directors have.

And this tip I am sharing with you is absolutely free! But not today. I'll share what it is in the next entry. Stay tuned next Friday! For new readers, I only update my blog on Fridays because of my busier schedules now.