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Traders Greed Fear

Greed and Fear: Enemies of Stock Trading Discipline

By Dr. Winton Felt

 

Greed will destroy the discipline of a stock trader.  Greed’s partner is fear.  Fear also works against a trader’s discipline.  Discipline is about balancing the relationship between expected gain and potential loss.  It is also about keeping fear and greed under control..

This writer once had a lengthy conversation with a friend who was working at the same brokerage firm.  His specialty was the futures markets.  He had a television show and liked to read his script to me before going on the air.  On one such occasion, I commented that I had heard that 80% of those who invest in the futures markets lose all their money.  I asked if that were true.  He said that it was definitely true.  “Why do you think I have a television show?  It’s because I am in constant need of replacing clients who lose all their money.”  I asked him why he does it.  “Doesn’t it bother your conscience?”  “Of course it bothers me, but I don’t know how to do anything else,” was his reply.  He said he knew of no other way to make a living, and he was too old to learn a new profession.  On television, he talked about the potential gains possible to those who play the futures markets.  The leverage available in those markets made it possible to double your money in a few days.  Of course some of his clients came out way ahead on some trades.  However there were also offsetting losses.  I have talked with people who watch such programs.  They tend to scorn returns that are less than 100%.  The stories told on television are intended to appeal to the viewer’s greed for quick gain.  The stories seem to accomplish their purpose.  The problem is that in their attempt for quick gain, investors usually do not adequately guard against loss.  It takes considerable discipline to use great leverage and still accumulate greater gains than losses.  To do that, one has to pay even more attention to the risk of loss than to the prospects of gain.  Greed does not permit that.  Greed focuses on the potential gain rather than on the potential loss.  The smart investor always looks at the potential loss and has a strategy that will protect against that loss.  Otherwise, he will look elsewhere for another opportunity, one with manageable risk.

Another individual I am aware of heard about Genentech’s “Tissue Plasminogen Activator” (TPA), a thrombolitic drug Genentech was able to manufacture by using gene-splice technology.  Before this technique was perfected, the only source of TPA was human cadavers and only in very small amounts.  There were over 500,000 heart patients a year who were candidates for the drug and it was projected that Genentech could charge at least $1000 a dose.  TPA was going to be a billion-dollar a year drug, and Genentech held the patents on the manufacturing process.  This person spent close to $100,000 to buy call options on the stock because TPA was under review by the FDA, and approval was almost certain.  After all, TPA was not foreign to the human body.  It was naturally created by the body but in very small amounts.  The FDA did not approve TPA.  Instead, they wanted more data.  The individual’s options plummeted from a high value of about $135,000 to nearly $0.  This individual thought it was his chance to make it big in a short time.  It was almost a sure thing.  The story behind the trade was incredible.  Again, it was greed for gain that caused him to take a much larger position than prudence would allow. This is also an example of a “story stock.” Greed enhances the attractiveness of the story.  The traders at stockdisciplines.com have learned to avoid story stocks.  Why?  The “story” causes a person to ignore clear sell signals, because the investor believes in the stock.  In other words, the “story” destroys discipline.

One individual bought Qualcomm and watched his stock run to a pre-split price of $800 a share.  It then started to decline.  He knew something about support and resistance lines so when it fell below support, he was prepared to sell.  However, a major Wall Street analyst said that it would be a big mistake to sell and that the stock should reach at least $1000 per pre-split share (the stock was expected to split 4 for 1).  The investor held.  The stock kept falling.  Once again this individual was prepared to sell.  Then the analyst again said it would be a mistake to sell and that investors should keep holding.  That is what he did, because he was afraid to lock in such a big loss and because the analysts assured people that they would be rewarded for holding.  Fear of loss, made his loss greater.  The stock declined until it reached a pre-split price of about $100.  The fact that he listened to someone else means he feared to rely on his own discipline.  He should have sold when he first intended to, regardless of what the analyst said.  The analyst was later cited for securities fraud.  It does not pay to depend on someone else to tell you when to sell.  You must take responsibility for your own actions.  

Greed and fear are the enemies of discipline and either one will destroy discipline if allowed to do so.  Each individual has the freedom and the responsibility of deciding whether discipline will prevail.