The Trader’s U E-Letter: Issue #167
Thursday, December 22, 2005

Portfolio “Junk Food” – The Curse of the Low-Quality Trade (Part III)
by D.R. Barton, Jr.
Chairman, Trader’s U

“The first principle is that you must not fool yourself – and you are the easiest to fool.“
- Richard Feynman

In our world today, it’s getting easier and easier for us to do the wrong things.

Want to numb your mind with moronic story lines and nonstop promiscuity? Your TV will give you hundreds of simultaneous choices, 24 hours a day.

Want a fast, easy, and nutritionally bankrupt meal? (Hey, there’s a reason they call it junk food.) You can find a broad array of fast-food outlets to help you.

Want to invest in that new penny stock, “We Don’t Need No Stinkin’ Business Plan, Inc.,” or in a tip that you heard at your Friday poker game? One click of the mouse and you’re in.

Bam! Another low-quality trade. Like junk food for your portfolio.

This three-part series on low-quality trades has taken us through some of the reasons why we take marginal trades (Part I) and the real cost of getting into poor-quality trades (Part II). Today, we’ll take a look at some of the tools and tactics that can be used to help you lay off the trading equivalent of “junk food.”

Identifying the Low-Quality Trade

If we’re going to avoid these trades – the “I shouldn’t have done that” trades – the first thing we need to determine is what separates them from high-quality trades.

The characteristics of a low-quality trade will be different for everyone, but here are some questions to ask yourself that might signal one:

• Does this trade meet all of your rules or requirements for entering a position?
• Are you taking a trade that “almost” makes it on one or two of your set-up or entry criteria, but requires you to stretch the numbers, fudge things a bit, or ignore some of your entry requirements?
• Are you taking a trade that just “feels right,” when you have no provisions in your trading plan for executing intuitive-style trades?
• Are you taking this trade just so that you can make back the money you lost on the last trade?
• Are you trading because you’re bored, or because you have nothing else to do?
• Are you acting on a stock tip or hot story that doesn’t fit your trading and investing rules?

There may be different and more useful ways for you to identify your particular reasons for entering marginal trades. But when you realize that your trade or investment was really a low-quality one, take the time to go back and reconstruct your thought process for making it. Write out your reasons for the trade in your trading diary (you do have one, don’t you?).

If low-quality trades continue to pop up, you’ll then be able to identify the patterns that affect your particular trading and investing style.

Regis, I Could Use Some Help

Once you’ve identified the low-quality trades you’re making, how do you keep yourself from making them? For many of you, the step you’ve already made will be enough to turn the tide. That step is realizing that you are taking trades that shouldn’t be made in the first place.

For those still struggling with taking questionable trades, here are some tactics that could help minimize or eliminate those trades:

• Keep a log of every trade. In addition to the trading information that you’ll want to include (date, time, symbol, number of shares, entry price, stop loss, target R multiple, etc.), put two wide columns at the end of every trade and label them “Why did I enter?” and “Why did I exit?” Just asking these simple questions will help you to see when you’re getting in a marginal trade. And subconsciously, since you know you have to explain to yourself – in writing – why you took the trade, you’ll find that you bend the rules less often.
  
• Phone a friend. If a trading log doesn’t completely end your low-quality trades, escalate your effort and find an accountability partner. You may find that reviewing your trades with someone else will help you ask yourself the tough questions (”Should I be taking this trade?”) before you hit the buy or sell button.
  Taking questionable trades can be a big performance drag on your trading portfolio. But with a little internal digging to help you find out why you’re taking them, you can set up a plan to minimize or eliminate them from your trading blotter. Taking fewer, higher-quality trades will always beat the alternative of wishing and hoping.

As we approach the holiday season, I’d like to extend my warmest wishes to all of our readers. Whether you celebrate Christmas with a childlike zeal or observe the rich traditions of Hanukkah, may you and your loved ones enjoy great blessings.

Today’s TU Tips & Tricks

• Part I and Part II of The Curse of the Low-Quality Trade series can be found here: Trader’s U #165 and #166.
• The opposite of taking a low-quality trade may be “trading in the zone” – that state of flow when everything just seems to work. At least two of the better trading psychologists out there seem to think so. In a weird literary twist, both Mark Douglas and Ari Kiev have written books with the same title, Trading in the Zone. Both have their useful points. Douglas’ book can be found here. You can find Kiev’s book by clicking here.

The Chart of the Week

Our chart shows six widely followed stock indexes. For a friendly holiday exercise, I’ll send a free copy of my book, Safe Strategies for Financial Freedom, to the reader who sends in the best explanation for this anomaly. For even more fun, I’ll award another copy for the most humorous explanation! Please send your response to investmentu@www.investmentu.com and type “Index Chart” in the subject line.

Great trading,

D.R.

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• Is Gold a Good Investment?: A Favorable Long-term Forecast
• Stop Loss Order: The Deciding Factor in Trading and Investing
• Investing in Oil: Is Black Gold Finally Topping Out… With Katrina’s Help?

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