This gut-wrenching market volatility certainly brings one's stop loss policy into sharp focus. For short-term trading systems, we use tight stops, but for our longer-term trend trades, we prefer to give them room to breathe. However, if we give them too much room, we can see our hard-won profits disappearing in one ugly week. Our compromise is to tighten our stops as the amount of profit at risk increases. So, for trades below 40% profit, we have no stops at all, just an exit on the moving average crossover. Above 40%, we start to tighten - so up to 50% profit we have a 15% trailing stop, up to 60% profit a 10% stop, and so on.
You have set your stops, and placed them as live sell stop-loss orders in the market. You assume that everything is under control - and then Wham! - the market opens down nearly 4%. The price gaps down, and your stop is not activated because the price never touched your trigger price. What do you do? Well, you don't sit there frozen with fear, like a rabbit in the headlights - this is when you need a plan, one that you have worked out in advance for just such an occurence. You may decide on a different course of action, but here is one plan to get you thinking:
- Compare the price 5 minutes after the Open with the Open price - if it is lower, sell half your holding.
- Compare the price 30 minutes after the Open with the Open-plus-5-minute price - if it is lower, sell the balance. If not, hold on, with the Open-plus-5-minute price as your new stop-loss.
Adjust this plan, depending on whether you can tolerate more or less risk.
If you have an investment earning a certain rate of interest or ROI, the rule of 72 tells you how quickly you can double your money. Just divide 72 by the interest rate or return, and that will give you the number of years. So, for example, the long-term return on investment in U.S. stocks has been 11%. If you invest today earning the same rate of return, you will double your money in 72/11 = 6.5 years.
It's very gratifying to see that the trade we picked using our simple system for beginners making their first trade has returned 10.4% in just 10 days - that's a nice supplement to your day job! For your free report, go here.
Albert Einstein called compound interest the 8th wonder of the world, and he was a pretty smart guy. I certainly wish I'd understood this amazing thing when I was much younger - look at this illustration from the book Street Wise by Janet Bamford: if you want to have $1 million when you retire at 65, and you start saving and investing when you are 50, assuming the stock market's 70-year average return of 11% per annum you would have to save $2,199.30 per year. If you start saving when you are 15, you would have to save only $38.57 per year!
If you're still young enough (not necessarily 15, but early 20's is still good), start saving and investing now. If you're a late starter you're just going to have to save more - but do all you can to pass on the message to your children, grandchildren, nieces and nephews.
Ahhh, it's finished at last! Our comprehensive Glossary of stock market terms is now online. It was a labor of love that gave us a few sleepless nights, but we think it was worth it. Check it out here, and if you find any errors or omissions please let us know, we want it to be the best!
We are passionate about investing. While the market is open, we are excited to watch the performance of our latest stock picks. It's not just the money, it's the fact that we have used our chart-reading skills to select shares that we believe have a higher chance of going up than down. And now we can get our kicks even when the market is closed, thanks to this wonderfully addictive online game from Matthias Wandel. Study the charts, then decide whether to buy, short, or do nothing. Click forward one day at a time, making your decisions for one trading year. Then compare your results with a buy-and-hold strategy. The charts are real, but the name is concealed until the end of the year.
Thank you Matthias - we're going back to the charts!
Many companies offer a low cost way to buy shares, or even parts of shares, directly from them through their Direct Stock Plans (DSP). If you want to save and invest regularly, this is the best way to do it while avoiding the excessively-high brokerage fees on small lots. These same companies will normally offer a Dividend Re-investment Program (DRIP), where dividends are not paid in cash but are instead used to buy shares or parts of shares - this allows the power of compounding to work its magic over time.
The site below seems to be a good resource for information on participating companies: http://www.dripwizard.com/home_dripsearch.asp
I'm sure I'm preaching to the converted, but here goes. Don't even think about beginning investing if you have unpaid credit card balances - pay off the cards first, then start investing. The reason is that the card companies unfailingly charge you 18-24% interest on your unpaid balances. You have to be a very astute investor, or just have a lucky break, to make a 20% return on your investments as a newbie. So, it doesn't make sense to make, say, a 10% return on your investments, but pay 24% on your card balances - please pay off the cards first!
Are you an investing sinner? The chances are good that if you are a beginning investor, the answer is yes. First, let me define what I mean by beginner. Trading is a profession just like any other, and all professions have a learning period. How long that period is will depend on the individual, and the amount of time they devote to trading each week, but it would not be less than three years.
Now let me enumerate the 7 Deadly Trading Sins:
1. No trading plan
As Yogi Berra said, “If you don’t know where you’re going, you might wind up someplace else.” How will you know if you are achieving your trading objectives if you haven’t defined them? A plan gives discipline to your trading, and stops you acting on impulse. If you can’t find the time to sit down and write your personal trading plan, you shouldn’t be putting your capital at risk.
If you are going to make a serious attempt at learning how to make consistent profits from stocks, you need a reasonable starting capital. Opinions vary as to the exact amount, but I would say you need a minimum of US$20,000. If you have less than this amount, you may be forced to risk a larger percentage of your capital on each trade, and three or four losses in a row could deal you a blow from which it is hard to recover. For example, if you lose 50% of your capital you need to make a 100% return to get back to where you started.
As a beginning investor you may feel that you have to be in the market all the time, and feel uncomfortable having your trading capital in cash. However, the fact is that this is often the most sensible place to be. Jessie Livermore, the legendary investor from the early 20th century, said, “It never was my thinking that made the big money for me. It always was my sitting.” So remember patience is a trading virtue - if there’s nothing suitable to do, do nothing!
4. Ignoring stops
Whilst researching this article, I went back to my earliest trading journals to see the most frequent mistakes I made. There was one clear ‘loser’ which cropped up again and again, usually accompanied by capitalized exhortations to myself to ‘ STOP DOING THIS’, and that was ignoring stop losses. If you are a beginning investor, I would be surprised if this is not also a frequent sin for you. The reason it’s so difficult to act on the stop, and sell the stock, is that selling crystallizes the loss and proves you ‘wrong’ – you hope that if you hang on a bit longer the stock may recover. If you do this, you are breaking the cardinal rule of trading, to ‘cut your losses and let your profits run.’ When you can take a loss with the same emotion as taking a profit, you can feel you have made great strides in your learning curve as a trader.
5. Emotion-driven trading
To trade well, you need to be able to concentrate and focus. This means that if, for instance, you’re feeling unwell, or have just had a big argument with your partner, it may be a good idea to put trading on hold for the day. It’s commonly acknowledged that stock trading is driven by two dominant emotions, fear and greed, but there are many other undesirable emotions that may come into play. We’ve already discussed boredom, which may cause you to overtrade. Anger after a trade goes against you may cause you to seek revenge. Pride after a series of wins may convince you to risk more than normal. None of these emotions is helpful to your trading. Be like Star Trek’s character Spock – his imperturbable Vulcan attitude will serve you well!
6. Strategy pinball
Are you still searching for the Holy Grail? Beginning investors tend to believe that there is a secret to profitable trading, and if they can just find that secret the money will roll in. So they try System A, until it produces three or four losses in a row, then they switch to System B, until the same thing happens again. It’s rather like switching checkout lanes at the supermarket – whichever one you pick, the other one always seems to perform better! When you find a system that feels right to you, and that you have back-tested through similar market conditions to confirm that it has an edge, don’t be too quick to abandon it. Realize that losses are just a normal part of trading, and not a reason by themselves to abandon a system.
7. Value judgments
Beginning investors tend to attach a value to a stock, sometimes in reference to a recent high or low, but often by referring to their purchase price. If the price of one of your stocks falls, do you now think that it’s ‘cheap’? If a stock you’re considering buying goes up by 5%, has it become ‘too expensive’ for you? The only relevant measure of value is the price – this is what the market thinks the stock is worth. Thinking the market is ‘wrong’ can lead to some expensive mistakes – the market can stay irrational longer than you can stay solvent!
If you can eliminate these 7 deadly sins from your trading, your consistency and profitability should dramatically improve. Happy trading!
Copyright © 2011 Mick Brooks
Copyright © 2018 Mick Brooks