Sunday, October 14, 2007

Keeping Stock Trading Simple

Last weekend, I wrote about elements I believe help lead to effective successful trading. Shortly after the article had been sent out, I received an extremely interesting email from a subscriber. Though I won't reveal this subscriber's name, he did give me permission to discuss his email. In his opening paragraph, this trader commented: "I find the singlemost important necessity is SIMPLICITY!" I agree completely.

In my classes and one-on-one's with students, I have often commented that I think a 5-year old can be taught to trade successfully, and perhaps with less effort than it takes to teach an adult. When I have said that, I was referring to the use of simple technical analysis; things like a bounce off a trend, or a break through support or resistance. The subscriber's email would make things even simpler. Here is what he said:

"My first rule of trading is quite simple: On any given day, any stock has an equal or 50/50 chance of making and losing money. Consequently, when you are a trader (as opposed to an investor) tossing a coin can often produce as good or even better results than all the technicals you can find!

Why is this? Because tossing a coin takes the emotion out of the trade! I'm not joking or screwing around. I believe in wisdom and knowledge but no more than I believe in the value of luck and good common sense, which is the prerequisite to success with the coin toss approach to trading."

I responded and suggested that the problem with the approach (and there are problems with literally every approach) is that it does not set the exit which I believe is even more important than the entry. I also noted that perhaps the coin flip method works pretty well for someone who is always playing bullish (e.g. buying stock) since the markets tend to go up roughly 2/3 of the time and down the other 1/3. Thus, if one is only going to be buying and buying when the coin comes up heads, there may well be an advantage since one would expect most stocks to rise when the market is rising.

The subscriber wrote back and clarified by saying that he is, indeed, bullish and once he selects the stock and entry price he flips the coin. He does set an exit using other information, not the coin. He suggests that he has been successful. His conclusion is telling: "Maybe I'm just lucky or just beat the 50/50 odds because the few winners always seem to make up for the losers--often in a big way." What that tells me is this is someone who does cut losses and let winners run. He knows how and does manage his money properly.

Having read this far, how many of you dismiss the coin toss methodology out of hand? I don't. What I see is a trader with a simple plan. Not only is the plan simple, it has apparently worked for the subscriber. Is it as simple as tossing a coin? Well, not really. It is based on a bullish inclination where the stock and entry price are chosen and then, only after those choices, is the coin flipped. An exit is then set and presumably followed. The simple act of formulating a plan has probably put this fellow ahead of most traders. Hopefully he paper traded the plan before putting it into motion. Evidently it has worked for him. Why not paper trade it yourself? See whether and how it works. Is it a simple plan ? Sure looks like it. Is simple good? It's really, really good if it works.

Is your plan simple? Do you even have a plan? What do you think -- is it better to have a simple plan than no plan at all? If you don't yet have a plan for your own trading, check out our earlier articles on the business plan and trading your own plan.

Many thanks to the subscriber who was willing to share the simplicity of his plan. Remember, it is your job to formulate your own plan. All trading does involve risk so make sure you know your risk before ever trading real money.

Bill Kraft, Editor
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