Extreme Trading? Not on Your Life

Trading is not about taking risk -- it's about controlling it. Those who don't understand that are handing us profits.
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Like many others who gravitate toward securities, I am an egomaniacal, opinionated control freak. And when I lose money in the market, it is precisely those character traits that cause most of the loss.

Actually, the point isn't to be right every time, or even to have your winners outnumber the losers. Bought the low on

Qualcomm

(QCOM) - Get Report

? Clean up in

CMGI

(CMGI)

? Big whoop: Save the bragging rights for

Squawk Box

. This is the view -- promulgated by the press in such articles as last fall's

Time Magazine

cover story titled "Why We Take Risks" -- that trading is one of the "extreme sports" now defining our culture. Gimme a break.

In reality, the best traders aren't risk takers, but risk managers. Trading isn't just about taking any risk, but taking

well-calculated risks

. It's about dealing with the very real possibility of being wrong. In my experience, the best traders are those who have no opinions whatsoever. They look for the trend and keep their bets small.

When you get right down to it, trading is a game of money management. The object of the game is not to lose money. When you hold on to a paper loss, you aren't winning the game. Hell, you aren't even playing. So if your methodology consists of "buy-and-hope," I kindly suggest you buy a mutual fund and get a pet. It's cheaper.

I have met countless individual "traders" who have most of their net worth riding on

America Online

(AOL)

solely because they use the service, or -- even more shocking, because they simply "believe in the Internet." (Full disclosure: While I am not short AOL now, I have been in the past 30 days.) Most of them bought the stock, not surprisingly, at north of 80 a share, and now spend countless hours consulting

CNBC

, research reports and message boards asking one simple question: "What happened?"

AOL Goes AWOL

Source: Baseline

What happened, of course, is that they were wrong. When you are long and wrong -- you need to

get out

. There's just no other way to put it. Amateurs nursing paper losses spend far too much time seeking outside opinions to validate their own. Message-board musings are useless

mishigas

. The market is going to do its own thing, and neither you, I,

Cramer

,

Smart Money

,

Abby Joseph Cohen

,

Tokyo Joe nor

Alan Greenspan

have any real idea what to expect.

When dealing with the uncertainty, traders need to have a plan. AOL double-bottomed over August and September of last year. So if traders bought at 88 because the stock broke to new highs in December, they were taking a risk. And, given the tendency for prices to move in trends, I think it was a good one.

But when the breakout wasn't confirmed and the stock began to slide,

they should have been out

. Traders are a gamblers, not masochists. Know when to walk away and know when to run.

A similar example comes from the energy sector. Kudos to the local who bought the first contract for $30 crude oil this week on the

New York Mercantile Exchange

. With media attention focused on that big round number, it took but a single trade at $30 to frighten the shorts into covering. That guy, whoever he was, made headlines around the world --- and he only had to risk one tick. Good trade.

But where do we go from here? If oil doesn't rally, you can bet it will break. If you are long crude, use a stop -- a real stop that is -- to limit your loss. "Mental" stops are as useful for your portfolio as "mental" gymnastics are for your flabby bottom. Put in a stop order and wait. If it gets hit, you can always get right back in.

The ugly reality is that "buy-and-hold" is a strategy largely propagated by the mutual-fund industry, not surprising considering they get paid as a percentage of assets under management. And for most investors with money in a 401k, buy-and-hold works.

The long-term trend of stock prices is clearly higher, and while nothing is guaranteed, we can generally expect that trend to continue over long periods. But for a trader, buy-and-hold just won't cut it. You can't be a trader when you are right and an investor when you are wrong. That's how you lose.

My best months have come when I've stopped worrying about making money and concentrated on not losing money. So with the major indices having already corrected year-to-date, this just might be the year to sell the dip, rather than buy it.

Jonathan Hoenig is portfolio manager at Captialistpig, a Chicago-based hedge fund

http://www.capitalistpig.com. He is the author of Greed is Good, recently published by HarperCollins. At time of publication, the fund was short CMGI, although positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he invites you to comment on his column at

cpmilken@aol.com.