By David Popper
In the New International Version, Proverbs 1:2 describes the purpose of proverbs is to obtain wisdom and discipline. Wisdom and discipline, what a combination. Wisdom is the ability to use knowledge (facts) in a situation. It is the ability to formulate a plan. Discipline is a self determination to execute that plan under fire. Websites, financial articles, books and seminars will, over time, give you the ability to gain knowledge and eventually wisdom. They cannot give you discipline. Discipline is easy when the trade moves with you. It is difficult when the trade does not move your way. When a trade moves against you, self doubt emerges. One begins to question the reason for the trade. One begins to feel like a fool. The world will end. You end the pain by closing a position and the pain subsides, until the stock turns on a dime and shoots for the moon. The pain is now worse than before. Before, you questioned your plan. Now you question your nerve. Trading can have psychological implications. Can you insulate yourself from this damage? Yes, with discipline and experience, over time. Let's discuss some possible remedies:
1. ONLY TRADE TOP STOCKS IN TOP INDUSTRIES.
I operate from the premise that technology is here to stay. I look for companies that are on the cutting edge areas of technology, where it is acknowledged that there is room to grow. In fiber optics for example, the battle is not a fight over an increasingly smaller piece of the pie (like the paper industry), the competition is more akin to the Oklahoma Land Rush. There is plenty of growth room for everyone. The fight is between the companies acquiring the best piece of land. In short, the market is not mature.
Within these hot sectors, I look for the acknowledged leaders using the criteria established by Investors Business Daily. (Earnings per share 90% plus, relative strength 90% plus.) I try to trade at a technically favorable time.
2. DECIDE THE METHOD OF TRADE.
Once I have selected the stocks I wish to trade, it is now necessary to choose the method of trading. As I have stated many times, I cannot watch the computer all day, therefore, I usually am more comfortable selling long term calls (four to six months) in exchange for a 20% to 25% return. However, during earning seasons or just before a split, I may hold the stock for the run, but afterwards, I will usually sell it or sell a long term call. Finally, I may periodically channel trade 100 shares of a stock if it is in a well defined channel. All of these methods together, involve less risk and provide a healthy return.
3. KEEP CASH.
I will keep a sizable amount of cash. With cash position and long term calls, you become enabled to take advantage of downside moves as well as upside moves. When I was fully invested and margined, I shuttered whenever an economic report was coming. I was upset when the report was bad and I rejoiced when the report was good. In short, I was emotional.
Armed with cash allows you to buy on dips for quick profits. Long term calls on great stocks allows you to ride out the stormy seasons of the market. Being armed with these two friends allows you to roll with the market instead of hoping the market moves your way.
When you are postured to be flexible, the volatility can be fun and profitable. You get a feeling of confidence and being in control - because you are.
No, this is not fool proof. Nothing in the market is fool proof. Nothing in life is fool proof. Your odds are better though. Is that not what a trading system is all about?