The Most Important Tenet in Trading
Friday, June 4th, 2010
By George Leong, B.Comm. for Profit Confidential
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| I have been involved in the markets for over 20 years. During that time, I have been able to hone my risk management strategy through trial and error. At the beginning of my trading life, I was quite inexperienced and speculated a lot with little regard for a portfolio’s risk.In finance classes, I learned about the theoretical aspects of DCF (discount cash flow), CAPM (Capital Asset Pricing Model), and Monte Carlo stimulation, but there was little discussion on the practical strategies used in trading. This I acquired through actual trading and losses. Fortunately, my investable assets at the beginning were lower than the balance of my student loans.After reading the strategies of some of the world’s best traders, a commonality surfaces: the most important tenet in trading is preserving your investable capital via the use of risk management. The last thing you want to happen to you is to trade sloppily and lose your tradable capital. Instead of being a player in the exciting world of trading, you would be relegated to watching from the sidelines. But guess what? You can avoid this by following some simple strategies.When the price of a stock trends higher, you should always think about a potential exit strategy. This does not mean liquidating profitable trades; it’s more like protecting your unrealized gains.
If you have a price target for your stock, you can sell the stock when it reaches that target. Alternatively, if the gains are significant, you can take profits on a portion of the position and let the remaining portion ride. For instance, if a stock rises by 100%, you can liquidate 50% of the position and let the remaining 50% ride. Under this simple strategy, you realize some profits, but, at the same time, create a zero cost trade, as you have already recouped your original investment. You can view the remaining 50% stake as risk capital. Another strategy that needs to be considered is the use of mental or physical stop-loss limits. The reality is that no one is perfect in trading. I make mistakes and so do many of you. If you can accept this, then that’s half of the battle. To protect against mistakes, you should use stop-losses on your positions. Where to place the stop depends on how much capital you are comfortable with risking. Stops can range from three percent below the purchase price to as Stops should also be used when a stock is trending higher. These stops are referred to as trailing stops and are constantly adjusted as the price of the stock rises. This can easily be done in a spreadsheet or by hand. Adapting trailing stops helps to protect your gains as the Some of you may be wondering if the stop-loss should be a mental or physical stop. I prefer a physical stop, as it effectively eliminates the potential influence that emotion can play when you trade. I’m going to say it here: EMOTION kills good trades and often makes you keep your losers. Keeping losers is counterproductive and will make you a viewer from the sidelines. EMOTION has no role in trading. I consider EMOTION the cancer of trading and it needs to For those of you familiar with options, you can employ a “Put Hedge” or “Protective Put” to help minimize the downside loss. If you own mutual funds, you can buy the appropriate index Put by If your portfolio is 50% technology, 30% large-cap, and 20% small-cap, you can hedge the risk by allocating 50% to Puts on the NASDAQ 100, 30% to S&P 500 Puts and 20% to Russell 2000 or S&P 600 Small Cap Puts. If you hold only a few large positions, say Microsoft, Pfizer, General Electric, Citigroup and Home Depot, you can simply buy corresponding Puts to match. Understand what I have discussed. If you are already adhering to risk management strategies, good for you; otherwise, learn them and it will make you a better and more successful trader. |
Tags: investment advice, Stock Market Advice, stock market tips, Stocks Trading Tips, The Leong Side of the Market
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George is a Senior Editor at Lombardi Financial, and has been involved in analyzing the stock markets for two decades where he employs both fundamental and technical analysis. His overall market timing and trading knowledge is extensive in the areas of small-cap research and option trading. George is the editor of several of Lombardi’s popular financial newsletters, including The China Letter, Special Situations, and Obscene Profits, among others. His trading advice on stocks and options is also found on his daily trading site, Daily Profits. He has written technical and fundamental columns for numerous stock market news web sites, and he is the author of Quick Wealth Options Strategy and Mastering 7 Proven Options Strategies. Prior to starting with Lombardi Financial, George was employed as a financial analyst with Globe Information Services.Tweet
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