Morning Market Thoughts
Looking for an edge in your trading? Start with getting a handle on your trading decisions.The decisions you make obviously determine the profit or loss that you take. One tendency that many traders have is the practice of closing their entire position in a stock or option trade. Whether it’s a stop loss order or a decision to sell, do you just liquidate the entire position? Or, do you assess the risk of selling too early and missing out on profits versus the risk of holding the entire position and losing more money?
When you trade “fractionally”, you gradually increase or decrease your exposure as your trade idea unfolds. You have an expectation for each trade. As the trade unfolds, is it consistent with your expectations or is it proving you wrong? And as it unfolds, are you sticking with your plan or just making emotional decisions based on money?
Focus on what the stock is doing, not on dollars and cents. If you have a position size that’s appropriate with your risk tolerance, then the dollars you are up or down shouldn’t influence your decisions. Focus on the chart instead, and let the dollars take care of themselves. What is an appropriate position size relative to your risk tolerance? One rule of thumb is a risk of 2% of the value of your account. And “risk” is the difference between the entry and the exit, multiplied by the number of shares you own. If your account size is $100,000, then you should never take a loss of more than $2,000 on any trade.
When you’ve got your maximum risk locked down, then you have the freedom to just let the stock work. There is an ebb and flow to even the strongest stock. If your position is working, you might have a tendency to fixate on your paper profit. And if you are fixated on the dollars, then each pullback in the stock seems like a loss. You think, “If I’d only sold it yesterday, I’d be up more money. Maybe I should sell it now.”
When you think that way, you’re actually trying to pick the top of the stock. You’re trying to sell right at the high, which is impossible unless you just happen to be lucky (or are a liar). It is obvious that the profit you have on an open trade will ebb and flow along with the stock. But your emotions about money might cause you to forget this linkage. In so doing, you let the money take over and your trading idea goes out the window. The result? You sell all at once,…and often watch the stock continue higher without you. You’ve turned a great trade into an average one by fixating on the money.
The idea is to make money. Anything you buy should be with the expectation of profit. So when you start profiting, be happy about it. As long as the stock is generally moving in the right direction, just let it work. You’ll make even more money. The only thing better than making money in trading is making…MORE money. Don’t let fear of losing some of your profit prevent you from maximizing your profits.
Two key points:
1. Make sure your position size is appropriate. If you are stopped out, you should not lose more than 2% of your account balance. The position should not keep you up at night. If it does, the position is too big. (And if you forget about the position, then it’s too small.)
2. Scale into a stock with multiple buys at various levels. As the stock moves in your favor, buy more. But treat each purchase as a separate trade. As the stock moves in your favor, be sure that you can raise your stop on your initial trade to close to break even. When you can do that, you’ve just minimized your risk of losing money on the trade. This enables you to increase the position size without going over your $2,000 risk limit.
While these two basic concepts are a starting place for maximizing profits, the devil is in the details. But if you follow these two disciplines consistently, you’ll find it much easier to focus on the quality of the trend in the chart rather than the bucks.
Also, I’ll be holding a training session on Wednesday at 12 noon ET (9 am PT). Hope to see you there.
–Dan
Market Update