We believe that trading psychology (TP) is the single greatest factor determining investment returns. One must possess the right mental and emotional composition to position the fund or portfolio, the opportunity to be successful and drive superior investment returns and of equal importance, consistent returns. Trading psychology also means trading rules and ways of thinking.
Trading Rules: Trading rules facilitate risk control and determine return-risk profile, position size, scaling positions (in and out), loss limits for long and short positions, price targets, trading around core positions, reasons and implementation for bracket orders and balance and prioritization of technical vs. fundamental analysis and event driven occurrences by position; and exercising patience as well as the opposite, reversal. Patience allows a company’s potential to unfold and therefore let winner’s run. Don’t react to short term gains, causing you to miss a geometric move in a security. Reversal is to identify without denial, a negative change of circumstances and exit the position immediately without riding mounting losses. The Quick…and the Dead!
Ways of Thinking: One must recognize greed and fear, regret, euphoria and panic, as well as over-trading and the worst of all, vengeance trading. Vengeance trading (aggressively trading without sufficient calculation, trading on impulse not on instinct, trying to make up for previous losses) is a fabulous way to self-destruct! Understanding ways of thinking is just as important as trading rules themselves. For example, to avoid unnecessary “blind spots,” it is important to understand that price action does not make a sound premise necessarily correct [think Tesla today at $400 per share]. Another example: Selling a core position on an illiquid, low volume day, due to high intra-day volatility; when nothing has changed, except an unsophisticated seller showed up. Whipsaw City! Still, most investors ignore application of trading psychology. We think it is paramount.
Until next week…
David N. Baker
Mercadyne Fund Management LLC
6565 Spencer St., Suite 205
Las Vegas NV 89119