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The Impulse Trader

We have been posting a lot of day trades to the message board recently and I think we may need to discuss this tonight.  Sometimes day trades are impulse trades trades we had not planned on but act on impulse because we see something happening in the stock which makes us want to get involved.  I try not to impulse trade but let's face it we all do it.  What we want to make you aware of and recommend tonight is that you limit this type of trading.  You can still follow a trading plan using the day trade premarket watch list or the bulletin the night before. These planned trades normally work out better than impulse trades. 

Curbing Your Impluse
Try this exercise.  Verbalize the reasons behind your trade.  This has the natural effect of slowing down your trading and making you distinguish between genuine trade ideas and mere trading impulses.  A surefire way to identify impulsive trades is by the lack of a preplanned exit in case the trade fails.  For impulse traders most of the effort is going into getting into the trade (the entry) because for the impulse trader the purpose of the trade is to just get in the market; they need to feel the rush of the action.  They are not thinking about an exit plan because of their desire to be in the market so badly.  They seek action not results.  They should be looking for the reasoned trade not the impulse trade. 

The reasoned trade contains the following components:

1. An assessment of current price behavior Is buying pressure expanding or contracting; is selling pressure expanding or contracting; is price volatility expanding or contracting

2. An assessment of market conditions at shorter and longer time frames trending or range bound

3. A target for the trade A move to new highs/lows for a trend trade or a move toward a price mean for a range bound trade. 

4. Criteria for stopping the trade Conditions that will convince you that your trade idea is no longer valid

5. A decision of resource allocation to the trade How much of your capital you are willing to put at risk on the trade idea 

We recommend a maximum of 10% in any one position for swing trading.  For day traders it could be much higher but any positions that are more than 10% should be closed out at the end of the trading day.  I sometimes put 50% of my capital in a day trade but with that large of a position I make sure to close it out at the end of the day. The exception is if the stock is closing strong I will treat it like a swing trade scale down the position to just 10% and hold that smaller position over night. 

By doing this you can still take advantage of any gap up the next day and you do not have the risk you would have if you held the larger position over night.  Imagine holding a stock over night with half your portfolio value in that one stock and it gaps down 50% in the premarket on bad news That is the danger when you have such a large position. 

Sometimes verbalizing the above listed components before each trade can lead you to trade less often and maybe lead you to trade far differently from how you are currently trading.  If so then there is a likelihood that you are currently overtrading.  There is definitely something to be said for having a feel for trading.  However it does not mean a feel for trading is a substitute for market knowledge and awareness.

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