Risk Assessment & Trade Management, by Sam
Posted by admin on October 07 2009 22:21:58
Both the Financial Times series, The Future if Investing and this week's Markets action have prompted me to discuss my methodology of investing in the Stock Market. Everyone needs a methodology or system and the discipline to stick to it.
I learned Point N Figure Charting through the Dorsey Wright Associates school. John Murphy's stockcharts.com also teaches the method and provides tools. I like to follow the Momentum/Growth stocks found in "Investors Business Daily", read Smart Money's stock screens and appreciate Benjamin Graham's 'margin of safety' value-style investing. Whereas I have no inclination to daytrade, nor can I be a passive "buy and hold" investor.
Predicting the market's course of action for any length of time can be as futile as predicting weather patterns. [After a multi-year drought, we now have had one of the rainiest years on record, and my hometown could use some of that "Global-warming"]. Markets fluctuate; change is the only constant.
Almost 100 percent of stock market analysis is meaningless drivel or noise. How does one trade GDP numbers, "V"-shape, "W"-shape, etc? I will leave that to pundits, analysts and experts. Point N Figure breaks things down to something quite useful, the ongoing battle of supply vs. demand. The Bullish percent is our Head Coach, determining whether we shift into an offensive posture of "wealth accumulation" or a defensive one of "wealth preservation". It is about making gains, then protecting the gains made - not foolishly giving them back.
Plan oyur trade in advance. Scout out what the primary Market trend is doing: positive or negative? Which sectors and industry groups are leading the markets (financials, banks, insurers; technology software, semi-conductors, mobile phones, etc.). Which stocks are out-performing their peers in terms of relative strength.
You can check fundamental, valuations and do your "due diligence". But a good looking chart will reflect all the above with a nice pattern. I lean heavily on technicals and watching for action points to know when to buy, hold or sell. I also look for a favorable risk-to-reward ratio and plan an exit strategy. Before I learned how to sell, I was at the mercy of the rising, then receding tides of the markets.
Emotions of fear and greed can be detrimental to an investor's psyche. By planning in case things do not go as expected, having a stop-loss order in place to protect against more serious losses makes sense. The same goes for planning to reap profits in a systematic way. For instance, if you buy a stock at $100 and a few days, weeks or months later see it trading 25 percent higher @125/sh, why not sell a third of your shares or at least place a stop-loss priced to execute preserving your 25% gain? If the same trade moves another 25% higher to $150/sh either sell another one third of your position or at least raise the stop-loss to lock in your gain. You may prefer to use trailing stop-losses. Option strategies also can be employed for hedging or insurance against market turbulance - especially if you are trying to hold out to qualify for long-term capital gain status.
Learn how to manage each trade. Plan your sells as you plan your buys. Find a system that works for you. Don't be a victim of the market. Education is your best investment and insurance policy. The market moves in trends and gives signs, both lagging and leading indicators. Learning to read them and watch money flows will add to one's success. You can become a skillful crafts-person instead of a "lucky" or "unlucky" stock picker.