I recently had the opportunity to sit down with a friend and go over his investment plan. He had just taken a bath on some spreads during the whipsawing market conditions and was a little gunshy. We discussed how spreads can provide some great percentage returns on risk, but at times can beat the trader up a bit even though they do limit risk.

What we found in our analysis was that my friend's primary goal was to increase his income relatively modestly and that capital appreciation was really secondary to income. As the conversation evolved, it became apparent that he had enough money to generate sufficient income to satisfy his desires with much less risk than he had been taking.

The conclusion he reached was that he could buy stocks paying relatively high dividends and purchase protective puts to preserve his capital with very small risk.

The lesson is that it is critically important to know what you really want. It seems that many retail traders fail to identify their real financial needs and goals and, instead, are constantly reaching for the brass ring or the big hit. Many successful traders are content with steady production and preservation of capital. Though the high risk/potentially high reward is the appropriate strategy for some traders, I suspect that is not the way most should go.

For those who do choose the high risk/high reward strategies, it should probably be done only with true risk money. I define risk money as money that you do not need. Money that can be lost and though the loss may be unpleasant, it has no effect on the trader's lifestyle. Any other money is best placed in low risk or no risk positions.

As many of my long time readers know, I am an advocate of establishing a plan before making any trades. In my new book, "Trade Your Way to Wealth", scheduled for release by John Wiley & Son publishers in January, I set out the specifics needed to formulate your basic plan. In order to prepare the plan, it is imperative that the investor or trader make a careful analysis of what they are truly seeking in their trading. Making money is way too broad an answer. Are you seeking to add $500 a month in income or are you satisfied to forego current income in an effort to enjoy greater capital appreciation? Do you want to protect all your capital or are you willing to put some or a lot at risk?

What we must first do in my view is truly examine our own personal financial needs and goals before we undertake our trades. Once we have made the effort to understand what we really want, we can begin to create the safest possible plan to satisfy those needs and wants.

Good Trading!
Bill Kraft

September 8, 2007

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