"Use Your Pain to Gain"
By Alan Farley
Special to RealMoney.com
02/05/2004 12:00 PM EST
"What do swing traders and the Marquis de Sade have in common? Both have an intimate relationship with pain and suffering. Fortunately, that's where the comparisons end -- at least most of the time.
Pain is a dynamic principle that interacts on a daily basis with our trading strategies, decisions, and learning mechanisms. That's why it is important to understand the many ways in which pain influences how we think and act as we participate in the market.
Many Faces
First, let's categorize four common types of market pain. Sadly, we know these unpleasant experiences very well. On the other hand, we wouldn't have come this far if they hadn't won our undivided attention at the time. That's the thing that makes us so crazy when it comes to pain: It feels terrible, but it's a highly effective teaching mechanism.
Atop the list is the pain associated with taking losses. This manifestation of misery has two quite different faces. It starts with the ugly knot in our stomachs when a position moves against us. It then evolves into quiet exhaustion when we finally bite the bullet and take the loss.
The second messenger of misery is missing a trading opportunity. This version is so powerful it's become the primary force behind the strategy we know as momentum trading. That might sound odd, but consider what makes the momentum trader so willing to buy above the market or sell below it. They're trying to avoid the pain of missing out by getting in or out at any price.
A third type of market pain is more subtle, but equally damaging to a trader's psyche. This is the genuine discomfort produced by boredom during periods when there's little or no opportunity in the markets. This pain producer grows exponentially when we're getting over the pain from taking a big loss. During those uncomfortable times, we're anxious to drink from the market's wells, but there's not a drop of opportunity in sight.
Finally, there's the exquisite pain associated with drawdowns following our most profitable periods. Our trading psychology changes exponentially when we make money in the markets. We quickly develop a sense of invincibility that blinds us to the cyclical nature of profit and loss. We're then shocked to find that we're mere mortals when the tables finally turn. I suspect this pain has become quite common in the last two weeks.
Making It Work for You
Traders need to accept their pain because it's a necessary learning and development tool. Like a child touching a hot stove for the first time, pain lets us know something is wrong. But the appropriate response to market pain is often counterintuitive. In fact, the best path of action may be to let those fingers fry for a while before pulling them off the burner.
Consider how often we dump our losses at the exact low of a price swing. This odd phenomenon suggests pain is a highly effective directional indicator. In other words, the loser that's causing us so much pain will probably bounce exactly one tick after we give up and get out. So shouldn't we wait just a little longer before selling out?
Unfortunately, it's always a two-edged sword. That pain may be telling us we've already stuck around too long and are in a very dangerous situation. Trying to hold on for one tick past a pain threshold could mean the end of a trading career. But consider the possibilities if you're watching from the sidelines and putting yourself into the mindset of those suffering traders.
Empathy with the pain of other traders is a superb timing tool that can get you positioned at near-perfect entry points. The trick is to step into their shoes and see where you'd be crying uncle. Then wait for a surge into that price, enter the market in the other direction, and protect yourself with a tight stop-loss.
One reason this bottom-fishing technique works so well is because traders get to use what they already know, instead of trying to interpret a lot of numbers and patterns. That's one good thing about pain. If we apply it constructively to our market experiences, it actually starts to work in our favor.
Getting Off the Mat
At its core, the opposite of pain is empowerment. Perhaps that's why I'm so focused right after my most painful market experiences. For example, I usually book my best profits in the days and weeks after taking a series of losses. The drawdown apparently wakes me from my bad habits and growing sense of complacency. It centers my efforts on taking profit out of the market, rather than chasing positions that have nowhere to go.
The key difference between a successful trader and a losing one is how empowerment becomes a more active market force than pain. The successful trader may lose money, but will make it back quickly by turning pain into motivation. Through their experience, they've acquired a level of confidence that awakens their ability to use pain as an urgent signal to change their habits and approach to the market.
There's an old saying that what starts out as pleasure in the end offers pain, while what starts as pain in the end gives great pleasure. So it goes with our relationship to pain in the financial markets. I think the esoteric word for it is transmutation, or the conversion of one object into another object. Why not try it the next time you feel like a whipping post for Mr. Market? "
(in
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Enviado: 5/2/2004 20:00