The Curse of the Low-Quality Trade (Part 2)

The Curse of the Low-Quality Trade (Part 2)

The Trader's U E-Letter: Issue # 166

Wednesday, December 14, 2005

The Curse of the Low-Quality Trade (Part 2) - Three Reasons to Remove the Spyware in Your Brain

By D.R. Barton, Jr., Chairman, Trader's U

Earlier this year, things were getting hectic. I had two writing deadlines approaching and a great trade set-up to act on. It was going to be a busy day in front of the computer.

And I'm sure you know what happened next - the same thing that happens to us all when things get hectic and we need everything to go just right…

Murphy's Law reared its ugly head again. Paraphrasing this famous law, "If anything can go wrong, it will; and at the worst possible moment."

My eight-month-old computer started acting weird. Then, it slowed w-a-y d-o-w-n. And the final blow? The infamous Microsoft "blue screen of death." My computer had been infected by spyware. The night before my hectic day was to begin, a member of my family had clicked on a box in a pop-up window that was supposed to close the window. Instead, it downloaded more than a quarter of a million spyware files to my computer.

I cleaned most of them out using standard spyware removers. But the next morning, my computer's malaise and eventual surrender told me that malicious files were still out there. And they were sucking all of the power out of my computer - in much the same way that "low-quality" trades can drain the profit potential from your account.

In last week's Trader's U, we talked about these types of trades and some possible reasons why we take them. Today, let's look at the real cost of taking these less-than-desirable positions.

Low-Quality Trades: Spyware for Your Brain

For many people, managing low-quality trades is the biggest drain they have on their profit potential. Why? Let's look at the real costs associated with low quality trades.

As a reminder, low-quality trades are those that don't quite meet your set-up and entry requirements. These are the trades where you "relax" your entry rules, and trade on a tip, or just because the market is in the middle of a big move and you don't want to miss it.

These marginal trades tend to be more like coin flips. Here are just three ways they hurt us:

  • Spyware for your brain. Managing low-quality positions dilutes the attention and resources that you can apply toward finding and executing higher-quality trades. This "opportunity cost" of taking marginal trades can be quite high if it makes you miss some really good trades or investments. Managing low-quality trades eats up a large part of your brain's processing power. Just like spyware. At the least, they're a distraction. At worst, they command your complete attention and keep you from finding and executing more profitable opportunities.
  • Eaten alive by transaction costs. While low-quality trades chew up your mental energy, the transaction costs of these trades (slippage and commissions) eat up your account's equity. Even if they're 50/50 trades, they will consume your account little by little. Let's look at an example… Say you make five low-quality stock trades per month, just to keep yourself from getting bored. With a $10 commission per side, and a $10 slippage getting in and getting out, you are spending an extra $200 per month, or $2,400 per year just on transaction costs! And if the frequency of your low-quality trades is worse, or your commissions and slippage are higher, this figure can balloon from there.
  • The physical and emotional cost. No one needs more stress in their life. But many of us add the stress of managing bad trades to our already taxed system. As we'll discuss next week, many low-quality trades are born out of stressed states when we are more prone to let our guard down.

Trading and investing have plenty of challenges of their own - without adding the costs of taking low-quality trades that we really shouldn't be in. Next week, we'll close out this series with some useful tools that you can use to eliminate these marginal trades and investments from your portfolio. Until then…

Great trading,

D.R.

Today's Trader's U Tips & Tricks

  • Since we're dealing with the psychological effects of marginal trades, this is a good time to re-iterate my strongest recommendation for the best trading psychology program on the planet. Dr. Van K. Tharp's "opus maximus," his Peak Performance Home Study Course is a "must-have" for all serious traders and investors. You can find this extraordinary course here.
  • Read Part One of the Curse of the Low-Quality Trade: Issue # 165

The Chart of the Week - Pat on the Back Edition

Note: There are "before" and "after" charts below:

BEFORE:

Hershey Co. Stock Chart # 1

AFTER:

Hershey Co. Stock Chart # 2

Hershey (NYSE: HSY) moved methodically up after our call for a reversal three weeks ago. On Tuesday of this week, the stock made a nice move up after the chocolatier reaffirmed its earnings outlook for the year. (Am I the only one whose mouth waters when talking about this stock?) Keep an eye out for resistance at the $60 level - it is the area of a previous swing high, and also of the 50% retracement from the big May to November down-move.

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