TheRumpledOne
6,411 posts
msg #70594
- Ignore TheRumpledOne |
1/12/2009 8:22:22 AM
In my inbox...
Where have I heard this before? LOL!!!
Trading Is Simple (But Not Easy)
Stockscores.com Perspectives for the week ending January 11, 2009
Trading is simple, but it is not easy. Let me begin with the simple part, here are some rules to help you make profitable trades:
1. Buy stocks that the buyers are in control of. Short stocks that the sellers control. If the bottoms on the chart are rising from left to right, the buyers are in control. If the tops are falling from left to right, the sellers are in control. Look at a one year chart to see the tops and bottoms but make the judgment of who is in control by focusing on the last two months of trading.
2. Understand the reward of the trade. The distance from your entry up to the next level of resistance is the reward potential, although there are no guarantees that prices will get to that level or stop at that level. Resistance is defined by the tops on the chart, the point in the past where the stock stopped going up and started to go down. For short sell trades, reverse everything.
3. Understand the risk of the trade. The distance from your entry down to the next level of support is the risk potential, although there is no guarantee that the stock may not gap through the support price leaving you with a bigger loss than expected. Support is defined by the bottoms on the chart, the point where the stock stopped going down and started going up. For short trades, reverse everything.
4. Only take trades where the expected value is positive. If the reward potential is twice the risk and the probability of succeeding is 70%, then you have a trade with a positive expected value. A trade that only has a 10% chance of working could still have a positive expected value if the reward potential is 10 times what the risk is.
5. Always exit losing trades when the market tells you to.
6. Only exit winning trades when the market tells you to.
7. Never add to a losing trade. If you are losing, it means you did not interpret the market's message properly.
8. Don't chase trades that are running away from their trend lines.
9. Write down a trading plan so you have a set of rules for entry, exit and managing risk.
10. Never think that you are smarter than the market, the market will take your money whether it is right or wrong.
Despite the apparent simplicity of trading well, we somehow find a way to make mistakes. It is part of being human to feel emotions that cause us to break our rules and deviate from our plan. Here are some of the reasons we complicate the simplest of trading plans.
1. Fear of losing money - it is natural to want to avoid losing money in the market since we are each programmed to avoid the pain of loss. However, since the stock market can not be predicted 100% of the time, it is inevitable that we will make losing trades. If we avoid crystallizing those losses when the market tells us that we are wrong we often see manageable losses grow in to losses that overwhelm our portfolio's overall return. Good traders know when the market has proven them wrong and takes the loss.
2. Fear of missing out on opportunities - it is easy to remember the trade that got away, that trade that we thought about entering which then went on to be quite profitable. The pain of missing out on a winner makes us worry about feeling that pain again and makes us more likely to take marginal trades, those that really don't fit our trading plan. Instead of trading what is probable, we trade what is possible.
3. Focus on information that makes us happy - there is a tendency to filter out information based on what our emotional response is. A trader who owns a stock will focus on the positive news, the positive signals in a stock chart and often miss out on the signs that tell them the trade is destined to be a loser. It is best to always consider the other side of the trade and what is motivating people to sell when you are buying and buy when you are selling.
4. Desire to prove our intelligence - most people want others to think they are smart. As traders, there is a risk of trying too hard to make an intelligent and insightful argument for why a trade is worth taking. The market often acts in illogical ways but no individual can convince the market with intellect that is wrong.
5. Desire to escape from pain - it is not fun to lose money in the market and the pain that we feel when that happens can affect our future decisions. We want to get rid of the painful feelings and may take marginal trades to try and gamble our way out of our losing positions. You must avoid taking trades motivated by the desire to erase previous losses.
6. Greed - money may not be able to buy happiness but it certainly helps. It is easy to think about the freedom that money affords and what it can buy and let those desires determine their trades. It is important to make decisions based on your trading plan and not on what you want.
7. Myopic outlook - it is natural to only look at the last trade or what is happening now in the market. Good traders look at the big picture, both in terms of what is happening in the market but also in their own performance. Do not judge your success one trade at a time.
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