Assess Your 2004 and Improve Your 2005

If this is the case, you've just matched your trading performance to the market indices. Unfortunately, this means you're vulnerable to a major drawdown as soon as the market stops going up. In fact, it's likely you'll lose money on the next downturn because this performance curve fosters an egotistic psychology.

There's a good chance this rally is making you feel smarter and more powerful than you really are. Of course, everyone wants to be a gunslinger, and the late-year run has supercharged this fantasy for many weak-handed traders. But the adrenaline-soaked market is also putting on the blinders and setting them up for a fall in 2005.

There's nothing personal in this admonition. It just describes the same psychology that caused a nation of overnight millionaires to lose everything after the bubble burst. Or consider how you started out in 2004, because the same dynamics probably will kick into gear early next year. As they say, don't confuse brains with a bull market.

The market was on a tear through most of 2003. This encouraged traders to become very aggressive at the start of 2004. The indices rolled over in the middle of January, entering a long consolidation period. But a majority of traders kept chasing the falling market and got their clocks cleaned. Were you one of them?

It's not difficult to recognize the warning signs of yo-yo performance before it slams your trading account. Start by looking back at 2004 and asking yourself these questions: Were you too short or just plain panicked in the middle of May? Were you heavily long and an emotional bull at the beginning of July?

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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. At the time of publication, Farley did not have any positions in any of the stocks mentioned in this article, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback and invites you to send it to [e-mail]. 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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