One Way to Deal with Trading Temptation

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  • on May 12th, 2011

Robert Sinn wrote a great piece on handling a market transitioning from one state of volatility to another.  Given the implications of the end of the commodity trade, I thought I’d share something that has worked for me in maintaining balance and perspective.

I have a terrible personality flaw that runs counter to trend exploitation.  I need to sell rallies; I need to buy dips.  That knee jerk fade is ingrained to an extent that I would get myself in trouble without tactics to channel it more productively.  This is not so unusual…as Ivanhoff and Dr. Phil Pearlman have written, mean reversion is the natural state of the human mind.

For me, a weak stock in a +100 Dow Jones offers the same temptation as the jar of jelly beans I crushed the week my wife put them out for Easter.  Temptation makes me want to sell anything that doesn’t lead or at least join the rally, or cover what doesn’t fall with a -100 tape.  I’ve grown to accept that stocks have their own clock, and while a week of diverging performance is cause for concern, every stock is entitled to a day of skipping the party.

To suppress one’s natural desires is likely to lead to an unhealthy binge in the end.  Why not acknowledge the temptation we face, and develop a rational blueprint not to avoid the temptation but give it an outlet that can’t ding our equity?  There is more than one way to express a bullish or bearish outlook; the following graphic shows the various ways in which I can fulfill a need to act in a bullish or bearish way:

This tells me nothing about the merits of any particular decision.  What it does is ensure that I’ve considered the full range of choices for satisfying a need but staying balanced in my decision making.  My last couple of trades were on the bear side, selling some Jun 39 $XLI Calls to replace the .15 Mays, and rolling the $DIA May 129 Calls down to 127 to grab a little extra coverage.  I’ll now satisfy my need to buy dips by buying some Jun $XLK Calls as a way to attempt the “old tech” theme, and then I’ll wait for evidence before doing anything else.

This balance is key for me; it’s not predictions that make us profits, but the ability to exploit the good ideas and move on from the bad ones.  Flipping back and forth from bull to bear transactions keeps me emotionally prepared to accept the next great trade, whenever that may come.  As Peter Brandt has said, this can mean taking scratch or loss on 65-80% of one’s trades but sticking with those that work…check your “need to be right” at the door!

We’re all looking to extract the most profit per unit of risk.  No matter our stage of development, we all seek better execution.  Like fad diets, new “indicators” will not only fail to solve our natural need to indulge, but steer us away from the real holy grail…developing the patience to wait for only low risk/high reward trades, and managing them as the evidence reveals itself.  Alternating between bull and bear actions keeps me focused on the road ahead and not the rear view mirror, open to new markers as the road becomes clearer.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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