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We're Only Human: Part 2

Five mental crutches you should cast off to become a great trader.

Note: In Part 1, trader Jonathan Hoenig shared his insights on how reducing risk means altering the way traders -- rightly or wrongly -- perceive the markets. Here, he continues his thoughts.

It is human nature to expect the near future to mirror the recent past, but it doesn't.

The answer is to remove your bias, and

listen to where the market wants to go

, rather than try to muscle the market into where you'd like it to go. Case in point: Many of last year's top performers, including

Qualcomm

(QCOM) - Get Qualcomm Inc Report

and

CMGI

(CMGI)

, have all but been

destroyed in 2000.

It is human nature to look for outside sources, such as research reports or the news, to validate our own market opinions.

Did

Microsoft

(MSFT) - Get Microsoft Corporation Report

TheStreet Recommends

report bad earnings? Is

Warren Buffet

of

Berkshire Hathaway

(BRK.A) - Get Berkshire Hathaway Inc. Class A Report

looking pale? The answers to these questions can't help your performance. The market might not be totally efficient, but it is efficient enough so that most newswires do little more than take up your screen space.

If you trade off the news, or Wall Street research reports, you are most likely broke, or a few headlines away from the soup kitchen. This is especially true if you are trading the more liquid names during the daytime session, which, as I've said before, offers you no

trading edge. In short, you want to trade ahead of the news, not in response to it.

I would also recommend that once you have taken a position, you systematically avoid following any of the fundamentals, as they tend to impede the proper discipline that good money management requires. When you have a position on, nothing should matter but your profit and loss statement. (Do you disagree? Shoot me an

email!). Research happens before you get into the market. It is truly kill or be killed, and a position moving against me is reason enough to reduce my exposure.

It is human nature to want to be right, but nobody is always right.

The answer is to keep your losers small and admit defeat early. To quote Gordon Gekko, "You win a few, you lose a few, but you keep on fighting."

While I was cautious on

Palm

(PALM)

back in March, I know more than one educated investor who bought the stock north of 70 a share.

Fine.

But if you are long at 70 ... then at 60 ... and 50 ...

and the stock keeps dropping

, and you are not even considering getting out, then you've got a problem with discipline.

The point isn't to be right. The point is not to lose money: Take your losses and reassess the situation. You can always get back in if you still like the trade.

Along with Xantax, I have found that taking small losses is a highly effective way of improving one's sleeping habits. When I am wrong and it's 10 minutes to the bell then

I am out

. Not surprisingly, hoping and praying that I will "get back to even" generally does not work.

It is human nature to feel as if one is playing on the "house's money,"

especially after we've racked up multiple years of double-digit returns. What's a 20% loss when you're still "up," eh? That's foolish. Today's losses don't know yesterday's gains. The answer is to take at least $500 in cash out of your trading account. Get it in small bills, run it through your hands, and carry it around with you for a day. This is real money here, people!

Protecting your gains through some well-placed stop-loss orders is just as important as limiting your losses.

Never let a profit turn into a loss.

It is human nature to confuse one's net worth with self-worth.

Only in recent years have I developed the mental tenacity not to hate myself after a losing day, or think myself a genius after bringing down some bank.

The answer is to approach the markets with humility and respect. After the market's recent correction, I've covered some of my recent short positions and am setting tight stops. After all, in this game you are only as good as your last trade.

Jonathan Hoenig is portfolio manager at Capitalistpig, 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.