- Stop placement
- Don’t place stops at round numbers (which are common support / resistance zones).
- Place stops below support zones (above resistance zones) to give price every opportunity to move in desired direction.
- Trade with the trend
- Select stocks that are moving with the general market and industry trends.
- Enter on breakouts near the yearly high
- Breakouts from chart patterns within a third of the yearly high perform best (statistically). If price doesn’t rise within a few days, consider selling immediately.
- Exit only on expected significant price turns
- Don’t be so quick to sell. Learn to predict significant price turns.
- Use trendlines as sell signals
- If prices are trending up and then drop below a trendline, the trend isn’t up any longer. However it doesn’t mean that the trend is down.
- Victor Sperandeo’s criteria to determine if a trend has changed from up to down: (i) price drops below an up-sloping trendline, (ii) lower high (or failed breakout), (iii) lower low.
- Ignore news
- Don’t believe scenarios spun by news outlets.
Anticipating a signal that never comes is common for traders monitoring the market closely and eager to get some money working. For example, a good buying opportunity arises when a stock breaks from an ascending triangle. Jumping in ahead of the breakout is not an ideal situation because the probability of success buying an ascending triangle is not as good as buying a breakout from one. What causes this mistake? I think a fear of missing out on the maximum amount of profit or the fear of too much risk in buying a stock are the two most common mistakes. Essentially, the two guiding forces of the stock market are at work here; fear and greed. By buying early, we can realize a greater profit when the stock does breakout since we will have a lower average cost. Or, by buying early we can reduce risk since a breakout followed by a pull back through our stop will result in a smaller loss as we have a lower average cost. What tends to happen, however, is that the stock does not break out when expected and instead pulls back. This either leads to an unnecessary loss or an opportunity cost of the capital being tied up while other opportunities arise.
The simple and obvious solution is to wait for the entry signal, but there are also some things you can do to help yourself stay disciplined. Rather than watch potentially good stocks tick by tick, use an alarm feature to alert you to when they actually make the break. Watching stocks constantly is somewhat hypnotic, and I think the charts can talk you in to making a trade. However, letting the computer watch the stock may help you avoid the stock’s evil trance. Another good solution is to focus on different thoughts when considering a stock. Don’t think about potential profits, don’t think about minimizing losses. Instead, focus in on the desire to execute high probability trades. It takes time to reprogram yourself, so persevere.
To be successful in the markets you need to know:
– what to buy (equity selection);
– When to buy it and when to pass on it (risk management);
– When to exit (time management).
The most essential part of equity selection is finding/creating a trading system with positive expectancy. Look for the catalyst/catalysts than has/have the potential to start a big move in the desired direction. There are two catalysts I focus on – earnings related and sector related. I pay attention to price, because it measures the only factor than really moves markets – confidence. It always says more than any other source of information. Reaction to news is more important to news itself.
Risk management has two basic elements: defining risk/reward ratio for every position I consider to get involved in and position sizing (how much to buy, what % of capital to put on risk).
Time management involves taking into account the opportunity cost. How long to stay in a position?
- Negative predictions: Overestimating the likelihood that a market or economic report will have a negative outcome.
- Negatively biased recall: Remembering negatives while ignoring positives.
- Basing future decisions on “sunk costs.” e.g., investing more money in a business that is losing money because you’ve invested so much already.
- Delusions: Holding a fixed, false belief despite overwhelming evidence to the contrary.
- The Halo Effect: Perceiving qualities to one company due to its association with another (ie, JC Penney’s CEO was Apple’s former head of Retail).
- Overgeneralizing Generalizing a belief that may have validity in some situations to every situation.
- Overvaluing things because they’re yours.: e.g., perceiving your portfolio holdings as more attractive because they are yours. Or, overestimating the value of your home when you put it on the market for sale.
- Failure to consider alternative explanations: Coming up with one explanation for why something has happened/happens and failing to consider alternative, more likely explanations.
- The Self-Serving Bias The self-serving bias is people’s tendency to attribute positive events to their own skills but attribute negative events to external factors. (See these Tips for overcoming the self-serving bias.)
- Failure to consider opportunity cost: There is a cost to every holding you have, as that capital could be deployed in productive uses.
- “You don’t know what you don’t know.” Having a 3rd party provide an outsiders perspective can help you avoid being blindsided by whats outside of your understanding.
- The belief that more information and analysis will lead to problem solving insight: Excess information often leads to excess confidence and poor decision making.
- The Peak-End Rule: The tendency to most strongly remember (1) how you felt at the end of a trade, or (2) how you felt at the moment of peak emotional intensity during the trade. Biased memories can lead to biased future investment decision making.
- The tendency to prefer familiar things: Familiarity breeds liking. Think about why people tend towards certain stocks or sectors or assets — its often the familiarity as opposed to something intrinsic about those holdings.
- Positively biased predictions: Once you commit capital to a given investment, you can easily allow your hopes and desires for it succeed to interfere with your ability to objectively evaluate it.
- Repeating the same behavior and expecting different results (or thinking that doubling-down on a failed strategy will start to produce positive results). What more does anyone need to say about doubling down on bad trades?
Intuition is not free
If you are thinking about exiting, it is too late. You are praying at that point. If it is in your plan for your targets to get hit, up or down, continue what you are doing. If you are just hoping your stop does not get hit, on behalf of the market, thank you. I am making the assumption that those who post or say that their stop is going to get hit have discretion in their system. The problem is not this trade it is the hundreds or thousands you will take after that. There is a reason you wanted to get it, that is intuition. If you cannot afford to not make money on a trade, you are fucked anyways.
You lost the lesson too
The market is constantly giving feedback. What happens after the “my stop is going to get hit” statement? What if the market goes in your direction? Are you going to get out at breakeven? Let it run? Take a small lost/gain? What are you going to do next time? The time after that? The outcome will affect your decision. The outcome you remember best will be the one that gives you the best psychological reward not financial rewards. Trading is about answers, not questions. Unanswered question impedes reactions and forces decisions. Decisions are bad over the long term.
Get out already (more…)
Everything has a cost. There is no free lunch. There is always a trade-off.Cost is what you give up to get something. In particular, opportunity cost is cost of the tradeoff.
One More. Rational people make decisions on the basis of the cost of one more unit (of consumption, of investment, of labor hour, etc.).
iNcentives work. People respond to incentives.
Open for trade. Trade can make all parties better off.
Markets Rock! Usually, markets are the best way to allocate scarce resources between producers and consumers.
Intervention in free markets is sometimes needed. (But watch out for the law of unintended effects!)
Concentrate on productivity. A country’s standard of living depends on how productive its economy is.
Sloshing in money leads to higher prices. Inflation is caused by excessive money supply.