Stock Market Success: It’s About How You Manage Your Risk

Stock Market SuccessThis is not a time to get too comfortable in the equities market.

Stocks need reasons to move higher. Revenue growth is muted. The economy is moving along but ever so slowly. There is no new stimulus, as both the Federal Reserve and the European Central Bank (ECB) declined to offer any except for bond buying. Spain is in deep trouble, as its 10-year bonds are trading at an unsustainable yield of 7.2%. The reality is that I do not see any reason for stocks to move higher at this point, and this is important.

While blue chips and large-cap stocks are holding up, it’s a different story for small-cap stocks and technology. On the chart, the Russell 2000 is down 2.3% in the first two days of August to below its 50-day and 200-day moving averages (MAs), which are also on the verge of a bearish death cross based on technical picture.

The key now is not to try to time the market, as this is difficult; instead, a good investment strategy is to make sure you have some trading strategies in place.

Having a good investment strategy, including risk management, is the key to successful trading. I have discussed this investment strategy in the past, but every so often, you need to be reminded; otherwise you could become sloppy.

I have been involved in the markets for over 20 years. After learning the investment strategy of each 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 do 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 the sidelines to watch. But guess what? You can avoid this by following a simple investment strategy.

When the price of a stock trends higher, you should think about a potential exit strategy. This investment strategy does not mean liquidating profitable trades, but more like protecting your profits.

Take some profits after a surge in the stock. Chances are the price will retrench.

Another key investment strategy is the use of mental or physical stop-loss limits. The reality is that no one is perfect in trading. I have made mistakes and so have most of you.

Some of you may be wondering if the stop-loss should be a mental or physical stop. I prefer physical stops, as they effectively eliminate the potential influence that emotion can play when you trade. Emotion can destroy good trades, and often, you end up keeping your losers, which is not a good investment strategy. Keeping losers is counterproductive and will also turn you into a viewer from the sidelines.

For those familiar with options, you can use a “put hedge” (see “Stock Market—Fragile Conditions Mean You’d Better Have Protection”) to help minimize the downside loss. If you own mutual funds, you can buy the appropriate index put by determining the type of fund it is (i.e. small-cap, blue chip, S&P 500, or technology).

If you are already adhering to risk management within an investment strategy plan, good for you; otherwise, learn the strategies, and they will make you a better and more successful trader.