The Right Trader Mindset Amidst Chaos

Great trading and investing, like greatness in any profession or art, is a balancing act. Each trade requires us to split ourselves into two parts: caution and boldness.  Caution to be patient, but with the courage to get in, and stay in, a winning trade.  Likewise, you need the caution to protect gains once you have them—but not too aggressively–so you don’t get stopped out on a mere wiggle.

And most important is the courage to admit that your trade is wrong and to get the hell out.

Yes, courage to get out and take a loss!  I know it sounds strange, but it is so true. Many investors equate the taking of a loss with weakness, when actually it shows strength.

Big losses don’t start out that way.  They start out small.  Cut losers off at the knees when it’s not a big deal.  Silver and gold are a good example of this right now.  In the short term they are volatile.  For traders who bought the recent highs, an investment in gold or silver is currently painful.  But in the long term they are solid buys.

This balancing act is the reason so many type-A personalities perform so badly in the markets. Because while they might possess boldness, courage, and decisiveness, they frequently lack the caution, patience, and ability to accept that their first impression was wrong.

Recent examples of this are buying gold when it pushed over $1900 or silver when it hit $50; when you by at the high, you must expect a drop. That’s why it’s called a pull back.

Or, more simply, the ability to concede that, while their setup might have been as attractive as a Swedish au pair in a swimming pool, it just didn’t go the way they expected it to go.  The market doesn’t care if the setup was a good one.  It’s still going to do whatever it wants to do.

Something happens at the beginning of a trade; and that is, a psychological battle occurs. It’s that classic scene of a devil on one shoulder and an angel on the other. One tells you to hang in there with all your might, that’s it going to go your way eventually, no matter what the evidence suggests, and the other screams in your ear to preserve your capital, to get out, take a tiny profit, take a tiny loss. Just get out!

It’s a powerful sensation, especially for the beginning trader, which is why a clear trading strategy is critical.

A trading plan in which you can place your faith is like a pair of mufflers, blocking out the sound of that noisy chorus.  Trading without a game plan is like swimming in the Amazon River with a couple of raw steaks strapped to your waist.  You might get some good exercise, but the longer you are in the water, the greater your chance of a violent end.

It’s when you’re not trading your plan that fear takes grip; and when it does, it’s easy to lose perspective and exit too early, cutting your opportunity for profitability off at the knees.  Bought gold at $1900?  That’s perfectly ok . . . If you have already decided how much risk you are willing to take to see if you are right.  If your risk is 8% then take that stop like a man and move on.  Remember, re-entry is only a commission away.

Yet fear also causes traders to do something that seems the total opposite of fear.  Fear causes traders to ratchet up their nerve, and stay in the trade long after signs of danger have presented themselves.

That is, fear triggers an irrational boldness in traders. It takes courage to stay in a trade, that much is certain, but the lesson that too many traders learn too late is that it takes just as much courage, if not more, to get out of a trade that’s clearly not working.

The irony here is that the greater a trader’s nerve is, the greater the chance of ruin.

Take the recent case of MF Global, which recently was trading at $10 a share.  It dropped steadily to 9, then 8, then 7 . . . and yes then 6, 5, 4 . . . until it was halted and the company is now filing for bankruptcy.  Having bought it for $10, wouldn’t it have been so much easier to dump it at $9 for a small loss than ride it all the way to zero?

Gold and silver are two of my favorite markets, and this article is a long way of saying, “Learn to be patient.”  People get excited about gold when it is making new highs, but that is not the time to buy.  At a minimum, a MINIMUM, always wait to buy on a pullback to the 21 period moving average on a daily chart.

For now, there are a lot of cross currents in the various markets.  I actually don’t expect gold to make new highs until well into 2012.  I’ve got a buy order in at $1,480 to establish a new position.  And if gold does make a new high before $1,480 is hit?  Great.  Then I’ll buy the first pullback to $1,480.

Patience is truly a virtue.

Successful investing,

John Frederick Carter

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