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Complexity -- By: Bill Kraft
Copyright 2009, Makin' Hay, Inc., All Rights Reserved
Bill Kraft
Editor |
One observation I have made over my years of trading, coaching, and
conducting seminars is that there seems to be a conception among many
retail traders that trading and trading plans need to be complex. I
couldn't disagree more. I have found that using simple, basic methods,
one can be quite successful. I have often said, and reiterate here,
that good trading is simple, but that does not mean it is easy. Doing
the simple things can be difficult. Difficult because we tend to have
fights with ourselves. We may have some specific entry strategy, for
example, but fail to make the entry because we decided to wait for more
confirmation and by the time we see enough confirmation to satisfy
ourselves, we have missed the trade.
Several years ago, a couple who had attended a series of my
seminars asked if they could spend some time with us on Hawaii while we
were over there so they could see exactly what I did in my own trading.
These folks had a great knowledge base and knew quite a number of
strategies. I spent the better part of a day one Sunday with them,
looking for some candidates to trade the next day. During that time we
found 4 or 5 candidates upon which we agreed and discussed entry the
next day provided they did not reverse direction. We also agreed to
meet the next morning and walk the beach. Since Hawaii is so far west,
the markets open quite early and around 4:30 A.M. Hawaii time, I placed
three of the trades we had discussed. Later in the morning we met and
as we walked the beach, I asked these folks which trades they had
entered. I was shocked when they responded: "None of them." After
having spent the greater part of a day trying to help them find some
entries, I was really curious why they hadn't entered even one. They
told me they were looking for more confirmation. By the time we got
back from our walk, they had gotten the confirmation, but with a strong
market, it happened that they missed all the trades. Fortunately, I was
able to close all of mine within a few days for a nice profit.
The principle I had tried to show them was to find an entry with an
adequate potential reward to risk ratio and an exit that would take them
out with a small loss if the position moved against them soon after
entry. By the time they had what they considered to be confirmation,
the reward side of the reward to risk equation was much less than we had
seen on Sunday and the exit or potential loss was much greater than it
had been had they entered as we had discussed. The entry concept was
simple, but, for them it certainly wasn't easy.
Clearly, these people believed that by waiting for what they
considered to be confirmation they thought they would be entering a
"safer" trade. Tain't necessarily so. Could they have entered after
seeing their confirmation and still seen the trade turn immediately
against them? Of course that could happen. No one can know the future
and some general market or stock specific news could have triggered a
reversal. What then would have been their situation? If they were
using the disciplined exit they had already pre-determined on Sunday,
the loss would be greater since the stock had to move to achieve the
"confirmation" they required. In this situation, the complexity was the
addition of a requirement of confirmation after they had already seen an
entry that would work.
These folks are not alone. I have often seen retail traders jump
from strategy to strategy each time they are exposed to something new
evidently believing that there is some secret holy grail of trading. If
there is, it isn't jumping from strategy to strategy.
Anyone who believes that added complexity can bring the answer
might want to review the Long-Term Capital Management debacle. Long-Term
Capital Management was managed by sophisticated and bright
professionals; it had two Nobel Prize winners on its advisory staff and
a complex plan using modern finance theory. In spite of the complexity,
it not only failed, but nearly brought down the U.S. if not the world
financial system (years before the current bailout issues).
The answer, I believe, is in learning how to cut losses and let
profits run. Though I have discussed these critical concepts in "Trade Your Way to Wealth" and "Smart Investors Money Machine" as well as in
numerous articles over the years, a subscriber recently suggested that I
keep tossing the notion out as a "tease" and further suggested that it
would be helpful if I could give some guidelines on how to do those
things. I agree. I am currently preparing a short series of articles
that should begin around the end of the month in which I will try to do
exactly that -- try to give some guidance on how a trader might go about
cutting losses and letting profits run. Again, the concepts are quite
simple, but as with so many things in trading, not necessarily easy.
Good Trading!
Bill Kraft
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FPL Group Inc. (FPL)
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Progressive Corp. (PGR)
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Bill Kraft
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MDU Resources Group Inc. (MDU)
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