Saturday, February 28, 2009

Priorities in Trading

In the years that I have been trading, teaching trading, and writing about trading, probably the question I am most frequently asked is how do I find what stock to trade. While that obviously can be quite important, there are a number of other factors that, to my mind, are at least as important. As anyone who has undergone private coaching with me will tell you, there is much greater emphasis on formulating an overall plan, formulating a plan for a specific trade, money management, reward to risk analysis, exit strategy, and discipline. Even if we aren't a particularly great stock picker, those other elements can serve to save the day and make a trader profitable if used properly.

In my book, "Trade Your Way to Wealth," for example, I go over those elements in some detail, and emphasize the importance of risk awareness and risk management. Shortly, my new book, "Smart Investors Money Machine," will be released, and in it I emphasize the need to create multiple streams of income and discuss quite a number of ways to do just that. Some individuals have suggested that my approach may not lead to fast wealth. I won't dispute that although I will say that some of the strategies I use and about which I write definitely can and do lead to wealth when used appropriately. I am a firm believer, however, that first we need to look to protect capital. There are many ways to do that, but I fear that most retail traders fail to make that a top priority.

Sadly, many of the calls I get inquiring about coaching are from people who have already lost large sums and are looking for ways to stop the bleeding. While "better late than never" is certainly apropos, I earnestly suggest that traders and investors make it an early priority to gain the knowledge of how to protect against catastrophic loss and how to minimize losses in their trading before heading off to put their money at risk. I don't mean you have to call me or hire me for coaching. There is plenty of information available on the internet, in books, and in DVDs that will help in that regard.

So many of us jump in with the hope and expectation of accumulating riches only to have our dreams dashed because we forget that trades can lose as well as win. We have no plan or strategy to protect us if things go the wrong way. We fail to employ a discipline or realize that we must expect that a fair number of trades are going to go the other way. What we need to understand is that we can still make money even when a significant number of trades are losers as long as we pay attention to important things like money management and reward to risk ratios.

I have often said, and I'll say it again, what we need to do to succeed is take our eye off the money and concentrate on making good trades. A good trade can actually lose money if we have followed our plan, employed a reasonable reward to risk ratio, and followed a pre-determined exit strategy to cut losses. A trade that makes money can actually be a not-so-good trade if we fail to follow our plan and cut our profits prematurely because we didn't utilize discipline, but rather followed our emotions.

by Bill Kraft, Editor
Copyright 2009, Makin' Hay, Inc.
All Rights Reserved


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12 comments:

Anonymous said...

Thanks to your book and reading your blog, for which I am very grateful, I am focusing much more on creating a trading plan that focuses on money management and reward-to-loss ratios.

A friend's (very bright) son once said when he was only about ten years old: "Inch by inch, life's a cinch; yard by hard, very hard". (Dmitri King)

I think that advice applies to trading. Steady gains, even if they aren't particularly gains, add up. If one follows your persistent advice about having a trading plan in place, one is far more likely to gain in the long run, even if it's only inch by inch.

After all, what's wrong with inch by inch?

~ GemmaStar

PS: And thank you for this wonderful blog!!! So many of us appreciate this gift from you.

William Comer, Loveland CO said...

Thanks to you, and another mentor, Phil Grande, the first thing I learned one year ago was risk management and capital protection.

After all, I had just opened my first online trading account with $2000. By October I built it up to $5200. Then came a market cycle that everyone had to learn how to trade. Now, 10 months later my balance is $3100. I made some errors, I took some hits. But, hey!...I'm still up 55%! And, the lessons I've learned? Gold!

Lets measure success in percentage not cash, when we're starting small.

Paul Roden said...

Hi Bill,

I wanted to add that in my recent coaching session with you (highly recommended) we discussed in depth the importance of having a plan, discipline, etc. You have said many times, that it matters less about what your plan is, and more about the fact that you actually have a plan. If a sailboat doesn't have a course or destination, it is simply adrift, destined to be tossed to and fro by the ever changing winds and currents (and markets). While we way may get tossed around by the waves occasionally, a well plotted course should keep us from being dashed upon the rocks. I may not have the best plan in the world, but I DO have a plan, and that alone puts me ahead of 90% of all other investors. All I need to win is a slight edge.

Thanks for the Wisdom.
Paul Roden

Anonymous said...

This article says PBT had high volume Fri 2/27/09. That's because Cramer talked on it Th 2/26/09 where it closed at 8.02 and went up 1.20 or so Fri. Cramer said if you pay over or much over 8.00 the trade isn't going to work. That doesn't make sense. He says PBT has been beaten down and looks ready to move up with other oil stocks. So how he can say it you pay 9.00 for it you are going to lose, would not be worth buying in the first place.

Bill Kraft, MarketFN.com said...

Thank you, Gemma Star. I couldn't agree more. The inch by inch philosophy fits my approach. As one fine instructor once told me, success in trading is achieved the same way we eat an elephant -- one bite at a time. The lesson is really important, I think, since all too many look only for the home run and fail.
Bill Kraft

Bill Kraft, MarketFN.com said...

Thanks for writing William and hearty congratulations on doing so well when most have been suffering with their investments. In my estimation, it is always important to measure the percentages rather than the raw dollars. A 55% gain in a year is greater than most will ever achieve unless they adhere to principles of money management, reward to risk analysis, exit strategy, and discipline. Sounds like you have definitely been moving in the right direction.
Bill Kraft

Bill Kraft, MarketFN.com said...

Paul, thank you. I genuinely enjoyed our sessions and sincerely hope that our time will add to your already strong abilities as a trader. We look forward to seeing you at the March event.
Bill Kraft

Bill Kraft, MarketFN.com said...

Thank you for writing, Anonymous. Whatever the reason, high volume is high volume and gives us information about the stock's performance. There is always some reason for high volume. In this case, it may well have been Mr. Cramer's mention. With respect to the remainder of your comments, I suspect they would better be addressed to Jim Cramer although his point may well have been that $8 was the right entry. Making $1.20 on an $8 stock certainly isn't a bad return. After big jumps like the one to which you refer, stocks often retrace and offer additional opportunities for entry.
Bill Kraft

leveragedlady said...

Dear Mr. Kraft: Your advice in Trade Your Way To Wealth helped me make a positive (though smaller than I had hoped) return in 2008, and a healthier 2009 so far. I would like to ask you about a trade I put on, regarding your topic of having a plan. Here is what I did:
I took a look at a ten year chart of COP last year, and have followed it down for over six months. At that time, I had determined that an entry price in the $37-39.00 range would be a long position I would buy into. Last week, COP fell to this level, and I bought shares at $38.66. I also sold an August 2009 55 call option for each hundred shares I purchased. The premium I collected was $1.04, I figured if Cop rises to $55 per share and I get called out, I will be delighted.
But, here is my quandary. For the downside, I assumed that COP's cash position is worth around $10.00 per share, so my real exposure is around $28.66. per share. I bought an August 2009 $30 put for 2.62 and sold the August 2009 $25 put for $1.30. So, I bought protection for the $5.00 spread for $132.00. I realize I have no protection should the stock fall below $25.00.
So, finally, here is my question: Have I missed anything to mitigate risk on the downside thru 8/22/09? My goal for this stock is to keep it and collect dividends, waiting for oil to rebound. I thought I could sell some puts and calls again after the August 2009 expiration, if I need to, or that I'd be out of it if it ran up to $55, and surely be out of it is it falls below $25.00.
Incidentally, I did this as a result of your book- your hedging tips are great. But I want to know if I am missing something in my plan, could improve it, etc.
Thank you for your consideration.
I am waiting for you to write a book exclusively about options trading. I will be first on line for an autographed copy! E. Stein

Bill Kraft, MarketFN.com said...

Thank you for writing, E Stein. I'm glad "Trade Your Way to Wealth" has helped with your trading. As you may know, I am not permitted to give personal investing/financial advice so I cannot comment directly on your trade and positions. I can say that I congratulate you for having a thoughtful plan formulated before entering your positions. Basically you have set up a collar by buying the stock, selling a call and buying a protective put. In addition, you helped pay for the put by selling another put with a lower strike price. The two put positions, of course, create a bearish debit spread by themselves. I can see that your exit strategy on the upside is set at the $55 where you sold the call. What is unclear to me is your exit strategy for the various positions on the downside. For example, at what price do you plan to exit the stock position in the event the price continues to fall? What do you intend to do with the spread if or when you exit the stock. The put spread is set up to gain $5 a share less the cost ($1.32) so are you planning to exit the stock position at some pre-determined level and continue to ride the spread if the stock is falling? If you did sell the stock at some pre-determined price what do you plan to do with the call? The call would be naked at that point and the issue arises whether you are willing to take that risk and, if so, whether you are a Level 5 with your broker so that the broker would permit you to be naked the call. All of the above is a long-winded roundabout way to say I can't tell whether or not you have missed anything because I am not sure whether your plan accounts for those possibilities. Again, regardless of whether it does or doesn't, you are definitely on the right track insofar as having created at least some relatively comprehensive plan in the first place.
Bill Kraft

leveragedlady said...

Dear Mr. Kraft- I realize that you can't give individual investment advice, and I appreciate your thoughtful response, because it was the general exposure I was asking about, and that you answered-for instance, I hadn't thought about the naked call scenario, but I do have a plan on how to handle that ( buy back the call, which would be almost worthless, anyway).
And now, I have just one more question for you: When will your new book be available? I want to order it! Best regards. E. Stein

Bill Kraft, MarketFN.com said...

Thank you, E Stein. The publisher (John Wiley & Sons) tells me that my new book, "Smart Investors Money Machine" should be released in early April. It can be pre-ordered at amazon.com now for delivery after release. Thanks for asking and I hope you find the new book helpful.
Bill Kraft