Saturday, April 25, 2009

Where Would You Like Your Trading to Go?

In the article last weekend, I suggested some serious introspection and self-evaluation to determine how you were doing with your trading. To me that means going well beyond whether I am making a profit or loss. It means I need to understand how I behaved in a trade to determine what influence my action or inaction had on the ultimate outcome of the trade. Obviously, I can't control a market and I can't make a stock do what I want it to do, but I can act to do things like cut losses by placing stop loss orders or by buying protective puts and I can decide not to pull the plug when something is still going my way. Recognition of how I acted and reacted can profoundly affect my future trading as can failure to understand why I've acted in certain ways.

There are probably as many answers to the question "where would you like your trading to go" as there are people answering the question. Certainly everyone would like to see their trading be profitable and most, at least, would like their trading to be safe. But answers will begin to differ when we ask: how profitable? or how safe? Are we satisfied if we make 1% in a year or do we need to make 15% or 50% to be satisfied. What is safety in a trade, and what reward can we reasonably expect relative to the "safety" we want?

Recently, a coaching student wrote reminding that most people seek high rewards, safety, and liquidity. Unfortunately, though we may find two out of three in a trade, it would be exceedingly rare to find all three in one specific investment. From the outset it is important to recognize that almost all trades and all trading involves compromise of one sort or another. For example, often when looking for a large reward we may need to take on high risk. Conversely if we set up a trade that is relatively safe, we may find that we may need to limit the potential reward to achieve the safety.

As each of us decides where we want our trading to go, we must both understand and make compromises that can lead us to the results we seek. In next weekend's article, I'll discuss some of the things I believe are essential for a trader to do in order to achieve success. For now, however, the first step is to decide where you want your trading to go. Is it to be a gambling venture where you buy a stock that someone mentioned at a cocktail party with the hope it will go up or do you want it to be your full time occupation? Do you want your trading to provide a regular stream of income as I discuss in my new book "Smart Investors Money Machine," or is it sufficient to dabble occasionally with the hope of snatching a profit here and there?

All the choices are yours. I only suggest that you not be too cavalier in deciding your approach to your trading. Trading can offer very significant possibilities to enhance financial success and it can leave you broke. Either of these possibilities carry serious consequences deserving of careful consideration. Those who may be unlearned or unsophisticated in trading may believe that I have put too much emphasis on this self-analysis, but I am confident that self-knowledge is an absolute necessity for anyone who intends to achieve regular success in the markets. We are often our own worst enemies in entering and exiting our trades. If we start with a specific understanding of where we want our trading to go, I believe we have a good beginning. If we don't have that specific understanding, it might be good to go back to square one and make the effort to understand ourselves and what we are willing to do to become better traders.

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

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Anonymous said...

This is really a very good article. Recently I did a number of "buy and write" trades to catch the dividend payment as well as a small call premium. I intended to make 5% in six weeks when the call expires. After entering the trades, I watched the stocks going up by 30% -- you guessed, these stocks were in REITs which had gone crazy recently. I got my dividends and the stocks were called away. Notwithstanding the 5% in six weeks, I can't help but wonder if I could have done differently. This article speaks well of those trades and the importance of knowing yourself.

Frank said...

My own trading success is subject to me and me alone. That was probably the greatest lesson I had to learn about trading markets. Your articles and other book sources, like "Disciplined Trader", "Trading in the Zone" and "Awaken Your Speculator Mind" certainly are good mentors.

Anonymous said...

Stop losses can kill you. I am a pretty good stock picker, and every time I have used stop orders, whether loose, tight, trailing or otherwise and have gotten stopped out, I look at the stock six months to one year later and usually find that they recovered and would have provided profits. It does help if you can find a good market timer. Do you know of any?

Bill Kraft, said...

Thanks, Anonymous. Glad your trades worked well -- 5% in 6 weeks stands up pretty well to CDs or savings accounts. Of course, you could have chosen not to write the calls or to wait until a downturn in the stock to write the calls, but what we give up when writing calls is the theoretically unlimited upside that we trade off for the premium. As with almost everything in trading, it is a decision the individual must make and it should be a part of each trader's plan as I set out in "Trade Your Way to Wealth."
Bill Kraft

Bill Kraft, said...

Frank, thanks for writing. You may have reinforced the most critical point of all when you wrote that your own trading success is due to you and you alone. I should add that the same is true of anyone's trading failures.
Bill Kraft

Bill Kraft, said...

Anonymous, my experience with stops is much better than yours has been. I suspect that the main reason is that I am willing to get back in a position after I have been stopped out and if it turns back up. What method do you use to cut your losses?
Bill Kraft