Treat Your Trades Like Merchandise

12/02/2009 12:01 am EST

Focus: STRATEGIES

Prudent traders buy stocks based on sound technical analysis, with a generous reward/risk ratio. When I place a trade, I expect the stock to act in a certain way or that stock is “fired”—it is sold, gone, and out of inventory, without haste!

Why should the decisions facing bullish traders with the intent of buying low and selling higher be any different than that of a retail automobile manager or east Asian art dealer trying to re-sell their merchandise at higher prices? It is not wise to develop emotional attachment to your stocks. Viewing the purchase of stock as inanimate “merchandise” should help you trade without any damaging emotional bond, which might prevent you from selling your “favorite” stock that has just hit your protective stop. So why would a trader buy stock and risk capital in stocks that become underperforming when that same person would likely not hold other assets (e.g., the retailer’s cars or art) intended for resale that were diminishing in value because of lack of interest by the public?

Supply and demand are the core factors affecting stock price. But what causes higher supply or demand (in a particular stock, car, or piece of art)? Mastering this seemingly simple concept will assist you as a trader. It is people’s perceptions, emotions, and fear and greed about the merchandise (stock) that determines supply and demand, and thus, what they are willing to pay for it.

Traders determine the supply and demand of stock on a moment-by-moment basis throughout the day with their buy and sell orders. What they are willing to buy or sell a stock for at any moment incorporates all of their beliefs about the future prospects of the company, including feelings of greed and fear. However, it is the public that is analyzed when professional traders are gauging the levels of emotions prevalent in the market place. When fear is too high, professionals are buying. When greed is prevalent, professionals are selling.

The general public is not sophisticated enough to determine that greed or fear have taken a hold of market sentiment, and thus, respond to it. Traders eventually learn to disassociate themselves from the public, or “the herd.” A stock rallies 100% in one week, for example, and some place a market order to buy because they can’t stand the “runaway train” rallying without them. Alternatively, even without company fundamentals substantially changing, something spooks the market and a company plummets onto support, where the skilled technician buys the stock at cheap prices from those who can’t take the pain (fear) any longer and want out at any cost.

It’s important to have a plan to keep you from taking anything other than trades with high quality, understanding when the best times to buy and sell truly are.

By Avery Meizner of Pristine.com

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