Saturday, November 28, 2009

What You Want from Your Trading

Before I launch into the subject of this weekend's article, I hope all of you had a fantastic Thanksgiving. Traditionally, the holiday is a time to give thanks for what we have and to reflect about our lives. In that spirit of reflection, I thought it might be a good idea to reflect on what we want from our trading.

Obviously, on the most basic level, we want to make money from trading. I suggest, however, that there are considerations well beyond the basic. Dr. Ari Kiev, a psychiatrist, an advisor to traders and a prolific author of trading books suggests that more self-examination is something that would benefit us ("Trading to Win," Wiley, 1998, p.7). I couldn't agree more. Few traders seem to take the time to determine what they really want and how they might go about it.

It seems to me that one thing almost everyone would like is more regular income. Before we can amass great fortunes, we need to pay the bills each month so it makes sense to me to consider utilizing trading strategies that provide regular streams of income. I devoted a whole book, my recently released "Smart Investors Money Machine," (Wiley, 2009) to precisely that concept. The book sets out at least 16 different strategies through which a trader or investor can create income flow beyond what he or she may earn through their employment.

I haven't been employed for years yet I am fortunate to live a comfortable life and am able to enjoy many of the things life has to offer with relatively little stress. One of the major reasons is that I have developed a number of streams of income and while no single one may be considered particularly large, together they provide more than enough to cover my costs of living. It is only after those costs are covered that we can look to increasing our net worth.

In my own case, I assign a portion of my assets to income production and the remainder to efforts to appreciate capital. Once I know expenses will be covered, I can be relatively relaxed and patient in my efforts to accumulate more capital. I would suggest that may be an important approach for many traders. As I have written before, patience is a critically important factor in successful trading. One of the impediments to trading I often have seen is the rush to make money. Recently I heard a speaker discuss a strategy he was using and as part of that strategy, he was taking profits at a specific target even if the move was continuing in a favorable direction. I call that cutting profits. The speaker admitted it was part of his personality in that he did not want to stay too long in any position. I look at things a little differently and would prefer not to stay too little time in any position that is continuing to add money to my account as time goes by.

The speaker to whom I refer may be an example of the trader who hasn't conducted a self-examination at least to the level where he recognizes that he is violating a cardinal rule of successful trading. He is not letting profits run. The idea of exiting a trade quickly just to be finished with it quickly does not appeal to me. It is hard enough to find really good trades, and makes little sense to get out of one that is still producing just because I want a trade to finish quickly. It's like capping an oil well that is still a strong producer in favor of drilling a new well in the hope that it will be productive.

Self-examination might lead such traders to a conclusion that they might improve the bottom line simply by staying with a trade until it is no longer productive. All of that is to say that if one knows precisely, not just generally what one wants, the results may improve. As Dr. Kiev suggests, setting a goal (and then putting it in the background) is often very helpful in getting where we want to be. My own suggestion is that we first consider how we intend to get to the goal once set. For many, I suspect that is the production of regular income.

In "Smart Investors Money Machine" I include many ways to add streams of income from simple concepts like investing for dividends to writing covered calls to selling naked puts or creating iron condors or investing in MLPs or bonds, annuities or even reverse mortgages for those older than 62. Each of these strategies is explained in detail and the reader is shown how each might be employed depending upon the trader or investor's age, station in life, and resources. These strategies can really help. I know; they've definitely helped me. In addition to helping me pay the bills they have provided income that permits me the luxury to be patient in my own trading.

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

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To comment on Bill's article click on the "comments" link below.


Joe Walsh said...

Bill, would you have any interest in doing an article comparing / contrasting what different brokers have to offer, and perhaps what guidelines one could use in selecting one ?
Should one stick with a single broker ?
Having never used one, I do not know where to start.

gdhaas said...

Having read your book "Trade your way to Wealth", I am a firm believer in your techniques. However in response to letting the profits run in this arcticle, I have to agree with the other gentlemman. Too many times, I've had a profit, set a limit order, only to have the stock or options gap down, below my limit to even below my basis. I realize that the market is against you at the start, but with those experiences why not take the profit and be happy rather than take the chance that you will lose?

Ed Z said...


Thanks for your series of instructive and inspiring articlesl
On the matter of letting profits run, I think this really does depend on one's trading technique, style and chosen timeframe. I'd love to see some published studies rigorously comparing the profitability of various profit-taking approaches. In one of Perry Kaufmann's books he presents some data to show that more rapid profit taking often leads to a better result. Riding out a longer term trend can involve getting stopped out at a very disadvantageous price, and there are also those periods of lost time (opportunity cost) when the price is just backing and filling.
If the objective of trading is to make large profits per trade, as in moving average systems, then of course it makes sense to try to ride the trend as long as possible, as long as one is aware that the actual percentage of profitable trades will likely be below 50 percent. (This then leads to further challenges in money management.) A shorter term swing trading approach has numerous psychological advantages (let's not underestimate those) not least of which is a higher percentage of winners, and the satisfaction of exiting positions as price is moving favorably rather than adversely.
I think many traders make the error of focussing primarily on maximizing profits. I think a more reachable goal is to set a specific *minimum* level of profit, which, due to the lower stress level, maximizes "ease of use" and ensures more adherence to the system.


Ed Z

Bill Kraft, said...

Thanks for writing, Joe. Broker selection can be quite important and in my view should not be based solely on who has the lowest commissions. I have written about brokers in the past and it might be a good time to write another article in the not-too-distant future. One thing I would suggest for a new trader is to use a broker whose site has good educational material.
Bill Kraft

Bill Kraft, said...

Thanks for writing, gdhaas. I've been trading for my living for more than a decade and only a handful of times has a stock gapped over my stop loss. Of course it does happen and that is one of the many risks of trading. However, I don't think that is a good argument for cutting profits. Perhaps the most important mantra for successful traders is to cut losses and let profits run. Taking the profit as you suggest rather than letting the price movement take you out of the play very often cuts profits and you miss the big runs that separate the truly successful trader from the mediocre trader or the losing trader. Thanks for getting "Trade Your Way to Wealth." I'm glad you like the techniques.
Bill Kraft

Bill Kraft, said...

Thanks for your comments, Ed Z. First, I have to say I am against cutting profits. I am not sure what you mean by "riding out a longer term trend" insofar as it would result in getting stopped out at some disadvantageous price. I certainly don't mean that a trader need stay with the original trend line as an exit if the stock moves sharply in the desired direction. At times like those, I will begin to trail candlesticks up (or down if short) or switch to a trailing stop or replace the old flatter trend line with a new steeper trendline exit. My point is that I want the stock movement to take me out, not some emotional decision on my own part.

I personally do not try to define how long I am going to be in a trade, but rather let the price movement of the stock make that decision for me. The result is that some trades are quite short in duration, some are swing length and some are quite long. Often the long runs are by far the best. I don't see the value of getting out of a trade simply because it has met some minimum profit level only to see the stock price move another $5 or $10 or $20 in my direction. All I can say is that methodology has worked well and provided a very good living for many years. I don't mean to say that other methods may not also be very effective; I know there are many ways to make money in the markets and if a different way is working well for you I salute your method as well.
Bill Kraft

Joe Walsh said...

I certainly agree that minimum price as a selection creteria should not be the driving factor. That principle applies in all walks of life. Perhaps you might post a link to your previous article(s) on brokers.

Bill Kraft, said...

Hey, Joe. There is a link to previous articles in the Newsletter. Using that link, you should be able to find previous articles that may interest you. Thanks for writing.
Bill Kraft