Friday, November 9, 2012

The Trader's mind IV - The bargain

If the mad rush on black Friday's shopping is any lesson, humans love a bargain. Who doesn't like to get a $100 item for $80? That's 20% off! You can use the $20 to get something else.

Humans like bargains because it maximizes your purchasing power and is an inbuilt efficiency behavior. Efficiency is not limited to shopping. All things being equal, you should obviously choose a toaster that toasts quicker, a commute that is shorter and so on.

A person who can more efficiently spend his resources has higher survival ability and efficient use of our resources is therefore an inbuilt characteristic of humans.

When it comes to trading, a trader's efficient mind makes him want to buy low and sell high. Buying low is a good thing, unless you are in a down trend and the price is going further down. The bargain hunter forces the trader to enter into dangerous trading patterns such as:

  • Bottom picking -- It fell to $3 from $10, what a deal! (All kinds of counter-trend trading)
  • Adding on to a loser -- At $1 its 3 times cheaper, my profit will be 3x as big when it goes back to $10
  • Entering before a signal bar forms -- its going to be a bull bar anyway, may as well buy now to save 3t
I have personally struggled for months to break these habits before I was successful. The key element is to realize that the price is not what's important, its the difference between the entry price and the exit price and the probability that your stop is not hit in between.

Focus on probability and nothing else. Measure probability of success by taking SIM trades before you take action. You need to have a modicum of discipline to do this. Focusing on probability will automatically shift your mind in the right direction.

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