Thoughts on Trading


I just wanted to take a minute to express a few ideas and concepts. This isn’t going to be elegant or well thought out as I’m doing 10 different things right now and the dog is sitting in my lap as I’m typing (he’s about 50lbs, no lap dog…don’t tell him). So, these are my thoughts, take what you like and leave the rest. First, please, please, consider giving up the desire to buy bottoms and sell tops. The sooner you do that, you’ll have less risk and you’ll have greater gains-I think. Trying to buy bottoms is also called “trying to catch a falling knife”. If you just wait until the trend has reversed by maybe breaking out(or breaking down for the shorts) and pulling back, you’ll be able to enter with much less risk and have a natural built in stop in place. If you lose 50% of $10,000 (=$5,000), you’ll have to make a 100% to make it back to break even. If you give up the idea of timing a bottom, you’ll have less risk and you’ll only be missing out on maybe the first 10% or so of the move, not a big price to pay considering the alternative.

Next consider giving up on trying to sell tops(or covering bottoms for the shorts). There is a time to take drive-by profits. There are certain times in the market when you want to take your gains quickly, but for the most part as far as I’m concerned, the big money is in a trend. If you are constantly trying to sell the top, you’ll miss a considerable portion of the trend that is yet to occur. If you settle in with the idea that “I’ll never again sell a top”, you’ll open up the opportunity to catch big trends. I’m not saying to be reckless and have no discipline or strategy, quite the opposite. Say you use a trendline for your stop, you can use a break of that trendline by a certain percentage (eg.3-6% depending on volatility )for a stop. The very nature of this system will not allow you to sell tops, but it will give you an opportunity to catch a big trending stock. It’s nice to make 10% gains and take them in a day or two, but for most traders, this relatively small gain will not be enough to offset all the losing trades that are a part of the game. You need stocks that trend, double and triple, so you must put profits at risk and forget about selling tops.

I think the idea of selling tops and buying bottoms originates in our “human” need to be right. It’s what we’ve been taught since we were children, 60% is a failing grade. Think of it in baseball terms, 60% is pretty darn exceptional. This is why the classic stock market question “Do you want to be right or do you want to make money” is so appropo. How much money have you lost trying to buy what you thought was a bottom? Think of it this way, you can buy something close to a confirmed bottom and significantly reduce your risk allowing you to catch 80% of the trend. Is that extra 10% or 20% worth the disproportionate risk?

Next, be careful about being too much a contrarian. Contrarian thought is worshipped as the idol of independent thinkers and is assumed to be a trait of the wise and weathered market mavens. It is true, there is a time to be a contrarian thinker. I love the “Tulip Craze” story. This is an obvious time to be a contrarian as were the late 90’s of the “E” craze, as are some of the local real estate markets. However, there is a fine line between successful contrarian thinking and simply doing the opposite of the crowd. Personally, I can tell you we were looking for a home about 3 years ago and the market we were looking in (South Florida), the houses went up 30% in 2 weeks while we were on vacation. My assumption was “this is crazy” I thought the market couldn’t support such an outrageous move. Well we continued to watch it go up an decided, forget about the contrarian thought, “Do as the Romans do”. So we bought and our house has more than doubled in the three years we’ve been in it. The point is, being too much a contrarian can often put you on the wrong side of a major trend. Fading huge spike type rallies or fading climax sell-off bottoms is a viable strategy, but it has it’s own rules. If this is what you want to do, you better understand those rules. I’d rather see you buy the strongest long positions and short the weakest stocks instead of shorting a strong stock that you think will pullback. This is much like selling tops, a strong stock that looks like it has rallied too much has a lot of momentum on its side. Just like I thought 30% in a few weeks was crazy, the momentum doubled and in some cases nearly tripled prices. An oversold or overbought market can go a lot further than it already has, just look at all the waterfall type sell-offs in the last month.

Finally (and I’ll end this rant) be picky about your positions. In one of my favorite booksMarket Wizards and The New Market Wizards there was an interview (I can’t remember who at the moment) and this trader/investor said more or less that he doesn’t enter any position until it is the equivalent of walking over to the corner and bending down to pick up the cash sitting there. The idea is there are a lot of good trades every day, don’t waste your resources on sub-par trades. Keep in mind, even if you don’t lose any money on that sub-par trade, you may have suffered an opportunity cost in having your money tied up and at risk in a trade that is second best. For some of us, myself included, it is difficult to sit still. I want to be on the road to success and in my mind, I need to be doing what I’ve always done-work hard. So, I think we assume that we need to do something to make something happen, NOT SO! Resist the urge! Think about that little factoid from earlier (a 50% loss needs to make 100% to get back to break even). If you have time, read these posts Position Sizing, The 2% Rule and Stops. These post will help you mitigate risk, but in the end, not getting into trouble in the first place with a crummy trade is a better option. You are better off risking nothing and making nothing than trying to force something to happen.

Okay, that’s it for now. If you have some ideas, let me know and we’ll see if we can’t get them on the main page. Thanks for reading-Good Luck!