Active investment in the stock market is very different to passive investing and hence requires a different mindset and different skill set for decision making. Successful active investment requires patience, knowledge, objectiveness, consistency and amongst other things trust in your investment approach.
So with a new financial year upon us, I have identified my ‘10 Trading Tips’ for a new financial year. I hope these tips will contribute greatly to your success throughout 2011- 2012 and beyond.
I also hope these tips will inspire you to take greater ownership over your investment portfolio and approach to active investment.
1. Write a Trading Plan.
The key to success in any of life’s endeavours is to have a written goal or plan to achieve success. This can range from a business plan for those operating their own business, to a training plan for professional athletes. Your trading activities also need to have a plan or roadmap which you use to engage the market. This will give you structure and purpose to enter trades and provide you with a valid set of rules and guidelines to undertake your trading and investing activities. Your plan should include your WHY, your financial and skills goals, how you will enter and exit each trade plus how much capital you will put into each trade. Your plan should also outline how you will manage both stock risk, sector risk and market risk amongst other risks. Your plan need not be a “war and peace” but it must fit your personality and lifestyle and contain specifics such as your goals and trading strategy.
2. Plan your trade and trade your plan
Not only is it important to document your trading plan, it is then important to stick to the rules you have agreed to use. There is little point developing your ‘rules of engagement’ only to ignore them when the game begins. Many people will go to the time and effort of writing their trading plan, but then fail to commit to it when the time arises and the opportunity presents itself. They fall victim to their emotions, or the views expressed by some ‘expert’, or a variety of other outside influences and either don’t place a trade, take their profits too early, or fail to take their stops.
3. Be Objective and Consistent
Perhaps two of the most important characteristics displayed by profitable traders and investors are those of objectivity and consistency. If you have a system or methodology for engaging the markets that is based on objective analysis, rather than subjective and arbitrary appraisal, then the consistent application of the signals for when to buy and sell will provide you with an edge. This probabilistic edge will allow you to achieve results that consistently outperform the market over the long term, thus ensuring long term profitability.
4. Manage your risk
Risk can be categorised into two main areas. The first is individual trade risk that relates to the downside potential of any one position within your portfolio. For each of these trades you will have a clearly identified stop-loss – the price at which you will accept that you are wrong, cut out of the trade and move on to the next opportunity. The second is overall market risk that relates to the potential for the market to have significant and often un-timely corrections! The first one we can manage on a trade by trade basis, the second we need to be aware of and adjust our overall portfolio risk in line with market conditions by reducing and increasing exposure inline with the markets ups and downs in the timeframe in which we trade
5. Execute your trades with confidence
If the system or strategy you are using has a proven track record over a reasonable time frame and large data sample and generates profits, then each and every time a buy or sell signal appears capital permitting it must be executed with confidence. Confidence can not affect the outcome of a trade but lacking confidence will cause traders to not take trades that they should and hence take s the trader out of the opportunity flow of the market
6. Take your exits.
In line with tip #5, exiting trades is vitally important. This applies to exiting winning trades as well as cutting losses on losing trades. If you have a system that exits profitable trades when a particular profit target price is reached – then do it! If you use a trend following system or strategy that exits profitable trades on the breach of a trailing stop – then do it, immediately, and without question! Otherwise very large loss trades can result in wiping out hard earned profits
7. You don’t have to be right in every trade to be profitable.
It doesn’t matter which trade delivers you a profit. Active investment is about finding high probability trends but not every trend will rise to ensure a profitable outcome. This is why it must become easy to exit trades according to the rules whether they are in profit or in loss at the time. Don’t hold onto a trade because you want to make more profit or less loss in that particular trade. It doesn’t matter, accept that you are wrong on this occasion; the next trade may deliver more profit. Detach yourself from your prejudices about past profitable or loss trades. You do not know what will happen next to be successful in the markets.
8. Be prepared for drawdown and know how to manage it.
All markets and all trading strategies experience drawdowns – when they give profit back. No strategy ever makes money all the time across all market conditions. They will make money when they are in sync with the market, and they will give some of the profit back when they are not aligned with the prevailing market conditions. The trick is to know and understand this fact and not live with a mistaken belief that you will always make money. If your strategy has a researched edge it will come out of drawdown at some stage in the future.
9. Take responsibility for your decisions and actions.
Take responsibility for your actions and results. If you do not there will always be someone or something else, i.e. not you, causing you not to perform. This mindset allows you to continue repeating your mistakes………..because it is not you making the mistakes! This means that you will never need to address anything to improve your performance because it will always be beyond your control. Learn to take responsibility for your actions so you can address any shortcomings and move on to grow and improve.
10. Measure your performance
You need to have some way of knowing that the actions you are taking and the decisions you are making are working and providing a suitable return for the effort you are expending. For this reason you need to have some way of measuring your returns and performance against a relevant performance benchmark. For share traders and investors this can be the All Ordinaries Accumulation Index, the S&P500, the FTSE 250, the JSE ALSH etc.
One last bit of advice. Don’t ever give up! Trading and investing is a journey not a destination.
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Another great post. In tip number 7 you say “accept that you are wrong on this occasion”. I think it should say; “accept that you do not have a profitable position on this occasion”. This means do not take the outcome of an individual trade personally. As long as you follow your trading system rules it is only one trade, exit and continue.
Response to Comment by Stephen K:
Great pick up Stephen. You are absolutely correct but only if (as you correctly state in your comment) ……..
….you have followed your Trading Plan flawlessly.
So to clarify, if an active investor follows the entry and exit rules of their method flawlessly and that produces a loss trade then he/she is not wrong, it was just a loss trade that is a part of the probabilistic edge that they execute in the probabilistic environment of the market.
It is important not to think of win and loss trades in terms of being right or wrong but in terms of whether I executed my plan correctly or incorrectly to produce the winning or losing trade.
Defining “being right” as executing the rules of your plan correctly means that it is possible for an active investor to never be wrong. “Being wrong” is making a trading error which is breaking their rules. This means that “being wrong” could even be a profitable trade that came about from breaking your rules.
I did go searching for a past blog that I wrote on this subject but couldn’t find it.
What indicators would you suggest would be useful in creating a trading plan for ETF’s – some of which have low volume.