Author: Chris Hood
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Last year in Q4, we had an amazingly lucrative Santa Claus rally that went on more or less unbroken from mid-October until mid-January.
I remember chatting with Ben, a newer client, right in the middle of the run.
“Chris, I made 8K last week! I think I have this trading thing figured out!”
Obviously, he was doing something right, so I celebrated along with him. I was raking in some tidy profits and was ecstatic that he was too.
I knew Ben’s account size and his skill level because I was tracking his trades online.
He did nothing but tell me how much money he was making each week that we’d talk.
“At this rate, by my calculations, I’ll be able to double my account in just a few months!”
I didn’t want to dampen Ben’s enthusiasm, but I let him know that he was doing well because the market was ripe for the types of trades he liked.
Of course, something about trading, but many of his wins were pure luck.
Ben’s entered trades on set-ups that were risky at best. And his positions were oversized – some were a full 10% of his account.
A whole week without a single loss convinced him he was unstoppable.
I tried to warn Ben about the volatility of February and March – sudden gap downs, sucker rallies, and unforeseeable, face-ripping reversals.
“People say trading is hard. What do they know? It’s only taken me two months to be a pro.”
Honestly, I had to stifle a laugh when I heard that. I knew what was going to happen. I felt like Cassandra, cursed to see the future but never be believed.
Ben was falling prey to two significant cognitive biases – traps you must avoid if you’re going to stay solvent.
The first is the recency bias, and the second, the hot hands fallacy.
The average trader will give much more weight to recent events than historical ones.
It’s this tendency that behavioral finance, the psychological study of markets, calls recency bias. Naïve traders assume that whatever the market has done recently, it will continue to do in perpetuity.
Believing this will bleed your account dry.
You have to know when to switch tactics. And this requires understanding what trade types work best in which markets and on what underlying stocks.
Ben also fell prey to another psychological trap – the hot hands fallacy.
Just as he thought the market was never going to change, he had so many wins in a row he felt invincible.
Were the market a craps table, Ben would have kept rolling and doubling down.
Why would you pass the dice when they’re on fire?
Traders who don’t respect probability always end up take a lot of pain when a trade goes wrong.
Ben mistook his luck for skill so it was only a matter of time before the inevitable happened.
I’m not trying to scare you away from trading.
I want you to find which faulty beliefs and biases are undermining your success. With a bit of introspection, you can fix them.
Ben eventually got over his exuberance, when a natural three-day pullback wiped out half his account.
All of his profits and then some.
Fortunately he didn’t go broke, and he’s come out of the drawdown a much wiser and more cautious trader.
Some lessons are expensive. I know because I’ve paid for them in the past.
My job is to help you avoid my mistakes and shorten the learning curve. But there will always be a Ben out there who has to learn the hard way.
Listen to me, or let the market teach you.
There are really only two choices, and I promise you that the first is much less expensive.
P.S. My colleague Dr. Kent Moors just used his successful Sigma Trader system to take a 100% gain on SPCE. Click here to find out more about this powerful trading system.