November 14, 2016
Any Joe on the street can invest in a stock.
But to succeed with that stock, he or she needs discipline to invest well.
So the question then becomes, how?
To begin, no matter your skill level, all investors must understand these key principles:
Also, know where you stand right financially and with your own goals.
Once you identify your risk, you must also begin to look at money management – the most important tool in any investor’s arsenal.
Without any sort of money management, you’re throwing money around without a care in the world if you lose it or not. It defines your overall risk.
How much are you willing to risk per trade, for example?
Since none of us have a crystal ball, we don’t know with 100% certainty whether our next trade is a winner or a dud. So, why bet the farm when you can’t afford to lose the farm?
None of us can afford to do that…
If I knew that 7 of my last 10 trades would be a winner, but I didn’t know which ones, how would I allocate my capital risk? To be safe, we’d allocate up to 5% max on each trade. This way, you control your risk without risking the farm. I apply the same risk to each trade.
Experts say to risk 1% to 3% of working capital on any one trade. The most I’d say is 5% max.
Once I know my personal risk equivalent, I can lay out a game plan.
You should also be familiar with stop losses, or a price trigger that protects you in case of falling stock value. It’s an insurance policy that will protect you if the stock falls. Some traders use a -25% stop loss for example. If the stock falls 25% from your buy-in price, the stop is triggered and the trade is over.
You should also be familiar with a trailing stop-loss, or the order given to a brokerage to sell a position once it drops by a certain amount or hits a certain price level.
Trailing stop losses are essential in today’s trading environment.
Say you bought stock ABC at $6 a share ahead of an FDA decision. As it pushed toward $9.00 a share just weeks later, you begin to get a bit nervous that the run is coming to an end.
To protect your gains should the bottom begin to fall out, you can use a 10% trailing stop-loss. In this case, you’d set your trailing stop-loss at $8.10 ($9 x 10% = 90 cents; $9 – 90 cents = $8.10).
It’s a safe, easy strategy that should be part of all portfolios.
Both stop losses help remove emotion from your trade.
Success is not always a guarantee
However, if you have a plan in place, you increase your odds of success significantly.
You see it’s not about having the “perfect” strategy.
It’s about the rule you abide by with each trade. Any one can trade a stock. But it takes a disciplined trader to trade that stock well.
One of the biggest issues facing all walks of traders is a severe lack of discipline and structure in stock buying habits. Many fail to use stop losses, or even protect gains with a simple trailing stop loss strategy. Others risk far too much.
A friend of mine once made 325% in a week’s time on a trade.
Then he risked it all on the very next trade that cost him 90% of that 325% winning.
That’s a recipe for disaster.
Know these things, and set a plan so you won’t run into “crash and burn” scenarios as often as those with no plan.
Here’s the number one rule to trading. Never risk money you cannot afford to lose.
If you can’t afford to lose $5,000 on trade – money you wouldn’t be comfortable losing in the first place – don’t risk it. This is Wall Street. This isn’t a get rich quick slot machine.
Failure to plan can – and oftentimes will – lead to unnecessary loss.
Plan ahead and you will be ahead of the game.