JOE ROSS – MONEY MANAGEMENT

There are some common mistakes traders make. Money management is all about money. It’s not like it’s like it’s like it’s like it’s like it’s like it’s like it’s like it’s like it’s like it’s like it’s like it’s like it’s like it Money management is different from other areas of management because it has many aspects that make it unique.

Some areas of money management seem to involve mental quirks that lead to costly mistakes.

LISTENING TO OPINION

Kim carefully studied as many factors as she could to make her decision to trade in crude oil. She entered the trade because she believes that crude oil prices will fall soon. Kim begins to watch one of the financial news stations when she turns on her television set. A person is being interviewed about crude oil.

He starts talking about how crude oil inventories are almost certain to drop this year because oil companies are not doing as much exploration as they have in the past. Kim begins to doubt her decision about the trade she has entered when she listens intently to what he has to say. The more she thinks about it, the more panicked she becomes. Even though she will end up with a loss, she considers abandoning her position.

Her confidence is completely shattered by the fact that an expert has decided something else. She took a $400 loss after exiting the trade. Her protective stop was $700 away from her entry. The market never moves far enough to take out her stop. By the end of the day, her crude oil futures have made a new high, and in the following days the market explodes into a genuine bull market. Kim has a loss. She has lost confidence in herself because of the loss.

WHAT SHOULD BE DONE?

You should set your own trading guidelines. You should forget about opinion. r It’s that of others as well. Unless you are one of a very rare breed that is good for trading, don’t trade on their opinions.

Go with the trade if you make an evaluation based on the facts. If you have a strategy for extricating yourself, you will have a better chance of avoiding big losses. Kim would have been a happy winner if she had stayed with her original strategy.

TAKING TOO BIG A BITE

Biting off more than can be chewed is a weakness of many traders. This form of over trading is caused by greed and not clearly defined trading objectives. It’s not enough to only trade to make money.

Pete is ahead by a full point after selling short T-Bonds. He is making money on his trade. He entered a long position in silver futures and also sold short Call options of wheat because he thought it would be smart to be diversified. As soon as he is in the market, wheat prices explode and his calls are in trouble. Pete sells additional calls on a two-for-one basis at a higher strike price after buying back the losing short calls.

He looks at other positions at the end of the day. As they close at the high of the day, silver has a spiked bottom. The T-Bonds have made an inside day, but to Pete they suddenly look weak. He found out at the end of the day that most of the money he had made on his short T-Bonds was used to buy back the short wheat Call options. He covered those and now has additional premium in his account, but he also has additional risk and is short calls in a rising market.

He is worried about his long silver futures due to the fact that silver closed at its lows on what seems to be a genuine reversal. He has lost confidence in himself. Pete has a good chance of ending up a loser on all three trades because what was once a happy, simple, winning silver long has now become an ugly, confusing mess. Pete could end up like the poor fellow in the picture if he keeps over-trading.

WHAT SHOULD BE DONE ?

Break every trade into goals. Before you add other positions, make sure you achieve your goals. Pete could have set a goal for the trade with a single short sale. One or two full points might be all he needed to retire that trade as a winner. He could have traded for an additional position. Few traders can successfully manage multiple positions in a variety of markets.

OVERCONFIDENCE

When people think they have special information or personal experience, it’s a trap that springs shut. Small traders get hurt trading on hot-tips.

Tim is a farmer. He buys a lot of feed to feed his hogs. Tim has a profitable farming operation. He sells 250 hogs a week. Tim doesn’t need to hedge his hog business because he is able to average the prices he gets for his hogs. Tim purchases soy meal futures in order to reduce the cost of feed.

Tim listens to the weather all day. He tries to gather as much information as he can from other farmers in order to be more profitable. Tim has a problem called tunnel vision. Whatever he sees in the grain fields in the area where he lives, he applies to the whole world.

Tim suspects that all fields must be dry if the surrounding fields are dry. Tim witnessed a local dry spell. He checked with all the local farmers and they said they were having a hard time. He looked at the news on his data feed and saw that there was a shortage in his area. In the state where Tim raises his hogs, there was a lot of dry weather.

Tim didn’t worry about his own feed bins. He had a lot of it in his silos. Tim speculated on what he considered to be inside information. He bought a lot of soy meal futures. Tim was positive. He was certain that soy meal prices would go up, and that he would make a small fortune. Tim may have become a hog because of his greed. The value of his investment began to shrink as the futures he purchased started moving down. Tim didn’t have a broader perspective. Farmers were having rain in the due season. Tim did hog raising in the state that was affected by the drought. Tim lost because he didn’t have a lot of knowledge.

WHAT SHOULD BE DONE?

We need to broaden our horizon. There is a need for a humble attitude. We can’t afford to be too confident in what we think is special knowledge. A trader is not going to let his guard down. Tim thought that others hadn’t caught onto something. Tim made a mistake as well. He only heard what he wanted to hear.

HEARING WHAT YOU WANT TO HEAR – SEEING WHAT YOU WANT TO SEE

This preferential bias is called by marketers. There is preferential bias among traders. They often distort additional information to support their view once they develop a preference for a trade. An otherwise conscientious trader may choose to ignore what the market is doing. We have seen traders convince themselves that the market was going up when it wasn’t. We have seen traders poll their friends and brokers and then enter a trade based on that opinion.

Fran and her husband, John, a student of ours, decided to live in the Missouri Ozarks. Everyone told them that it was not possible for them to make a living there.

EVERYONE THEY ASKED ADVISED THEM NOT TO DO IT.

A minister in the Church told them that they were going to serve there. The minister was the only one who told them to come. It was what they wanted to hear. They sold their home and most of their possessions.

They went broke a year after moving to the Ozarks. They had to leave and start all over again. John needed to find a job. Fran did the same. She had to give up her job as a trader to put food on the table.

WHAT SHOULD BE DONE?

Look at each trade from a different perspective. Don’t allow yourself to marry to your opinion. Understand the difference between what you see, what you feel, and what you think. Throw out what you don’t like. Once you have made up your mind, lock out the input of others. Don’t let your broker tell you what you want to hear.

Don’t ask your friends or relatives for an opinion. You don’t need to hear what they have to say if you turn off your radio or TV. If you want to look at the price bars, take all indicators off your chart. Go for it if you still see a trade there.

FEARING LOSSES

Being risk averse and fearing losses is different. You have to hate to lose. You can find ways to not lose with the help of your brain. Not losing is not an emotion-based reaction.

Two human tendencies come into play. The sunk-cost fallacy is the first and the exaggerated-loss syndrome is the second.

SUNK-COST FALLACY:

You are in a trade that is going against you. You have costs to make up for because you have already spent a commission. You have spent a lot of time researching and planning this trade. You think that time and effort is a cost. You are afraid that you will have to miss the trade because you have waited so long. The time spent waiting is a cost.

You decide to give the trade a little more room because you don’t want to waste all these costs. The pain is overwhelming when you realize what you have done. You have to take your loss which is larger than it might have been. The bigger the loss, the more afraid you are of losing again. Brain lock is a result of inability to pull the Trigger on a trade.

EXAGGERATED-LOSS SYNDROME:

Losing on a trade is more important than winning on a trade. In your mind, losses are more important than wins. Neither is more important than the other. If the wins are larger in size than the losses, they don’t have to be as many. It’s best to have more wins than losses with the wins greater in size than the losses.

WHAT SHOULD BE DONE?

Evaluate your trades on their potential. Future. Either loss or gain. What do I stand to lose from this trade, and what do I gain from it? Think about it. What is the worst thing that can happen to me if I take this trade, and do I have a plan to extricate myself before it happens? Is there a way to turn things around if I start to lose?

As part of your business overhead, look at the costs of a trade. You will not throw good money after bad if you have a mind set. You are throwing away money when you give a trade more room.

VALUING INVESTED MONEY MORE THAN WON MONEY

There is a tendency for traders to be more careless with their money than they are with their money. Good trades don’t mean you should gamble with your money. People are more willing to take chances with money they think is winnings. They don’t realize that money is something. Valuing money based on where it comes from can be bad for a trader.

Capital makes no sense as the tendency to take greater risk with money made from trades than with money invested. Money won in the markets will be riskier for traders than money from their savings account.

WHAT SHOULD BE DONE?

Wait to place at risk money on trades. You should keep your account constant. Take your winnings out of your account and put them in a conservative place. The longer you hold on to money, the more likely you are to use it.

FORGETTING ABOUT MARGIN INFLATION

Before the crash of 1987, S&P 500 stock index futures had an exchange minimum margin of about $12,000. The margins required by some brokers went up immediately after the crash.

Willie was a trader who figured if prices on an index went down, he would add to his position whenever prices broke out to new lows. The index he was trading became very volatile, and his broker raised margins by 1/3rd.

Willie tried to sell short additional contracts onto his already short position, but his broker wouldn’t allow him to do so. The broker was adamant in his refusal. Willie would not be allowed to use his paper profits to cover the extra margin.

He told Willie that he wouldn’t be allowed by the broker’s firm to build a pyramid position if he did that.

The money illusion is what some call the mistake Willie was making. Willie assumed that he had more selling power because his position was moving in his favor. Willie was brought face to face with reality by his broker.

Unhedged paper profits do not constitute additional funds that may be used for margin. Willie had a dream of huge profits from this trade. Willie was not allowed to get into trouble by his broker. Pyramiding with paper profits is not the way to make money as a futures trader.

WHAT SHOULD BE DONE?

Each add-on to an open position is a whole new position. Each add-on brings you closer to the add-on trade which will fail and become a loser. When planning a trade, be aware that if the market becomes volatile, margin requirements may go up, defeating any strategy for adding on to your position.

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It is possible for option sellers to quickly get into difficult positions. As they roll out new strikes to defend a threatened short options position, they can find themselves not only facing the need for a larger position, but also facing increased margins in creating that larger position. They may have to eat a large loss if they discover that they no longer have enough margin to defend their position.

MORE KEY MISTAKES

Key mistakes commonly made by traders are mentioned throughout our courses. Here are a few more.

ERROR: CONFUSING TRADING WITH INVESTING.

Many traders think they need to keep their money working. This may be true of money with which you invest, but it is not true of money with which you speculate. Selling short is speculation if you don’t own the underlying commodity.

You don’t usually invest in futures. A trader doesn’t have to worry about making his money work for him. A trader’s concern is making a wise and timely speculation, keeping his losses small by being quick to get out, and maximizing profits by not staying in too long, i.e., to a point where he is giving back more than a small percent of what he has already gained

ERROR: COPYING OTHER PEOPLE’S TRADING STRATEGIES.

A floor trader told me that he tried to copy the actions of one of the bigger, more experienced floor traders. My friend lost while the floor trader won. It’s rare for trading copycats to come out ahead. You may have different goals than the person you are copying. He may not be able to mentally or emotionally tolerate the losses.

The person you are copying has a lot of trading capital. If you follow a futures trading advisory but don’t use your own good judgement, it won’t work in the long run. Some of the best traders have had advisories, but their subscribers fail. It is almost impossible for two people to trade the same way.

ERROR: IGNORING THE DOWNSIDE OF A TRADE.

When entering a trade, most traders only look at the money they think they will make. They don’t think about the trade going against them and they could lose. Someone else is selling the same futures contract that someone else is buying. The buyer thinks the market will go up. The seller thinks the market has ended. You will become a more conservative and realistic trader if you look at your trades that way.

ERROR: EXPECTING EACH TRADE TO BE THE ONE THAT WILL MAKE YOU RICH.

People argue when we tell them that trading is speculative. Must be. The next trade they take could make them a lot of money. If you want to be a winner, you can’t wait for the big trade that comes along every now and then to make you rich.

There is no guarantee that you will be in. That particular is what it is. It is a trade. If you trade with objectives and are satisfied with regular small to medium size wins, you will earn more and be able to keep more.

A trader makes money by getting his share of the day-to-day price action of the markets. You don’t have to trade every day. If the trade doesn’t go your way within a period of time that you set, be quick to get out. If the trade goes your way, protect it with a stop.

ERROR: HAVING PROFIT EXPECTATIONS THAT ARE TOO HIGH.

When expectations are too high, the greatest disappointment comes. Many traders get into trouble when they think they will make more money from their trading. They will often get into a trade and, when it goes their way, they will mentally start spending their winnings, and may even borrow against their anticipated winnings to take on additional risk.

You rarely make all of the money available in a trade. I can’t remember the times when I took hundreds or thousands of dollars in paper profits only to see most of them melt away before I could get out. A trader made $700 per contract in a eurodollar trade. He lost his position on the news of a 50 basis point cut in interest rates.

He got out with $350 per contract. The overhead costs of trading arrive on time, even though the money from trading doesn’t come in as fast or as plentifully as you have been led to believe. aspiring traders have left their jobs because of false profit expectations.

They lose the money of friends and family because of false hope. They borrow against their home and other assets because of false hope. Too high expectations can be dangerous to the well-being of traders and those around them.

ERROR: NOT REVIEWING YOUR FINANCIAL GOALS.

Before you make a position trading decision or start a day of day trading, review your goals and motives.

• Why are you trading today?
• Why are you taking this trade?
• How will it move your closer to your goals and objectives?

ERROR: TAKING A TRADE BECAUSE IT SEEMS LIKE THE RIGHT THING TO DO NOW.

Some of the sad calls we get are from traders who don’t know how to manage a trade. They are in trouble by the time they call. They entered a trade because they thought it was the right thing to do.

They thought that following the dictates of opinion was smart. They didn’t plan their actions in the event the trade went against them. It’s not a reason to enter a trade when the market is hot.

When you don’t fully understand what is happening, the wisest choice is to not do anything at all. There will be more trading opportunities. You don’t have to trade.

ERROR: TAKING TOO MUCH RISK.

It’s hard to believe that trading carries with it a tremendous amount of risk, with all the warnings contained in the forms with which you open your account, and with all the required warnings in books, magazines, and many other forms of literature you receive as a trader.

You don’t really take it to heart and live it until you are caught up in the sheer terror of a major losing trade, as though you know on an intellectual basis that trading futures is risky. Greed makes traders accept too much risk. They get into too many trades.

They put their stop too far away. They trade with very little capital. We are not telling you to avoid futures trading. You should embark on a sound, disciplined trading plan based on knowledge of the futures markets in which you trade, with good common sense.

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