Maxims and Clichés that Guide and Mislead Day Traders - dummies

Maxims and Clichés that Guide and Mislead Day Traders

Clichés are useful shorthand for important rules that can help you plan your day trading. But they can also mislead you. Here’s a run-through of some clichés that you’ll come across in your trading career.

Pigs get fat, hogs get slaughtered

A day trader wants to make money. Get too greedy, however, and you’re likely to get stupid. You start taking too much risk, deviating too much from your strategy, and getting careless about dealing with your losses. Good traders know when it’s time to take a profit and move on to the next trade.

In a bear market, the money returns to its rightful owners

A bull market is one that charges ahead; a bear market is one that does poorly. Many people erroneously think of themselves as trading geniuses because they make money when the entire market is going up. When the markets turn negative, those people who really understand trading and who know how to manage risk are able to stay in until things get better, possibly even making nice profits along the way.

The trend is your friend

There are two problems with this maxim. The first is that by the time you identify a trend, it may be over. Second, sometimes, going against the herd makes sense because you can collect when everyone else realizes their mistake. In such a situation, the psychology of trading comes into play. Are you a good enough judge of human behavior to know when the trend is right and when it’s not?

Buy the rumor, sell the news

Rumors are often attached to such news events as corporate earnings. For whatever reason traders may believe that the company will report good quarterly earnings per share. That’s the rumor. If you buy on the rumor, you can take advantage of the price appreciation as the story gets more play. When the earnings are actually announced, one of two things will happen:

  • The earnings will be as good as or better than rumored, and the price will go up. The trader can sell into that and make a profit.

  • The earnings will be worse than rumored, everyone will sell on the bad news, and the trader will want to sell to get out of the loss.

Of course, if the rumor is bad, you want to do the opposite: sell on the rumor and buy on the news.

Cut your losses and ride your winners

No matter how much it hurts and no matter how much you believe that you are right, you need to close out a losing position and move on. But the opposite — that you should ride your winners — is not necessarily true.

Although good traders tend to be disciplined about selling winning positions, they don’t use stops and limits as rigorously on the upside as they may on the downside. They’re likely to stick with a profit and see how high it goes before closing out a position.

You’re only as good as your last trade

One of the biggest enemies of good traders is overconfidence. Especially after a nice run of winning trades, a trader can get caught up in the euphoria and believe that he finally has the secret to successful trading under control. While he’s checking the real estate listings for that beachfront estate in Maui, BAM! The next trade is a disaster.

If you don’t know who you are, Wall Street is an expensive place to find out

The best traders know their limits. They know what gets them excited, what gets them angry, and what they need to watch out for. They’ve looked back on their lives and realized how to apply their strengths and weaknesses to trading. If you are new to trading, consider your own capabilities when designing a trading plan and think carefully about the things that are likely to trip you up.