Trader's Thread 02 (Jan 09 - Mar 10)

Re: Trader's Thread (Jan 09 - Oct09)

Postby winston » Sun Aug 16, 2009 8:24 am

Complexity -- by Bill Kraft

One observation I have made over my years of trading, coaching, and conducting seminars is that there seems to be a conception among many retail traders that trading and trading plans need to be complex. I couldn't disagree more. I have found that using simple, basic methods, one can be quite successful.

I have often said, and reiterate here, that good trading is simple, but that does not mean it is easy. Doing the simple things can be difficult. Difficult because we tend to have fights with ourselves. We may have some specific entry strategy, for example, but fail to make the entry because we decided to wait for more confirmation and by the time we see enough confirmation to satisfy ourselves, we have missed the trade.

Several years ago, a couple who had attended a series of my seminars asked if they could spend some time with us on Hawaii while we were over there so they could see exactly what I did in my own trading. These folks had a great knowledge base and knew quite a number of strategies. I spent the better part of a day one Sunday with them, looking for some candidates to trade the next day.

During that time we found 4 or 5 candidates upon which we agreed and discussed entry the next day provided they did not reverse direction. We also agreed to meet the next morning and walk the beach. Since Hawaii is so far west, the markets open quite early and around 4:30 A.M. Hawaii time, I placed three of the trades we had discussed. Later in the morning we met and as we walked the beach, I asked these folks which trades they had entered. I was shocked when they responded: "None of them."

After having spent the greater part of a day trying to help them find some entries, I was really curious why they hadn't entered even one. They told me they were looking for more confirmation. By the time we got back from our walk, they had gotten the confirmation, but with a strong market, it happened that they missed all the trades. Fortunately, I was able to close all of mine within a few days for a nice profit.

The principle I had tried to show them was to find an entry with an adequate potential reward to risk ratio and an exit that would take them out with a small loss if the position moved against them soon after entry. By the time they had what they considered to be confirmation, the reward side of the reward to risk equation was much less than we had seen on Sunday and the exit or potential loss was much greater than it had been had they entered as we had discussed. The entry concept was simple, but, for them it certainly wasn't easy.

Clearly, these people believed that by waiting for what they considered to be confirmation they thought they would be entering a "safer" trade. Tain't necessarily so. Could they have entered after seeing their confirmation and still seen the trade turn immediately against them? Of course that could happen. No one can know the future and some general market or stock specific news could have triggered a reversal. What then would have been their situation? If they were using the disciplined exit they had already pre-determined on Sunday, the loss would be greater since the stock had to move to achieve the "confirmation" they required. In this situation, the complexity was the addition of a requirement of confirmation after they had already seen an entry that would work.

These folks are not alone. I have often seen retail traders jump from strategy to strategy each time they are exposed to something new evidently believing that there is some secret holy grail of trading. If there is, it isn't jumping from strategy to strategy.

Anyone who believes that added complexity can bring the answer might want to review the Long-Term Capital Management debacle. Long-Term Capital Management was managed by sophisticated and bright professionals; it had two Nobel Prize winners on its advisory staff and a complex plan using modern finance theory. In spite of the complexity, it not only failed, but nearly brought down the U.S. if not the world financial system (years before the current bailout issues).

The answer, I believe, is in learning how to cut losses and let profits run. Though I have discussed these critical concepts in "Trade Your Way to Wealth" and "Smart Investors Money Machine" as well as in numerous articles over the years, a subscriber recently suggested that I keep tossing the notion out as a "tease" and further suggested that it would be helpful if I could give some guidelines on how to do those things. I agree.

I am currently preparing a short series of articles that should begin around the end of the month in which I will try to do exactly that -- try to give some guidance on how a trader might go about cutting losses and letting profits run. Again, the concepts are quite simple, but as with so many things in trading, not necessarily easy.

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Re: Trader's Thread (Jan 09 - Oct09)

Postby kennynah » Sun Aug 16, 2009 6:47 pm

Journal Entries

while it is useful to record all trades and related issues pertaining to trading into a journal on a daily basis, i also find it very useful logging down trading thoughts and lessons of the past week, over the weekends...

personally, i aspire to spend some time on sundays, alone, doing this task.... it reminds me to avoid mistakes and reinforces good practices....

do you do this and has it been useful to you?
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Re: Trader's Thread (Jan 09 - Oct09)

Postby winston » Sun Aug 16, 2009 7:08 pm

Yes, I try to do an After Action Review on each trade:-
1) What did I do wrong and should not do in the future ?
2) What did I do right and should continue to do in the future ?

Also, I try to survey the landscape, once every 2 weeks, normally during the weekends and put my thoughts together ..
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Re: Trader's Thread (Jan 09 - Oct09)

Postby winston » Wed Aug 19, 2009 6:31 pm

Dr. Bob Rotella is a famous sport psychologist for professional golfers (including Padraig Harrington). Recently he wrote an interesting article in Golf Digest offering 10 Rules to help golfers achieve better performance. The concepts outlined there are as helpful to a golfer looking to win as it is to a trader looking to achieve peak performance in the market.

Rule 1: Believe you can win. If other traders can do well in the market, so can you. However, if you don’t have enough courage and confidence in yourself, you will never achieve success. The events over the past year have tested many people in this regard and some now think the game is rigged against them.

Nothing could be farther from the truth as opportunities remain. Those who will win in the markets first start by believing they can do it. Then they back up that strong belief with serious hard-work and determination to find their trading edge. However, it starts with you first having faith in yourself.

Rule 2: Don’t be seduced by results. You must stay in the present and focused on executing each trade to the best of your ability. Don’t let yourself think about how much you’re going to win (or lose) in the market or how great of a trader you are or not, but instead focus on what matters most - each and every trade you make. Do that and the results will take care of themselves.

Rule 3: Sulking won’t get you anything. The worst thing you can do for your prospects of winning is to get down when things don’t go well. If you start feeling sorry for yourself or thinking the trading gods are conspiring against you, you’re not focused on the next trade. Good traders readily accept their mistakes and move on to the next trade. They don’t let one bad trade carry onto the next one.

Rule 4: Beat them with patience. Every time you have the urge to make an aggressive trade, go with the more conservative one. You’ll always be OK. The moment you get impatient, bad things happen. In tough markets, stay patient and let others beat themselves.

Rule 5: Ignore unsolicited advice. You’ll have lots of well-meaning friends and experts who want to give you advice. Don’t accept it. In fact, stop them before they can say a word. Their comments will creep into your mind when you are trading and conflict with your own strategy. If you’ve worked on your game, commit to the plan and stay confident with it.

Rule 6: Embrace your personality. The key is to find what works best for you. There are many approaches out there, but there is only one trading approach that will utilize your best skills and talent to create and sustain an edge. The worst mistake you can make is to simply embrace a strategy of someone else that doesn’t match your own personality and strengths.

Rule 7: Have a routine to lean on. Every trader should follow a mental routine on every trade. It keeps you focused on what you have to do, and when the pressure is on, it helps you manage your nerves. You may not have control over the market, but you have control on how you trade the market. Having a routine will inject consistency that will keep you calm under pressure.

Rule 8: Find peace in the market. The market has to be your sanctuary, the thing you love, and you can’t be afraid of making mistakes. Yes, you’ll experience both good and bad times, but you must enjoy and revel in the challenge.

Rule 9: Test yourself. Don’t look for easy trades and setups at all times. Test yourself by working hard trades and difficult markets in order to test and improve your skills. For example, if you’re uncomfortable with trading options, spend a month just trading options. If you’re uncomfortable with shorting stocks, spend a month shorting stocks. We only get better if we constantly test what we think is most difficult.

Rule 10: Find someone who believes in you. Having confidence in yourself is important, but it helps to have someone who believes in you, too, whether it’s a spouse, a friend, a teacher, or a mentor. No man’s success can be entirely attributed to his own actions. You must surround yourself with people who believe in you at all times.

Source: Charles Kirk, The Kirk Report, August 17, 2009.
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Re: Trader's Thread (Jan 09 - Oct09)

Postby winston » Sun Aug 23, 2009 6:51 am

Random Thoughts on Trading -- by Bill Kraft

The other day it occurred to me how much I really like trading. It has given me a quality of life I never dreamed I would enjoy. In my former lives I practiced law for many years and then ran a photo processing business and portrait studio. The law practice was interesting and relatively lucrative but came with heavy burdens of time and obligations to courts and clients. Many times my work day began at 6:00 A.M. and didn't end until 10 or 11 at night.

I don't mean that as a complaint, only as a fact to be compared to my trading experience. The photo business came about as a result of my passion for photography. The only problem was that it was a retail business and as anyone who has been or is in a retail business knows, you are a slave to it.

As I have written in "Smart Investors Money Machine" and in "Trade Your Way to Wealth," trading changed my life completely. Once I advanced through the learning curve, my time became my own. I am no longer beholden to clients or customers and my calendar is not set by the courts or the needs of others. I can pretty much do what I want and when I want to do it.

Rarely does my trading day extend beyond a couple of hours and I can do it anywhere in the world that I can hook up my computer. It has given me the ability to travel, spend more time with my family, and live life as I choose.

Of course, I do perform functions that take up some of my time. I edit the three alert services (Option Trader, Trend Trader, and $10 Trader), and I write this Newsletter article each week, but I am able to do those things because I choose to rather than from any financial need. I take on the occasional coaching student because working with people who are interested in trading helps keep me sharp and introduces me to some fascinating folks.

Trading enables me to do these things that I enjoy and have fun doing. If there is a time when they are no longer fun, trading has enabled me to be in a position where I can just stop doing them.

As I write in "Smart Investors Money Machine," I have learned, and in that book I share a variety of ways to create streams of income that are at least somewhat independent of the constant use of my time. I've learned that almost anyone can add substantial income with relatively little effort once they have made an effort to learn what to do and how to do it.

Maybe that's the rub. All too many come to trading thinking it will be easy and the truth is that it isn't easy. Successful trading can be simple, but that isn't the same as being easy. Before trading can work for any individual I am convinced that the person must make serious efforts to understand that it is a business and as such requires knowledge, a specific plan, and practice. Successful trading also requires self-knowledge and understanding.

One of the greatest battles we seem to fight in reaching the ultimate status of becoming a winning trader is against ourself. We must learn to achieve a level of discipline that removes as much as possible the elements of greed and fear from our trading decision making process. All of these things involve real effort and without that effort it is difficult if not impossible to become a really good trader.

For most, the question becomes is it worth it? For me the answer has been a resounding yes. One of the best trading teachers I have ever known once said something like: "If you are willing to do for 6 months or a year what others won't, you will be able to do for the rest of your life what others can't." That thought has stuck with me for more than a decade of trading now and it rings as true today as when I first heard it.

When I began, I spent about 5 or 6 hours a day studying and I did that for at least 4 months. At that point, I had no job so I was able to devote the time. I understand that most readers simply can't devote that much time a day to study, but most could afford an hour or so on the average. Maybe it would be a great trade-off in the long run to give up an hour of TV a day in exchange for a better quality of life not too far down the road.

Sure, it will take longer devoting only an hour a day to study than it took at 5 hours a day, but in the end the rewards can be unbelievably great. Imagine a life where someone could work half the time and make three or four times the money. Would that be worth the effort? Only you can say. Trading and investing definitely isn't for everyone. It involves risk and oftentimes risk that an individual may be unwilling to take, but armed with appropriate knowledge risks can be managed and controlled.

Anyway, that's my ramble for this weekend and I hope it provides some food for thought. Personally, trading has been very, very good to me and maybe it could be to you as well.

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Re: Trader's Thread (Jan 09 - Oct09)

Postby kennynah » Tue Aug 25, 2009 2:25 pm

must give star award to San mei mei...

so far, the lady with the golden finger(nails).... touch which counter, also make money...

C, FNM, ex-GM, and probably a few undeclared ones...

so...the question we got to ask is...

was it TA, FA or AA (anyhow analysis) ?
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Re: Trader's Thread (Jan 09 - Oct09)

Postby winston » Thu Aug 27, 2009 7:18 am

Rule #1 of trading by Andy Swan

Always make money when you’re right.

You know the story….XYZ is trading at 14.45 and you’re SURE it’s going to 20 bucks. So, what do you do? Naturally, you lever your buying power to the max, go “all in” on XYZ and then….

Flip out when it hits 14.22, realize the mistake you’ve made and sell all of your shares for a .23 loss, or about 4-5% of your account value because of the leverage.

Then, of course, the stock moves swiftly to 20.00 over the next month.

This CANNOT happen if you’re going to be a good trader. You MUST MAKE MONEY when you’re right.

There are a few ways to help yourself do this:

Clearly define the point at which you are wrong. This doesn’t have to be a price level, it can also be a time limit, etc. “If it’s not over 16.00 by next Thursday, I’m wrong”. “If it hits 12.21, I’m wrong.” Now that you know what it means to be wrong, you can take a position that lets you be comfortable with the loss that will occur at that point….and STOP YOURSELF from exiting before this “wrong point” comes true. REMEMBER–until the market proves you wrong, YOU ARE STILL RIGHT!

Trade option spreads. Verticals, Iron Condors, etc….these all have clearly defined, limited risk. For example, on this trade that I shared on mytrade, I know that if I’m wrong and SPY rallies, the worst that can happen is that I lose $5025. So if SPY jumps 3 points tomorrow, I won’t flip out….my risk is defined and I’m committed to holding through expiration no matter what….now it’s up to the market to determine if I’m right or wrong. NO EMOTION, no reaction.

Those of you who know me know that I prefer the option spreads method. If you’re not comfortable with that yet, just hit mytrade, search “vertical” or “iron condor” and copy the trades into your thinkorswim account. Try a few 1 lots that you agree with and you’ll see the liberation that comes from defined-risk trading that forces the market to prove you wrong in order to lose.

p.s. In that spread above…. even if the market goes up a little bit (in other words, I’m wrong), I’ll still make money. In other words: Through option spreads, I even make money when I’m slightly wrong. Now that’s a breath of fresh air!

http://andyswan.com/blog/2009/06/08/rule-1-of-trading/
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Re: Trader's Thread (Jan 09 - Oct09)

Postby winston » Thu Aug 27, 2009 10:12 pm

How to Grab Significant Short-Term Profits From Technical Trading by Mark Skousen

Highlights in this issue:
Why you should add a few technical tools to your investment arsenal.
How to gauge investor sentiment, "tech-style."

"The overwhelming majority of economic theories, market forecasts, trading strategies, investment systems, hot tips and sure-fire speculations never pan out." ~ Alexander Green

In the August 14 Investment U issue - "Why Most Investment Systems Simply Don't Work" - Alexander Green urged you to stick with the tried-and-true method of fundamental analysis.

He did so using this mantra: "There is only one thing that dictates where a stock will go: earnings."

I agree that earnings are the ultimate determinant of stock prices in the long run. But that's not the only way to gauge where a stock is headed next.

I firmly believe that technical analysis - volume, trading patterns and historical trends - can enhance your returns tremendously and can keep you out of trouble in many cases. Here's why...

How an Earnings-Based Investment Model Crippled Bank of America Buyers

The problem with taking a straight earnings approach to investing is that stock prices aren't determined by current or past earnings, but by future earnings in relation to the current price.

Throughout the past decade, for example, earnings looked great for Bank of America (NYSE: BAC). In June 2008, it earned a record $3 billion. You'd have made a bundle of money investing in BAC during the new millennium. Factoring in rising dividends, stock splits and share price appreciation, you'd have tripled your money.

But over the next year, Bank of America's earnings plummeted, and by the end of 2008 it had lost $2.3 billion. The stock followed, collapsing from $50 to under $3 a share, wiping out all of the previous eight years' worth of profits (although the stock has since rebounded to $17 a share).

By time the bank announced a sharp drop in earnings, the price was way down - and investors who bought based on earnings had lost their shirts.

So how does one anticipate an earnings collapse like that?

Use Technical Analysis to Prevent Pain - And Profit

Needless to say, sound economic analysis doesn't hurt. Many economists (including our own Alex Green) predicted a real estate collapse and the subsequent financial trouble.

But using technical and historical trend analysis can also prove extremely helpful in improving your investment results.

For example, many technical analysts have fared extremely well over the past decade (and more), using chart patterns, volume and historical trends. And investors like Bert Dohmen, Jim Dines and Dennis Slothower profited from major trends in commodities, stocks and foreign currency, while avoiding most of the financial crises in 2008, because they used an advanced version of technical analysis.

Here are two other simple tools that have proven very effective...

The 200-Day Moving Average: Developed by Doug Fabian and his father d**k, this system has worked well for over 40 years, with only a few whipsaws. It was effective in both keeping investors out of the market during 2008 and getting them back into the market now.

The New Highs/New Lows Index: This divides the number of stocks hitting new highs each day by the number of stocks hitting new lows. I've illustrated this on the red line in the chart below and it has worked especially well over the years.

If you used these two technical tools together, you'd have got out the stock market in October 2007 and not re-entered until April this year - without being whipsawed back into the market. Not bad.

Chart: http://www.investmentu.com/images/iu082709chart.gif

Gauging Investor Sentiment... Tech-Style

Put simply, technical analysis isn't a crystal ball, but it's a good way to measure the psychology of the market.

When new highs and new lows are at all-time highs, it suggests a strong bullish trend. Conversely, if the indicator is at an all-time low, it signals incredible pessimism.

The new highs/new lows indicator gave a sell signal in October 2007 and a buy signal in April 2009 it's still bullish.

According to the chart, the market is headed higher, so investors should consider several choices...

Buy an ETF (exchange-traded fund) such as SPDRs (NYSE: SPY), which tracks the price and yield performance of the S&P 500 index.

Buy a five-star, no-load mutual fund such as the Janus Triton Fund (JATTX).

Buy individual stocks, such as Bank of America (NYSE: BAC).

Of course, technical traders use a variety of ratios, indicators and charting patterns to make their buying and selling decisions. Their systems are never perfect because human action is not always predictable, but human behavior and the herd instincts are sometimes quite apparent and experienced traders can make a great deal of money and avoid the worst of bear markets.
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Re: Trader's Thread (Jan 09 - Oct09)

Postby winston » Sun Aug 30, 2009 8:12 am

Part I - The Basics of Profitable Trading by Bill Kraft

Perhaps the most basic concepts necessary to achieve profitable trading are to cut losses and let profits run. The idea is obvious and simple on its face, but it seems that many traders have no idea how to accomplish either objective. In fact, I would hazard a guess that a majority of retail traders do just the opposite. They cut profits and let losses run. That is an almost certain road to losses and frustration.

Recently, a commentator on the blog took me to task and suggested that I use the concept of cutting losses and letting profits run as a tease and suggested that I write a little about exactly how to do those things. I can only guess that he has not been following my articles for very long and has not read my books because I have tried to deal with the "how to" aspect many times. My coaching sessions focus specifically on those actions as they apply to the individual with whom I am working.

Accepting all that, I, nevertheless agree with the comments insofar as I believe it could be extremely helpful to at least some readers to discuss specific ways to cut losses and specific ways to let profits run. This article, therefore, is the beginning of a three part series in which I'll try to suggest ways in which the individual can set up his or her trading so that they do cut losses and let profits run in ways that could work for them.

The blogger suggested it would be a cop out to say that the "how" of cutting losses and letting profits run is an individual decision. In that regard, I believe he is mistaken. Each of us must determine the methodology that fits our personal risk tolerance, our goals, our available time, our knowledge base, and the strategies we utilize and with which we are familiar.

For example, someone who only trades stocks may have a much different loss cutting strategy than someone who trades call ratio backspreads and someone whose primary strategy is selling options may have a different approach than someone whose primary strategy is buying options.

Recognizing that how we cut losses and let profits run is, indeed, a personal decision and should be part of an individual plan, we can still explore some of the basic concepts that we might consider applying no matter who we are or what our strategy might be.

As many of you may know, in addition to private coaching, I have taught a number of trading seminars over the years. In addition, I often get calls from other traders and often speak with people who have questions regarding trades or investments. With that background I would suggest that it is fairly common that retail traders generally buy stock with the hope that it goes up in price. They tend to enter positions for a variety of reasons, and, among those reasons, may rely on something they have read or heard on TV; they may get a tip from a friend who already owns a stock or is about to buy it; they may act upon a broker's suggestion; or they may have some personal knowledge gained through research or some first hand experience.

In many of those cases they are buying a story; a story usually with some basis in fundamentals. When they buy, they give little or no consideration to their entry price, particularly as it might relate to an initial exit in the event the stock turns against them right away. The entry is made with little consideration of how much is actually at risk and with little or no consideration of how much they are personally willing to risk in the trade. Often these are the people who have been taught that the only way to invest is to buy and hold and they will defend "buy and hold" with great fervor.

In its purest form, the strategy of buy and hold generally has no plan as to when or how to cut losses. Positions are simply to be held no matter how much the stock drops. Any exit strategy is ordinarily based on need or whim. The question I always ask buy and hold investors is: "Hold until when?" I usually get a blank look. Hold until death is certainly a strategy and one that may be wonderful for the heirs, but maybe not be so good for the investor. Using this strategy, profits may well run and that is generally something we want to achieve, but so too do losses.

Anyone who held the likes of Lehman Bros., or Enron, or Bear Stearns knows exactly what I am writing about. So too, albeit to a lesser extent do longer term holders of issues of even great companies like GE or CAT or MSFT. Of course they may "come back" and hopefully they will. But why hold them during the downdrafts; why let big profits turn into big losses?

If you accept my arguments so far, it only seems logical that you would agree that the first part of cutting losses and letting profits run is to have a plan. Using a plan, you can create a disciplined structure in the beginning that will dictate at what point to get in and at what point to get out. In other words you can set yourself up before entering the position with a trigger mechanism that extricates you relatively quickly from a losing trade and keeps you in a trade that is winning until it turns against you.

I discuss precisely how you can create such a plan for yourself in "Trade Your Way to Wealth" and in "Smart Investors Money Machine." In my view, without such a plan one has no disciplined basis upon which to cut losses and no way to make sure profits are permitted to accumulate.

The first key is to recognize that cutting losses and letting profits run can be instrumental in realizing success in trading and investing. Once accepted, the next step is to create a plan for yourself whereby you set out where and how the losses are to be cut. That involves some system to determine the level of loss you are willing to accept and that will be the subject of Part II of this series.

Next week, we will look at very specific ways for you to determine the "where" of the loss cut. In addition, we'll address certain orders that traders and investors might consider to implement the loss cut. Once the initial level of acceptable loss is determined, we need to structure the trade in such a way that we try to attempt to avoid cutting profits. In Part III, I'll discuss specific ways a trader can attempt to continue to capture profit while letting the play continue so that profits that are running can continue to do so.

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Re: Trader's Thread (Jan 09 - Oct09)

Postby winston » Sun Sep 13, 2009 9:12 am

Part II - The Basics: Some Ways to Cut Losses -- by Bill Kraft

Last weekend I began a three part series of articles dealing with cutting losses and letting profits run.

In the first part, I discussed the advisability of the process and suggested the first two steps that need to be accomplished. The first step was to recognize the importance of the concepts in achieving trading and investing success and the second was the necessity of formulating a specific and personalized plan.

This week, my focus will be on relatively precise ways traders and investors might consider in establishing a plan whereby they can cut losses.

One of the first things to recognize in investing is that we can't know how a trade turned out until it is closed. In other words, we find out whether we won or lost and we find out how much only when we exit. Therefore, to my mind, the exit strategy is critically important and it is the precise formulation of that exit strategy that sets us up both to cut losses and to let profits run.

It is my belief that in order to effectively cut losses we must have an exit strategy in place before we ever enter a trade and the entry should be based upon the initial exit. I want to enter a play in such a position that if I am wrong on the direction and the stock turns against me fairly quickly I am out of the play with only a small loss.

As you can see, that philosophy first encompasses the concept that I could be wrong and that I could suffer a loss. The simple fact is that anyone who trades will, at least at some time, suffer a loss. Since that is the case, the first criteria for me in establishing an exit strategy is that I want the losses when they do come to be as small as possible.

I need to emphasize, however, that does not mean there is no rationale for setting the point at which the loss is to be cut. That is one important purpose of the plan. I want to use some discipline that takes me out when the stock price moves against me in some pre-determined fashion.

There are probably as many ways to plan that exit as there are traders and I am going to explore a few of the possibilities here while also looking at some considerations in determining what method to use.

In general, when buying a stock, the highest risk of loss is often near the time of entry. That seems true because there are ways to at least attempt to protect profit as the price moves in the direction you want. Initially, then, I suggest that each trader or investor decide upon their personal real risk tolerance.

In that vein it is important to understand that there might be a significant difference between what one thinks their risk tolerance may be when getting ready to enter a trade and what it actually is going to be when real money is being lost. This step involves a little serious soul searching, and only once determined can we use a specific loss cutting method.

Once you have decided what you are really willing to lose on any given trade, it is time to decide on what loss cutting exit strategy you will use. One specific way to cut losses is to employ a strict percentage approach. In your plan, you might decide that if the stock price drops 5% from your purchase price you sell and cut your loss. This basic methodology is suggested by William J. O'Neil, publisher of Investors Business Daily, in his popular book, "How to Make Money in Stocks." In the book, Mr. O'Neil suggests cutting the loss when the price is 7% or 8% below the price you paid. That may or may not sound like a lot to any individual trader or investor and that is where the personal decision must be made.

However, the important point is that it does provide a disciplined loss cut. If the stock price drops a percentage that you determine in your plan then you get out with no if's, and's, or but's. The loss is cut. There can be no argument that "it'll come back" or "I'll just let it go another 10 cents." Create the parameter and follow the discipline.

As I mentioned earlier, the percentage loss cut is definitely not the only way to discipline loss cutting. I personally use some basic technical formation for many of my exits. Take, for example, a situation where a stock we'll call XYZ has just formed a double bottom bouncing off a level of support. I may choose to enter on that bounce and use a retreat back below the support as my initial (and I emphasize initial) exit.

Let's say the stock formed the double bottom by dipping to $15 and then moving up on two separate occasions. The double bottom support would be at $15. I would like to catch it shortly after the bounce so suppose I entered at $15.20. I would make my exit a break below support and might set a stop loss to close the position at $14.90. That means that if the stock price dropped to $14.90 or below, my position would automatically be sold as an "at the market" order.

One caution I should include is that a stop loss order does not guarantee that you will get the price at which you set the stop loss. It only assures you will be sold out of the position. Suppose that with my stop at $14.90, XYZ gapped down from $15.10 to $14.30. The gap would have gone through my stop and my stock would be sold at the market which might then be expected to be around $14.30.

Another way to specifically cut losses might be to use a break through a moving average. Suppose you see a stock bouncing up off the 50 day moving average and decide you would like to buy it. The exit could then be a break below that same 50 day moving average. As an aside, that could also be used as a way to let profits run, but that is information for Part III next weekend.

Any moving average could be used as the exit trigger, not just the 50 day. I often personally use a variety of others, but the important thing is that I know which one I am going to use before I ever enter a position. A last thought for now is that I might also use a trend line exit where I exit the play on a break through the trend line.

Each of these methods is relatively simple, but serves the purpose of setting a disciplined exit; one that is not dependent upon whimsy or emotion. If whatever line is chosen is broken, the idea is to just get out. The stock price movement tells you when to exit. Always remember if it turns back your way you can always re-enter a position.

Source: MarketFN.com
It's all about "how much you made when you were right" & "how little you lost when you were wrong"
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