Two Species of Trader -- Which Are You?

Two Species of Trader -- Which Are You?
By Mike Parnos of Online Trading Academy*
Posted: February 9, 2007


In the wide world of directional trading, two species exist, basically -- trend followers and contrarians. Trend followers take a "hitch your wagon to a star" 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 into 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, they usually discover that the party’s over, and they’re out some money.

Contrarians are a different breed. They believe that when too many people agree on a direction, they're simply confused, don't 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. A number of mutual funds use contrarian strategies to take advantage of the follies of retail traders.

A Contrarian Story
My son is a day trader -- a very successful one. Currently, five other traders are still at the office where he plies his craft. They are the few survivors. Years ago, when the market was hot, four or five day trading offices were thriving 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 a ton of manure, so did the mass of irrational day traders. They only knew one style of trading, couldn't make the adjustment and watched in amazement as they gave back most, or all, of what they had made.

These days, an occasional visitor to the office where my son works is a former day trader named Little Richard. A great guy (approximately 5'6" in height, hence his nickname), he was affectionately known as their "contrarian indicator."

Some people in this world have the Midas touch. Whatever they touch turns to gold. Then, there are those who, whatever they touch, it turns to something you wouldn't 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 approximately 80 percent of the time. Notice that I said Little Richard is a "former" day trader.

Identifying a Trend
Lotsa luck!! It ain't easy. Technical analysis may give you some guidance. But, the question is, once you've identified the trend, how much trend is left? That's 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 an oscillator and, before you know it, the chart looks like last night's 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 and chart reading skills, as well as the self-discipline, of the individual trader. Developing these skills is not like making Minute Rice. It takes time, effort, practice and a commitment.

The market is an unforgiving animal that eats traders for lunch and spits out what little is left. You don't want to take a knife to a gunfight. Be prepared.
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Very good story boss! You hit the nail on its head!!!