Risk - Reward Essential to Success
Stockscores.com Perspectives for the week ending October 16, 2005
In this week's issue:
If I told you that my stock picks were right 70% of the time and that I only lost money 3 out of 10 times, would you think that I was making money in the market? Most traders would love to have that kind of accuracy and assume that it ensures consistent profitability. But beyond stock picking prowess, there is another factor that is more important to determining long term trading success.
How much you make when you are right and how much you lose when you are wrong is key.
Consider the numbers. A trader that makes an average gain of $1000 when he is right and then loses $7000 a trade when he is wrong has to be right 88% of the time to make money. While it is very difficult to be right that often, it is not hard to have that lopsided of a gain/loss ratio.
The reason is simple. As human beings, we are programmed to let losses grow bigger over time and sell our winners early. If you are a normal human being, you are wired to fail in the stock market.
To be a great trader, you have to think differently about risk.
The best traders I know are those who don't care if they lose money. They don't judge their market performance one trade at a time. They don't let small losses grow in to big losses. They add to their winners. They ride a strong stock until it has shown important signs of topping out.
What do you do?
If you are like 90% of investors, you don't plan your losses and instead hold on to a weak stock way too long with the hope that it will turn around. Hope turns traders in to long term investors. Hope belongs in the bedroom, not in the stock market.
If you are like 90% of investors, you sell your profitable trades at the first sign of weakness. You may even sell them before they show weakness because you love to rejoice in the feeling of making a profit. You worry about your winner turning in to a loser and are afraid of the pain that you feel when this happens.
It all comes down to pleasure and pain. These two words are why most people have trouble beating the stock market. If you want to be a great trader, you have to reverse your mental associations to them. If you do, then making money is easy.
I have met many traders who tell me that they would make money if they only shorted when the bought or bought when they shorted. The truth is, reversing the position is not enough to reverse your fortunes. The reason is simple; it is not the stock pick that determines your success, it is how you react to seeing a loss or a gain. It is what you do after you enter the trade that matters.
Some simple rules:
Never add to a loser
Plan your stop loss points
Execute your exit when the stock hits your stop loss point
Don't take more risk than you are comfortable with
Don't watch the profit/loss figure, watch the chart
Be prepared to ride out short term pullbacks in long term trends
Sell when there is a reversal signal, not when it feels good
Be selective about what you trade
These are simple rules that are hard to follow because of the eight inches between your ears. If you can keep your emotions in check then you can trade well. If not, go to Las Vegas. At least there they give you free drinks.
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Over the last week and a half, almost every major oil stock went down pretty heavily. Not because the oil market is in trouble or because these companies don't continue to make tones of money. Instead, it is simply because emotion over inflated their prices and when there was some weakness, everyone ran for the exit door at once.
If you did not sell on the breakdown signal that came six trading days ago, then you may get another chance. Looking at the charts of the oil stocks, they almost all show signs that a short term bounce back is likely over the next few days. If you are a fairly savvy swing trader, you may want to look at trading the bounce on some of these stocks.
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1. T.HSE
Should jump up to $60 or so, it has fallen to support from the dip in mid August. If it closes below $55, take the loss and move on, the bounce did not work.
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2. T.ECA
Nice support on T.ECA at $55, it looks to me like this stock can rally back to the mid $60's before the buyers get tired again. Set your stop on a closing basis below $55.
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3. VLO
Simply pulled back to its upward trendline, it was weak in the morning on Friday but came back to close above its open. A move from $100 to $110 reasonable for the short term, set your stop at Friday's low.
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4. T.PCA
It may take a week or two, but I think that Friday's low will hold and this stock will come back with at least a 10% gain. If it fails to close above Friday's low however, then consider the trade idea a losing one.
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References
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Disclaimer
This is not an investment advisory, and should not be used to make
investment decisions. Information in Stockscores Perspectives is often
opinionated and should be considered for information purposes only. No
stock exchange anywhere has approved or disapproved of the information
contained herein. There is no express or implied solicitation to buy or
sell securities. The writers and editors of Perspectives may have positions
in the stocks discussed above and may trade in the stocks mentioned. Don't
consider buying or selling any stock without conducting your own due diligence.
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