The Four Wolves of Wall Street

There are four primary forces that plague traders on a consistent basis. Avoiding these scoundrels will insulate you from the emotional baggage that weighs on traders’ net take-home pay.

FEAR­ — Besides eroding your profit curve, future emotions appearing real (FEAR) leads to poor decisions. The most troubling is the shrinking of one’s perceptions of choices. Your perceptions of market reality are severely reduced by fear. When you are fearful, you simply don’t perceive all the possibilities available. Your choices become limited to only what you perceive is possible. And if you don’t know by now, in trading, anything is possible.

Let’s take an example of an option position you hold long in sample ticker ABC. You did your homework on whatever edge you found on ABC. Your technical analysis indicates a breakout. The sector is hot, and the industry group is outperforming the rest of market as well. You wait for a pullback on ABC instead of chasing it upward, and your alert triggers. Rather than hesitating you jump right into your trade. This trade looks so good you enter full bore and instead of legging into the trade as planned with a few option contracts. You buy ten right out of the gate. Oh yeah!

Immediately ABC drops. Within minutes your trade is down 15%. You look for news but find none. It drops another 15% an hour later. Fear rears its ugly head. You think, “What am I missing here?” You reexamine your technical analysis and see a flaw you missed. One indicator says ABC is teetering on collapse. You exit your trade before you lose a bundle, with relief. By the end of the day, your trade is up 20% … had you held as planned

GREED — This one most often is found in chasing trades and not taking some profits out of the market as the market makes money available. If you enter full positions and your trade profits as anticipated, why not take a little off the table and reload in another opportunity? You can always let some profits in the trade continue to produce for you, but you will gain more trading confidence by cashing some in to hip pocket national bank. No one ever got hurt by taking a profit.

The best way I know not to chase trades is to have a rule that you only enter positions on pullbacks with pre-set alerts. That, coupled with a general guideline to only enter short trades on up days and long trades on down days, has served me well. Overtrading by chasing has caused a lot of damage to trade accounts.

PANIC — This wolf frequently occurs after “Breaking News.” Your company just issued 250 million more shares after hours, thus diluting the float. Your position tanks 10% immediately and another 10% the following day. Three days later when the dust settles, your trade is positive again. The market now realizes the profits generated from the new issuance were not to salvage a dying company, but to pay off debt early and buy some modern technology that will lead to better margins. 

By jumping off a trade during the panic, you sacrificed a nice gain. Panic is not a strategy. It’s just another way to lose your profits. You can remove yourself from this carnivore by limiting your exposure to headlines and other media-generated attention grabbers. This is especially important during open market hours when you may foolishly enter an abrupt trade.

EUPHORIA ­­— This one seems rather counterintuitive. I have encountered this one often and only through my own sacrifice and reading of others in the same boat, have I learned to overcome its bite.

After a significant gain, its easy to become overconfident and aggressive. This “I’ve got this market by the horns” attitude leads to euphoric trading, specifically overtrading and over positioning. This is often more dangerous than the other wolves and can lead to misery after a nice profitable run.

A good management technique with euphoria is first to recognize it. Your trading platform should allow you to track your net liquidating value on a daily basis. By looking at graphs of your account you will immediately see sharp bounces, telling you it’s time to take a breather. You can chart your account values just like any other ticker. This gives real insight into whether or not what you are doing is working or not.

You can also set alerts when a certain profit level for a day is surpassed. An example may be gains of 10% or more in a single day’s net liquid value alerts you via text, “take some profits winner!” Take those profits and at least a day off trading. This will allow a better balanced market perspective when you return relaxed and wealthier.

Enuf said.