Trading Trends

"The trend is your friend." Certainly that is one of the many stock market adages. Generally, I think a saying becomes an adage through repetition over time. Those sayings don't seem likely to be repeated unless there is some truth to them. Trend trading as we try to practice it is a form of momentum trading. We prefer to try to capture profit out of the middle of the trend rather than try to catch reversal at bottoms and tops. A wise man (maybe a 'wise guy') once said that a trader only catches one top and one bottom in a lifetime.

One of the positives about trend trading is that it is relatively easy to find an entry and to set an exit without letting emotion creep into the decision making process. While there is never any guarantee of profit, this trend trading method can keep losses relatively small in many cases when the stock turns against the investor or trader. Once the trend is broken, it is time for the trend trader to exit the position. As long as the trend is continuing, the trader can see the value of his position increase. If he holds the position until the trend is broken, he is much less likely to cut his profits short.

There are many ways to define a trend. Since I am talking about bullish (up) trends in this article, I look for stocks that may be faithful to a moving average (e.g. 18 day, 20 day, 40 day, 50 day, 200 day or whatever) or one whose line chart may be traced by its retracements touching a straight diagonal line. Trend breaks are seen whenever the moving average or trend line (whatever the trader is using) is broken. Of course, until that break happens, the stock remains in the trend.

I am convinced that emotion is one of the greatest enemies of the average person who trades or invests. Many times the unsuccessful investor buys near the top and sells near the bottom -- exactly the opposite of what the successful trader does. I think that occurs because the unsuccessful person wait until the chatter about a stock reaches a crescendo, an emotional fever pitch. He sees, for example, a positive magazine article about a stock after he has heard the 'talking heads' on TV talk up the stock. Maybe he has friends who have 'gotten in.' By the time the magazine article comes out, it may be the last of many positive statements. As the stock was 'talked up' it may have run up. Our poor trader (pun intended) loses sight of the fact that it may take quite some time to develop and article and bring it to print in a national magazine. By the time the magazine hits the streets, the move may have run most, if not all, of its' course. Now our trader is excited and makes his buy, but almost everyone else has already bought their shares and there is little demand left. The stock turns over. Rather than realize his mistake and get out quickly with a small loss, our trader falls into the trap of talking himself into the belief that "it's coming back." He watches and anguishes as the stock falls and falls and makes little arguments to himself like: "If it just comes back to 'x' dollars, I'll sell." Forgetting, or perhaps not knowing, that the first loss is often the best loss, our trader hangs on until finally he despairs, just gives up and takes a big loss. Do you know anyone to whom that has happened?

The trader who trades the trend can avoid that kind of emotionalism; avoid staying in the position as the stock drops farther and farther. Instead of kidding himself that "it'll come back," the trend trader can exit on the objective evidence that the trend has broken. So, too, the trend trader can enter on the objective evidence that the trend has been tested and has held. The "it'll come back" investor (and all of us) needs to remember that in order to recover from a 50% drop in price the stock must make a 100% gain just to break even! For example, if a $100 stock drops to $50 (50% drop), it must double in price (100% gain) just to get back to $100. I sincerely believe it is much better not to hold through that 50% drop. "What if it turns back up," the trader says. Well, there is no law that says you can't get back into the position. As an aside, if a loss was taken, the trader might want to consult with her tax advisor about the "wash rule."

Trend trading can enable an investor to cut losses and let profits run. As Warren Buffet once reputedly said when asked how to make money in the stock market: "Don't lose." While using a break in the trend as an exit won't necessarily avoid losing, in many cases, it will keep losses small and let profits run. It can help remove the emotionalism that has been the downfall of so many traders.

Some investors like to be in the market all the time and are concerned that they will be left out if they are trading trends. The truth is that some sector, some stocks are almost always in an uptrend even if the overall market is not. Of course, there is nothing to prevent one from trading the down trends as well, but that is a subject for another day.

Trading the trends,

Bill Kraft, Editor
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Bill Kraft is the editor of the Trend Trader Service at MarketFN.com.

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Business Plans for Traders and Investors

I teach seminars on stock and option trading and in the basic class, I always begin with the necessity of having a business plan. Trading and investing are businesses. We need to treat them that way. If you were going to open a retail store or a medical practice or an oil exploration company you'd certainly have a business plan, wouldn't you? So why wouldn't you have a trading or investing plan? Clearly, each of us who trades and/or invests should have a plan, but many don't. In all the seminars I've taught, I'd guess that less than 1% of the attendees had a business plan before they came. Now, I hope they all do.

Emotion is the enemy of the trader and the investor. If that investor doesn't have and abide by a plan, don't you think the chances are high that his trading will be controlled by emotion? Fear and greed take over and generally seem to lead to poor decision making. The undisciplined often enter at exactly the wrong place and exit just as badly. One of the ways to avoid the dangerously undisciplined approach is to have a plan. I remember being on the trading floor of a large brokerage house in New York when I first began trading for my living. I was fortunate enough to meet the head trader and he asked me what I was doing and I excitedly expounded the trading plan I was following. I hoped he would acknowledge the obvious brilliance of my plan. He didn't. What he said, however, has stuck with me for many years. He said it wasn't so important what my plan was; it was important that I had a plan. He told me that most of the retail traders and investors he knew had no plan and that almost any plan was better than having no plan.

As I began to teach trading, I tried to incorporate that message to my students. Generally they would glaze over when I went into my sermon on having a business plan. They were waiting for the "good stuff" about how to make money. Well having and making a business plan is definitely a huge part of that "good stuff." Without it, making money is infinitely more difficult. One of the perks of our basic trading class is that everyone is entitled to a free retake and many of the students wisely avail themselves of that opportunity. We throw an awful lot at them in the initial two day class and repetition helps them finally own the knowledge. Anyway, I began asking the retake students whether they had completed a business plan and they never had. When I asked why, I learned that they had no clue how to formulate the plan. Now, in class, I take some time and go over some detailed suggestions as to what the business plan should include.

While the following is not intended to be complete or exhaustive, it is intended to give the reader a starting point in formulating their own personal business plan for investing or trading. Here are some of the elements of a business plan that I suggest to my students:

1. Will I trade full or part time?

2. How much risk money will I assign to the business? (I define risk money as money you can lose that will not affect your life or lifestyle. It does NOT include mortgage payment money, rent money, grocery money, car payments, insurance premiums, clothing money, or any other money you absolutely can't afford to lose).

3. What will be the size of my trades? (Equal dollar amounts, or equal percentage amounts).

4. How will I make my trading decisions?

5. When will I make my trading decisions? (In the evening? Only on weekends? Once a month? It depends on what is going on in your own life).

6. How will I enter?

7. How and when will I exit?

8. What strategies will I employ?

9. What are my business hours? (In my view, this is very important. If we had a store, we would be open certain hours. If we assign business hours to ourselves, they should be treated as exactly that -- business hours. It is not a time to play with the dog or have non-essential interruptions. The business needs to be treated like a business).

10. What is the maximum number of trades I'll have in place at any one time?

11. What type of stops or alerts will I use?

12. What are my specific trading expectations?

13. What will I do to increase my trading knowledge? (Reading, seminars, paper trading, DVD's, etc.).

Again, these questions are intended as a starting point only. Other questions will occur to you as you develop your plan. Remember, the business plan is always a work in progress. It is expected to change over time. You may start trading part time and ultimately go full time. You may learn new strategies over time and that could change the strategies you are going to employ. You may begin with only a small amount of risk money and not have enough money to make equal 5% percentage trades at first so you may decide to trade equal dollar amounts. Later, when your account grows, you may switch from equal dollar amounts to equal percentage amounts.

The critical point is that you do develop a business plan of your own for your own trading and investing. The act of devising the plan will require some thought and will reveal important information to yourself about yourself. Completing the plan will give you a foundation for better trading. Abiding by the plan once you have completed it will put you in a rare class of trader and investor.

Good Trading!

Bill Kraft, Editor
P.S. Bloggers! Subscribe to my Trend Trader Service and use this link for $50 PER MONTH SAVINGS!.

Bill Kraft is the editor of the Trend Trader Service, The $10 Trader and the Option Trader at MarketFN.com.

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