The Compulsive Impulsive Trade

Feb. 04, 2011 12:35 PM ET
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Contributor Since 2009

Frank started market timing in 1982 when the Federal Reserve cut interest rates and sparked the 1980’s bull rally. Realizing that this rally could have been forecasted, he began to search for indicators which had similar forecasting ability. Within a year, his first newsletter was launched, “Growth Fund Strategies Report” which used a market timing strategy consisting of changes in interest rates, Fed changes, Market breadth and market price (using the S&P 500 Index). The strategy was hugely successful and issued a major sell signal on September 10th, 1987, just five weeks before the market crash on October 19th. In 1996 his first market timing website was launched. “Market Timer Report” used a refined strategy to market time the general U.S. stock market, and followed a variety of growth stock mutual funds. It was geared towards more conservative mutual fund investors and averaged only one to two switches a year. By the end of the 1990s, the strategy was refined to one that followed market trends instead of using interest rates and breadth on which to base market timing decisions. Because trend following never missed major trends trends, and those trends which failed resulted in minimal gains or losses, it became apparent that this was the better way to profit in what was quickly becoming a hugely overbought stock market. The bear market of 2000 through 2002 generated substantial “bearish position” profits by following trends and Frank began using Fibonacci support and resistance levels to look forward and help identify trends. In 2002 we changed the name of our timing service to FibTimer.com (live link) to better identify ourselves to prospective subscribers. We also began the process of adding new timing strategies, using our trend trading systems to develop both aggressive market timing strategies as well as conservative market timing strategies. In time we added sector fund timing, gold fund timing, bond fund timing and small cap fund timing. In 2003 we expanded to ETF timing strategies as well as starting a portfolio of individual stocks. All using our trend following systems to time the markets. Frank is currently the editor and chief market analyst of FibTimer.com, as well as president of Market Timing Strategies, Inc.

The Stereotype

We are all familiar with the stereotype of the compulsive trader. Traders who are compulsively looking for trading thrills, while telling themselves they are doing it to make a profit.

The rush of adrenalin that comes from making the "big" trade and then watching to see if it is followed by a "big" win.

It is not so different from betting at the race track.

It is far removed from what is required for successful market timing.

Compulsive impulsive market timers take trades because of emotional responses to news events, market rallies, or market sell offs, because they "feel" they know what is going to happen next in the markets.

They take trades not because the trade is required, but for the thrill of the trade itself. All risk controls are ignored, no logical trading strategy is followed, and no exit strategy is prepared ahead of time.

Of course anyone can act impulsively at times. But in the investing world, impulsive trades are almost always losing trades. And compulsive impulsive trading, can lead to outright ruin.

Delaying Gratification

An interesting test was run to measure a person's impulsive tendencies:

Participants were asked to decide between taking an immediate, small monetary reward (that is, $100 right now) or a larger reward given later, $500 in six months.

Impulsive people tended to take the smaller, immediate reward. They have difficulty delaying gratification. They can't wait for the larger reward. They want what they can get as soon as possible.

Even disciplined people can act impulsively when the conditions are right.

There is little harm in impulsively going for a latte instead of your usual morning coffee, black with two equals.

Yet while some impulsive decisions may have little effect on one's life, impulsive decisions when trading the stock market can have major negative consequences.

Compulsively Impulsive

Trading (market timing) requires that investors clamp down on emotional impulsive behavior. Market timing is possibly "the" perfect example of unemotional, non-compulsive and non-impulsive planning. Timers look far ahead in time, planning for gains that may not be realized for months. If in cash during a bear market, actual profits may be postponed years.

Instant gratification is the exact opposite of what market timers must expect. Those who think that long term buy-and-hold investors hold the edge in long term planning are not correct. It is market timers, following a plan that takes years to unfold but offering gains far in excess of a simple buy-and-hold, who have the real long term strategy.

Conclusion

Compulsive traders will have great difficulty being successful (profitable) market timers. Market timing is the non-compulsive execution of a planned strategy, that can only be successful over time.

Impulsive traders will have great difficulty being successful (profitable) market timers. Market timing requires adherence to a trading strategy that requires trading not when you feel the urge, but only at specific points in time when your trading strategy tells you to do so.

Compulsive impulsive personalities face many difficulties. But in investing, be sure to hold those impulses at bay if you want to successfully beat the markets.



Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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