Trading Plan & failures

Folks and friends asked me about my trades and I exclaimed “never better”. Some confided in me with dejected looks and told me how much losses they have made.

From my own experience as well as that of most amateurs in this stock trading game, most if not all folks don’t sell when prices acted against their plan. Nicholas Darvas (who wrote “How I made 2 million in the stock market”) said: Investors are pure gamblers when they stay with a stock even if it continues to drop. A non gambler must get out when his stocks fall.

That is exactly how most traders became gambling investors and console themselves that it is alright to hold on until the stocks pick up again. In other words, they are willing to allow their hard-earned savings to be thrown away indefinitely without any indicative evidence of recovery. It is all HOPE!

Emotion is the worst enemy in share market trading. Hence, a proper trading plan is pertinent to ensure a higher probability of winning any trade.
1. Cashflow plan
2. Open positions
3. stops
4. trading failures

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Cashflow plan

I usually encourage people to trade with money they can afford to lose. Of course we do not like to lose money but at the very least, we do not have to borrow money to cover the losses, if any.
Some like to trade with margins for leverage. In fact, it is borrowing to gamble in the biggest casino if no proper plans are established. For margin accounts, I propose to use the funds (borrowing) to add positions in advancing and winning trades only.

Open positions
The next area of concern is the number of opened positions. Novice in share trading like to ask for tips and buy whatever sounded good. In the end, he/she has many opened counters. It will be difficult to monitor.
Some gurus encourage a 50/50 win/loss ratio. That means, open 10 trades in 10 counters and hope 5 win with 10% profits and 5 with 5% cut loss. I am not sure how these will enhance chart reading skills and instead may confuse the person following such manner. I prefer 2 or most 3 at one time. Nicholas Darvas (who wrote “How I made 2 million in the stock market”) had many positions and ended not much gain/loss but he made his big money through a few stocks.
Watch a few strong performers and buy one or two (depending on your capital size). Smaller capital traders should hold a small portfolio of one or two.

Stops
Nowadays, most stock brokers have online platforms to trade and the software have elaborated “Stops” of many combinations.
First entry in every trade must have a stop loss – this is the support level from the charts.
Next, when the stock prices begin to rise, move the stop up to the breakeven level so that you will not lose if the price suddenly reverses.
Finally, monitor the stock movement daily by looking at the end-of-day chart only. As a busy employee trying to make extra money, you have no time to check prices in the day. Most successful traders don’t look at prices in the opening hours.
Let the price run until weak signals appear. Sell when weakness confirm.

cardinal rule 4: trade with protection - protect capital and protect profit by setting trailing stops. 

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15 trading failures commonly committed by stock investment traders and how to avoid them:-

1.     Jump the gun – traders who enter a trade before buying signals. They can only imagine that the price would move above resistance any time and they’ll be lucky if it did. A less risky way is to follow a trading system and buy on system’s entry signal only.

2.    Bottom fish into deeper pond – those who tried their luck to buy low but the market got lower. Failure to see volume patterns are the usual consequences. As a stock falls in prices, there must be reduction in average volume of daily trades and the prices should seem to be bouncing on a certain level which signifies support.  A breakout of the resistance with unusually higher than average volume will be a less risky entry point.   

3.    Out too soon –That is quite common with novice traders who sell too quickly upon a slight pull back in prices. Too often stocks are sold upon slight pullback but all rebounded and rose more than your frustration. Instead, one should follow a trading system’s exit signals and let profits run.

4.    Penny wise – the traders who favour penny prices i.e. buy a stock at $0.20 thinking that a small rise of five cents can make a great 25% quick profits. What if the stock drops by 5 cents? It is important to check your risk-reward ratio before making a buy.  

5.    News monger – many folks are confused by the analysts’ reports and market news. A famous stock trader said before – if the so called secret tips can reach your ears; the big fishes would already have pushed the prices a fair bit. 

6.    Fundamentalist’s lie – similar to the above, fundamentals may lie but the index does not lie. Trading systems usually base on chart reading or technical analysis but sometimes may combine with the fundamentals of the stock for less risky trades. Focus more on the charts than the fundamentals.

7.    Margin of greed – Over hedging and over leverage may result in margin calls and result in substantial losses to the traders. Always calculate profits and losses together with position sizes. Fix a rule to your style of trading like a maximum level (maybe 7% to 10% of your total capital) of total loss in case your trades got stopped out. Also, set a maximum level (maybe 2 times to 3 times capital) of leverage. Set stop loss to all trades.  

8.    Stop the stop – keep lowering the stop loss level. Upon checking your entry and stop loss level, you key in both prices upon buying a stock. Never try to lower the stop once the trade starts to go down. Worse still is the trader who won’t set stops! If a trade goes against you, let the stop closes it. The stock may be technically and fundamentally correct to buy at that time but Mr. Market may not favour you.  Even if you got stopped out, you can still buy again when it turn around!

9.    Scared to lose – More scared to lose, more you’ll lose. When a stock plunge, prices fall but may not go back to the last high prices again for a long, long time. Darvas (author of “How I made 2 million in the stock market”) said: those who hold a falling stock with the hope of it rising again are gamblers.

10.  Predict the market – never try counter-trend. How can one predict the direction of the market when no one can predict the feelings of all the people around us at any one time? The market is a result of people’s feelings at any time. When most of us feel that the situation is bearish, the market will be bearish. Let the charts tell us the direction. Charts will not lie, remember?  

11.  Over bought – If you open too many trades you may be unable to monitor all of them.  Proper position sizes are important to stock trading. The number of open trades will depend on your ability to monitor closely at any time. Some busy people prefer 3 to 5 open positions, some lesser busy folks may hold up to 8 stocks and some may be more. Again, hold just enough so that you can monitor them closely at any time. The total should include all markets (many people invest in multiple markets) and also include derivatives.  

12.  Chasing the split – after share split, prices dilute and if the stock’s capitalization is comparatively small, prices may drop fast. A less risky way is to wait for correction phase to complete and enter after rebound. Sometimes, prices may drop after the ex-date of dividends pay out.   

13.  Catching the falling knife – never chase and buy average down when prices are falling. It is like catching a falling knife and you will get cuts seriously. After a down trend, a stock needs to go through a consolidation and accumulation stage. It can take weeks or months before the next up trend again. Patience is very important part of trading psychology. Wait for rebound and buy high to profit higher prices (new paradigm).

14.  Warrants & options better leverage – these derivatives of stocks usually move a few percent more than every percent move of the mother stock. That is because the warrants’ or options’ prices are fractions to the mother stocks’ trading prices. Remember, derivatives would behave like penny stocks and a very careful risk-reward ratio calculation together with understanding of qualifying criteria of the derivative is very important (especially expiry dates). Do not trade derivatives if you do not understand the game or you may incur substantial losses.  

15.  Short and got shot – shorting the stock when the overall market is rebounding. It is nice feeling when you can short the market in down trending times as stocks fall faster than they rise. However, what goes down must come up. Close your shorting position quickly when market rebounds. A good way is to check US option market VIX (CBOE Volatility Index) for direction.