Contributor Since 2009
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.
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, $200 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.
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.
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.