Introduction
The essence of success and happiness results from actualizing your potential, which requires a constant process of learning and growing, as well as the recognition that making mistakes is an inevitable, even essential, part of life.
This short discussion is meant to give you what I consider to be the proper guidelines to set up and manage your trading account. While no one has all the answers, and volumes could be written on the subject, we hope you will begin thinking for yourself. We will provide you with the proper guidelines that once understood, will help you design a management plan to fit your individual needs and circumstances.
Initially, most novice investors, perhaps unknowingly, adopt a “seat of the pants” approach. They act in a variety of ways; a hot tip; a magazine or newspaper article; a recommendation from a friend; or perhaps TV commentaries or analyst recommendations. Often they are most anxious to buy after stocks have already risen substantially and the economic outlook is the rosiest. Often this is the time to be selling your stocks and not buying them.
First allow me to ask you a simple question – why do you trade stocks? Is it for fun and excitement? Is it for profit? If it is for profit – Do you have a management plan?
Why a management plan? A plan is simply a road map that will take you where you are looking to go. If you do not know where you are going, ask yourself, “How are you possibly going to get there?” Every business has a plan. Every professional has a plan. An investor or trader needs a plan too. Imagine for a moment building your house without a plan —- I am sure people would come from miles away, just to see!
We will not be talking here about stock selection or market timing. While these are certainly subjects of importance, in this author’s humble opinion, they come into play only after you have your management plan set up, not before. Step One.
Personal Goal Setting
Life consists in what a man is thinking of all day — Ralph Waldo Emerson
The very first step in setting up any sound trading plan is to set realistic, attainable goals for yourself. We will give you a quick overview of some of the principles of setting goals. At the bottom of this section are links to sites with a wealth of information on goal setting and motivation. If you do not have personal and professional goals we strongly urge you to visit the sites below, and start!
The process of setting goals and targets allows you to choose where you want to go in life. By knowing exactly what you want, you know what you have to concentrate on to do it. You will also know what is merely a distraction.
Goal setting is a standard methodology used by business-people, top-level athletes, and achievers in all fields. It gives you long-term vision and short-term motivation. Goals focus you on your acquisition of knowledge and help you organize your resources.
By setting goals you:
- Decide what is important for you to achieve in life as well as in your investments.
- Separate what is important from what is irrelevant.
- Motivate yourself.
- Build self-confidence based on measured achievement.
Goals need to be complete and focused, much like a road map. Below are steps to help you put that road map together. Remember the difference between a dream and a goal is the written word, the map to get us there.
- Make sure the goals you are working for are things that you really want, not just something that sounds good.
- Develop goals in all areas of life.
- Be precise; set precise goals that you can measure your achievement against.
- State each goal as a positive statement.
- Set priorities: where you have several goals, give each a priority.
- Write your goals down; this crystallizes them and gives them more meaning and force.
- Understanding the power of compounding below will help you with your financial goal setting.
If you do not already have goals set now is a great time to start!
Unfortunately many traders and investors do not understand the simple concept of compounding. An understanding of this basic principle is essential in helping you initially set your goals, and keep them realistic.
It should not surprise you that the higher the return, the higher the potential risks.
Before continuing take the time to do some self-analysis. This is not an easy task; self-analysis rarely is. It will, however, be time well spent. Keep a log, and in it write where you wish to be financially 3, 5, 10 years hence; how much risk capital you have; what is your risk tolerance (how much of that risk capital can you afford, not only financially, but psychologically as well) to attain your goal. Once you have completed this task then continue on to the next sections.
Guiding Principles for a Sound Trading Plan
Knowledge alone is no guarantee of success. You must have a management plan and the emotional discipline to execute your plan in a way that keeps you free of psychological turmoil. I believe there are 4 guiding principles in the development of any sound trading plan. In order to trade the stock market, or any market for that matter, successfully over time, these principles must be understood and a part of your trading plan.
Preservation of Capital
If you had asked many traders and investors in the bubble technology and Internet market of the late 90’s what was the effect of risk on their investments, you would often hear, “The greater the risk you take, the greater the reward you will get.” If you ask the same question now, you will probably hear “The greater the risk, the more you can possibly lose.”
There are many reasons people lose money in the markets. One easily avoidable mistake is putting too much capital at risk in a single position.
Start to think of your trading account as a business. Good business people look to cover their expenses and make a steady growth in earnings, rather than striving for the big hits. Not surprisingly the big hits come along, but they come along without excessive risk. Excessive risk is the killer of many good traders and investors.
Preservation of Capital, therefore, becomes the cornerstone of any good trading plan.
Remember, to trade you must have capital, and every time you trade you put that capital at risk. To survive, to prosper, you must preserve your capital. Before asking yourself, “How much can I make” ask yourself “How much can I lose” This is what risk/reward really means! In our opinion and in our selections we never enter a position unless we believe the potential reward is 3 times the risk we are about to take.
Steady, Consistent Performance
Anyone entering the market expecting to be right on even a majority of his or her trades is in for a rude awakening. Think of it this way. As this is written, the baseball season is about to begin. In baseball, who are the all stars? Would you agree anyone with a batting average of 300+? Looking at this statistic in reverse it means that this individual makes an out 7 of 10 times at bat and a hit in only 3 of 10 trips to the plate. The good player, however, knows that the hits help more than the strikeouts hurt. The reward is greater than the risk.
To gain capital you have to be consistently profitable, but to do that you must limit your losses while allowing your profits to run. In the risk section I will outline a plan that will make you a success if you are right only 1 in 3 times.
The Pursuit of Enhanced Returns
While we have talked a lot here about risk, there is a time you may take additional risk to enhance the overall return of your portfolio. You accomplish this by only risking accrued profits not your original trading capital! This does not mean that you abandon your risk / reward ratio, as previously discussed. It means that with accrued profits, you may take a larger position, or you may utilize the increased leverage afforded by the options market. A discussion of options is beyond the scope of this tutorial. To learn more visit The Chicago Board Options Exchange site at CBOE The important point to be made here is this: you only pursue enhanced returns with profits made, not your original trading capital.
Commitment to Make It Happen
I am quite sure most of you are familiar with the word commitment. Hopefully, you are committed to your family, and your profession. To be a successful trader you must be committed to the task. The following is an excerpt from Victor Sperando’s book Methods of a Wall Street Master. If you do not have this in your library we suggest you follow our link to John Wiley & Sons (publisher) in our Library section.
To trade well you must:
- Establish goals
- Acquire knowledge of the markets
- Define your rules of trading
- Execute in strict adherence to your rules
Only by establishing these rules will you be able to adhere to the discipline needed to insure your Success.
The nature of this business requires a set of personal attributes without which I doubt anyone can be a successful trader, speculator, or investor.
First is a soundly based self-confidence, a realization that our mind can learn the truth and apply it with positive results in every realm of life.
Second is a self-motivation and commitment, the ability and willingness to put the time and energy into learning what to trade and how to trade it.
Third is intellectual independence, the ability to stand on your own judgement based on the facts as you see them in the face of countervailing opinion.
Fourth is a fundamental personal honesty, a total commitment to identifying and dealing with the truth about yourself, the markets, and your decisions.
And finally is a sincere love of what you do, the recognition that the greatest reward comes from the process of the work itself, not the money or fame that may come with it.
These attributes are fundamentally important in every area of life, but the rapid pace and volatility of the financial world make them even more critical. Without self-confidence, you will live in constant fear of making a wrong decision and sooner or later the fear will paralyze your ability to think and make decisions. Without intellectual independence, you will be swept away by the changing tides of opinion into the whirlpool of financial ruin. Without fundamental personal honesty, your wishes will become claims on reality, and you will find yourself making choices based not on the facts, but on your wishes and hopes. And without love of what you do, your work will become stale and uninteresting; you will lose your motivation and drive to continue.
All of these attributes are attainable, but only through a complete commitment to understand yourself and your relationship to reality.”
Start thinking for yourself! Start Your Planning!