It probably won't come as any astounding revelation, but it can be
important to recognize that we have no control over the market or any
particular stock. We can think whatever we want about the direction a
stock will move, but unless we have some podium from which to affect the
public opinion, what we think has no influence on what the price does.
Markets move in response to a variety of factors such as news, supply
and demand, panic, euphoria, and so on, but no matter what the reason
for the movement, we can do little but react in one fashion or another.
It is our reaction that is critical. Do we race to place a buy
order because a CEO being interviewed on CNBC says his company is
getting ready to introduce some new product? Have we ever jumped on a
stock just before it peaked and turned over? Have we ever held onto a
falling stock because we thought "it will come back?" Each of those
situations is a result of reaction to what we thought about the
situation. Certainly, I am not against thinking, I just want to point
out that what we think has no influence whatsoever on what the stock
price may do.
We may think a stock will go up, but that definitely does not make
it so. Obviously, we will make our trading decisions based on what we
think will happen. If we didn't think a stock was going to go up in
price, we wouldn't buy it. We could be wrong. It seems like there is a
50% chance it will go up and a 50% chance it will go down in spite of
our thoughts. Since we can't control the movement, what can we control?
We can control what stock we trade, and that decision could well be
made based on what we think will happen. We can control what strategy
we will employ. Will we buy the stock or sell it short? Buy LEAPS
calls or enter a bearish put spread? Most importantly, however, is our
ability to set our entry and our exit. To my mind, those are the
critical elements over which we do have control.
If we set our entry near our initial exit (the exit to use in the
event the move goes against us), we unemotionally have established a
place at which our losses are cut. We then need to predetermine an exit
strategy to utilize as and if the move goes in our desired direction.
In order to permit profits to run, I favor an exit that, in some way or
another, trails the move and gets me out in the event of a turn. Using
that theory, it is unlikely that we will catch the exact top or bottom,
but it can help take a nice chunk out of the middle.
Targets undoubtedly have their place, but I am not convinced that
they serve as the best exit strategy since they could result in a
premature exit. Take, for example, a situation where we are bullish on
XYZ. We buy it just above support at $30. Our initial exit, we'll say
is just below the support, so maybe we set a stop at $29.75. Our target
is $34. Suppose the stock moves our way and hits our target of $34 so
we get out. Then the stock rockets to $50. We have, indeed, made a
profit, but we have also failed to let our profits run. In fact, we
have actually cut our profits. If we had chosen to exit using, for
example, a break of the 30 day moving instead of the target, we could
likely have remained in the trade.
The bottom line in trading, I believe, is that we need to focus on
what we actually can control and decide precisely how we will exercise
the control before we ever enter a position.
Good Trading!
Bill Kraft
Mr. Kraft's past articles are posted on our website for your review.
