So You Want to be a Trader…
Today’s guest is Chuck Young from Rebel Traders. Chuck is going to give us his insight into what it takes to become a successful and disciplined trader. I have to say that I think he nailed it…what do you think? Check it out then leave a comment, let Chuck know what you think makes a successful trader. Enjoy!
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Ask anyone who has been holding stocks for many years what the previous two years has done to their portfolios; I’m sure you will get some nasty comments. For many years everyone from professional financial advisors to our parents told us that the “buy and hold” strategy was the only real way to make money in the long term. Well I’m sure those who have been doing just that are not very happy now that nearly 50% of their portfolio has evaporated.
In the span of 9 years the U.S. markets have gone through two very ugly bear markets, and the current bear market is not yet over. So the ‘buy and hold’ people have taking a real beating in the past decade.
If you told someone 10 years ago that you were a ‘stock trader’ you might have received a strange look or perhaps a lecture about how dangerous trading stocks would be. “Listen young man… the only way to save for your retirement is to put your money into stocks and ignore it… you will have a lot of money when you retire”. How many times have we heard something like that during our lifetime?
Today if you told someone that you traded stocks you might get an evil look because the media has painted traders as a group of people who have contributed to the massive stock market declines experienced during the current bear market. There are numerous types of traders; currency traders, hedge fund traders, and commodities traders (recall last summer the media blamed traders for the rapid rise in oil prices) just to name a few.
But actually individual traders who trade from their own homes are nothing at all like those portrayed by the mainstream media. We are market participants who look to capitalize on short term price movements, take our gains, and then move on to another trade when one presents itself.
The ‘buy and hold’ strategy has been proven to be flawed for guaranteeing that you will have enough money to retire with. The nature of the markets now requires an active involvement on your part if you are to preserve and grow your capital. And how do you actively manage your holdings? You become a stock trader.
As a stock trader you are simply managing your holdings actively. It does not mean you are buying and selling every day (that is for highly experienced day traders). It means that you use various charting tools, your understanding of chart reading, and by keeping track of trends to know what and when to buy. And by keeping a close watch on your holdings you know when the time comes to sell them and take your profits.
This is referred to as “swing trading”, or sometimes referred to as “position trading”. It means you initiate a position in a certain stock based on your analysis of the charts using healthy risk management, and then when the charts communicate that the time to sell is upon you then you exit the position. That is ‘swing trading’.
Swing trading can mean you hold a stock for a few days or a few months, regardless of the time frame the goal is the same; to capitalize on short term price movements and then get out before there is a significant change in the trend of the stock. This is an active involvement in your portfolio that helps you prevent the types of losses experienced by those who ‘buy and hold’ and walk away hoping their money will be there when they need it. And ‘hope’ is not an investment strategy; if a person relies on hope then they are prone to fail.
So now your interest is peaked, and you want to get started right away at becoming an active manager of your stock holdings, a trader. Your next step is to learn how to read charts, understanding the fundamentals of technical analysis, and get setup with the electronic broker of your choice. Now you think you have everything ready and you take your first plunge into trading. You have studied the charts, you keep an eye on the broad market trends, and then you identify the best risk to reward entry price and you ‘hit the button’, now you’re in! So you begin to watch your trade by keeping a close watch on the performance of your trade, you know where your exit price is based on your understanding of the chart, and you have a ‘stop loss’ set to protect your capital in case the stock goes against your analysis.
Things are humming along great and you spot another chart that is providing you with a great entry price and you want to take a position in that stock now. But now you have to decide if you should sell your first trade in order to move your money into the new one… STOP.
If you ever find yourself needing to sell your stock in order to buy another then you have to stop right away. A smart trader never puts all of his or her capital into one trade at once. Placing all of your trading capital into one trade puts you on a direct course to failure.
As a trader you have to manage your trading capital by dividing it up into pieces. And only one piece can be allocated to any one trade. In this manner you reduce the risk to your overall capital. But wait you say, how can I make any decent money if I don’t go ‘all in’. You do it slowly, that’s how. If you want to be a successful trader with growing funds that enables you to trade another day, then you must absolutely practice good trading capital management.
For example, let’s say you have $20,000 set aside to begin your trading career with. You put all $20,000 into one trade and unfortunately the trade does not work as you expected and you end up taking a 4% loss on the trade. Now you are left with an $800 hole in your account. But, had you divided up your trading capital into 10 pieces now that same trade would result in a loss of only $80 because you only had $2,000 on the trade.
But you say this will take forever for me to make any money. You say that I want it faster. If you become impatient then you will fall into the trap of letting greed dictate your trading system, and once you cross the line to greed then your trading plan will be prone to fail. Patience and self discipline are very important in trading; you must keep reminding yourself of that.
Getting back to your statement that ‘it will take forever’ to make any money this way. It may appear to be slow at first but following healthy capital management techniques ensures you are able to stay in the game. Remember, your gains may be small at first but for every profitable trade you add that money back into your capital pool of funds. So your next trade instead of being $2,000 now you might be able to put $2,500 into each trade. It is only a matter of time before your portfolio begins to increase rapidly, so long as you always stick to your trading rules, your capital management techniques, and your discipline.
As you expand your trading capital over time you can increase the number of slices you make in your trading capital pie. But, I never recommend anyone just starting out to try and keep track of more than 10 trades at any one time. For me I have made good money over the years using the 10% rule, occasionally I will go upwards to 20 trades at one time, but I always come back to my average of 10.
Also keep in mind that you do not have to have all 10 slices of your trading capital in the market all the time. If you only have 3 or 4 trades that is fine, remember that the smart trader waits for the best trades to come to him or her, never go chasing trades for the sake of just being ‘in the market’.
Trading can be a very rewarding endeavor, it can be fun, and it can also be dangerous if you don’t practice proper trading disciplines. And one of the most important disciplines is to manage your trading capital properly.
There are two very important rules that traders must follow:
1. Practice capital preservation
2. Make money
You cannot perform rule #2 if you don’t learn how to do rule #1!
Best of luck,
Charles Young
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For more on Chuck and Rebel Traders be sure to check out RebelTraders.net
Grandma was right and one heck of a trader
Did you ever have your grandmother tell you not to put all of your eggs in one basket?
Well it turns out grandma was right. Grandma, knew a great deal about the power of diversification and how it reduces risk both in business and in trading.
IN BUSINESS …
What if McDonald’s only sold hamburgers, do you think they would still be competitive when the world is turning to healthier lifestyles. Now don’t get me wrong every once in a while I like to chow down on a nice juicy hamburger. But I also like to eat healthy and so do a great many other people. McDonalds moved with the times and diversified into chicken wraps, salads and a whole host of other healthier food groups. In other words they diversified.
IN TRADING …
It just doesn’t make sense to trade just one market, there’s just too much risk and too little opportunity in one market. A trader needs to stay flexible and at the same time be diversified.
Before we get into the meat and potatoes of market diversification let’s take a look and see how the dictionary defines “diversification”
1. the act or process of diversifying; state of being diversified.
2. the act or practice of manufacturing a variety of products, investing in a variety of securities, selling a variety of merchandise, etc., so that a failure in or an economic slump affecting one of them will not be disastrous.
Based on the Random House Unabridged Dictionary, © Random House, Inc. 2006.
That’s the official version of diversification. Now let’s apply that to the markets. First off, we have to accept that the market can do only three things, it can go up, it can go down and it can go sideways.
Your portfolio on the other hand, can only move two ways. It can go up, or it can go down.
We all know the direction our portfolio should go, and we want to see it go in that direction with the least amount of risk. That’s where diversification comes in.
NUMBER ONE SECRET TO DIVERSIFICATION
Here is the number one secret to market diversification, spread the risk and trade in non correlating assets.
Here’s an example of a non diversified portfolio.
Say you are bullish on Crude Oil and you buy a futures contract in crude, but what if
the rest of your portfolio was full of energy stocks?
What you have created is one basket of eggs. In this case a basket of energy eggs. Your portfolio is dependent on one sector and that is energy. This is just too risky for the average investor. No matter how many stories you hear from the various experts saying that energy is going through the roof you don’t bet the farm on one market … ever.
You need to have as many non correlating asset classes as you can follow. This short video illustrates diversification perfectly.
The other key to diversification is cash. You don’t have to be in all the markets everyday. Cash is a way of diversify … Swiss Francs, Canadian Dollars, Euros, etc etc.
Here’s an example of how a well diversified portfolio.
Stocks, bonds, futures and cash.
Out of those four asset classes, you have a multitude of choices. Stocks allow you to cover a broad spectrum of different domestic and international sectors. Bonds do the same thing, and the futures markets cover everything from raw commodities to financial instruments.
You can divide your portfolio into different percentages and allocate then to various asset classes. The more you divide into non correlated asset the less your risk will be.
Here’s what I am suggesting. I call it the Will Rogers approach. Here Will Rogers was known for his famous quips.
“I’m more concerned about the return of my money than with the return on my money”.
I guess Merrill Lynch should have remembered that when it had to write off 8.4 billion dollars and cause the firm to have it’s first loss in 93 years. Diversification would have smoothed that disaster for Merrill, what got in their way was plain old fashioned greed.
The American humorist Will Rogers (1879 - 1935) had a special way of making a point. Here’s another one of his insights about trading and investing.
“Don’t gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don’t go up, don’t buy it”. — Will Rogers
Will was right!
Only buy sectors when they are going up. When they turn down, get out and move into cash. Then look for another non correlating market sector for your portfolio that’s moving up. For sophisticated traders you can even short different asset classes which is a way to turbo charge your returns.
Learning when a market is moving higher or lower is not as difficult as you might think. Take a look at how you can tell if your favorite market is going higher or lower here.
Yes, it takes time to analyze the markets and find winners, but the time of a buy and hold strategy is gone forever.
We are living in extraordinary times, never before have we had so many people living on the planet. Never before have we had so many major countries competing for an ever shrinking supply of raw commodities. Never before have we seen times like this that present both great opportunity and great risk.
Diversify … spread your risk, don’t be a Merrill. You can do well and thrive in the future with a well balanced and diversified portfolio.
Have a super profitable trading week.
Adam Hewison
How to tell or refer a friend (short video)
Traders Toolbox: Money Management 4 of 4
This is the final portion of the Trader’s Toolbox: Money Management series. This post will recap the 5 main rules discussed. If you missed our previous post please click here for : Part 1, Part 2 or Part 3.
♦ Setting a goal - Decide what your trading objective is (quick profit and steady return) as well as your risk tolerance level
♦Diversification - If possible, allocate your finances between different products to avert the danger of getting wiped out in a single market. Don’t go overboard, though; think in terms of three to five unrelated instruments. Stick to markets you know, rather than risking the unknown for the sake of diversification.
♦Deciding how much money to risk - The total amount you risk at a given time in a particular market group or on a particular trade should be based on a a percentage of your total trading equity. Exceeding your allocation parameters can result in overexposure.
♦Use of stop orders - The name of the game is preservation of capital. Placing conservative stops to cut your losses will ensure you are around to trade another day. Stick to the limits determined by your equity allocation percentages.
Traders Toolbox: Money Management - Part 1 of 4
Crucial but often overlooked, money management practices can mean the difference between winning and losing in the markets.
Plenty of books, manuals, and software packages will help you form and opinion of a market, but not many will tell you how to trade once you have decided to get long or short. The goal of money management is to increase the odds of high quality trades. And as we’ll see, leaving the money management variable out of your trading equation can lead to ruin, even if you’re correct about the market direction.
In a broad sense, money management can encompass those elements of trading outside the initial decision to get long or short in a given market or markets – that is, how many positions to put on, when to get out, where to place protective stops. More specifically, it refers to the strategic allocation of capital to limit risk and optimize trading performance in the long run. Allocation of capital can refer to how much money to put into any one market or how much money to risk on any one trade. These decision directly affect how many positions to put on and where to place stop orders.
Given the negative odds inherent in trading (a successful trader can expect to lose money on 60% of his trades), how do you go about maximizing the profit potential of the few winning trades you can expect to have? The answers vary with the disposition and trading style of the individual trader. There exist, however, basic concepts that can be successfully adapted and modified to individual needs, and when the followed in spirit, can boost the promise of long-term trading profits and take some of the stress and uncertainty out of trading.
-Establish A Goal- Having a clear idea of what you want to accomplish by trading, whether it is a short-term profit on a single trade or the desire for a long-term trading career, can go a long way toward building successful trading habits. Regardless of whether or not the goals are set on a per trade, daily or long-term basis, establishing from the outset basic levels of acceptable risk and financial reward will help curtail avoidable risk and extreme losses. Also, determine a specific time frame in which to trade: Will a position have to be liquidated by a certain time for tax purposes or for same other reason?
-Diversification- Just as in the stock market, a portfolio of different instruments can be one of the best hedges against several and unsustainable losses; a loss in one market will hopefully be offset by gains in others. Traders must take caution, though, to truly diversify their portfolios with contracts that are price independent. Spreading your trading among three or four different interest rate contracts that move in a similar fashion is not a good example of diversification, because a loss in one contract is likely to be mirrored by losses in the others. But over-diversification is dangerous, too. A trader can spread his money over too many markets, and not have enough capital in any one of them to weather even small adverse price swings.
A good rule of thumb is to stick with what you are comfortable; do not venture blindly into unknown markets just for the sake of diversification. A balance must be stuck between available resources and a manageable trading scenario. Capital constraints will, of course limit the choices traders can make, forcing those with smaller trading accounts to bypass or minimize diversification.
