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SECRETS OF SUCCESSFUL TRADING Recently, I've been reading in the financial press about how today's popular gurus are split on whether we're in the middle of a long-term bull market or bear market. How do you know what to believe or what to do? I suggest you don't subscribe to either the bull or the bear side. As Jesse Livermore once said, “I prefer to be on the right side.” It’s a bold title this go around, so let’s get right to it. What’s the key to making money in the stock market over time? The answer is simple--don’t lose money during the down periods. I can see you rolling your eyes on that advice, but before you give me a “thanks a lot for that,” I can tell you this advice is actually profound. One of the keys to success and wealth building is to turn some of your paper profits into real cash when available and not to lose money when profits become elusive. Now, I’m not talking about every trade or every investment--of course, we'll all lose money at times. To clarify what I’m talking about, don’t ever lose big money. And when you’re fortunate enough to have paper profits significant enough to make a noteworthy improvement in your net worth, don’t leave it on paper--turn it into real cash. At a wedding not too long ago, a relative of mine told me she was in on a dot-com IPO from the beginning with an initial investment of $100,000, and at the top she was worth $8 million (on paper). The company is now extinct. What was her net result? A loss of $100,000--she didn’t even cash in $1 of profit (and yes, she’s still working for a living). What was she thinking? I don’t get it, but after a few decades of doing this I’ve heard the same story in varying degrees time and time again. There must be some psychological explanation beyond what I’m able to comprehend. The key to wealth is to limit your loss during losing periods and accept some gains during the good times. Sure, this sounds great in theory, but how do you go about putting it into practice? First, let’s stop and think for a minute about how a price is determined. What determines the price of a stock (or an index for that matter)? Is it the economy, the government or corporate earnings? No, the price is determined by the buyers and sellers in the market (who may or may not be influenced by these other factors). In any case, you and I are only concerned with the results in our trading account, which are directly influenced by the price of whatever we’re trading. My 27 years in this business have also taught me how to minimize my losses on the trades that don’t go my way. And as anybody who’s ever even dabbled with futures knows, minimizing your losses is every bit as important as riding your big winners. I've shared this simple methodology with my Futures Market Forecaster subscribers that's designed for safety, plus above-average stock market returns. Heighten Your Earning Potential Market statistics on winners and losers indicate the great majority are missing an essential element for success. Most traders embark on their journey with confidence, so why then do so many encounter problems? The losers in the game must overcome what I term the “6 Hurdles to Successful Trading,” in my book, Trading Commodities and Financial Futures: A Step by Step Guide to Mastering the Markets (FT Press, 3rd Edition, 2004).
The six hurdles to successful trading
are: Here’s how to overcome the hurdles, from Trading Commodities and Financial Futures: Condition Yourself to be Unemotional If you are trading for the thrill of it, you’ll trade when the conditions favor your methods and you’ll trade when they don’t. Because you are trading emotionally, you will overtrade---the inevitable outcome of thrill trading. You will also overstay your welcome on trades not going your way and this invites disaster. It might work for a time, but there will come a time when it will wipe you out. Revenge Trading; Another Recipe for Disaster Has this ever happened to you? You have just been stopped out for a loss, a bigger loss than you had anticipated. Perhaps, it was a ‘gap open’ beyond your stop due to some unexpected news. It is early in the trading day, and you feel you must make it back. The market owes you your money back and it must do so today! Have you ever had this feeling? Well, I have, and let me tell you when I’m out for revenge, 9 times out of 10 it ends badly. This is because the state of mind is unstable leading to bad decisions. When you get this feeling, force yourself to take a step back and relax. The market will be there for you tomorrow and there are always opportunities. Preservation of Capital is Your Primary Mission When you have no money management program, it’s impossible to preserve your stake. Unless you tell yourself you will only risk X percent of your account on any one trade, that one trade that looks so right will inevitably come along and you will overtrade it. Let me share a secret with you; they all look so right. I would not enter a trade unless it looked real good, but it seems there is no way to know in advance which trade is going to be the big winner. If we knew this then these would be the only ones we would trade. For me, I’ve found it’s a small number of trades that makes my year each year, and many times not the trades I thought would be the big winners. You must preserve your capital, and this means taking small hits on the many and inevitable losers. The goal is to still be in the game when those ‘mega-trades’ finally materialize. Your Plan Must be Well-Defined Nobody enters a position expecting it will result in a loss, however it will not come as news that even top traders experience numerous losses. So if the best will lose, why would you be any different? A well-defined plan will define success and failure both. Ask yourself why are you buying gold? If the answer is something like, ‘because it just broke above the 30 day moving average’, or ‘because the CPI indicates inflation is heating up and in the long run gold is sensitive to inflation’, you have not defined your plan. You have reasons why you entered, but no clear exit strategy. You are trading on hope and this is not a recipe for success. You must define your loss point before you enter the trade, and if you are not mentally prepared to lose, you’ll never win. It is essential to realize you’ll lose countless battles in this trading war, or the war will never be won. You should have a profit objective. Stop loss points should be written in stone, however profit points can be flexible and you should have contingency plans when your profit objective is reached. The plan could be nothing more than something like this; ‘I am risking $500 per contract on this trade and my technical profit objective is $1200. If the market moves $500 my way, I move my stop up to an approximate break even and if it moves $900 my way, I move the stop up to approximate a $400 profit. If it reaches my technical objective I watch very closely for signs of failure; if the market shows these signs, I sell at the market, however if it moves through, I tighten my stop to just under the previous low’. This plan may or may not work, but at least it is a plan, and without a plan you’re ultimately doomed to failure. You Must Act Without Hesitation (if there's good reason to do so) When you ‘paper trade’ you always take the loss or the profit. In the heat of the battle it is not as easy to pull the trigger. Remember, you must lose to win in this game. Too many times, even good traders will not take the loss when the planned risk point is reached. It is a human trait not to be able to admit you are wrong, and it is seductive to wait just a bit longer or take just a bit more risk in the hope the market will turn back your way. In the great majority of cases, this just exacerbates the pain. How do you overcome this shortcoming? Very simple. Place a physical stop loss order with your broker the moment you enter the trade and then just let the “Market Gods” determine your fate. Trust me when I tell you this; you won’t be stopped out of the very best trades. Condition Yourself to be Humble You cannot have an ego and be a successful trader. With apologies to Vince Lombardi, winning is not everything, and it is not the only thing. I had a client with an S&P day trading system that made money four out of five trades. The problem was that fifth losing trade more than offset the other four winners. Yet, until he ran out of money, he kept trading it for small profits because it felt good to him. I have seen numerous clients try to pick tops and bottoms, yet this is an almost impossible task because every major move has just one top and just one bottom. Who cares if any one trade makes money or if you have more losers than winners? The name of this game is not how many winners you have, but making money at the end. Forget about being right on any particular trade and focus on making money!
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