Bulkowski's Trading Commitment

Written and copyright © 2009-2011 by Thomas N. Bulkowski. All rights reserved.

One Secret to Trading Success: Commitment

Consider the following three trading situations for Basket Case Bob.

1. He places a trade which results in a small profit, but he did not follow the rules of his trading system.
2. He follows his trading system, but expects a reversal which could lead to a loss.
3. He follows the advice of a trading advisor with an excellent record, but doesn't trust him.

Now consider the following similar three situations.

4. Basket Case Bob makes a small profit by following the rules of his trading system.
5. He sticks to his trading system because, over time, he knows it will make money.
6. He follows the advice of a trading advisor with an excellent record because he trusts him.

What is the difference between situations 1-3 and 4-6? In situations 1-3, Basket Case Bob ignores his system, does not trust it, and doesn't trust his mentor. He lacks a commitment to his trading and the system he uses. In situations 4-6, there is no conflict. He is confident, in control, and committed to trading well. Which type of trader would you rather be?

One way you can tell if you are committed to trading is consistency of profit, making money year after year. But how long will that commitment last? Will you tire of the stress after a string of losses and just give up?

Trading Obstacles

Good traders know that there are many trades out there that will inflict serious losses or even bankrupt them. Their job is to avoid those trades. What are some of the obstacles to trading commitment, problems that if not fixed, chip away and distract from greater success?

• Avoiding Losses. If a trader is trying to avoid losses, he will not cut his losses short. He lets a small loss grow, knowing that if he were to sell, the stock would recover immediately. So, he holds on, hoping the stock turns around. In some cases it does, and that reinforces his bad habit that if he only waits long enough, he can ride out a loss.

  The problem bites him when a small loss grows and grows, turning into a massive loss. That massive loss eventually forces him to sell near the bottom, just before the stock recovers. And that recovery reinforces his belief that he should not have sold, that if he only held on for a few more days or a few more weeks, the trade would have turned the corner, eventually making a profit. Clearly, if he kept the loss small to begin with, he would not face this dilemma.

  Remember that regardless of when you take a loss, you will still be faced with the same problem, that of seeing the stock recover after you exit. Would you rather have a small loss or a huge one given that the stock will move up after you sell? It is still possible that the stock will continue down, so selling when the loss is small is the best choice. Cut your losses short.

  Just be careful that in your zest to cut losses short, you do not go overboard. I know of a trader who limits losses to 1% or 2%. He is always being stopped out. Why? Because his stops are too close to the trading action. Learning how to correctly place a stop is critical for trading success.

  A trader that focuses on huge gains tends to see profits turn into losses when they hold on too long, waiting for that last penny of climb in a rise-retrace pattern. When the retrace sees price continue to drop, they freeze.

  One example comes from another writer and trader I met. He turned a 5 bagger (price of the stock climbed by five times his purchase price) into a three bagger. Why didn't he sell? Because he was hoping for a 10 bagger. Oops.

 

• Laziness and disorganization. Another obstacle to trading commitment is laziness and disorganization. Lazy traders do not scan their charts daily, so they buy subscriptions to newsletters to solve that problem. "Let the hotline alert me to a new trade" they think. Then what happens? After a period of time, they stop reading the newsletter or they ignore the advice of the hotline. But they are still losing money!

  Next, they try buying the ultimate trading system. They may spend a few days or even a few weeks getting to know the system, but after a few losing trades, they start to ignore the signals. For each obstacle that comes along, instead of doing the work necessary to conquering the problem, the lazy trader takes medicine that only masks the symptoms, but the underlying problem remains.

  One lazy trader I know paid thousands and took classes at a trading school. But those lessons did not generate prosperity. So, she paid for private lessons and then claimed that the school was just ok, but the private lessons were the solution she was looking for! When that didn't work, she joined a chat room, spending more money and yet she still hasn't turned a profit. She now claims that the school was lousy, that the private lessons were no good, but the chat room is wonderful! What she will try next? She is demonstrating a lack of commitment.

• Trading as a hobby. Some traders consider trading as a hobby and not a business. Professional traders have a business plan. Where's yours?

  The pros use a trading notebook to log every trade and review it periodically so they can spot bad habits developing. The diary also helps them see developing trends in the markets and helps them shift strategies to capitalize on evolving trends.

• Trading for the adrenaline hit. I know a woman that made something like $300,000 in the stock market and then frittered away the entire sum and more just because she enjoyed the adrenaline high that trading brought. Another person has a full time job, but he sneaks time to monitor his stocks during the day, placing trades on the sly. He loves trading for the rush it brings and he is doing well, up 50% in about a month. The time bomb waiting to explode is that he does not know how to sell. A short-term trade that goes bad turns into a buy-and-hold situation until the stock recovers. The nail in the coffin: He is trading with his retirement money.

Trading Commitment: Solutions

What is the solution to lack of trading commitment? It often depends on the problem. I told one trader that was having problems selling by imagining that his mother was in the trade instead of him. What would he advise her to do? Some may find it helpful to think of the ideal trader. What would they do? Would they hesitate selling a position, or would they sell it and move on to the next one?

Make a list of your problems. If you do not know what your problems are, then track your trades. Are you entering too early or too late? Are you selling well before you should or holding on past the peak? Are you trading when you are upset or unduly happy? Are you trading for the excitement instead of the profit? Is there a common element or flaw shared between your trades? Do you hesitate when entering a trade, suspecting that this will be the one that knocks you out of the ball game? Do you know that this trade is a "no brainer," a sure win, so you double your bet and then lose three times as much when you know that the trade will work out but doesn't (so you hold on too long)?

Deal with the mental issues that are causing these behaviors. Make peace with the obstacles to commitment and put them behind you, rendering them impotent and unimportant. For example, if you fear taking a loss, then imagine taking a series of huge losses. How would you feel if that were to happen? Make the thought of these devastating losses so real, so alarming that taking a small loss is insignificant by comparison. Make taking a loss in a timely manner seem routine. Over time, those losses will diminish in importance such that taking a loss in a timely manner becomes easy.

Whether you are trading full or part time, trading commitment is measured by how serious you are about trading well. It is not about profit. It is about execution. If you execute each trade to the best of your ability, the profits will follow.

This article was based on an idea from Tharp's "The Secret of Trading Success: Commitment" article in the 1994 Bonus issue of Technical Analysis of Stocks & Commodities magazine.

-- Thomas Bulkowski

Copyright © 2009-2011 by Thomas N. Bulkowski. All rights reserved. In prison, you can join many programs which you can leave at any time. At work, there are some programs you can never get out of.