Trading Lesson: 10 Critical Rules for Investing

LessonsTrading Lesson
The stock market is constantly evolving and every day I work to improve how I trade it. Year after year I use the same basic principles and methods, just apply them in different ways to suit the current market conditions.

One of the constants that never seems to change is human nature- how fear and greed guide the market action. Succumbing to either of these emotions often leads to financial loss.Here are 10 things you can do to become a better investor and avoid these traps:


1. Use Strategies that Work
Your approach to the market won’t have a hope if your analysis methods are not effective. There are many ways to analyze markets/stocks, take one that you like and test it until you have confidence that it works. Then apply it.
2. Write a Trading Plan
Success has a better chance of happening when you write down a plan to get there. Make your plan include your rules for entry and exit, risk tolerances and a process for review. Adapt your plan over time as you find better ways to achieve success.
3. Manage Risk
Understand the risk in every trade you make and don’t take risks that you cannot tolerate. If your exposure to loss is more than you are comfortable with you will inevitably break your discipline. I like to define my risk based on my overall portfolio. Not just from entry to exit.
4. Limit Losses
You should always know where the exit door is in case something goes wrong. Before I buy a stock a know exactly where I am going to exit (if wrong) and how much I’m going to risk (% of my portfolio). Pick your exits based on important areas where the market has proven your decision to enter wrong. If the stock falls to that price, get out. Don’t let small losses grow in to big losses.
5. Take Responsibility for Your Decisions/Actions; Don’t Blame Others
There may be a good argument for why a loss you have suffered is someone else’s fault. The newsletter writer could have been wrong, the media could have been wrong, the government could have gone back on a promise, the company could be corrupt, etc, etc. Blaming others will never get your money back or help you learn from your experience. You will not change the actions of others, you can only change your own. Therefore, blame yourself for everything that happens with your money and take steps to make it better.
6. Date Your Stocks; Don’t Marry Them. Stop Falling in Love
The more you know about a company, the more likely you are to ignore the market’s message. Companies want you to own their stock; the more investors that they get to own their stock, the higher the price goes. As a result, there is a bias to the information that you are exposed to, if you listen too much you may miss activity in the market that is telling you that something is wrong.
7. Profits Are A Function of Time; Practice Patience
Profits are a function of time. Be patient with your winners and impatient with your losers. The profit is in the patience, hold on to strong stocks so long as they are showing strength. When looking at a company, avoid a short term outlook that can mislead you about the long term trend.
8. See the Other Side of the Story
Everything you know about a stock may tell you to buy it and you may do so with complete commitment. But, always ask yourself, “Why is someone willing to sell to me at this price.” If you understand their motivations for selling versus your motivations for buying, you can better determine who is right. Without an understanding of the other side of the trade you can not determine whether the other side is wrong.
9. Avoid the Herd
The crowd usually loses. When buying, look around at your fellow buyers. Are they well informed, smart investors or are they generally uninformed people watching 60 Minutes? Always try to be one step ahead of the herd.
10. Post Analysis- Analyze Your Results
The market is always evolving, making constant evolution in your approach to the markets important. On a regular basis, analyze your trades and looks for patterns of self destruction. Make changes as necessary.

Source: Loosely Based on Stockscores Perspectives for the week ending August 31, 2013

Sun Tzu's Advice For Wall Street; Trading Is Like War

WarThe Trade War
The stock market is a forum for debate between buyers and sellers on the values of companies. That is the nice explanation. To frame it in a another light – the stock market is a war between buyers and sellers, who each want to take the others money. The stock market is rough, and if you don’t approach it with the disposition of an irritated general, you will lose. In the stock market, nice guys finish last.
Sun Tzu’s, The Art of War serves to highlight many aspects of trading, since trading the market is much like warfare. Here are some quotes from the book, and their application in trading:
“All warfare is based on deception.”
Suppose you are a large hedge fund, and you want to accumulate a stock. You know that taking a sizeable position will move the stock higher, and you will end up paying higher prices as day traders jump in to the frenzy. With shares on the books already, you can afford to sell a little bit and paint the chart with a negative technical set up that should entice some selling pressure from nervous retail investors and overzealous short sellers. That selling pressure will help you fill your larger buy order.
You may also bring your buying in phases. Let the stock fall back and trigger stops, shake out nervous investors and free up stock to build the position. You may post fake orders in the Level 2 screen to make traders believe that there are large sellers and add further worry among the uncommitted buyers. These are just a few of the tactics they use.

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Deception vs True Intention:

As a trader, you have to be able to differentiate between deception and the true intention of large investors.
Further words from Sun Tzu:
“Therefore, in your deliberations, when seeking to determine the military conditions, let them be made the basis of a comparison, in this wise:
(1) Which of the two sovereigns is imbued with the Moral law?
(2) Which of the two generals has most ability?
(3) With whom lie the advantages derived from Heaven and Earth?
(4) On which side is discipline most rigorously enforced?
(5) Which army is stronger?
(6) On which side are officers and men more highly trained?
(7) In which army is there the greater constancy both in reward and punishment?”

Let me translate this in to stock market terms:
Among buyers and sellers, the side who will gather the greatest profits will be determined by:
(1) Which side believes that the stock market is always right (up or down)?
(2) Which side is led by the largest investors (bulls or bears)?
(3) Who is trading with the trend?
(4) On which side is discipline most rigorously enforced?
(5) Which side has more money?
(6) Which side has the best understanding of fear and greed, and how the crowd behaves when pressured by either?
(7) Which side lets profits run, and limits losses?
“According as circumstances are favorable, one should modify one’s plans.
We should only add to winning positions and never average down on a loser. Profits are carried by momentum, and if you are on the right side of momentum, you can make a lot of money. When losing, stick to the plan and exercise stop losses. When winning, increase position size as new entry signals are confirmed.
“When you engage in actual fighting, if victory is long in coming, then men’s weapons will grow dull and their ardor will be damped. If you lay siege to a town, you will exhaust your strength.”
If the expectation of your trade is not working out in a timely fashion, then you have read the market wrong and it is best to exit the position.
“It is only one who is thoroughly acquainted with the evils of war that can thoroughly understand the profitable way of carrying it on.”
If you think the stock market is fair, quit trading immediately.
“Hence the saying: If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb to every battle.”
If you know the market and know yourself, you will consistently profit. If you know the market but not yourself, your success will be random. If you do not know the market or yourself, you will consistently lose money. Success in the stock market is not just about the market, it is also about knowing how you react to fear and greed.
“The onset of troops is like the rush of a torrent which will even roll stones along in its course.”
The trend is your friend.
“The good fighters of old first put themselves beyond the possibility of defeat, and then waited for an opportunity of defeating the enemy.”
Good traders know that they can consistently make money, and that confidence fuels them to consistently make good decisions.
“To lift an autumn hair is no sign of great strength; to see the sun and moon is no sign of sharp sight; to hear the noise of thunder is no sign of a quick ear.”
Great traders see more than the obvious.
“There are not more than five primary colors (blue, yellow, red, white, and black), yet in combination they produce more hues than can ever been seen.”
Keep stock trading simple. You need only understand support, resistance, optimism, pessimism, price volatility and abnormal behavior.
Source: Stockscores Summer 2013

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Uncommon Market Sense: 10 Basic Thoughts & Rules on Trading:

10 TopThis week, I share some basic thoughts and rules on trading:
1. Don’t apply logic to the stock market.
So often I see people make decisions in the market on what makes sense to them. It makes sense to buy stocks when the company insiders are buying. It makes sense to buy stocks that are making positive announcements. It makes sense to listen to what the CEO has to say about the company’s prospects. However, all that matters is what the market thinks of the company and whether the buyers are more motivated than the sellers. So often, the market does things that do not make any sense until we later learn of what motivated the market to do what it did. Remember, the market is forward looking, most times, what makes sense is judged on what has happened in the past.

“Losers, Average Losers”
Paul Tudor Jones

2. Never Average Down on a Losing Position
Legendary Hedge Fund Manager Paul Tudor Jones said it best, Losers, Average Losers. Buying more of a bad thing is not much different than continually betting on a losing horse. Winners win for a reason and losers lose for a reason. Your stock has to prove that it is a winner. Until it does, don’t add more to a bad situation. If you like a company whose stock is losing you money, sell it. You can always buy it back later when the market starts to like it again.
3. Successful Investing is Not About Being Right, It is About Making Money-
Most good traders are usually wrong. They will lose small amounts often and make big amounts occasionally. What matters is how much they make over a large number of trades. Don’t try to always be right, simply work to make money.
4. Get Out of Your Comfort Zone- Resist Doing What Feels Comfortable
We have a tendency to look for the market to prove our decision is a correct one before we make our move. The problem is that this often means we are too late to capitalize on the opportunity. We have to move before the crowd, and that often feels like a dangerous thing to do.
5. Anyone Can Get Lucky in the Short Term, Only Good Traders Succeed in the Long Term
Don’t confuse making money in the stock market with knowing what you are doing. It is easy to get lucky on a stock or on a sector and enjoy gains that give credence to your analysis method. However, short term winners often give back all of their gains because they fail to recognize their success as luck.
6. Be Patient With Your Winners, Not With Your Losers
The natural tendency is to sell your winners too early and hold on to your losers, hoping for a turnaround. A simple, but not easy, thing to do is reverse this tendency. When the market proves you right, wait to sell on a signal that indicates the stock is likely to go lower. When the market proves you are wrong, let the trade go and take the loss.
7. Publicly Available Information is Priced in to the Stock, Don’t Rely on it to Make Decisions
Once information, no matter how good, is made public, it loses its usefulness to you. Public information is priced in to the stock by the market of investors. Information only has value to you if the market has not priced it in or if you use it differently than others (see things others don’t).
8. Make Sure Your Trading Strategy Has an Edge
A trading strategy is only worth trading if it can be shown that it consistently makes money. Establish your trading rules and test them over a variety of market conditions so you know that it is effective. Time spent testing a strategy to prove it is a money maker can save you a lot of money in the market.
9. People Lie, Markets Don’t
I have learned the hard way to never trust what people say, their actions say much more. Learn to read the market and understand it’s message. No matter how much insight a person may have, recognize that they have a bias based on their own emotional attachment to money.
10. It is Easier to Trade with the Trend Than Against It
Understand the mood of the market and trade with it. Don’t chase euphoria, but seek to buy stocks that are in the control of the buyers. Don’t sell on fear, but seek to sell stocks that are under seller control.



Source: Stockscores Perspectives for the week ending July 8, 2013

The Perception of Fundamentals Matter

PerceptionThe Perception of Fundamentals Matter
What moves a stock’s price? At the most basic level it is Information. Unfortunately, life is not that simple. Arguably, one of the most important market moving components is not the actual data but the perception of the data that matters. It is the perception of fundamentals that determines stock price, and it is changes in the perception that leads to changes in price (technicals).
Fundamental Analysis:
Investors who make decisions based solely on fundamentals alone use various methods of interpreting the company’s business to arrive at the value for their stock. If this logical value of the stock is higher than the price the stock trades at, the stock is deemed worthy of purchase (or undervalued).
This analysis process leaves little room for the artful interpretation of value. Fundamental analysis tends to be black or white (e.g. overvalued or undervalued), leaving little room for the color of reality.
What make the financial markets colorful are the characters, motives and moods that taint the process of logical deduction. A stock whose fundamental value is $20 may only trade at $10 because a large investor has lots of stock to sell, a group of short sellers may have the stock gripped in fear, or investors may simply not like the color of the story.
Investing is an Art:
There is an art to predicting stock price change.
From our perspective, it is not enough to know what the fundamentals will be tomorrow, it is also important to know how the market will judge those fundamentals. It seems obvious that a company announcing positive news will go up in price, yet we as investors have often seen the opposite happen.
How Will the Market Judge The Fundamentals:
Investors will judge fundamentals not only on their merit, but also on how they relate to expectations. Sometimes, fundamental change will be ignored in favor of more pressing macro economic issues.
Suppose you are told that a mining company will announce the discovery of a significant gold discovery. In anticipation of news, and based on your information, you buy the stock. You are excited by the prospect of what will be easy money, to materialize when the news is made public.
Two days later, the news is announced and you watch the stock with excited anticipation. But instead of jumping higher and higher, it goes up for a couple of minutes, and then suddenly begins a free fall lower. Your expectation of quick and easy profit quickly and easily turns to loss.
You can not understand why, it seems to make no logical sense.

5 Reasons Why Markets React Differently Than You Think They Will:
Here are some of the possible reasons why the trade did not work:
1. The stock market is not fair. The information that you received was obtained by others weeks earlier, and the stock already priced in its value. Your stock has been going up in anticipation of news for some time.
2. Expectations rarely live up to reality. Investors have a wonderful imagination, and the visions of those who were buying the stock in anticipation of the news pushed the stock beyond what the news was worth.
3. Without a reason to own, investors will sell. Many short term investors bought this stock in anticipation of news. When the news came out, so went the reason for owning the stock. Investors who buy in anticipation of news often sell when it is released.
4. The exit door is only so big. When a stock starts to do what investors don’t expect it to do, investors panic and all try to get out at once. This creates emotional selling that has no regard for fundamentals.
5. Every stock correlates to the market. If the market is going down and pessimistic, buying a stock is like trying to paddle up stream. Some can succeed, but most eventually go with the flow. In fact most studies show that over 75% of stocks follow the major averages, up and down.
Conclusion: Fundamentals are important but only one part of the overall equation. From our opinion, it is imperative to ask, what does the market think? How will the market judge this company? What effect will the mood of the market have on the perception of fundamentals? How is the market behaving? When will I exit if wrong? How much do I want to risk on this idea? How are the technicals (price action)? Etc… Etc.
Fundamentals alone are one part of the equation, the more important factor is the perception of the fundamentals.
Source: Based on Stockscores Weekly Note




If You Do Not Have a Sound Trading Plan, Stop Trading

pathThis Week’s Trading Lesson
Sound Systems Yield Success:
When you think of the best run companies in the world, what names come to mind? Wal-Mart? Proctor and Gamble? Perhaps Apple? Think of the worst run companies and you might think of a company like Enron, which is now out of business because it was run so poorly.
If we compare Wal-Mart, the world’s largest retailer and a model of incredible cost efficiency, with Enron, the once high flying energy firm that ultimately burned out on bad deals, we see that the price paid for leadership meant little. Wal-Mart executives, by Enron standards, are poorly paid. Enron sought the brightest and best and paid them very well. Wal-Mart grows their leadership internally and pays their highest earners with modest salaries. Enron went bankrupt despite their smart and talented people.
What is the difference, does money not buy quality?
With my very limited knowledge of either company, one thing that stands out to me is the difference in systems and processes for (e.g. risk management) that each employ. Every task that a Wal-Mart employee is clearly defined and modeled for success. Employees at Enron were allowed to sort of do what ever they thought would help the company succeed. A noble idea, but the lack of standards allowed for individual goals to take priority to the detriment of the company.
Plan & Processes Take Precedence Over Talent:
From this example, it seems that plan and process take precedence over talent. A disciplined, highly calculated and planned business is able to do well even though it may not have the smartest people running the business.
And so it goes for trading.
I have taught aspiring traders from every possible background. The well educated and the drop outs, Mensa level IQs and those who might be referred to as not the brightest bulb on the tree. I have taught those who have already achieved financial success and those who are in pursuit of that dream.
Anyone Can Succeed or Fail:
And what stands out, after teaching a few thousand people, is that there is nothing about a person’s background that predicts trading success. When trading, anyone can succeed or fail.
Sound System (Plan & Process) Win:
So what does matter? At the very top of my list would be having a sound back-tested system (plan + process). Having a detailed, well tested and constructed plan for making money in the market is a must. Every aspect of the plan must be well thought out and based on prior market action. The more steps in the trader’s plan that are left to human judgement, the greater the chance that the plan will achieve a poor result.
With a good plan, can anyone get the job done? If you ask Wal-Mart, the answer is probably yes. They hire thousands of people to do the various jobs that they employ and could not possibly expect that talent will allow each employee to get the job done. Their people succeed because their jobs are well defined.
Define Your Tasks:
What is important is how the tasks are defined. Wal-Mart succeeds in part because they have so much retailing experience. Their employees and management use their experience and resources to develop the very best processes. With those processes, even people who lack experience or talent are able to succeed.
This is exactly how it works for traders. I have seen so many successful and bright people fail in the stock market simply because they did not have the experience to develop the right plan.
Is Your Job Hard?
Think about what you do in your career. Is your job hard? Most people would answer no to this question since doing their job is what they are experts at. To the surgeon who has performed 1000 surgeries, the 1001st surgery is not particularly difficult. For the person who has never done one, it is a great and dangerous challenge, no matter how smart they are.
Can Anyone Succeed on Wall Street? Most Lose
Does this mean that anyone can succeed as a trader if given a good trading plan? No, at least no better than anyone could succeed at removing your wisdom teeth if given a step by step process for doing it. You still need to practice the plan before you can achieve success.
Having a planned process helps us shorten the time it takes to learn something. The Wal-Mart employee or the surgeon can each do their job well by combining a good plan with some time for practice. The Enron employee might have had better success if they had a good plan to work from.
If You Do Not Have a Sound Trading Plan, Stop Trading:
If you do not have a trading plan, stop trading. You might argue that you have done really well in the market over the past couple of months and you therefore do not need a plan. I would respond with some of the examples of people who gave back all their profits and more when the stock market was not working in their favor. Remember the old adage: Everyone is a genius in a bull market. A trending market can make the inexperienced look like they know what they are doing.
You can either create your own plan or you can buy one from someone who has put in the time to create a good one. I think that everyone should try to create their own plan because you learn a lot by doing so. Investing your time and money in studying what other successful people on Wall Street do (and have done) is a great way to find success on Wall Street.
Simplicity in a Plan Usually Works Best:
Your plan must be written down. It must be tested. It must be practiced. It must have a positive expectation. All trading plans should evolve with the market and as you gain experience. They need not be complex, simplicity in a plan usually works best. Plan the trade and trade the plan.



Source: Perspectives for the week ending July 16, 2013

Few (More) Questions To Before Buying a Stock

questiosnThis Week’s Trading Lesson
It is sometimes difficult to know where to begin when deciding whether a stock is worth purchasing or not. Here are 7 questions that I think everyone should ask before buying a stock, as well as what I look for when answering the questions in the most basic form.

1. Is The Market In An Uptrend? 
Stocks go up because investors are optimistic about the future. This is shown on a stock chart in a number of ways. The most important and easiest way is to look for whether the bottoms on the stock chart are rising and if the market is in a general uptrend (moving from the lower left to the lower right). That means that the buyers are in control of the market, making the stock more likely to go higher than lower.
However, it can also happen that conditions are right for a stock to go up if the tops are falling if investors are motivated by fear. When investors are afraid of prices going lower they will sell with emotion and accept too low of a price. When stock’s in this situation find a catalyst for emotional change, they often bounce back quickly.
2. Do Investors perceive significant fundamental change may be likely in the future? 
It is important to realize that stocks do not go up because of what happened in the past. They go up because of what will happen in the future. We also need to accept that the stock market is not fair and that some people use information better than others. These investors will create abnormal trading activity in a stock when they expect significant fundamental change in the future. To beat the market, we have to leverage this break down in market efficiency and focus on stocks that are showing abnormal trading activity in both price and volume. Remember perception is realty and the market always knows best.
3. Is the probability of the stock going higher strong enough to justify the trade? 
While the market may be showing optimism, as evidenced by rising bottoms on the stock chart, we also need to know that the probability that the optimism will continue is good enough to justify entering the stock. The best way to determine this is by using chart pattern recognition. Patterns like ascending triangles, pennants, flags and cup and handles are very helpful (because human nature doesn’t change) so it is essential to learn how to recognize them. Often, investors will buy a stock that is well in to an upward trend because the stock is showing a lot of optimism. However, because stocks that have been trending higher don’t usually have good chart patterns any longer, they may not be worth entering. We want to find stocks that are starting upward trends so that we can maximize the probability of success.
4. Does the reward potential of the trade justify the risk? 
All signs may indicate that the stock is likely to go up but if there is a limit to how high it can go then we should evaluate whether the reward potential is significant enough to justify the trade. Stock’s will often stall at historic ceiling prices which chart readers call resistance. We should exit a trade if the stock falls below its historic floor price, which chart readers call support. If resistance is not twice as far away from your entry price as support is, the trade is probably not worth taking.
5. How Much Will I Risk? Can you, the investor, handle the risk of the trade? 
Always know exactly how much you want to lose if you are wrong an where you are going to exit – if the trade moves against you. The greatest enemy of any trader is emotion. Emotion causes us to avoid taking losses when the market tells us the stock is likely to go lower. It causes us to sell our strong stocks to early. Emotion is at the root of almost every break down in our trading discipline and it is the reason most people fail to beat the stock market. If you take more risk than you are comfortable with on any trade you will likely make emotional mistakes. Therefore, it is essential that you are comfortable with the risk of every trade you make. To be successful, you must not care about the money.
6. Is the overall market condition right for your trade? 
Every stock has some correlation to the overall market. No matter how good your analysis or disciplined your trading, you will do better if you go with that thing that is out of your control. Trade with the mood of the overall market and buy stocks aggressively when the overall market is going up. For long-only investors, being conservatively when the overall market is down tends to be a highly rewarding proposition. Remember, 3 out of 4 stocks follow the major averages and if the market is falling trying to find a stock that will buck the trend is not ideal.
7. Does the stock have enough liquidity to justify the trade? 
The public listing of a stock does not mean it will be easy to buy and sell. A stock needs buyers and sellers to create the liquidity of the investment. Stock’s that trade with little volume or not on a regular basis are best avoided simply because the costs of entry and exit are too high.
Based on: Perspectives for the week ending December 17, 2012



How Much Can You Make Trading Stocks?

MoneyThis week’s Trading Lesson
Few Make Money; Most Lose:
People frequently ask me, “How much money can you make trading stocks?” I understand why people ask the question but it is a question that does not have one easy answer  because there are so many variables. It is like asking, “How much money can you make playing a professional sport?” For some, it is millions, for others, it only costs them money.
Improve Your Trading Skills; Most People Can’t Control Their Emotions 
Of course, trading skill is the most important factor. Trading is not complicated, in fact, it is the simple things that work the best. This is not to say that trading is easy; it is actually quite hard but not because it is intellectually demanding. It is just hard for most people to disconnect themselves from their emotional attachment to money.

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Learn Rules & Follow Them
The rules for most of my trading strategies could be written down on the back of a napkin – they are simple. Executing them properly takes practice and emotional control. For some, that is not too hard. For others, it can be close to impossible.
It Takes Discipline, not Genius To Beat The Market
You do not have to be exceptionally smart to be a good stock trader; I think most people are smart enough. It does take more determination and hard work than a lot of people are willing to invest but the great thing about both of those things is that neither is exclusive. No matter what your age, gender, looks, intelligence, nationality or social status, hard work and determination are achievable.
Risk and Reward Ratio
Before I go in to the economics of trading, let me first explain a few important concepts. The first is risk, the difference between the price you buy a stock and the stop loss point. If you buy a stock at $20 and have a stop loss at $19, you are risking $1 a share.
The reward is the difference between the entry price and the profitable exit price, assuming you are not stopped out with a loss. That stock you bought at $20 has a reward of $5 if you sell it at $25.
The reward for risk is the reward divided by the risk. In this example, the reward for risk is 5 since the profit was $5 for a risk of $1. How much you actually make depends on what your risk tolerance is.
If you are willing to lose $500 on a trade then you would have bought 500 shares in this example. $500 of risk tolerance divided by $1 of risk demands you buy 500 shares. With an exit at $25, you earn $2500 or five times your risk.
Leverage Works For You & Can Work Against You
How much money did it take to make the $2500? 500 shares of a $20 stock costs you $10,000, assuming you only use your capital. If you use leverage, which most brokerages will give you at 2 to 1 and some brokers will give you at 3 to 1, you lower the capital requirement. With 2 to 1 leverage, you need $5000 to make the $2500 profit. With 3 to 1, you only need $3333. With more leverage, the percentage return goes up but so too does the potential percentage loss.
Now, what can you expect to make in terms of reward for risk? This is where there are variables outside your control that have a big effect on performance. If the market is hot, it is much easier to find winning stocks and the size of those winners will be greater than if the stock is dead. No matter how hard you work or how skilled you are as a trader, you can not control how many opportunities the stock market is going to give you.
Risk Vs Reward:
As a general guideline, on average, the goal for a skilled trader in a reasonable market is to earn at least 5x-10x the amount you risk on a trade. So, if you risk $500 on each trade, you should be able to make $2500-$5000. I want to stress, however, that your skill and the state of the market are two very important variables in this calculation.
How Much Capital Do You Need:
The final question is how much capital do you need to risk $500 on each trade? Again, the state of the market is an important part of this equation. There are times when the hot sector of the market is the low priced stocks. The size of your position in these stocks tends to be smaller because these stocks are more volatile. You may be able to take $500 or risk with a $5000 position (which with leverage may require less than $2000 of your capital).
In a market where the large cap stocks are the hot area you could need 10 times as much capital to achieve the same amount of risk.
As a general rule, take your risk tolerance and multiply it by 100 to get the required capital, before leverage. So, if you risk $500 you will need $50,000 of capital to take the trades that come to you. With leverage, that could be half or one third of that amount.
Avoid The Gamblers Mentality:
Above all else, none of this works if you are a person who approaches the market with a gamblers mentality. Losses are part of trading and you have to be prepared to take the small loss when the market leads you astray. When you get a winner you have to be willing to let the profit run so that the winners can pay for the losers and still leave you some overall profit.
Based on: Perspectives for the week ending December 10, 2012

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Don't Do it for the Money


This Week’s Trading Lesson

“Anything worth doing is worth doing for money.” – Gordon Gecko, Wall Street
Does Money Motivate? Depends on The Task
It is generally accepted that money is a motivator; if you link pay to performance, performance will improve. For that reason, many people’s salaries vary with their performance. This is most prevalent on Wall Street where bankers and traders receive most of their compensation in the form of incentive based pay.In his book, “Drive”, Dan Pink considers whether pay for performance really works. Does dangling a carrot and threatening with a stick cause people to deliver better results? The research finds that this is not always the case.
“Money causes us to focus on something that is irrelevant to the problem. 
In doing so, it complicates the puzzle, making it more difficult to solve.”
Mechanical vs Analytical Tasks:
For very mechanical tasks, incentive based pay does work. A brick layer who is paid by the brick will work more effectively than one who is paid by the hour. However, for tasks that require analytical thinking, his results show that performance is actually worse when it is linked to pay.Pink cites research involving the solving of puzzles. The person who was told she would receive a financial reward if she solved the puzzle in the shortest time performed worse than a person who had no potential for financial reward if the puzzle was solved quickly. The person who was solving the puzzle for the sake of solving the puzzle did it quickest.
Follow Rules That Work & The Money Will Follow:
I have been teaching people how to trade the stock market for over ten years, teaching a lot of people from many different backgrounds. One constant that I have seen is those who perform the best as traders are those who don’t care about the money. They trade with a set of rules and the discipline to follow the rules, making the money irrelevant.
Market Is A Puzzle That We Want To Solve:
The market is a puzzle that we want to solve. Why does a focus on money make us ineffective traders, or puzzle solvers?
I am not a behavioral scientist and I have not done the kind of research necessary to really answer that question. However, I do have an opinion based on what I have learned from trading. Money causes us to focus on something that is irrelevant to the problem. In doing so, it complicates the puzzle, making it more difficult to solve.
Focus on High Probability Trades: Positive Expected Value
If we aspire to make money from the market, we should change our focus to find trading opportunities with a positive expected value. Money will be the determinant of success, but it will not be something that is part of the problem to be solved.Suppose you buy a stock and it is showing you a profit of $1000. It is near to the end of the month and you need $1000 to pay your rent. There is a good chance you will sell the stock because of your need, regardless of what your analysis would tell you about the stock’s potential to move higher.
Keep it Simple: Money Doesn’t Help You Solve The Puzzle
Money causes a greater problem to our trading when it comes to taking losses. A stock may remain a good hold despite the fact it is showing as a loss. The size of the loss often causes traders to exit the trade simply because the money, and the potential loss of more, causes them too much concern.Avoid Emotional Decisions:
Not only can money bring an irrelevant condition in to our problem solving equation, it also tends to bring emotion which hurts our ability to make good decisions. Most people function poorly under stress and the fear of losing money brings stress. When we focus on the money, we trade with emotion and that means we make bad trades.Do The Right Trade: Trade To Solve The Market’s Puzzle
Every trader has to overcome their emotional attachment to money. Trades have to be based solely on the merit of the trade. Our pursuit must be on doing the right trade, doing good analysis. If we trade to make money, we will lose it! Our chances for success improve when we simply trade to solve the market’s puzzle.
Source: Perspectives for the week ending May 27, 2013

Focus on The Best Ideas

Light bulbMaintain a High Trading Standard

There are approximately 15,000 actively traded stocks on the major North American stock markets. That gives investors looking for a stock to trade a lot of choices. Good traders respond to these varied alternatives by being selective and taking the best of the best. Struggling traders end up taking marginal opportunities that may not have a high probability of success. What causes traders to trade marginal opportunities?
3 Main Reasons For Making Mistakes In the Stock Market:

  1. Lack of trading knowledge
  2. Succumbing to fear
  3. Succumbing to greed

Look For Good Opportunities
An experienced, well trained trader should know how to trade and identify good opportunities. Despite their knowledge and skill, many of these traders still take marginal trades because of one of the other two mistakes. Simply put, they are afraid that they will miss out on something good.
The Psychology Behind Taking Marginal Ideas
Most traders can remember a time when they thought about entering a trade but decided not to because the set up was less than ideal. What makes the memory stick is when that trade turns out to be a great money maker. Being left on the curb as the bus is leaving the station on its way to Profit City is frustrating. The next time a marginal trading opportunity comes along, we decide to take the trade. Essentially, we are reacting to our painful memory of missing out on the previous marginal trade that proved to be successful.
We are afraid of missing out, and are eager to make money. Blinded by fear and greed.
A marginal trade is marginal because it has a lower probability of success. Keep in mind that the nature of probability is that there will be instances when the low probability outcome occurs rather than the high probability outcome. Otherwise, we would be talking about certainty and not probability.
If you are looking at a marginal trade, it probably means that the expected potential for profit is less than 60%. That means that the trade will work some of the time. The problem is that we remember those times that it did work and take the trade the next time a similar set up occurs. But, because probability is not on our side, that reactionary trading decision often leads to a loss.
How Losses Affect Your Confidence:
The real problem comes when our losses affect our confidence. With the losing trade fresh in our mind we tend to shy away from high probability trades because we are afraid of losing again. The problem is not the quality of the trade that we are considering but our conditioned response to risk as a result of taking a marginal trade.
Post Analysis:
Any time I have a streak of losers I find that I almost always have taken some marginal trades, those that do not quite fit my trading criteria. When I go back and analyze these trades I realize that the problem is not in my rules but the undisciplined application of my trading rules. By getting back to disciplined trading I almost always reverse my losing streak.
Our Brains Remember Pain:
Our brains are wired to remember pain. The pain of missing out on a good trade can lead us to take a marginal trade. What good traders remember is that there are a lot of busses leaving the station. By sticking to their disciplined trading approach, good traders will find the high probability trades that provide some nice rides and for those marginal money makers that we miss, remember that there is always another bus.
Source: Perspectives for the week ending June 3, 2013

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