This statement may sound paradoxical… it is intended to. It only applies to active traders, so if you are a long-term investor who doesn’t time the market, you can skip this article.

[Editor’s note: Read another story by Dr. Kenneth Reid: The Five Trader Personality Types—Which One Are You?]

For the rest of you, bull markets are a slippery slope psychologically, because the dangers lurking within are well-hidden. If you remember the Roaring 90’s, it was difficult to lose money. The average trader/investor profited by simply holding on to random positions long enough.

One could buy impulsively and eventually feel like a genius.

What was wrong? What was dangerous? Well, the blow-off rally created a psychological state of over-confidence in a large number of market participants; an unjustified over-estimation of their trading/investing ability.

Then The Game Changed

Once the bull market ended, many ‘genius’ traders lost their shirts in the ensuing 2-year downtrend, because the one so-called ‘skill’ that they learned during the Bull market (buy anywhere and then wait patiently to sell higher) did not work during the Bear.

In fact, the opposite rules applied: sell high and wait to cover the short almost anywhere. Few 90’s traders even knew about short-selling and virtually none had any practice with it. So they found themselves at a gunfight with only a knife. And a dull one, at that.

We are in a similar market environment today as the upswing of the 1990’s and who knows where it will stop. The longer it lasts, the more traders get conditioned to hold through all drawdowns, because their experience suggests that the market will eventually come back… in a few hours or days or weeks. And they have been rewarded for that belief, so it’s been strongly reinforced.

Thin Ice?

The truth of the matter, however, is that strong Bull markets excuse sloppy trading methods because no one gets held accountable. Long-term success as an active market participant, however, is all about assuming risk; but not vague risk… risk that is always pre-defined. There needs to be a point at which one admits one is wrong. Otherwise, you are playing Russian Roulette with the Market and you are the only one spinning the chamber.  

Don’t think for a minute that trading without proper risk controls is due to being stupid. It’s human nature… male human nature to be precise. Research shows that men are twice as likely to make all-or-nothing bets as women. Nobel Prize economists (all male) blew up several large hedge funds in the 1990’s doing just this because they just couldn’t conceive of being wrong. A statistical ‘black swan’ ate their lunch.

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To find out whether you have a healthy attitude toward risk you can take my free risk profile by filling out a short form.  Afterwards, you may also contact me for a free 15-minute consultation to discuss your results. Traders tend to isolate. If that’s true for you, you might benefit from a chat with another trader who understands trading psychology. And there’s never any obligation.  —Dr. Kenneth Reid, Daytradingpsychology.com