The Part-Time Trader (18 page)

When I employed wider stops I tended to be much more flexible with risk and add more than I really needed to have on the trade simply because I was comfortable with losing 10 percent on a given trade. I would also be less particular about the entry price as well.

The bigger problem with this, though, is that I was spending far more time in trades that was not necessary (particularly in losing trades), and the extended time factor of the trade also increases the possibility for an unexpected news event associated with the stock. When it comes to trading, I want to spend the least amount of time in an individual trade as possible. The more time you spend, the more opportunity there is for downgrades, surprise earnings announcements, scandals, and anything else under the sun that can drive a price lower.

By keeping my stops tighter I don't have to wait as long to find out whether the trade will be a success or a failure. If I am wrong, I get in and then I get out fairly quickly, but when you use these 10 to 15 percent stop-losses like a lot of traders do, I think much of the time it is out of desperation because there is the hope that a trade will, within that wide range, eventually be proven right. The need to be proven right is the worst characteristic that you can have as a trader, and it is what often leads to capital capitulation.

One more note about stop-losses that deserves mentioning: when you keep the stop-loss tight, you are naturally going to spending less time in losing trades, and putting more of your capital in winning trades. A stock cannot go against you for very long with a tight stop in hand, before you will eventually be pushed out of the trade. On winning trades, and when the stock starts to trend in your favor, you will ensure that your capital is locked up into trades that are actually making you money and not the other way around.

By having the stops tighter, you aren't necessarily taking on more losing trades as a result of the tightness in your stops, but you are being more patient and waiting longer for your entries. There is no risk in waiting. If you are waiting for a stock to come down to your price and it takes off without you, who cares? I don't. The stock has the right to do that, and I do not feel violated because it did not wait for me to get into the trade. When you feel that way, you are personalizing your trades and incorporating too much emotion into your trades. Far too often, we get caught up in what the trade is doing when we are not actually in the trade by fantasizing about all the money that we “could have” made on the trade, instead of refocusing our efforts and going after the next trading opportunity.

As a trader, you have to be willing to lose. It is going to happen. As I said before, I am wrong at least 40 percent of the time and I think nothing less of myself because of it. In fact, I could be wrong more than 50 percent of the time and I would still be a successful trader. Much of that has to do with how I position myself for the trade.

Since I am waiting for the right price to come to me, and because my stops are much tighter, I find out very quickly if the trade is going to go in my favor, and if it does not, I can move on to the next trade. Because of this, I can trade at a much greater frequency because my capital is not tied up in some stock that I'm waiting for a 10 percent stop-loss to trigger on.

If you are confident in your trading strategy and that statistical evidence it has produced for you over the years, and you know you are right about 55 percent of the time and average about $2 in gains for every $1 you lose, then would you rather have the opportunity to trade 10 stocks at this rate or 20? Of course, you would choose the latter, and that is why, once you get settled into your trading strategy and can consistently extract profits out of the market, you will not want to tie up your capital in do-nothing trades longer than you have to.

Instead, you want to keep your winners as long as you can without getting stopped out (but constantly doing everything you can to secure as much in profits as possible in the trade while it rises) while moving your capital from the small losing trades into the next opportunity that you can profit from. That, my friend, is how you make your money work for you and not be a slave to the need to ultimately be right in your trading efforts.

More to the point of keeping your stops tight comes the inspiration from one of my most favorite movies of all time:
The Patriot
. In the movie, Benjamin Martin is on the march through the country backwoods to free his eldest son from his British captors. He brings his two younger boys and their rifles along for the ride to provide some cover. Prior to opening fire on the enemy, he asks his sons, “What did I tell you fellas about shooting?” In unison they reply with “Aim small, miss small,” after which they go on to wreak havoc and reunite with their captured brother and son.

In your trading, you should keep a similar motto when defining your risk on a trade. If your risk is contained, minimal and small, any loss you might incur will likewise be small. If your trading resembles some hellion taking a rifle and firing recklessly at anything that moves, without even taking the time to focus in the sights of the gun on the target you are aiming at, then what are the chances that you will actually be able to consistently profit in your trades and, more important, be able to close out year after year with a profit in the markets. It is not likely. So in your trading, take the risk side of the trade as seriously, in fact more seriously, than any other aspect of the trade. If you do this, the profits will take care of themselves, and that is a promise.

I like to equate the gains from winning trades to hits in baseball: singles, doubles, triples, and home runs. Everyone loves the home run trade, where you are able to bank a lifetime trade of insane profits. They do happen from time to time, but I would not “bank” on that happening all the time or even all that much. It is always the exception to the rule despite the fact most traders will kill themselves in the process of finding the holy grail for home run stocks.

Over the past 20 years, some of the biggest names in baseball have been Barry Bonds, Sammy Sosa, and Mark McGwire. They managed to tally numbers in their baseball careers as well as in single seasons that had never been matched before and probably will not be ever again. Unfortunately, though, they had something else in common: it is widely believed that all three have used performance-enhancing drugs to assist them in their home run totals.

But athletes like Cal Ripkin Jr., Ichiro, and Derek Jeter, who are much smaller guys in their body frame and stature, have never been accused of taking any performance-enhancing drugs. Unlike the home-run sluggers, they are either in the Baseball Hall of Fame in Cooperstown or they are guaranteed a placed in it one day when they retire. Despite having 1,954 home runs between them, Bonds, McGwire, and Sosa will likely never step foot into the Hall of Fame.

Jeter, Ichiro, and Cal Ripkin Jr. are well known for reaching base on a very consistent basis, sporting solid career batting averages, and coming through in the clutch when their teams needed them the most.

With that said, the question that is expected: what do drugs, baseball, and home runs have to do with trading stocks? A lot, actually!

Let me explain. Far too often, we swing for the fences in our trading, thinking that we can buy a certain product, follow a certain guru, or buy a certain stock and hold on to it for dear life, believing that doing so will fulfill our wildest trading fantasies of striking the “big one.”

Here's an illustration as it pertains to baseball: What would you think if the batter at the plate had a 3-0 count (only needing one more ball for a walk) and instead of waiting for a pitch to come right down the middle for him to swing at (i.e., make the pitcher do the work), he starts swing at the next three wild pitches regardless of how close they are to the strike zone and subsequently strikes out. If you were a fan of the team that he played for, you would be yelling and cursing at your television set and think the guy was an idiot, wondering how he ever made his way into the starting lineup.

But often, we do the exact same thing in our trading, where instead of taking some gains off the table, or looking to make consistent gains in the market, we instead swing for the fences despite having made a very solid trade (same thing as being up 3-0 in the count and swinging no matter the pitch's location)

Instead, you have to take some balls maybe a strike or two, but avoid swinging at everything that comes your way. If the home-run ball comes down the middle of the plate, take the swing, but for Pete's sake let it come to you—do not try to make it happen with every trade you take, and that is what so many traders do.

It is hard to be satisfied with just “getting on base” when it comes to trading. We thumb our nose at 1 or 2 percent on a given trade, and think it is not much to speak of and envision our trades being in the range of 10 to 20 percent, which is much more rare, and those who aim for those kinds of consistent returns strike out a whole lot more (just ask Babe Ruth).

As a part-time trader, you are limited by the amount of time and resources that you can devote to a stock in attempting to unearth some kind of rare gem. So do not try to do so. There are thousands of such people at the major brokerage firms with far more connections, resources, and inside tracks doing what you are trying to do on your own as a part-time trader. It simply doesn't make much sense at all. That is why I prefer technical analysis over fundamental analysis as well. As a retail trader, you have more of an advantage.

First, most brokerage firm shun the technical analysis craft, and second, it allows for retail traders such as ourselves to see where the “big money” is leaving its footprints, through the use of technical analysis.

So if you're frustrated by your trading, if you think you let too many winners turn into losers, or you place trades on the hype surrounding you (be it Twitter or some discussion forum), then ask yourself, in the long run, are you better off missing out on a few home-run balls and also avoiding some mega-losers, for the opportunity to consistently extract profits from this market by taking the gains that you have, and not holding out for the gains you hope for and are likely never to come your way?

Home-run hitters will definitely sell tickets, because who does not like seeing a slugger strike the ball so hard that the ball flies out of the park? It is truly something to marvel at. But what any general manager will tell you is that it is not the occasional home run that wins you a championship, but the on-base percentage of his players—the frequency with which you can get on base and score. If your on-base percentage is not at a high enough percentage, your team is not going to go very far.

As it goes, then, with your trading, your obsession should be consistently and successfully closing out winning trades at a level where the profit far outpaces the risk taken on the trade, as well as not striking out when you are up on the count (i.e., letting winners turn into losers) and, most important, having a strategy in place that keeps you from striking out too much (that is, managing risk) in hopes of getting the long ball.

This runs counter to what most will tell you, particularly those who are trying to sell you a product or service, because what they are trying to do is appeal to your vulnerabilities, hopes, and aspirations of riches and easy living. They are trying to sell you a dream. Sure, it would be nice to always strike it big with every one of our winning trades on a regular and consistent basis, but we are fooling ourselves if we think we can take that as a normal trading strategy and actually succeed in doing so.

If you are still not certain about what I have told you in this section, then just ask Jeter, Ichiro, and Ripkin. I'm sure they could tell how the simple walk, single, or double has done wonders for their career.

I
f you are not going to use stops because either (1) you prefer mental stops, (2) the market makers will “steal” your shares, (3) you are afraid of it popping back up as soon as you get stopped out, or some other reason not mentioned, you are wrong—there is no excuse for not using the stops.

You see, small losses are okay and are very easy to recover from and that is what you want when it comes to a losing trade. Being able to put the losing trade behind you and move on to the next trade is key and using tight stops as I have discussed throughout this book is what leads you down the path to successful trading.

There will no doubt be occasions where the market makers steal your shares or you simply get stopped out pure and simple only to witness the stock moving back up to new highs before the day is over. It is frustrating, I know. I have had it happen to me countless times, but that is part of the game, and trust me, I would rather take a small loss from someone who wants to take my shares at a cheap price, than let one of these stocks rip me a new one because my ego was so big that I had to control my losses by a means other than a stop-loss, namely, some belief that I would know before it was too late that I needed to get out of the trade.

When it does happen, though, and traders get stopped out of their trade early on, it is easy to become discouraged. In general, when I am stopped out of a trade, I do not even bother looking at the price action in the stock anymore. My stop-loss placement is such that when it is hit, there is something technically contrary for my original reasons for trading it. As a result, once that stop-loss is hit, I trust my analysis and move on, not allowing for the stock to occupy any of my thoughts going forward.

Being fallible as a human, if I watch a stock rip higher after I had been stopped out or just sold my shares in general, it adds nothing to my plate nor helps my trading to witness the stock's action after the fact. A stock is bound to go up or down after we get out of it, and since there are only two options for a stock to take, why should I allow myself to get upset or frustrated simply because the stock is moving in some direction after I get out?

I also do not want to see a stock that reverses course and crashes after I get out at the peak (capturing peak profits is not a regular occurrence for me or any other trader for that fact), because I may grow overly confident that I might have some kind of psychic powers that allows me to foretell the future of a stock price's movement. Such an attitude can also be detrimental to one's trading.

Getting stopped out early on, though, and watching the stock run without the trader in the pilot's seat can cause discouragement and allow for the trader to become leery of using stop-losses and instead rely on their own instincts and discernment for determining when to cut the losses when they inevitably occur. This is probably the worst decision that one can make and can take you out of the game faster than you can imagine.

I am here to tell you that getting stopped out of trades is a part of life. Furthermore, getting stopped out of a trade prematurely only for it to go on a major run soon thereafter is also going to happen to you as long as you trade with stops (which I hope you will always do). The sooner you come to grips with this reality, the better off you will be. The use of stop-losses is not a perfect science. Every time you get stopped out does not necessarily mean that the stock you are trading in is going into the crapper (though we would all like for that to be the case). Instead, you should be placing your stops at a strategic point on the chart that should the price of the stock hit your stop, you know that there is a strong or likely possibility that the behavior of the stock itself is diverging from the thesis that ­propelled you to buy the stock in the first place. When that happens, you should actually want to get out of the stock.

It is also worth noting that just because you get stopped out does not mean that you can't get back in, but there has to be a reason for jumping back in. Probably 95 percent of the trades I get stopped out of, I never get right back into. Most of the time it is just a trade that did not work out and I move on. Nonetheless, my stop is, in essence, an insurance policy from a stock blowing up my portfolio and taking me out of the game, as well as protecting me from myself. But as long as I manage my risk and therefore my losses, I stay in the game and allow myself the chance to experience success on the next trade.

There was a time while in the corporate world where I had a little more time on my hands than I typically would, so I thought I it would be a great idea to expand my trading into futures. Keep swing trading successfully as I always had, but now add a new a new element to my trading strategy: ­futures trading.

In my opinion, anything that can be charted and where technical analysis can be used, I believe, can be traded. Futures were no different. The only problem with futures, though, was that I was far too distracted by the position sizes. I was primarily trading the S&P 500 e-mini contracts and in doing so was scalping the index for small gains to the tune of one- to-two point moves.

Not only were the positions distracting, the system I had developed was distracting for me and my job as well. I relied on intraday signals that were unpredictable in nature, in regard to when they would actually fire off. I could go to a meeting and miss five or six trades in a one-hour period and not get another alert the rest of the day. Nonetheless, I pushed forward. What was even more distracting was how annoying it was to everyone I worked with.

When I had a signal to buy a position in the e-mini S&P 500 contract, it would be based off a certain set of parameters that indicated the market was oversold and ready for the bounce. As a result, my trade alert signal was Charlie Brown saying “Oh, good grief” in the most depressing of ways. However, when the markets were rallying hard and ready for a pullback,
Toy Story
's Buzz Lightyear would come to life and say, “To infinity . . . and beyond!”

This was not just annoying me, it was annoying everyone in the office. It was incredibly distracting for me from a work perspective as well because every time one of those blasted alerts went off, I had to react immediately, and it could really interrupt the flow of assignments that I was working on for my actual job. Now my office mates had no idea what I was up to. It never occurred to them that I had created some sophisticated trading system alerting me to buy and sell signals.

Instead, they just thought I had modified my e-mail system to where each time I received a new e-mail, Buzz Lightyear or Charlie Brown would let their voice be heard. I did not try to change their opinion of this at all. I figured it was best for me and them that they did not know the true reasons for those cartoon characters coming to life in the workplace.

It would not be unusual for me to be in someone else's office talking to someone about an important matter, to hear Buzz Lightyear's voice ring through the air. Upon hearing it, I would cut off any conversation we might have been having and would make a hurried beeline back to my office to place the trade that Buzz called for. Make no mistake about it—this became a huge disruption for me and my job. I found myself watching the charts even when I did not have a trade on or even alerted. I was trying to anticipate the trade.

Despite the distraction it was creating for me, I was extremely successful trading the futures contracts. I had a method to my madness and it was working for me, but the interference with my job priorities was putting me at risk to where if I stayed on this path, the problems it would create with the boss man would far outweigh the measured success trading futures I was experiencing. I was only three months into trading this strategy, but the profits, while nice, were not big enough that that I could simply quit my job, nor would I want to, based on a three-month futures track record.

Even more distracting became the position sizes. While I was not taking on outsized large positions, futures in their very nature carry a lot of risk, because of each individual contract value and the level of margin that is required for each trade. I always used stop-losses on the trades, but because the position sizes were large simply due to the general nature of trading futures, I was not willing to leave my desk while I had a trade under way nor could I go to meetings or focus my efforts on other activities I should have been working on.

A lot of it was paranoia. I knew that if I went off to a meeting, I would always assume the worst: my stop-loss was put in incorrectly, and a meteorite hit planet Earth, wiping out half the world's population, and the markets subsequently crashed, taking my entire position with it. By being in front of my computer I could spare myself the fear of the worst case scenario taking place and my not being around to act accordingly in response.

Some of you might be shaking your head while reading this and saying, “Here you had a system you could trade, you were doing good at it, and you let yourself get in the way of it.” Quite frankly, I would not disagree with you on this assessment either. I would follow up that thought with my own, and that is trading is about finding a system that fits your personality, your circumstances, and your risk profile. Trading futures intraday on an alert system that I had created while at work was by far moronic to the
n
th degree.

My personality was not geared to trading futures in the manner I had created it for. I found myself trying to anticipate trades, and though I might have gotten away with trading like this in my work environment, eventually it would have caught up with me. I could not trade at work with Buzz and Charlie sounding the alarm bell 6 to 10 times in a given day, not to mention the missed alerts I would experience due to having to be in meetings, on travel, or some other reason beyond my control. Finally, I was constantly worried and paranoid about a black-swan event taking place that could have rendered my portfolio useless, and, consequently, I would often find myself stressed out and unable to concentrate on my responsibilities on the job, so then it clearly did not fit my personality.

Often, traders will buy someone else's system for trading at a premium price thinking that because the system works for that individual, it will most definitely work for them as well and eliminate any doubt otherwise. However, within that system are all sorts of complicated elements that the original trader to the system understands and is comfortable with, but nearly every person who tries to duplicate his efforts fails miserably. Assuming that the system is legitimate and not some sham (like many of them are), the most likely cause for the failure lies in the purchaser of that system because the system does not fit his environment, personality, or risk profile (in some cases all three).

Over the years I designed a trading system to try to meet the personality of the typical part-time trader. Understanding that the person may not be able to watch the markets from opening bell to closing bell like the full-time traders can, I created a system that minimizes research time by only sending out 40 to 50 trade alerts each year (sometimes more), using a position sizing system that is designed around the trader's personality (the default risk profile is 10 percent position sizes, but you can make it more or less depending on your risk profile). Obviously, I wanted a system that could outperform the S&P 500; otherwise, what would be the point of trading my system if it did not beat the market (otherwise you would just buy the SPY ETF)?

The next and final aspect of the system was to manage risk in a way that did not create uneasiness among its traders. In doing so, I limited the system to trade only those stocks listed in the S&P 500 and no other. The other half of the risk management was to always use a trailing stop-loss of 10 percent that gave the system enough room for the investment to play itself out. This may sound contradictory to how I swing trade stocks for a living when my average stop-loss is 24 percent from my entry price. It is different because my investment system has its average position last three to four months at a time, whereas my swing trading is looking for positions that last a max of a couple of weeks.

My investment system only has 40 to 50 trades, whereas my swing trading has well over 250 trades per year. So the contrasts are startling because the approach to investing in stocks long-term versus swing trading on a short-term basis is startling as well.

Simplicity was a huge factor in creating my investment system because I knew traders could not be on standby like I was when trading futures waiting to place seven or eight trades each session. Therefore, I made it where the investment picks, where there was one on a given day, would be sent out before the market opens. Then to top it off, the goal of the system is to not to wait around to use one's discretion of when they should buy the stock. Instead, the system dictates that the purchase should be made as soon as the market opens.

What I created was a trading system that should have a low level of conflict with most traders' personalities and their job responsibilities. The biggest criticism that I receive is that they wish the investment system was more active, but if you want that, you are better off subscribing to my swing-trading alerts.

Investments, by their very name, are always going to be less in frequency. On the risk front the investment system will not ruffle a lot of feathers. Sure, there will be stocks that get stopped out just like any system has, but at the end of the day, the volatility is much less than what you would see in just about every other newsletter on the planet. Keeping the part-time trader in mind, the SharePlanner Investment System is geared toward the working environment of Corporate America, while also striving to be personality and risk profile friendly. If you have not tried it out yet, I would highly encourage you to do so at SharePlanner.com.