INTUITION & HOT TIPS

The discretionary trader uses several sources for his trading decisions. One is intuition, for example, “I see a lot of people in stores, so I think the economy is good, and earning will increase, so the stock market should go up, and I should buy Sears.” He usually spends a lot of time talking to his broker. “What do you think Joe, isn’t Woolworth’s going to turn around?” Another is reading and watching the news, “Retail sales are looking strong and Woolworth’s is closing stores to lower their overhead.”

Hot tips are a common way that a discretionary trader gets ideas. A call from his broker or good friend, or a tip from a discussion at a cocktail party are all places the discretionary trader gets his trading ideas. “Hey George, HTECH Corp. has a hot new product in the works, here’s a stock you can pick up cheap.” If it gets dry in the summer, our discretionary trader may decide to buy Corn, Beans or Wheat. However, when he looks out the window and notices that it’s raining, he sells the position immediately. A news story on the nightly news may cause a discretionary trader to short the airline that has just had a crash.

CRAVES EXCITEMENT

What a discretionary trader loves is the excitement. He loves being “in the markets,” playing with the big guys. He craves the risk, the excitement of trading, and the gambling rush that he gets from calling his broker and putting in the order to buy. He loves being able to sell Gyro Corp. based on the news story of the health hazards of their top selling Gyrometer. He has a real obsession for buying Cotton based on the hot tip from his broker that the upcoming crop report was going to be bullish, and he covets the tip from his friend who called to say that he just bought Techno Corp. because the latest quarterly earnings were going to be a surprise on the upside.

Discretionary traders retain the flexibility of changing their buy and sell criteria from moment to moment, and change they way they trade from minute to minute and day by day. “Well, that last trade was a disaster, so tomorrow I will buy McDonald’s only if it opens up from yesterday’s close.” They don’t have any discipline, nor do they think they need any. They use their intuition and their gut instinct, and feel justified in doing so. They think, “Making money is easy, you just have to be smarter and quicker than the next guy.”

I personally don’t know anyone who has made money by discretionary trading. They may have been lucky and won on a few trades, but overall, over time, discretionary traders always lose money.

It is after enough money has been lost that the discretionary trader in some way stumbles across technical indicators. It may be from the chart book he just looked at where there was a Stochastic Indicator underneath the chart. Or he may have gone to the latest Make a Million Dollars Trading the Stock Market seminar and found out that using the Relative Strength Indicator is the sure way to stock market profits. He thinks, “So this is how they do it!” These indicators look like magic. They add some rationality to an otherwise irrational trading style. He thinks, “This must be how the big money players make the big money—they use technical indicators!”

DISCOVERS TECHNICAL INDICATORS

Once the discretionary trader discovers technical indicators, he or she incorporates some rudimentary ones into trading, usually as additional justification for making the trade. “Not only did Ralph (my broker) tell me to buy Gizmo Corp. but Gizmo has great relative strength. Gizmo’s moving averages are bullish, and the Stochastics are oversold and giving a buy signal as well.”

These newfound technical indicators give the discretionary trader a new lease on trading. Now our trader has a whole new world in front of him—the world of technical trading. For a while, this newfound world combines with intuition and the discretionary trader views himself as a strategy trader. He says, “I trade a strategy using moving averages and Stochastics with a dash of daily news and tips from my broker. I am now a real objective strategy trader.” While the trader may view himself as a strategy trader, this could not be farther from the truth. The discretionary trader’s style is still undisciplined, based on newly educated guesses, and he is probably still losing money.

For a moment, these technical tools were thought to be the answer, and while they add a little more rationale to his trades, the losses continue to pile up. Despite his continuing angst, our discretionary trader is now on the way to becoming a technical trader.