Lessons from a Pro Stock Trader - Don't think of paper gains/losses in terms of cars or vacations
Background
Tom Baldwin worked as a meat packer in Ohio. After graduate school, on the advice from a friend, he moved to Chicago to begin bonds trading. Though his specialty is trading the 30-year bonds, his knowledge of trading can be easily applied to stocks as well.
What is so intriguing about his story?
He turned $25,000 into a $1,000,000 before his first year was up. In addition, he was paying $2,000 per month to lease the seat on the exchange and at least $1,000 for living expenses. Oh and his wife was pregnant at the time.
For all of you people out there who are looking for excuses not to trade bonds or stocks, consider Tom Baldwin's story. Tom Baldwin went from meat packer to bond trader investor and according to Jack D. Schwager from Market Wizards, Updated: Interviews With Top Traders
30 million dollars is a conservative estimate for Tom Baldwin's total winnings.What is the single most important lesson in stock trading?
From the interview conducted by J. Schwager in the book mentioned above, the biggest take away I got from Baldwin's interview was the fact that he didn't view trading paper gains/losses in terms of what the money could be spent on or in the case of losses what the money could have been spent on.
What does that mean?
Most stock traders will translate what they loss or gained from the stock market into terms of what can be purchased at a store or spent for shoes, TVs, or what not. This occurs almost automatically. After all, what we gain from the stock market, we eventually will spend especially if we do not reinvest it.
Suppose you are in a long-term trade ranging from 6-12 months and risked $8,000. Suddenly after weeks of entering the trade you see that you are down $3,000. If you start to think of the paper loss in terms of money that could have been spent on a mortgage payment or a down payment on a new car, you will be tempted to liquidate the position.
The original reason you entered the trade was because you had a theory (backed by research) that the company has solid financials and numerous growth opportunities. Unless these factors have been disproven or you no longer like the position, there is no reason to exit the position.
Don't exit a trade just because you impulsely translated your risk into tangible terms.
Trading Lesson with a Personal Touch
Personally, liquidating a position prematurely has happened to me many times. This happens usually when I risk more than I am usually comfortable with. The minute it declines more than I am comfortable with, I exit the position. My theory had not been disproven and the only reason I exited the position was because I started to think of the cash in terms of what I could buy. This is a flaw in my trading strategy/behavior. In hindsight, most of these positions ended to be big winners.
Trade the ideas and charts and manage your emotions. Don't exit a position solely because you start to think of what the money could have bought or can buy.