Traders, Here's Your Reality Check

January is shaping up to be a solid month for me, but it's been a roller-coaster ride all the way. I'd sure like to enjoy more of the ups -- and avoid the downs -- as the year progresses.

There are just two things traders must do to make money in 2006:

1. Take advantage of the low-hanging fruit when it appears.

2. Don't throw money away on bad positions the rest of the time.

Good opportunities come in cycles. Successful traders recognize that 80% of their yearly profits are booked in just 20% of all trading days. Unfortunately, this mathematical truth stands in direct conflict with our overpowering urge to be in the market at all times.

And it doesn't take long to get fooled into believing we're smarter traders than we really are. What happens after most of us break a nasty losing streak, through luck or chaos? The few wins go right to our heads and trigger another round of losses.

For a good example of low-hanging fruit, look at the perfect triangle ground out by the biotech company Pozen (POZN - commentary - Cramer's Take) last week.

This well-formed bull pattern set up at exactly the same time the major indices were nearing a major selloff. A tight stop-loss supported a long position with very little risk and excellent reward potential.

Perhaps we all need a reality check right now. Let's start with the obvious. Did your performance in the first three weeks of 2006 live up to your expectations? If not, it's time to ask a series of questions.

Did you show good results over time last year, and if so, how much time? Is it possible that you caught one or two rally waves but didn't plan for a market that acted differently from your expectations?

Go back and look at every year since the bubble burst in 2000. Each set of 260 or so trading days required a different approach to make money. It seems that Mr. Market reinvents himself every January, and the only way to prosper is to play his new game successfully.

Also, examine when you made money in 2005, and when you lost it. Did you book big gains during index rallies and then lose it all during index selloffs? If so, you're chasing the market around with little discipline, exposing yourself to major losses on each downturn.

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Alan Farley is a professional trader and author of The Master Swing Trader. Farley also runs a Web site called HardRightEdge.com, an online resource for trading education, technical analysis and short-term investment strategies. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback; click here to send him an email. Also, click here to sign up for Farley's premium subscription product The Daily Swing Trade brought to you exclusively by TheStreet.com.

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