Of the various jobs that I have had during my twenty-two year career at Charles Schwab, I have enjoyed my current role the most. I am currently the host of a weekly market analysis webinar called Charting the Markets. During each session, I share a technical perspective on recent market movement as fellow traders follow along and ask questions. I have learned some valuable lessons over 30 years of trading that I hope to share with you in this article.
As investors and traders, our past experiences and training can influence how we approach the financial markets. As I found out myself, these experiences can be helpful in trading, but they can also stand in the way of success.
My formal academic training was as a biochemist. I did research for several years at a major university medical center. When I first contemplated trading, I felt that it would not be that difficult. After all, I was trained as a scientist and considered myself quite adept at analyzing data to make reasonable predictions. I soon found out that trading is not quite that simple. Here are some lessons I have learned, some the hard way.
Markets are made up of people, not just data
As a scientist I was used to relying on natural, biological, and physical laws to make predictions. I soon learned that the financial markets are not always rational. They are made up of people who often act on emotions such as fear, greed, and hope to make financial decisions, sometimes to their detriment. In fact, the emerging field of behavioral finance has been developed to try to explain why people sometimes don’t act in their seeming best interest when investing.
The lesson for me was that I had to learn how to follow price and volume action, not just a company’s balance sheet to manage my risk. Looking at charts is essential. For example, I learned early on that buying a stock making a new low, while tempting, was rarely a winning strategy. Also, buying stocks breaking out to new highs, while scary, often worked.
Successful trading takes work and practice
People who are accomplished in their fields often feel that they can be good at anything immediately. It took me many years of study to learn my trade as a biochemist, so why did I think I could master trading in a few weeks? Many people will put years of their savings at risk after only reading a couple of books or going to a seminar. If you are thinking about starting to trade, start small until you gain more experience.
Let’s say you have set aside $100,000 for trading and want to take equal positions in five stocks. You may not want to start with the full $20,000 in each position until you gain more experience. You can even consider starting to trade “on paper”. Many exchanges and brokerage firms offer virtual trading accounts where you can try out your strategies using “fake money” and get an idea of how well they might work. I will point out, though, that while virtual trading can be useful, it doesn’t completely replicate the trading experience when you have real money on the line and emotions come into play.
Keep your ego out of it
Most successful people have firmly held opinions based on their training and experiences. They also like to be proven right. These attitudes can sometimes lead to detrimental behaviors. A common example is when a trader holds onto a losing position rather than taking a quick loss and admitting that they made a mistake. Or when they sell a position too soon because a profit, no matter how small, proves that they were right all along. A way to fight against these all too human tendencies is to have an exit plan in place with specific exit points both on the upside and downside prior to entering into a trade. Examine the chart and see if there is likely support and resistance. If so, consider using these as potential stop and target prices. Also, many chart patterns, such as triangles, flags, horizontal ranges and head and shoulders to name just a few, can offer clear target and stop loss areas.
Modify your behavior and your way of thinking when appropriate
The biggest breakthrough in my trading came when I finally was able to overcome my hesitancy to re-enter a stock after I was stopped out if conditions warranted. It is psychologically hard to buy a stock at a higher price then you sold it, but the ability to do so separates the best traders from the rest of the pack.
Trading can be a rewarding experience both financially and intellectually. Pitfalls and factors of success in trading are often the same as other areas in our lives where we are driven to succeed. If you learn the rules, practice your craft, and check your ego at the door, you will increase the probability of finding success and the financial independence that comes with it.