Learning Risk Management Requires Taking Risk

Market Thoughts

At present, it sure does appear that last Friday’s selloff was the latest in a series of healthy “flushes” that shakes money from the trees, which puts that money back into the “potential buyer” mode where ultimately it pushes the market higher.

Look, since February, investors have been so aggressive that they have not tolerated more than two down days (where the close is lower than the prior close).  This merits some attention.  I’ll continue to say (frankly, I’m probably making my career from this) that focusing on the daily action of stocks in your portfolio has the potential to do more harm than good.

Transports are doing just “OK”, though railroads are pretty strong.  KSU (my fave), UNP, and CSX all constructive.  Watch the entire sector as a part of your overall market assessment.  Healthy transports = healthy market.  Weak transports = precarious market environment.

AAPL: You’re on your own with respect to “trading” AAPL around earnings.  I’ve got a decent sized position, but it consists of stock and long-dated call options.  I’d love to see AAPL knock the cover off the ball because I would then quickly become a trader and sell some of my position into the exuberant buying of the Appleonians.  (I would also be kicking myself for not owning more because, after all, I just KNEW the Apple would have blowout numbers).   I’d then look to buy it (and more) back on the weakness that follows the rush of buying. 

But if the stock sells off, I’ll be looking to build my position from a lower level, lowering my average cost basis in the stock.  My reason for liking AAPL is two-fold.  First (and most importantly), the company fundamentals are deadly strong.  Tons of cash.  Massive innovation.  Small market share.  Very loyal consumers who are growing in number, many of whom would buy and iAnythingf just because it’s an Apple product.  The other reason is the weekly chart, which is quite strong (as noted over the weekend).

But the bottom line is this: If the stock really pops, I’ll be kicking myself for not having more.  If the stock drops, I’ll be kicking myself for not taking 100% profits and then waiting to buy the stock back on the dip. 

Either way, there will be regret in my position.

But…and this is a Big But…I am practicing what I preach, Team.  I am managing my risk.  As a risk manager, you always have some downside.  But you control the downside.  You manage it.  You balance the risk of missing out on more profits against the risk of incurring more losses. 

The “woulda, coulda, shoulda” dynamic is present in every single trade.  As soon as we can truly accept the fact that “woulda, coulda, shoulda” is a fact of trading and that it must be put in its proper perspective as both confirmation that trading is a risk management game and that there is always room for improvement, then you will be able to focus on the most important aspect of your trading: Self-Management!

I was talking with a friend of my brother’s last night about what I do.  I found myself explaining to him that StockMarketMentor is really geared towards “students of the market” and not just those who are looking for stock picks.  I explained that there must be stock picks for two reasons: First, we all want to make money…and you’re paying me for something other than my quick wit and dashingly good looks.  :o)  Second, all the knowledge in the world won’t make you a dime.  I know many knowledgeable people who are theoretical geniuses.  Oh, they know everything about what “should” work.  What “will” work.  But they have no practical experience.  They have knowledge, but they don’t know how to apply it.

You’ve got to be in the game.  Not because you want to make money…but because being in the game puts you in the position to actually benefit from all the theoretical crap that is out there every day. 

• “Buy low, sell high”. 
• “Buy at support, sell at resistance.”
• “Buy good stocks and let them work.”
• “Don’t get shaken out by the wiggles in the daily ebb and flow of stocks.”
• “Take an initial position that’s small…and then build on it.”
• “Don’t hold your losses.  Just don’t take big losses.”
• “As long as the stock is going up, just let it ride and use a trailing stop.”
• On…and on…and on….and on.

I can spout 80 different rules that make sense.  But the devil is in the details. 

• “How low is low?  How high is high? 
• How small is small? How good is good? 
• When is a loss a big loss? 
• No stock goes up every day; so how many days of declines should I tolerate?
• The stock is at support and trading just a slight bit below support.  I’m supposed to buy at support…but I’m also supposed to sell on a break of support…So do I buy or sell, darn it!

These are the very important details and nuances of trading that must be addressed and taken head on if we are to succeed for any duration of time.  And the only way we can address them is if we are in the game. 

Paper trading is fine for certain things.  But you won’t learn one single thing about yourself and about how you really react to price changes in stocks because we are motivated by money.  With no money on the line, there is little learning about the single biggest factor in trading: The Trader!

Use paper trading for assessing methodology.  That’s a great use of paper trading.  But at some point, you’ve got to get in the game so that you can begin the process of exploring your “inner trader” and get to know who you really are.  Once you get to know yourself within the realm of trading, you can then begin the process of refining the types of skills that are required to trade in the way that makes sense to you.  You’ve got a sense of direction.  You know where you want to go because you have determined a style of trading that appeals to you…and you know where you do not want to go “because that’s just not the way I trade.”

Give yourself the time and leeway to be a student of the market.  When you have a sense that you are a student, then you also have the confidence and leniency to give yourself room for error with minimal self-loathing and maximum desire to learn and apply what you have learned.

“Applied knowledge” makes you money.  “Knowledge” just makes you interesting to talk to at cocktail parties.

Dan