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It goes without saying that 2009 had its ups and downs. However, some of us profited through all of it. How, you may ask? By adopting a solid investing strategy and trader discipline. This post is about being the best trader you can be, and how to profit in any market. I was inspired to write this post last night after watching Jim Cramer’s “Mad Money” show. His theme was how to avoid the mistakes of amateurs and trade like a pro.
“Tonight’s show is all about teaching you to invest like a pro,” Jim Cramer told viewers. Jim covered five mistakes that amateurs make, and that pros avoid.
I’ve written several Investor Guide posts over the past couple of years that cover each of the points Jim made in his show, and they’re so important to EVERY trader and investor that I decided to offer them to you as the Apple Investor’s New Years Resolution. These points reflect an underlying philosophy that all disciplined traders should embrace in their trading practice, and it also happens to be the motto of the AppleInvestor website.
Capital Preservation First, Maximum Profits Second
So, here are your resolutions, you need to know them and live them. Keep in mind, this is how pros trade, so you should to. Remember the old maxim; if you want to be rich, do what the rich people do. You can click on any of the resolutions to go directly to the full text, or just read on.
1. You Should Never Be Fully Invested
Without cash on hand, or as a lot of traders like to refer to as “dry powder,” you are putting yourself at great risk should the market move against, there will be no way to buy in at a lower price, or take defensive measure with hedge positions. When you’re fully invested you limit your options. You should never be fully invested.
The big question then, is how much cash should I have in reserve? That is a “depends on” question. It depends on your tolerance for risk, and it depends upon market conditions. Most professionals might recommend 5% to 10% cash on hand. I personally like to have much more than that, usually 25% or more.
2. Amateurs look at the upside, Pros look at the downside
It’s really hard being an optimist and an active trader at the same time. I see the good in everything. I see it in people, I see it in the future, I even see good in government. But I’ll be damned if I ever let myself see good in my stock setups.
While it’s true that you have to see opportunity in a stock setup, I mean why else would you consider it? The important thing is to understand the risk you are taking on. All your trades should be designed around managing your risk, or the downside your willing to endure. That risk has to be measured against not only the potential, or anticipated reward, but also your individual capacity for risk. Your capacity for risk is the amount of your investment capital that you’re willing to lose should your stock setup go against you.
3. What do you need to know about that stock? Everything!
Too many people enter into positions without a clue as to what they are doing or what the company they are investing in does, or how healthy that company is. They simply get a hunch, or a tip. They heard about a hot company on CNBC, or Mad Money. For a long-term investor, this is required homework. Learn everything there is to know about that company, it’s financials, the markets it does business in, the health of its competitors. Only then can you develop a cogent thesis, one that’s supported by evidence. Only then should you consider taking a position.
If you’re a Swing Trader or Day Trader, then your knowledge of the company your trading typically lies with a very different set of data points. You’ll be more interested in price history than the earnings, chart patterns than balance sheets. But I guarantee that you’ll want to know when earnings will be reported, or that there’s a market cycle that could influence the stock price. And you certainly want to be a skilled chartist and technical analyst. In short, you need to know everything, or as much of everything as humanly possible for your particular style of trading. The more you know, the more risk you can shed from the equation.
4. Know your Limitations (tolerance and capacity for risk)
Cramer’s number 4 was be wary of making too much money. And while his point has validity, in that Pros aren’t searching for the big score, they’re looking to make steady, predictable profits. I think number four should be a related topic, one that goes to the core of how you approach each trade, and that’s to be risk adverse. Take profits as you approach resistance, add to positions as you approach support. This is Technical Analysis speak for “buy low, sell high.”
Too many people let their profits run, they hit resistance and the stock falls. They think if it hit that top once it’ll do it again, so they double down and add to their positions. The problem is that the stock usually keeps on falling, and they end up losing double what they had originally invested. Don’t be this person. Take your profits quickly and smartly. Don’t ever double down, take your losses like a man, or woman.
5. Don’t play fast and loose with earnings, avoid them
I get this question all the time, “How would you play into earnings Ernie?” They’re thinking Apple is going to have another blowout quarter, it’s easy money, all they need to know is how to maximize their profits, right? WRONG! I avoid earnings like the plague. Earnings are fraught with risk, it’s a HUGE wildcard. There’s no way to tell if a stock is going to rise or fall after earnings, there are too many variables, and you can’t anticipate all the things that the big money are going to key on.
The Pro will wait for earnings to pass, evaluate the company’s position and the market reaction, then make an informed, reasoned and calculated decision. Anything else is just a gamble. The stock market, contrary to many people’s opinion, is not a casino.
Now to Your Resolution
If you resolve to do these five things, I guarantee that you’ll have a more prosperous 2010. Also, repeat the AppleInvestor motto, as if it’s a mantra. “Capital Preservation First, Maximum Profits Second.” Say it five times every morning, and refer back to these five resolutions. I’ll be asking you at intervals throughout the year, what’s resolution number three, what’s resolution number one, etc. Happy New Year.
Tagged as: resolutions