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Educational Article

Two Species of Trader - Which Are You\?

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In the wide world of directional trading there are basically two species trend followers and contrarians. Trend followers take the hitch your wagon to a star kind of approach. When they see a stock moving in a particular direction, they figure that someone smarter than they are must know something. So, they jump in the fray and hope for the best. Whether they profit or not depends largely on when they have this epiphany. If they get in early in the trend, they may make a few bucks.

If they come late to the dance, all the pretty girls are already dancing and the song is almost over. So, you either dance with a Linda Tripp look-a-like -- or you go home. Youve lost your pride, the cover charge, and then some. A few stiff drinks may make your Linda Tripp look like Brittany Spears, but when you sober up, the reality is there (ugghhh), and your money is still gone.

Contrarians are a different breed. They believe that when too many people agree on a direction, theyre simply confused, dont understand the situation and are in for a rude financial awakening. Contrarians believe that an overwhelming majority of retail traders tend to buy high and sell low.

Instead of jumping on a bandwagon (trend), contrarians try to determine when the euphoria will end and then short the herd of traders who will be scrambling to get out. There are a number of mutual funds who use contrarian strategies to take advantage of the follies of retail traders.

A Contrarian Story

My son is a daytrader a very successful one. At the office where he plies his craft, there are currently five other traders. They are the few survivors. Years ago, when the market was hot, there were four or five daytrading offices in metropolitan Detroit. Each office had 15 to 20 traders, plastered to computers, making money hand over fist. But, remember, that was in the day when monkeys throwing darts at the Wall Street Journal stock pages outperformed analysts and an embarrassing number of professional traders.

When the irrational market hit the wall and fell like ton of manure, so did the mass of irrational daytraders. They only knew one style of trading, couldnt make the adjustment, and watched in amazement as they gave back most, or all, of what they made.

An occasional visitor to the office is a former daytrader named Little Richard. A great guy, about 56, he was affectionately known as their contrarian indicator.

There are some people in this world who have the Midas touch. Whatever they touch turns to gold. Then there are those who, whatever they touch turns to something you wouldnt want to step in. Well, Little Richard was the latter.

Whenever Little Richard would enthusiastically announce that he just bought 500 shares of XYZ stock, the other traders in the office would immediately short XYZ stock. It worked about 80% of the time. Notice I said Little Richard is a former daytrader.

Identifying A Trend

Lotsa luck!! It aint easy. Technical analysis may give you some guidance. But, the question is, once youve identified the trend, how much trend is left? Thats the $64,000 question.

Look at the trend line. The steeper the trend line, the more powerful the trend may be. Some traders look for crossing moving average lines or other momentum indicators.

Throw a few support and/or resistance lines on the chart. Then, add some moving averages. Toss in another an oscillator and, before you know it, the chart looks like last nights spaghetti. A good knowledge of technical analysis can make some sense of it. Some say it gives traders an edge.

Both the momentum and/or contrarian approaches can work. It all depends on the trading skill, the chart reading skills and self-discipline of the individual trader. Developing these skills is not like Minute Rice. It takes time, effort, practice and a commitment. The market is a non-forgiving animal that eats up traders for lunch and spits out what little is left. You dont want to take a knife to a gunfight. Be prepared.

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Hey, this is good stuff - especially if you're serious about learning options. The Pulitzer people won't likely be knocking at my door soon, but I've taught a lot of people how to conservatively and consistently make money - and they're still making money to this day. I hope you'll become one of them.

Who Is This Guy? --

Mike Parnos has "been there and done that" - plenty! Known as the MasterTater and "Options Therapist," Mike has been writing the profitable and popular Couch Potato Trader column (for OptionInvestor.com) for almost five years. Hes been trading, consulting and teaching option strategies for over 12 years and now manages a hedge fund. Both individually, and through his writings, Mike specializes in teaching conservative and non-directional option strategies while providing therapeutic guidance to thousands of individuals, brokers and institutional traders. Have questions? Contact Mike Parnos at Contact Support.

For serious option traders, Mike also offers a comprehensive advanced two-day seminar covering many fascinating and profitable non-directional strategies.

Over the years, he has learned from his mistakes, and the mistakes of others, and he's here to share his wisdom with you. "Trading is as much psychological as it is skill," says Mike. "Keep an open mind. You never know what might find its way in there."
 

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