The wild ride on Wall Street this past decade saw traders and investors alike amass and lose enormous fortunes. The bubbles in Internet, housing, commodities and credit conditioned many of us to expect nonstop market booms and busts.
Investing and trading in this recent era of extreme volatility provides all of us with valuable rules that can improve investment performances and gains. Below are a few I adhere to in navigating this manic market:
1. Preserve Capital --- This rule is vital because of the prophetically true maxim presented by John Maynard Keynes that stated, “The market can remain irrational longer than you will remain solvent.” No matter if you are a trader or investor the key is to live to trade another day, which means to cut your losses and do it early. This past bear market and the historic market bounce that followed it would have crippled even the wealthiest bulls and bears. As far as a recommendation for when to cut a loss, I don’t have a fixed rule or number. It can range from 2% to 15% depending on the given strategy and stock. I find that small and micro cap stocks may require a little more room to turn into a winner. On the other hand, there are other situations where if a stock breaks a certain resistance or support point, you may not want to hold your position for even one more tick. This point leads me to my next lesson: control the trade.
2. Control the Trade --- Before you enter any trade you should have a detailed plan as to where and when you are going to enter and exit the trade. Your strategy should account for prices to scale in and out of a given position based on the stock’s direction. When taking a position, don’t buy all at once. When selling at a profit, don’t sell all at once. Conduct both the buying and selling in half or thirds of a position. I think these practices help you to control the trade rather than the trade controlling you.
3. Follow the Market --- I ascribe to the theory that a stock will perform only as well as the market surrounding it. In a declining market, strong stocks will weaken; and in a booming market, weak stocks will rise. Trade with the market. In a choppy or directionless market, I look for certain sectors to move sharply. Once I spot a sector move, I try to find individual stocks within that sector that could benefit me from a significant move in the group.
4. Exhibit Patience --- “It never costs anything to watch.” There are times when direction can be difficult to ascertain on any given stock. Even great companies can cost shareholders money if their stocks are bought at the wrong time. Whether it is a momentum rally or volatile sell off, avoid becoming caught up in the moment. Do your homework and pick price points for entry and exit and stick to them. There is a big difference between following the market and chasing the market. Following tends to be more profitable.
5. Take Profit --- Profit is why people are involved in the market. Thus, there is no such thing as a bad profit. In this recent environment, following this lesson has been extremely helpful. I have become a scalp trader the last few weeks because it appears the market is topping out. The increase in volatility has caused stocks to oscillate violently putting long and short positions at risk daily. When a trend is turning or not completely exhausted, profit taking and capital preservation are vital to ensuring your portfolio realizes gains. As longer market trends emerge, you can allow profits to grow larger without being so quick to bank them. Profit taking is as important as preserving capital. Investment success is impossible without these two rules.