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Strategies & Market Trends : Booms, Busts, and Recoveries -- Ignore unavailable to you. Want to Upgrade?

To: tradermike_1999 who wrote (3)	10/22/2000 1:26:59 PM
From: tradermike_1999	Respond to of 74559

The Secret of My Success - Money Management The other week I wrote a piece about the psychology of stock trading. It is the first part of a series I am writing to explain my philosophy of trading. I thought I’d start with psychology last time, because I think it is the most important thing a trader or investor brings to the table. Whatever intelligence, knowledge, or abilities they have is ultimately overshadowed by their attitude and psychological makeup. It basically comes down to how the emotions of fear and greed will effect them when they make or lose money. As I said the other week the trader must counter these emotions by building a trading strategy that he has the confidence to stick with in losing and winning trades. Half of all online investors lose money and only a small minority ever achieve outstanding results. The odds are stacked against you. But you can put them in your favor by creating and sticking to a trading strategy. Most people who enter the market do so without any preparation or careful strategy. They try to deal in something they know very little about and have no conception of how to deal with psychologically. They are walking disasters. If you have a toothache you go to the dentist and not the plumber. If a construction company builds a house the first thing they do is start with a set of floorplans. But when people decide they want to speculate in the stock market they almost never seek out expert guidance or else fail to begin with a strategy to build a sound foundation with. Instead they buy on what they believe is inside information, false tips, message board hype, crazy rumors, and gamble in penny stocks. They put their trust in the jackal pack of manipulators that exist on Wall Street. They trade on the promises and hopes of con men. Others just watch prices fluctuate and gamble on guessing bottoms, a guess no one can consistently make accurately and makes losers out of those who try. They buy high and sell low. They are the perennial losers who help line the pockets of brokers, market makers, professional traders, and manipulators. But unlike the bright lights of Las Vegas there is no free booze or call girls to look at. You get no consolation prize for losing money. The stock market is not a casino. Your brokerage account is your own personal business. It’s not a toy. You must have an attitude that you are going to run it like a business with a business plan. Any trading strategy that succeeds in the stock market has at it’s core money management principles. It is these very principles that catapulted me out of the loser category and made me a success in the markets. I don’t care if you use a trading strategy that is at odds with mine, if it is successful you will use money management tactics. For any business to succeed it must generate more revenues than expenses. Businesses generate expenses by paying for such things as advertising, wages, and goods. Your trading account’s expenses consist of commissions, margin rates, and losing trades. Successful traders see losing trades as expenses and nothing more - they are not signs that you are an idiot or are deficient. What the successful trader does though is make sure that, just like a business ledger, his account generates surplus profits overtime. As this surplus grows his net worth grows. The main way this is done is through money management and risk control. I cannot repeat this enough. A system that generates successful trades 90% of the time and does not practice risk control will eventually blow up. Instead strict money management can create a surplus profit even when most of the trades in the system fail. You can be wrong most of the time and still be a net winner. That’s how you put the odds in your favor and get on top. Let’s play with some numbers so that I can show you what I mean. If you have $10,000 dollars and lose $500 per losing trade and make $1,500 per winning trade, you only have to be successful with a small percentage of trades to generate a surplus. This would be risking %5 a trade with an average gain of 15% on the winners. With these type of odds if you lost on 7 trades and only made 3 successful ones(30%) then you would still make $1,000. That is the magic of money management. If you aren’t playing with these types of odds then you are at an extreme disadvantage and are making things very difficult for yourself. Every successful trader develops strict rules to manage their equity in their account to create odds such as those above. All of these rules have one basic function which is to protect your equity. This is the lifeline of your account. You make money with money. If you lose all of your money then you are finished just like any other bankrupted business. You protect your equity by limiting your losses and generating a surplus. This means that you have to be patient and wait for the best opportunities to arise. Every year there are plenty of chances for gain in the stock market, but the average person squanders their equity on low percentage trades and lets the best of opportunities go by. But, more importantly it means in every trade you enter the risk to return ratio must be calculated. You must figure out how much you are willing to risk on the trade. At what point will you take a loss and get out? Not asking this question will only put you in a position in which you will be unable to make the correct decision to get out. Without a strict application of planning on every investment or trading decision one will be caught in the trap of making decisions based upon emotion instead of common sense. Once that happens you would be better off going to the craps table. These are same basic rules any money management system should be built around: 1)Limit all losses to 5% of your equity. Never risk more than this in any single position. Using the 5% rule it would take 20 losing trades in a row to put you out of business. That’s not very likely to happen. 2)Use a stop loss order on your positions in order to enforce the first rule. Don’t trade until you can discipline yourself to do this and not be phased by getting stopped out. 3)Never average down on a losing position. If you make a trade and it goes against you then you are wrong. Why put more money into a losing position? Averaging down is for schmucks. 4)Never let a good profit run into a loss. It’s hard work to get a profit, the worst you should do is break even. That’s no big deal, just don’t a profitable position turn into a loser. 5)Distribute the risk - divide up your capital into at least two or three positions. The more money you have the more positions you should have. The whole secret to making money in the stock market is keeping your losses small. Only a small percentage of your trades or investments will be truly outstanding. The trick is to keep your money from being stuck in losers and moving it until you find a true winner. All stocks are bad unless they are going up. Using stop loss orders will help force you out of bad ones and move into good ones. That’s the key to creating a profit surplus and exceptional returns.