U.S. Markets close in 1 hr 7 mins

The perils of overthinking the market

David Russell (david.russell@optionmonster.com)

"The Gods Must Be Crazy" is a great 1980 film that contrasts the frenzy of modern existence with the calm of African tribal life. In one of its very first scenes, a woman turns to the main character and asks, "Does the noise in my head bother you?"

The point, of course, is that some people get more than a little deranged stressing about their careers, relationships, and other driving forces in their lives. So many things compete for attention and pull their minds in conflicting directions that pretty soon they don't know which end is up.

While we might not hear voices or howl at the moon, you might not know it if you look at our trading decisions. And I'll be the first to admit when I should be wearing the straitjacket.

Consider my actions back on July 25, when the S&P 500 was doing everything I wanted and expected it to do. It was holding support at its 50-day moving average and making yet another higher low . It was also demonstrating a pattern of light volume on selling and heavier volume on buying.

How did I respond to all these positive conditions, which should have told me to put more capital to work? I exited some long positions in indexed products and missed the subsequent rally.

So what happened? I thought too much. I considered all the bad things that could happen, rather than the good things that were happening. And while all this imagination may have been engaging, it cost me a 5-10 percent gain in the value of my portfolio.

Going through this several times now, I have come to realize that my head tells me to do one of two things. On one hand, it invents bogus reasons to exit valid longs. On the other, it encourages me to ignore bad price action in stocks I own.

"Don't worry about it. Sell it later," the voices tell me as my positions erode.

I have found that when I sit back and dispassionately analyze the S&P 500, I am almost always right. The problem is following that assessment when trading is underway and things are moving. That's when I start thinking that I know better, and I usually wind up losing money.

In sum, we need to separate strategic decision-making from executing trades. It's easier said than done, but there are many ways it can be accomplished.

One way to recognize the pattern is that it just doesn't feel right. Those annoying voices in our heads don't want us to succeed, so they will try to make us uncomfortable with our decisions.

Case in point: One has recently emerged on researchLAB, with stocks making higher highs and higher lows while the secular babyboomer growth story makes a lot of sense. I'm talking about funeral-home companies such as Service Corporation, Steward Enterprises, and Carriage Services.

It might not feel right because no one is talking about them, but the charts look good and they could make a lot of sense as long-term investments.

(A version of this article appeared in optionMONSTER's What's the Trade? newsletter of Aug. 8.)

More From optionMONSTER