In the article last weekend, I talked about understanding how
even a trade that loses can be a good trade. That was intended to
reinforce the concept that cutting losses can be critically important
to successful trading. This weekend, I want to discuss stock picking
a little.
Of all the questions I am asked about trading, the most frequent
is probably: "How do you pick a stock." That is what seems to concern
most retail traders the most and many spend untold hours trying to
find just the right one. I once had a student who had suffered severe
losses in the downdraft that began in 2000 and when he came to me he
was afraid to make any trade at all. He was consumed with the effort
to structure a method by which he could select the perfect stock so he
would have no chance of losing. Though there is a strategy that I
discuss in
"Trade Your Way to Wealth" that protects against loss, I
don't think there can ever be a stock that assures success. No matter
how hard we try and no matter what fundamental analysis we undergo and
no matter what marvelous mathematical formulae we construct to find
the perfect stock, there is always the chance that 10 minutes after we
buy it there will be some world event or some news announcement by the
company that will result in the price dropping.
I believe that one of our jobs as traders is to make things as
easy on ourselves as possible. Many retail traders just buy stocks.
If that is all they are going to do, they should at least give
themselves an edge. Buying stocks in a falling market can be similar
to trying to catch a falling torch. It is a good way to get burned.
When markets are falling, most stocks are falling with it. Trying to
predict when a market (much less an individual stock) will turn is
pretty risky business. If all a trader wants to do is buy stock,
consider buying when the markets are turning and/or trending up. If
the markets are falling, go fishing or play golf. They will turn up
again and then our trader can go back to buying.
In my estimation, we need to spend less time hunting for the
perfect vehicle and more time in developing a sensible exit strategy.
No gain is ultimately realized until we exit the play. Exit, then,
becomes a key element in successful trading. If we develop an exit
strategy that removes us from a losing position with only a small loss
but keeps us in a winning position as long as our gains are
increasing, I believe we can be successful traders.
Is there such a strategy? Probably there are many. One example
would be the use of a moving average. We could decide, for example,
that we would enter a bullish position when a stock price crossed
above a moving average. Such an event signals bullishness. The time
frame would depend upon our personal business plan, but it could be a
5 day, a 20 day, a 50 day, or whatever the trader chooses. As long as
the stock remained above that moving average, we could hold the
position, but we would exit if the price fell below the moving
average. Now, the stock price movement is making both the entry and
exit decision for us. We have found a basic method to remove our
emotion (the enemy of traders) from the decision process. In trending
markets, this method can be pretty effective though one runs the risk
of whipsaws in sideways markets. Some traders choose to use MACD
crossovers as entries/exits; others may move stops using candlesticks
or exit on breaks through trends. The point is that utilizing an exit
strategy that provides the discipline and removes the emotion can help
us become more successful traders.
Good Trading!
Bill Kraft
Editor of $10 Trader, Option Trader and Trend Trader
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