OVERTRADING:
How to Recognize it
and Avoid it

© Daryl Guppy 1998
 

Over-trading is an affliction difficult to self-diagnose and a very enjoyable way to go broke. We recognize it easily in others, but not in ourselves so it is useful to understand some  of its causes.

The two main roots of over-trading lie in a need to chase the market to recover losses, and in a desire to look busy. The first leads down a road to gambling and we will consider this in a later article. The second, our instinct to look busy,  usually  costs us a great deal.

Often we find it difficult to develop the patience to wait for good trades. We feel we should be doing something. Our partner encourages this feeling, stating openly that she cannot understand how we are making money by drinking coffee and reading fiction books while waiting for our buy and sell criteria to materialize.

This criticism gets to the very core of our belief about the relationship between reward and work. We tolerated long hours, high levels of stress and frenetic office environments  because they delivered high pay, relaxing holidays and an upmarket lifestyle.

Private traders offers the opportunity to have all of benefits above without the downside. This breaks the relationship between work and reward and many of us feel very uncomfortable. As top Australian trader, Gary Smith noted in an earlier edition of YTE, "People with intensive work ethics have to stare at the screen all day to reassure themselves that they have worked hard."

So we  create more work , extending our activities by taking on new market segments or derivative markets such as options and warrants, by taking many new positions financed by trading profits, by additional capital borrowed from other sources, or by margin borrowing. No matter which combination we choose the effect is the same. We create more trading activity  to satisfy our work ethic.

This is one of the causes of over-trading, but how do we recognize this affliction in ourselves?

Over-trading is about motivation, and it starts when positions are opened primarily because the trader feels the need to do something other than wait patiently for the best opportunities to arise. This temptation is always present because somewhere in the market good money is  made every day. We suspect  if we were more fully exposed, more fully committed, then we too could take part in the great accumulation of wealth.

Putting a hard number on over-trading is difficult. The day trader takes on more positions than an investor. A position trader completes less trades than an active commodities trader. In assessing the tendency for over-trading the primary test is money management so we look for a  "Yes" answer to each of these four questions:
 

Is each trade clearly based on sound financial analysis?

Is each trade part of an over-all money management objective based on matching position size with risk?

Does each trade have clear financial objectives which determine the exit conditions?

Does each trade only use capital allocated from previous trades?

Ask these questions of each new trade. If  the answers are all affirmative then the trade is well considered and part of a strategic market approach.

If two or more questions are honestly answered  "No" then the danger of over-trading is real. A "No" answer suggests  trading decisions are emotionally driven and this often draws on a need to justify the rewards.

Over-traders do not answer these questions honestly. Our trading actions always give us true answers. The  typical actions below suggest over-trading.
 

The proposed trade is quickly assessed on the basis of gross returns, or the current low with the highest high over the last year.

Position size is determined by how much cash is currently available for trading.

Exit is loosely based on previous highs or gut feelings. Some positions are closed early to free up cash for new, more attractive positions.

Money from other sources, such as your day job, is constantly added so new position sizes can be increased.

Catch yourself doing any of these and you take a step towards over-trading.

Over-trading is avoided when we accept that significant rewards do flow from work that does not involve long hours, stress or sweat. We appropriately value our intellectual and analytical contribution to the process of trading and accept our rewards as commensurate with this. We
understand no additional work is required to justify our income so we use our increased leisure time wisely for some activity other than trading.

First published in Your Trading Edge magazine.

DARYL GUPPY  is one of Asia Pacific's leading writers and speakers on share trading. He is the author of Bear Trading: Strategies for Survival (1998), 'Trading Asian Shares', 'Share Trading' and 'Trading Tactics' and is a frequent speaker at investment seminars and conferences in South East Asia.

He will present an evening talk on Run with the Bulls, Hunt with the Bears! for stock market private investors and traders on June 29, 1998 (7.30pm-10.30pm); and a one day seminar on Trading Shares for Profit for brokers and traders who want to survive in the stock market on June 30, 1998 (9.00am-5.00pm) at Shangri-la Hotel, Kuala Lumpur, Malaysia.

In-house seminar details, contact RAYMA Management Consultants Wendy Song at tel: (03) 7044-666, fax: (03) 7044-484 or e-mail: raymaseminar@po.jaring.my

Search for ANY Book or Author!