Beware of Your Rat Brain
Research for Online Investors

by John Dalt

The difficulty with trading stocks is the trader's "rat brain". This technical term is part of our psyche going back to Neanderthal Man. Before modern medicine and doctors, any injury could lead to death.  Man lived in fear of danger.  He would run rather than fight.  We are hard wired to avoid conflict or injury. We run at the first hint of trouble, and love to jump on the bandwagon.  These emotions cause traders to buy high and sell low. We get in for the party and try to squeeze out the backdoor when all the drunks are leaving.

The other difficulty in trading stocks is staying with a losing position.  Just like the Neanderthal Man, sometimes we freeze when confronted with danger.  Like an animal, we ignore a problem if unable to escape.  Like a opposum, man would lay still and hope that the preditor would leave him alone.  When you get caught in a trade that goes against you, what do you do?  Do you flee at the first sign of trouble?  Do you ignore your losing position, hoping it will come back?  A trader has to be able to reverse position at the first hint that his trade is in trouble.

Reconciling the emotion to avoid trouble (rat brain) and staying off the momentum party wagon with cool switching of positions when the facts change is a struggle all traders have fought.  Watch the trend of the broader market.  Is the market going up, but your position is breaking down?  Do you have a loser, or is every stock a loser, today?  These questions will help you understand what went wrong, and what you should do next.  IBD tells us to sell when down 7% on any position.  I do not agree.  If the market as a whole is down, your position will come back with the rest of the market.

I am against solid rules for taking losses as much as I am for taking profits.  You have to find what works for you.  Test it over time till you have confidence in your 'system'.  You will find your comfort level on trades.  Remember, you can't win them all.  The smaller your losses are, the easier it is for winnings to overcome them.  In talking to our readers I am convinced everyone talks about being a long term investor, but when a stock is down 30% take a more short term view.

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