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How To Avoid Getting Killed
By Jobo Smith
Anyone who trades the stock or futures markets, needs a set of money management rules to live by or the market will quickly take all of your money and sanity. Too many times I see people picking decent ideas only to lose over and over due to poor use of money management and other trading strategies to minimize risk. Here are 3 basic rules that can help anyone who is active in the markets: 1. Before entering any trade, make sure you have an exit plan: This seems simple but a lot of people don't or they only have half a plan. By half a plan I mean they have an expected target OR a stop level. You need both. Where would you get out if you are wrong, and where would you get out if you are right? In addition, if you are partly right (goes 1 point up and you thought it should go 3), where does your stop move to, and at what level do you risk nothing - meaning your stop is moved to break even. 2. Assess current market conditions for both long and short: Watch what the market is doing overall - is it super choppy (lots of erratic up down moves), or is it trending higher or lower. This definitely has a big deal to do with stock selection and risk. If the market is trending higher steadily, shorting most anything carries additional risk as investors and traders are in a buying mood. Most of the time the smart thing is to cut expectations if shorting into an uptrend, or buying into a downtrend. While occasionally you might catch the exact turn, the most likely scenario is you are right for a small amount, then the trend continues. This is also the spot where people tend to either ignore stops or give something a wide berth when its not warranted because of "gut feel" or using logic like "its way overvalued/undervalued here based on today's action." 3. Scale your size so that all potential gains and losses are somewhat equal. This is very important. Based on the volatility of a stock and risk, you should play more shares if less risky, and less shares if more risky. Usually with more risk comes more movement. What you don't want to happen is you play 500 shares of a stock that can at most move 1 point per day and also play 500 shares of a stock that can move 7 points in a day. If the trade does not work out, the one that can move 7 points kills your account, and its hard to make up. You should scale size assuming every trade will lose. I cannot stress this part enough. Ignore the potential gain, scale the size so the losses, if wrong, will be close to equal. The gains will take care of themselves. This way you have a decent shot on the next trade to make back the loss on the prior trade if it does not work out. Its kind of hard to make back a 5 point loss if most of the stocks you are trading can only move 50c at a time. Actually its impossible really, as you would have to be 100% right on 10 trades in a row which is a rare feat. These are by far not the only rules needed, but are some basic ones that most people do not follow. These will not make up for poor trade selection and timing, but can and will help any trader or investor to improve results. |
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May, 2012
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