Matthew Kerkhoff, options expert and editor of Dow Theory Letters, continues his 14-part educational...
The #1 Priority Before Any Trade
10/25/2011 4:00 pm EST
By ignoring profit targets and planning and executing a hard stop with every trade, Robert Seifert explains that traders can avoid many pitfalls and preserve their account for the long term.
My guest today is Bob Seifert and we’re talking about the trading mindset and what you should know as a trader when you’re getting into this. The psychology and what your attitude should be about trading the markets.
So Bob, talk about the mindset; what’s the right mindset for a trader?
Well, what I try to teach, and what I’ve learned myself from really good traders is when you enter into a trade, the most important thing you should think about is where you’re going to take your loss.
I think that most amateur traders when they enter a trade, they think about how much money they’re going to make, and I try to tell them that winning takes care of itself.
When you put a trade on and it goes to a winner, then you know how to manage it. Worst case is you stop yourself out at breakeven.
On the other hand, if you go into the trade and you have no place that you can get out, no place that will stop you out and let you enter the next trade, you’re going to lose money.
The majority of traders that I talk to that have been unsuccessful, it’s because they really don’t believe that we take stops. That somehow magically the market always goes our direction. It simply doesn’t.
So in order to compensate for that, I tell them that the stop is actually the start of their next winning trade. So that’s important psychology.
Also, as an example in gold, what makes gold worth 10% less than it was yesterday morning? [Interview conducted in late September - Editor]
I mean, it couldn’t be anything fundamental. So, what happens is panic sets in. Just like greed was setting in weeks ago. So the same thing that drove the market to its top, the panic top, is driving the panic bottom, and I teach them how to learn to use that in their favor.
Instead of fighting it when it’s happening, you go with it, but when the price starts to go vertical in one direction or another, the market is not being rational anymore. There are no fundamentals to support it. I don’t care if you’re a fundamental trader or not, and I’m a technical trader, when that market goes vertical or that market’s plunging straight down, that’s a technical factor.
That’s greed and that’s fear, and at those two extremes, there’s a lot of profit opportunity, but you have to know how to trade it.
NEXT: The Debate Over Mental Stops vs. Hard Stops|pagebreak|
Going back to the stops for a moment, you talked about knowing exactly how much that is. Some people use mental stops where they just have in their mind when they’re going to get out, or some use a hard stop in the computer that will take them out when it gets to that price. What do you recommend for either of those?
Well, I recommend two things: There is a mental stop, but there’s always a hard stop, and I think this is the real problem that happens. People have been getting beat up, and that’s how they learn. I’m going to be honest…you get beat up.
You learn that the mental stop turns into “OK we can let this one go a little bit more,” or “You know what, maybe we’ll add to it now.” “Well, it’s down too far to get out now, so we need to add again” and what happens is they get out at the bottom of the market and they’re devastated.
If they would have taken their hard stop to begin with—the absolute amount of money that they will risk on that trade—and put it in the computer, they can always take another stop.
As an example, I’ll put a trade on and I buy in at 100. The trade goes to 103; that trade is now a profit. I don’t care where my old hard stop was, it’s now breakeven, because in the worst case I can’t lose any money.
On the other hand, if I put it on and it immediately goes down, I’ve got to have a hard stop. I may have bought the high tick of the day—which I do many times—and I may sell the low tick of the day getting out, but I have to have that stop.
The amateur trader thinks that they can do it mentally, and when it comes down to it in the end, they can’t. They can’t hit the button. It’s paralysis by analysis. They freeze; they sit there and they watch it.
I was on a trader’s forum earlier, and I had the people laughing because I said everything I knew they had done. Why? Because I do it.
I’ve been doing this for over 30 years. I still do the same things. I still make mistakes, and I know they’re making mistakes because they’re looking at me and they’re laughing every time I say something because they’re thinking, “How does he know? How did he know I did that?”
I think the thing is it’s the hard stop.
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