Yo-Yos
Reprinted with permission from The Master Swing Trader Toolkit Alan S. Farley McGraw-Hill 2010 All Rights Reserved.
There are three types of traders in this world: winners, losers and yo-yos. It doesn’t take much effort to comprehend the virtues of winning or the liabilities of losing, but what exactly constitutes a yo-yo trader? Quite simply, these folks know how to make and lose a ton of money, sometimes all in the same day. Sadly, yo-yos comprise such a large segment of the trading population they may represent the silent majority of the financial markets.
This common affliction is simple enough to understand. Many traders develop enough skills to put on profitable positions with relative ease but they also play all the stinkers, paying the price with substantial losses. In this bipolar purgatory, there’s enough positive reinforcement to keep them in the game for years, but not enough profit to make a real dent on their bottom lines.
Yo-yo traders emit two very different profiles. The first type grinds through mediocre results on a daily basis, hoping that lightning will eventually strike. The second type shows profitable results over long periods, only to crash and burn in an orgy of bad trades over equally long periods. All traders display both incarnations of yo-yo performance, from time to time, during the course of their careers. The trick is to recognize its onset as early as possible and to engage in prophylactic practices that will reduce the inevitable damage.
Two major flaws lead to yo-yo trading performance. First, the afflicted individuals lack effective risk control techniques. This causes them to act inappropriately, or not at all, when positions move against them. Unfortunately, operant conditioning kicks in at the worst possible time because they’ve gotten bailed out often enough to believe the market will come back in their favor, if they just wait it out. Of course, the math fails to add up and bad karma takes over, with rising losses and dwindling profits.
The second flaw reveals a far steeper challenge to long-term survival. Their equity growth actually tracks the market and looks like an index chart. In other words, these yo-yo traders make money when the broad market is rising and then lose it when its rolls over, and starts to sell off. This is a tough proposition because the secret to long-term success is holding onto your winnings through all kinds of markets. This major defect exposes a bull market mentality that reaps destruction during pullbacks, corrections, and every downdraft in a typical week. Unfortunately, it’s also how most traders play the markets because it follows an unconscious mindset that gives legitimacy solely to uptrends, while it assumes that all other environments are aberrations or freaks of nature.
This mental mistake reveals the primary reason so much money was lost after the March 2000 and July 2007 tops.
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