Trader Homework
Stockscores.com Perspectives for the week ending February 13, 2011
In this week's issue:
Most traders start trading the stock market without much of a plan. They get a tip from a friend, perhaps read an article or watch a stock report on TV and decide to make that first trade. If the market is doing well they can get lucky and make a profit. Some virgin traders might even go a number of months trading profitably, convinced that they know what they are doing.
After 20 years of trading and training thousands on how to trade I can tell you that a person who trades without a well thought out plan will eventually lose. Their stock market profits are just short term loans which, as long as the trader continues in the game, eventually get repaid.
My first stock trade was motivated by a tip from a friend; I lost money. Despite the pain of losing I was captivated by the stock market and the notion that I could make money without having to work. Foolish thoughts to be sure, for making money in the stock market is certainly work, but that was something I would come to realize later.
After a few years of stock market loans and repayments I realized that I was not getting any closer to my dream of making a living from the stock market. I decided I needed a plan and at the core of the plan would be a trading strategy.
It seemed obvious to me that if I was going to get good at picking winning stocks I should look at how winning stocks behaved early in their trends. I downloaded chart data for every stock that I could and manually went through those charts one at a time in search of the important trends that I wanted to be able to predict. I filled large binders with chart printouts, marked up with pencil identification of patterns that I found repeated over time.
Through this process I created a list of trading rules which I tested and retested. Satisfied that my rules worked I started to trade them. I did not have an abundance of capital when I began which is good since it meant that my mistakes did not cost me a lot. However, the process of applying my trading rules was informative and it led to modifications to my strategy. With time, success came and I started to pull money out of the market consistently. In one three month period I earned better than a 1500% return.
This sounds great, and it is a fun process. However, while it is simple it is not easy. There are a number of components that are needed to form a trading strategy and ultimately, the trading plan.
First, you need to have an idea. This should be the relatively simple foundation of the strategy, the source of the opportunity. Many of my trading strategies revolve around the idea that abnormal market activity is a clue to future price trends. I use this idea in different ways and I have a number of different strategies based on this same idea.
From the idea comes the rule development phase. First, what are the criteria for entry? These should be as simple and concise as possible for you need to be able to apply the rules over and over again without a lot of room for bias in how they are applied.
Most aspiring traders focus on the trade entry and forget to consider risk management and the entry point. Trust me when I say that the entry decision is the easy part; having good risk management and a set of rules for maximizing profit and minimizing loss is more important.
Traders don't get to play if they lose all their capital. Capital preservation is absolutely essential and should be the focus for all traders. Taking big losses or tying up your cash in stocks that are going no where is how traders become long term investors.
For every trade you should know and be comfortable with the risk. You should have a set of rules to determine when the trade is a bust and you need to hit the eject button. I have never met a trader that was always right and so we all need to have a plan for what to do when we are wrong.
Our emotions get most involved in the exit decision. It is normal to worry about whether we are selling too early, that there may be more upside that we might miss out on if we sell. Of course, we also worry about the loss of profit, watching a winner turn in to a loser. Overcoming these emotions requires well tested rules for the best time to exit. The rules should maximize profitability over a large number of trades rather than trying to extract the most out of every trade. Trying to sell stocks at their tops is an expensive way to trade since it rarely happens. Be happy with getting most of the profit along the way but always be willing to leave a little on the table.
The process of developing a trading strategy can take months but as you gain more experience it should be far less time consuming. I developed a new trading strategy this past week over a couple of days and had fun doing it.
Be aware that a trading strategy should always evolve as market conditions change. That very first strategy that I developed years ago is something that I still use but I have constantly tweaked the rules over time to make sure it kept up with the changing market.
So, before you make another trade, make sure you have a plan. Write down your rules, test them to prove to yourself that they will make profits and then put money to work.
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I went looking for good long term trades. For a longer term hold, we must look at longer term charts, so my focus was on the weekly chart. You can see these on Tradescores.com.
As always, I am looking for some signs of abnormal market action out of an optimistic trading pattern. For those of you who want something to potentially hold for a longer period, check out these three stocks.
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1. T.TD
This week, T.TD breaks through long term resistance from an ascending triangle pattern. Looks good to move in to an up trend provided support at $74.50 is not broken.
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2. AHII
AHII had a very good week on abnormal volume as it broke out of a lengthy period of boring, sideways trading. Support at $2.45.
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3. CNA
CNA showed a sign of life this week as it announced it was resuming its dividend. That took the stock through resistance from an ascending triangle pattern that has been building for about a year. Support at $26.75.
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References
Get the Stockscore on any of over 20,000 North American stocks.
Background on the theories used by Stockscores.
Strategies that can help you find new opportunities.
Scan the market using extensive filter criteria.
Build a portfolio of stocks and view a slide show of their charts.
See which sectors are leading the market, and their components.
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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