Matching the Tactic with the Price Action

As most people know, I’m big on defining risk in your trading. But the downside to setting stops is that, if they are too tight, you my incur “death by 1,000 paper cuts”. In other words, no loss is a big one (which is good), but virtuallyl every trade is a small loss.

To piggy back on my poker player analogy from yesterday, that would be similar to a card player anteing up on every hand, and then folding when he first gets his cards. Ultimately, he surrenders his all of his chips without ever really putting himself in a position to win.

There are two ways to define your risk:

1. Position size — take a big position; take a lot of risk. Take a small position, the risk is minimized by the size of that position.

2. Stop placement — set a tight stop; take a small amount of risk. Set a loose stop and you risk more.

It is the combination of the two that will ultimately be the “goldilocks trade”, where your position size is large enough to matter, and your stop is loose enough to allow you some wiggle room, yet tight enough to avoid taking a big loss.

To everyone: Don’t discount the value of experience. The above concepts are general rules (with no specificity whatsoever) that will enable you to trade long enough to gain some self-awareness, and also gain sufficient experience to develop your own rules.

Let’s consider a few scenarios:

First, are you trading a stock that is trending?

Second, Are you trading a stock that is NOT trending, but that is instead either trading in a wide channel (sufficiently wide to provide a decent return if you buy at the bottom of the channel with the intent of selling at the top)?

Third, are you trading a stock that is in a tight volatility squeeze (still technically a “channel”, but it’s really too tight to just buy it at the bottom and sell at the top? You’d be grinding out a trade for just a few percentage points.

Each of these scenarios should be treated differently.

A trending stock (already making a series of higher highs and lows) can be traded with more confidence because you know who is in charge — the bulls! You look at the slope of, say, the 50-day moving average. Is it moving at a healthy upward angle (say — 30%..maybe even 45%…even 20%!).

Bottom line: is the 50-day moving averege continuing to reveal a healthy uptrend; or is it rolling over a bit, where the price action is technically still printing higher highs and lows…but the advance has slowed down enough to alter the slope of the 50-day moving average? In that case, you’ve still got a stock that’s trending…but the trend is mature!

Different approach for each — get it?

A stock in a healthy uptrend enables you to get to a larger position earlier in your involvement in that stock. You still buy a small portion at support — pullback to the established level of support…and then wait for signs that buyers are soaking up all the supply (i.e., the pullback is halted and the price moves a bit higher. When the stock starts telling you that you are right, you can then add some more and increase position size. Note that this first “addition” can occur very quickly — I’m talking in the same day. Maybe later in the day,…maybe just 10 minutes later!

Once you’ve got your first position on (say, 1/3rd of what you’d feel comfortable with), then you are in charge. You’ve got a small profit. That’s a cushion. If the stock rallies to resistance (I draw these resistance lines every night in the videos, so you should understand that concept), then you may sell say, 1/3rd of what you bought…maybe 1/2. You’ve booked some profits, yet you are still involved.

Then, when/if the stock falls back to support — should be a higher level than your first entry — you buy back what you sold…and a little more!

You are building your position!

And if that’s the strategy, then why not sell it all when it hits resistance? Because you don’t KNOW that the stock is done. And if you’re going to sell it all, then you’re not “building a position”…”trading around a core position”. Rather, you’re timing the market — which is something that is extremely difficult to do. Success is sporadic at best.

I could go on and on about this stuff because it is my passion — though teaching it to hard-working people who want to take charge of their finances is a more intense passion!

But this is a process, not a forumla. Every stock is different, and over time, each of us will develop an “INSTINCT” for trading.

This is important: Instinct is a by-product of experience.

Are some people just “instinctive” traders? Sure, but that’s the rarity. Most successful traders have good instinct built upon constant and extended involvement in the market, where they make a lot of decisions…and then learn from those decisions.

This is precisely why I do not “pick stocks”. When all you get is stock picks, the only experience you get is that it pays to do nothing except wait for someone else to tell you what to do. That takes you away from where you need to go — self sufficiency!

I have succeeded in my task when someone develops to the point where they are picking their own stocks, and have the tactics to exploit those stocks. I can say with pride that there are several members of SMM who fall into that category. They came with a burning desire to learn to trade, but little experience (and what experience they did have was not particularly constructive experience — kind of like training yourself to golf. You teach yourself nothing but bad habits).

Over time, some members of StockMarketMentor.com have developed into really solid traders. Not because of what I’ve done. Rather, because of what they have done with the lessons and concepts I am presenting here.

I hope this is of value to you. Trading is a journey, not a simple matter of punching the “Buy” button. So be patient with yourself and give yourself room to grow.

I promise you that I will do my part to keep you on the right path. All I ask in return is that you strive to learn from me, from others in this forum…but most importantly, from yourself!

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OK, I’ve got to catch a plane to fly back to Orange County, and it’s gonna take me a while to put on my exploding underwear. Have a great day, and remember that these dog days of 2009 will be volatile because the real professionals aren’t doing much. (And there’s no reason why you can’t be real professionals either! When the big guys aren’t trading, the market is unpredictable and subject to many false signals!)

–Dan