The interesting thing about baseball is its similarities to the stock market.
Success in baseball circles around the abundance of statistics, as is the case in trading stocks, but there are major and subtle differences. In fact, the key to achieving stock market success is more akin to pitching than batting.
Let me explain. In baseball, the ultimate goal for every batter would likely be to hit over 0.300—that is three hits for every 10 at bat for you baseball neophytes. Of course, there are exceptions for homerun hitters, unless you’re a Willie Mays—one of the top baseball players in history. In trading, winning in only 30% of your trades isn’t considered stock market success—it would quickly send you to the sidelines or the poorhouse.
Stock market success is more like pitching. A pitcher who wins 65% of his starts would win about 21 games based on 32 starts. Winning at a 70% win rate would equate to 22 games, and possibly a Cy Young (top pitcher) award for the mantelpiece. In trading, if your win rate was 65% to 70% and you cut your losers, you would likely achieve stock market success.
The key to stock picking and stock market success is simple—make sure you make more money than you lose. To do this, you need to make sure you cut your losses, while you ride the winners.
Many inexperienced traders often get caught up in the emotional roller coaster by taking profits on the top stocks and keeping the poor performers, refusing to admit a mistake was made; of course, this doesn’t bode well for stock market success.
You need to understand that being prudent is important for stock market success, just like it is in baseball. Let’s assume the bases are loaded. The batter, in this situation, doesn’t necessarily try to hit a homerun, but aims for a hit to drive in runners. This is called playing “small ball.” In the World Baseball Classic, the U.S. team managed to beat Canada in a critical game by playing some small ball, despite having numerous power-hitters in their lineup.
The same goes for trading. Aiming for a homerun with each trade is fruitless and doesn’t mean stock market success. I would rather play small ball and drive in runs; albeit, hitting that occasional long ball over the fences would be a bonus.
Risk management drives stock market success, just like it does in baseball. (Read “Big Risk? Try This Strategy.”)
A pitcher is unlikely to throw a fastball down the middle of the plate on a 0–2 count—instead, perhaps offering up a curve-ball, splitter, or change-up.
The key is monitoring your pitches in relation to the situation—just like trading stocks.
When the price of a stock trends higher, you should think about a potential exit strategy for overall stock market success. This does not mean liquidating profitable trades; rather, it means protecting your unrealized gains. Take the current stock market rally as an opportunity to take some profits. Trust me; you’ll feel better about it if stocks slide.
Babe Ruth was arguably the best baseball player in history, while Warren Buffett is widely considered one of the top long-term investors. The key to success in both baseball and trading is to understand the situation and risk, and to have an exit strategy.