I hate to see any year end because every one has provided wonderful experiences and pleasant memories. 2008 was no exception in those categories, but most of us are glad it is over from a market perspective, at least. The Dow finished down 34%, the S&P 500 lost 38% and the Nasdaq and NYSE both fell 41%. Most of the calls I received from prospective coaching students included comments that they wanted help because their accounts were down significantly.

In mid-December, I received an email from Dr. Alexander Elder (author of several excellent trading books including "Trading for a Living" and "Come Into My Trading Room") pointing out that up to that time, none of the U.S. Stock Mutual Funds tracked by Morningstar, not one, was up for the year. In fact, the average performance was a whopping minus 43.63%. That information underscores the importance of cutting losses, paying attention to reward to risk ratios, and of money management, topics I have repeatedly addressed over the years in these articles. If we are down 50%, it means our position must gain 100% just to get back to even. That is a significant problem with the buy and hold philosophy.

It has often been said that even the best traders only win about 1/2 their trades. If that is so (and I believe it is) how can they succeed? First, they can cut losses so that the amount of gains, in general, exceed the amount of losses. One important way to do that is to pay attention to the potential reward versus the risk assumed in any given trade. If, for example, we enter trades where the potential reward is 2.5 times the risk we are taking, we can lose 70% of our trades and still make money. Looking at the Table below, we can see that if we lose $1 on each losing trade and make $2.50 on each winning trade, in 10 trades, even if 70% are losers, we would still make a little.

    Lose                  Win
1.  -$1
2.  -$1
3.  -$1
4.  -$1
5.  -$1
6.  -$1
7.  -$1
8.                          +$2.50
9.                          +$2.50
10.                        +$2.50
_____                    ______
   -$7                     +$7.50

Of course, in some cases, the winners would run beyond the $2.50 while the losers can most likely be kept fairly close to the loss set at the beginning of a trade.

All that aside, I reviewed my trades in the three subscription services I edit for MarketFN and found that I did not trade particularly actively as a result of market conditions. I closed 19 trades in Trend Trader, 27 trades in Option Trader, and 28 trades in $10 Trader. Not surprisingly, in light of the downward direction of the market, Option Trader had the highest percentage of winning closed trades with 63%. $10 Trader came in a close second with a winning percentage of closed trades of 61% and Trend Trader with a not too shabby 53% profitable trades. Both Trend Trader and $10 Trader are services in which I am looking to buy stocks so they are directed more to bullish plays where I want to buy the stock and then have the stock price increase. 53% and 61% winners, respectively, in those services when the Nasdaq fell 41% and the Dow 34%, and not a single mutual fund followed by Morningstar had made money by the middle of December seems pretty decent all things considered.

What will 2009 bring? I can assure you that absolutely no one knows. One thing we can do is add to our knowledge. I guess I wasn't surprised when the publisher of my book "Trade Your Way to Wealth" told me that sales of trading books were down this year, but it seems to me that it is exactly at times like these when people should be reading books, adding to their knowledge, learning how to cut losses and let profits run rather than throwing unopened brokerage statements into the trash. I feel assured that those who took advantage of my reduced price offer for private coaching all came away with added knowledge about risk management, discipline, money management, and methods by which they could cut losses and ways to avoid cutting profits. All trading is risky, but the more effort we make to learn, the better chance we give ourselves to succeed.

Good Trading!
Bill Kraft

January 10, 2009

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