Make sure you know your trading style very well and stick to it

One of the most common mistakes that traders and investors make is that they do not know the trading style that best suits them. The confused traders keep changing their style...sometimes a few times a day.

Put this bizarre practice in perspective, it is similar to changing your job a few times a day!

Yes, your trading style basically defines what kind of trader you are. Imagine, you are a hedge fund manager. Your new fund just successfully closed on Friday evening and you had told your investors that you are a medium term trend trader, i.e. you would hold your position for medium term trends which could last for months.  You also told them that you would never trade against long term trends for short term short selling opportunities.

Then you go into office on Monday morning and you bought 10,000 shares of various blue chip and tech companies for your fund. The stock started climb slightly before going into a free fall. The S&P 500 was down 1.5% that day. You cursed your luck as your fund was down 1.8%.

The bloodbath was repeated again on Tuesday and Wednesday morning. Your fund was already down 5% in the first 2.5 days of trading. You looked at the S&P 500 and read the news. The economic fundamentals appeared intact but there were rumors circulating that the Fed might threaten to increase interest rates if inflation continued. You weighed the possibility of such a statement from the Fed on Wednesady afternoon.

Fearing that your fund will lose further once the annoucement was made, you decided to go against your trading style and principles by short selling S&P 500 futures to hedge your fund from further losses. However, when the Fed did not threaten interest rate increase an hour later, the stock market soared. Your short positions ended up in steep losses and prevented your fund from recovering with the market. You immediately closed your short positions and ended up with 2% realized loss in your fund.

After you closed your short positions, the market began to tank as war in the Middle East broke out. You cursed your luck and angry that you had just closed your short positions, you reactivated the same short positions again.

Then on Thursday morning news broke that USA and Saudi Arabia managed to broker a ceasefire between the warring nations. The stock market rebounded on this good news. You lost another 2% from your short positions. This time, you thought the ceasefire would not last and held on to the short positions. However, the ceasefire did last for a week and during that time your short positions lose you 8% of your portfolio when you closed out the positions.

The bad news did not end there, war again broke out 2 days later and the S&P500 tanked 2% in a day as it coincided with worse than expected consumer confidence report. Your fund lost 10% from short positions and another 5% from your long positions for a disastrous total of 15% loss in less than 2 weeks.

Your boss called you up after clients began to complain and he fired you from the job for not following the fund's trading style which was what investors were looking for when they subscribed to the fund.

The above is a long story. But you have to put yourself in the position of the hedge fund manager. Tell yourself you are hired to manage the funds that you have and you cannot change the trading style of these funds anyway you like.

If you really need to change your trading style, you must do so for an extended period of time after some deep thougths, analysis and practice. Do not take it lightly as changing your trading style from day trader to long term trader by refusing to cut losing positions, or changing from long term trader to day trader by cutting the smallest losses and taking small profits would kill your fund before you realize it.

That's why having a clear and sound trading system is so important.