Pull the Weeds
The life of a trader is not what most of us might imagine it to be - ie. glamourous, exciting and paved with gold. More likely it is solitary, private, a bit boring and when done right, provides a living.
We could all be traders.
We could all be Arnold Schwarzenegger too. Go to the gym every day, lift heavy weights, drink protein shakes, avoid chocolate, and talk in a vague middle-European accent. But the reality is, who can be bothered?
We could all be traders. We could all be Arnold Schwarzenegger too.
And who can be bothered to be a trader because to do it properly is pretty much a full-time job, and most of us already have one of those, and those of us who don't probably don't want one.
But that doesn't mean we can't adopt some of the core principles of the job, principles that apply not just to traders but to investors as well, principles like "preserve your capital" and "cut your losses". Clichés all, but as any trader will tell you, no trading system will succeed without them and no long-term investor will either.
With that mindset long-term portfolio investors "excuse" the losers and do nothing about them. But if you really want performance the losers are just as important as the winners and you need to protect against them. To do that you have to pull the weeds and plant flowers in their place. And if flowers turn into weeds, pull them and plant some more. Do this relentlessly and you will end up with a garden full of blooming flowers.
How do you pull weeds? Simple. Use stop losses. How? Let's cut to the substance.
What are they: An order that automatically closes your trade at a predetermined price, thus limiting your loss. A stop loss is a mechanism that short circuits debate and emotion and provides certainty.
Requirements: Forget the concept of "portfolio". Think of every stock you hold as a separate trade. Preset a stop loss for each individual holding, preferably when you are unemotional and in possession of a clear mind. The time of purchase would be good, but any time will do.
The mechanism: It is impossible to set a rule for everyone. For those of us without trading systems, you can use a number of different methods to set stop loss levels.
Ultimately there are a lot of ways of setting stop loss levels. As noted, a flat percentage is very basic. But the core to it is to make the decision to use them rather than rely on guts, to set your stop loss levels early, to set them for each individual stock and stop thinking in terms of "the greater portfolio".
I suggest you read some trading books - the foundation stuff that takes you ahead of the average punter in terms of trading discipline. Most good trading books are very hard work (dull) and full of theory. And they often, interestingly, have nothing to do with picking stocks but are about risk management.
Managing the investment, not making it. Most high (low) brow investors working off Buffett quotes have been brainwashed to think it's all about choosing what to buy. For a trader its all about what you do after you buy. That's the bit that needs a plan and discipline and vigilance and where almost everyone goes wrong and doesn't bother.
If you are one of those "Set & Forget", Buffett quoting, ineffective "Invest as if they are going to shut the market for ten years" investors, shut your eyes, exercise your first stop loss, and see what happens. You will instantly move from confused, indecisive and unfit to invest, to something…better.
It's not hard. Try it.
Author: Marcus Padley, Founder of Marcus Today
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