Seven Trading Mistakes to Say Goodbye To By Mark Kelly KNISPO Solutions Inc. www.knispo.com
Bob Proctor asks people this question - What do you want, what do you really want? In regards to stock trading, my first response would be to be a great stock trader. A trader who has mastered enough skills to consistently pull money from the market. However, upon thinking of the question, with my current state of awareness, my true response would be: To be financially free. One of the vehicles I have chosen to become financially free it trading. I believe, trading will ultimately allow me to be financially free. There are a number of lessons which need to be learned prior to that happening. If you are new to stock trading or not quite sure what to do next, this guide detailing seven mistakes which I have made, may move you to the next level. When you read this short manual, provided you get one idea that moves you forward, I will have done my job. I hope you get more, however when you can pull one piece of information from everyone you talk to you will be well on your way to becoming a better trader. All the best, Mark 2010 Mark Kelly September 23, 2010 2
Seven Trading Mistakes to Say Goodbye To 1. Introduction As I review my trades, I see a number of mistakes which are obvious after the fact and not so obvious before or during the trade. I have written this short report in the hopes that identifying your mistakes early will keep money in your pocket and not someone else s. When you are looking for more information on trading stocks visit us at http://www.knispo-guide-to-stock-trading.com/index.html When you overcome these common mistakes you will be well on your way to trading well. 1. Not selling 2. Over trading 3. No trading plan 4. Too many trading plans 5. Taking low probability trades 6. Taking it personal 7. Talking about your wins before you sell 2. Not Selling So why can t you sell a loosing stock? You see lower lows, you see trend lines breaking, you see volume increasing on the downside, you see negative news, you see insiders selling yet with all the information saying this stock is going down you hang on. Why do people have such an emotional attachment to a loosing stock? Why can t they sell the looser and use the cash to buy a winner? I think one of the main reasons traders find it difficult to sell is, that from an early age you are trained not to make mistakes. This training happens without most people even realizing it. Coming home from school with a 40 % average would immediately label you as a child without too much of a future or smarts. One of the first rules of trading is to cut your losses and let your winners run. Let s look at a basic example: School 90% pass, brilliant 40% fail, stupid Stocks 90% of trades make $100 (+9,000) 10% of trades loose $1000 (-10,000) 2010 Mark Kelly September 23, 2010 3
Results in a loss of $1,000 Or 40% of trades make $1000 (+40,000) 60% of trades loose 100$ (-6,000) Results in you making $34,000 even though you were right just 40% of the time. This is why you repeatedly hear people say: cut your losses and let your winners run. This is not an easy job because while teachers and society in general are quick to tell you below 50% is a failure there is very little said about the subconscious mind. The subconscious mind works on habits. You are programmed from an early age to win. Therefore, selling a losing stock for most people goes against your training whether you realize it or not. Essentially, selling a looser has not become a habit. However, since most people do not start to play the stock market until they are 20+ years old you have 20 years of subconscious programming to erase. To trade well you need to develop the habit of selling your losers quickly and without emotion. Look at the evidence and sell. No remorse, no second guessing just get rid of the position. Your job is to break this unconscious habit that has been developed over 20+ years. It will take time. The next stock you buy immediately put a stop loss in place for as long as you own the stock. When this does not work for you, identify where you will get out when the position starts to weaken. Move your stop up as the stock advances and never move it down. There will be times that your stop will be hit and the stock will rebound right after that. I have been taken out on the low of the day, it happens. Expect it and live with it. This is why trading is an art not a science. You cannot control everyone that owns the stock that you own. When someone gets a margin call and chooses to sell a large volume of a stock you own, resulting in your stop being hit, don t take it personal, it is just part of the game. Over time and a number of trades you will see that the weak stocks are being taken out while the strong stocks continue to advance. Trading is a probability game. All you can do is put as much probability on your side as you can prior to entering a trade. 2010 Mark Kelly September 23, 2010 4
3. Over Trading Do you need to trade? In many cases I likely take trades that I should not. It seems a waste of time to do all of the work required to screen for stocks, short list them, look at them in detail, and check the risk vs. reward only to find out that no stock passes all of my tests. It is frustrating and every so often I decide to take a position in a second rate stock just because it seems better to do this than not take any action. In essence, I would prefer to risk my capital in the hopes of a gain instead of not taking the trade and missing out on the potential win. Of course the best thing to do is to sit tight and wait until a more favorable trade comes along. As trading is a probability game and as an individual trader you do not have to enter a position, wait until the very highest probability trade presents itself before entering the market. In the famous book Reminiscences of a Stock Operator about Jesse Livermore, Edwin Lefèvre writes It never was my thinking that made the big money for me. It always was my sitting. This statement was later followed up by Jesse Livermore in How to Trade In Stocks when he said When I said it was the sittin and the waitin that was important I did not mean AFTER the stock was purchased I meant BEFORE the stock was purchased that s when you have to sit and wait for all factors to come together to merge into the perfect trade Overtrading results in a couple of negative aspects in regards to your trading. Taking low probability trades tends to lead to losses vs. gains and increases your commission costs which ultimately reduces your profits. How do you eliminate overtrading? There are a number of ways you can do it and it all boils down to increased discipline and forming new habits. Start by writing a trading plan. I will go over this in the next section. In the trading plan be specific as to when you will get into a stock and when you will get out. Ensure your money management is appropriate for your account and personality. Write a checklist which contains key points which you need to have before you will even consider a trade. When using a stock screener put as many parameters into the screener as you can to ensure you are only looking at stocks which meet all of your criteria before you even look at them. Thus, a stock screener for a trading plan which limits you to stocks which have a 30 day average volume of 500,000 should be set up to only return stocks which have a 30 day average volume of 500,000 or more. Build a spreadsheet which has key parameters in it. You can color code specific blocks to make them stand out. For instance, you may want to only get into positions where the difference between your buy and sell point is 5%. When you enter your buy and sell points and the results come back at a risk of 6% then you should not take the trade. Although you may have another rule that states you will cut your position size in half when the trade risk is between 5.1 to 7.5%. 2010 Mark Kelly September 23, 2010 5
You should be looking for why you should get into the trade and make every effort to cut your losses by not making questionable trades. Sometimes we overtrade due to boredom, thrills, desire to take a gamble, dreams of hitting it big, social reasons and many more. The bottom line is that there is only one reason to get into a trade and that is because it meets all of your rules. Plain, simple and potentially difficult to follow. 4. No Trading Plan Do you have a trading plan? A trading plan is what you are going to do day in and day out in regards to your trading. Each trading plan you use should have a name and a theory as to why it works. It identifies the way you are going to find stocks, the type of characteristics they will have, volume and price. It then goes on to identify where and how you will enter the market. Further it will tell you how many shares to purchase and when to get out when you are wrong. For the sake of this report I will use a simple system. This is a trend following system and can have many false signals. It is being used for illustration purposes only. Let s break the plan down into sections. Title Long Term Trend Following System Theory Once a trend is established it will continue until at some point it will end. This trading plan will buy the stock after the trend has been confirmed and sell when it appears to have ended. The trend will be identified by a 30 week moving average. Search Criteria After the markets have closed for the week, search for stocks where the 5 week exponential moving average is crossing the 30 week simple moving average and the 30 week average volume is greater than 5 million and the close is above $20.00. Buying Buy the stock when it moves above the high of the trigger week. Money Management Risk no more than 2% of the account on each trade. This means that we will exit the trade once we loose 2% of our account capital. In other words, for a $10,000 account we will sell the position once we loose $200. Exit The initial exit is placed 1% below the 30 week moving average on the week the entry signal is given. Note the initial exit is determined before we buy the stock and stays in place until the stop is moved up to protect profits. Position size or How Much Stock Should be Purchased For an illustration of this let s look at the stock chart of JNJ (Johnson and Johnson) shown below in mid 2006. The buy signal of interest was given during the week of May 22, 2006. The 30 week moving average was at 53.65 and it is decided to place the sell stop about 1% below this at 53.19 and purchase the stock at 55.52. In this case, the trader is risking (55.52 53.19) or $2.33 per share. Since the trader only wants to risk a maximum of $200 per share the trader can purchase 200/2.33 or 85.8 shares. Likely the trader would purchase 80 shares in this case. 2010 Mark Kelly September 23, 2010 6
Trade Termination Continue to move the stop loss up 1% below the 30 week moving average. Following the above example the stop loss was hit at 59.28 during the week of February 20, 2007. Profit on this trade is (59.28 55.52 = 3.76/ share) or $300 before commissions and slippage. Stock chart courtesy of Investools http://www.investools.com and http://www.prophet.net 2010 Mark Kelly September 23, 2010 7
5. Too Many Trading Plans How many trading plans do you have? Most people suffer from not having any trading plans so when you have too many in some respects you are way ahead of the vast majority. Here is the catch. Can you successfully trade them all? To really understand and trade a system properly first you need to conceive it, test it and then trade it. As time passes and you record your wins and losses with comments on why you did what you did, then you will likely notice that your original plan was okay and there have been new observations that will improve it ever so slightly. You should find your win/loss ratio increasing over time as will the amount that you win vs. the amount that you loose. The improvement of your system will take time. Now compare this to someone who is trading 10 systems all different and cannot master any of them. They get frustrated as they see that the idea works, they just cannot make any money off of it. As with any task you are mastering slow down and master one trading plan before going on to a second plan. 6. Taking Low Probability Trades A low probability trade consists of entering a position when the odds are against you before you even open the position. While this is never known for sure, you are likely taking low probability trades when, after looking at your indicators and the stock chart there are a number of mixed signals. However, you ignore some of them as you want to do the trade. The simplest one to identify is buying a stock when the market is in a clear downtrend. In trading you need to find and identify what is working today. When the market is in a clear downtrend then buying a stock, unless it is a reversal ETF, really makes no sense. It is better to wait until there are signs that the market has at least stopped falling. Markets normally go from falling, to some form of stability to rising and back to stability before they begin the cycle again. Another low probability trade would be taking a position in a stock where the difference between getting in and out is say 10% and you only expect the stock to move 10% before it hits strong resistance / support. Over time, when one considers probability, slippage and commissions you cannot make any money on this type of trade unless your ability to select stocks is greater than about 60%. A better trade is to find a situation were you are risking 5% of the stocks price to make 10%. Now you have the odds at least pointing in your favor. 2010 Mark Kelly September 23, 2010 8
7. Taking it personal In school you were taught that you needed to achieve 50% to pass (sometimes 60%), you were average when you got around 70% and the smart kids got 80% and above. You were likely encouraged to do better when you got much lower than 70% and when your grades were less than 70% people probably hinted that university was out for you and likely a trade or community college was where you should be looking. After 12 years of schooling you have it ingrained in your subconscious mind that in order to succeed you need to be right likely better than 60 to 70% of the time to be a winner. While this may be true in academics, it is not true in life and it is definitely not true when trading stocks. Trading stocks is a probability game. In order to win you need to loose. You need to understand that loosing is just part of the game. In a famous quote Wayne Gretzky one of the greatest hockey players ever stated that you miss 100% of the shots you don t take. So it is with trading, you cannot win at trading without taking a position and as in sports not all of your positions will be winners. It is just a fact of life, don t take it personal. You may think that when you take a position and it becomes a looser then you are a looser. This is false thinking. You need to alter your perception just a bit. Think of it this way. When you follow your trading plan and loose you are a winner as you followed your trading plan. However when you lost money because you did not follow your trading plan then your trade gets a failing grade. Further, when you make money and do not follow your trading plan you get a failing grade. 8. Talking About Your Wins Before You Sell This is a mistake I have made a number of times. It seems anytime I have a great trade on paper I want to tell someone. The very day I tell someone is generally the day the stock reach s a peak. You must remember that a profit is only a profit after the trade is closed. Anything can happen between now and the end of the trade. Once you tell someone that you are in a stock that just doubled you start to believe that you now need this gain to be successful. This is just another psychological barrier to success that you do not need. Learn to keep your trading results to yourself until after the trade. This can become quite difficult when you are in the habit of talking about your trades all of the time. You may have a group of friends that talk stocks all of the time and want to contribute to the discussion. Refrain from this. When you want to participate in the discussion or talk to people about trading learn to talk about closed positions. Instead of stating XYZ just advanced state I just sold XYZ because it hit my 2010 Mark Kelly September 23, 2010 9
stop and I made x% in the trade. I followed my trading plan and am pretty happy with the results. 9. Summary That s it for this version. I expect that you learnt a bit more about trading and how reducing the number of common errors people make when trading will improve your overall results. I thank you for giving me this opportunity to educate you and for reading this report. When you are looking for more information on trading stocks please visit us at http://www.knispo-guide-tostock-trading.com/index.html Happy trading Mark Kelly KNISPO Solutions Inc. Disclaimer - STOCK TRADING IS RISKY. THERE IS THE REAL POSSIBILITY THAT YOU MAY LOSE ALL OR MOST OF THE MONEY THAT YOU INVEST IN A SECURITY. IF YOU ARE CONTEMPLATING TRADING IN A SECURITY, YOU ARE STRONGLY ADVISED TO CONTACT AN INVESTMENT ADVISOR AUTHORIZED TO ADVISE YOU ON THAT INVESTMENT. ALL MATERIAL PUBLISHED IN THIS ARTICLE IS FOR INFORMATIONAL AND EDUCATIONAL PURPOSES ONLY AND IS NOT INTENDED TO CONSTITUTE THE OFFERING OF INVESTMENT ADVICE OR AN OFFERING OF SECURITIES IN ANY JURISDICTION. The information set out in this article should not be used for the purpose of making any investment decision in any security. None of the material published in this article is intended to qualify, amend, modify or supplement, in any way, the information that any company discloses pursuant to the corporate and securities laws of any jurisdiction. The information presented here is based on the author s opinions and is believed to be true at the time of writing. The author is not licensed to give investment advice. Please visit us at http://www.knispo-guide-to-stock-trading.com to view our complete Privacy Policy and Website Agreement. 2010 Mark Kelly September 23, 2010 10