Deciding What Kind of Trader You Are

When you're developing an effective trading style, one of the most important considerations is whether you are going to be anticipatory or reactive. 

In general, someone who uses an anticipatory style of trading tries to call tops and bottoms. They will buy weakness and short strength with the hope that the market will soon reverse and that the positions they build up will quickly become profitable.

The reactive trader uses a momentum style of trading. They will stick with the trend until there is an actual change in the price action, at which point they make their move. The thinking is that stocks tend to trend in one direction longer than most people think they will, and that you will make more money by not focusing on the turning point. There may be some losses when the market eventually reverses direction -- but, by then, the investor should have built up enough of a cushion from riding the trend that those losses will be minor in comparison.

Neither style of trading is inherently superior. What works best depends on the individual. Some traders, such as Doug Kass, tend to think in a contrary manner. That makes them much more comfortable with an anticipatory approach. These traders are constantly looking for signs that the market is too stretched in one direction or the other. They are often more likely to rely on macroeconomic and big-picture arguments and tend to become more bearish as the rest of the market grows more positive.

I've always favored a reactive approach to trading. I have found that, when I simply stick with the trend while others constantly debate the potential for tops and bottoms, it keeps me in good stocks that I'm often tempted to sell too early.

A reaction approach works particularly well when the market has a tendency for V-shaped bounces and to become technically overbought. It has been nearly impossible to anticipate when bounces will fail -- mainly because, quite simply, they don't fail. But, over the past few years, the Fed has become only thing that's really mattered, so the logic used to call market tops has been rendered virtually useless.

I bring up this topic because many traders really don't think about it very much. One of the biggest complaints I've heard from traders the last few years is that they always seem to be underinvested. That is mainly caused by being too anticipatory and selling winning stocks prematurely. It has certainly been one of my most common mistakes, and I have to be very cognizant of my inclination to take profits before there is any real sign of weakness.

What works best always depends on market conditions, and the dynamics of the current market have strongly favored those who just stick with the trend and don't anticipate. Keep that in mind as you develop your trading methodology.

At the time of publication the author held no position in the stocks mentioned.