Ten Trading Survival Techniques

IN THIS CHAPTER

check Setting up hardware and software for success

check Understanding and using analysis and averages

check Taking profits and minimizing losses

check Reviewing your journal

Trading is not a risk‐free activity. Although all traders know that losses are inevitable, they want to minimize those losses and stay solvent to trade another day. In this chapter, we review ten of the top trading survival techniques that can help you enter the world of trading and enable you to continue to trade for a long time to come.

Build Your Trading Tool Chest

Before you buy that first share of stock, that first option or futures contract, or any other security, you need to have the right mix of trading software, hardware, and Internet access to be successful. You need the right tools to identify trading candidates; display and interpret charts; research trading opportunities; screen stocks for technical or fundamental constraints; and monitor and analyze your portfolio, open positions, market indexes, sectors, and trading statistics. In summary, the proper tools are critical to finding the right trades and then monitoring those positions after you’ve found and entered them.

Even after you’ve found them, if you don’t have the right tools, you may not be able to enter and exit positions efficiently; control or track your orders; track your profits and losses; analyze your trading history; or monitor economic reports, earnings, and other business news.

The proper tools help you evaluate your trading system and test your trading ideas. They enable you to keep trading logs to review your trading performance. You also can use tools to stay in touch with other traders and exchange ideas that ultimately may help you improve your trading skills and discover new trading opportunities.

Tools are the core of any good trader’s business. Without the right ones, your chances of success drop dramatically. Don’t scrimp on the tools you select for your trading activities. For more information, see Chapter 4.

Choose and Use Your Favorite Tools Wisely

As you begin sorting out your software and hardware and making contact with other traders, you’ll probably find out about the hundreds of tools and charts that are out there on the market. You don’t need to learn and use them all. Using too many tools can be as dangerous to your trading system and your sanity as using too few. You’ll find that you get mixed signals and will probably end up in a state of analysis paralysis trying to figure out which tool is giving you the right signal.

To avoid driving yourself crazy, pick the top two or three trading tools that make sense to you and fit your trading style. Take your time getting to know how they work and how best to interpret the information they generate. Use them to build the types of charts that match your trading style and don’t worry about learning all the new gadgets. If your tools are working and you’re making a good profit, don’t rush to add the newest tool innovation.

Keep your eyes open for new tools that can improve your trading profits, but use caution before making changes to your winning trading system. For more information, see Chapter 16.

Use Both Technical and Fundamental Analyses

You may have heard that all traders use technical analysis and think that fundamental analysis is a waste of time. Don’t believe it. Although technical analysis is crucial to finding the right entry and exit points, fundamental analysis improves your ability to make the right stock choices, given market and economic conditions.

You’ll find as a trader that knowing the current state of the economy and the state of the market is critical. You obviously want to buy stocks in a bull market and sell them, or short them, in a bear market, but do you know how to recognize when the market is entering a period of transition so you can make your moves when the opportunity for making profitable trades or minimizing potential losses is greatest?

Using a combination of fundamental and technical analyses, your chances of identifying bull and bear markets and finding phases of transition and consolidation improve dramatically. Your best trading opportunities are at the beginning of these phases of change, so be sure that you understand the six phases of the market and know which sectors offer you the best trading opportunities within each of those phases. For more information, see Parts 2 and 3.

Count on the Averages to Make Your Moves

You may think that using data from averages to find the right time to enter or exit a position is counterintuitive, but moving averages can be powerful trading indicators. Moving averages actually smooth out the data for you visually and help you identify any trends. Although they can’t predict the future, they nevertheless help you understand the past so you can more effectively extrapolate what may happen to a stock in the future.

Traders use many different types of moving averages in hundreds of different ways. Stock closing prices are the most common data being averaged, but any value on a price chart can be smoothed for interpretation. For example, traders sometimes manipulate the moving averages by using the midpoint between the high and low prices to develop the moving average. Others look for the moving average using the open, high, or low price. It’s all a matter of trading style and how the charts you’re developing match your trading system.

Be sure to find out how to use moving averages and what they mean. After you understand them and what goes into them, you can manipulate moving averages to your advantage and to coincide with your trading style. Moving averages are powerful indicators, but they’re not the only type of indicator you need to use in choosing your trades; use moving averages in conjunction with other indicators. For more information, see Chapter 11.

Develop and Manage Your Trading System

You need to have a road map that helps you find buy and sell signals for your trades. A trading system is such a map because it’s developed using a collection of tools created from technical and fundamental analyses woven together to let you know when it’s time to enter or exit positions. You can buy trading systems off the shelf, but these systems are available to thousands of others who ultimately will end up with the same buy and sell signals.

To be able to trade outside the pack, you need to develop your own trading system, using your own favorite tools. Although you can use tools provided in off‐the‐shelf software packages, you want to develop and adapt a trading system that fits uniquely with your personality and trading objectives.

After initially developing and testing your own trading system, your work isn’t finished. You’ll need to constantly monitor your system’s successes and failures and look for ways to make improvements. For more information, see Chapter 16.

Know Your Costs

Trading isn’t cheap. Not only do you have to worry about commissions or transaction fees, but you also must watch for any slippage in your trades. Even though you may be using stop or limit orders, you rarely end up executing trades at the exact entry or exit prices you plan. Some slippage, or the difference between the quoted price and the actual price for the security, is bound to occur, so be sure that you carefully monitor your commission costs, transaction fees, and slippage costs.

In addition, don’t forget to consider the tax man. If you’re trading stocks that you hold for less than a year, any profits you make are taxed as current income instead of at lower capital‐gains tax rates.

Traders must also avoid being caught by wash sale rules. Most trading losses can be used to offset trading gains and thus reduce your income tax burden, but if you sell a stock for a loss and repurchase the same stock within 30 days, you can’t deduct your trading loss for that transaction. You have to wait until you sell the stock again and use any losses to reduce the cost basis of the trade, which reduces the tax owed when the position is finally closed. Full‐time day traders receive special tax treatment, but you must be a bona fide day trader to qualify. For more information, see Chapters 2 and 15.

Have an Exit Strategy

Knowing when to take your profits and get out and when to accept your losses and close a position before it becomes even more damaging can be among the hardest lessons any trader must learn. All too often you’re enticed by the win and want to ride it to the absolute top.

Wise traders plan their exit points at the top and bottom of each position long before they ever enter that position. And more important, they stick to their plan. Getting caught up in the emotions of a winning trade is easy, but don’t forget you’re operating a business. Take your profits when you reach your goal and get out so you don’t risk turning a winning position into a loss.

When you make a mistake, own up to it quickly, take your hit, and get out of the position. If the stock recovers, you can always reenter the position at a later time. Don’t ride a stock to the bottom just to try to prove you were right. Plan your exit points before you buy and stick to them. For more information, see Chapter 12.

Watch for Signals, Don’t Anticipate Them

After you make a decision to buy a stock, you may find that you’re impatient to actually get into that position. You start watching the charts and waiting for the right signal to buy. Often, you’ll see charts move close to your planned signal but not actually reach it.

Be patient. Wait for the signal you’ve designated in your plan. Don’t anticipate any moves, even if the stock price is getting close to that point on your charts. You may miss the perfect entry point, but you’ll be less likely to make that fatal mistake of entering a position before the signal is triggered only to see your stock reverse course and thus be forced to take a loss. For more information, see Chapters 10 and 13.

Buy on Strength, Sell on Weakness

Buy on strength and sell on weakness is a mantra you’ve probably heard frequently from investment and trading gurus. The reason for its popularity is a good one: It works! And it needs to become your trading way of life.

When you see a stock showing strength and heading into an uptrend, it’s time to buy. When you see a stock falling and showing signs of entering a weakening period, it’s time to sell. If a weak stock takes a turn for the better, you can always reenter the position. For more information, see Chapter 13.

Keep a Trading Journal and Review It Often

The only way you can ever improve your trading skills is by keeping track of what works and what doesn’t and trying to gauge why. After each trade, write down the details of the trade and what went right and/or wrong with that trade. You can only improve what you measure, so measure everything and put it in your trading journal.

Don’t forget to review the contents of your journal every week. You may find that reviewing your successes is enjoyable but reviewing your failures is difficult. Failure, however, sometimes is the best teacher. Many people discover more from their failures than from their successes. Try figuring out why your failed trades didn’t work and what you could’ve done to improve your results. Of course, don’t ignore your successes. After all, you need to know what works and why and then try to incorporate those winning strategies more consistently into your trading system. For more information, see Chapter 16.