MarketFN.com: November 2007

Before getting to the meat of this week's article, I have to say I was amazed and humbled by the sheer number of positive emails I received about last weekend's article. Thank you. Only one email so far was negative and that from someone who admittedly did not read the article but who was offended because I entitled the article: "Lots of Ways to Skin a Cat." Let it be known that I do not really advocate skinning cats. It is an old expression not to be taken literally.

Anyway, I digress. I frequently do get very helpful suggestions in emails and one I received was from a subscriber in the stock brokerage industry who, among his many insightful comments, suggested that he never understood why paper trading was so frequently recommended because it is definitely different when real money is traded. He is absolutely right that things are very different when real money is placed at risk as I'll discuss below.

I am an advocate of paper trading, but not because it is the same as putting real money at risk. Paper trading has its place, and, in my opinion, that place is a continuation of a trader or would-be trader's education. Paper trading is simply practicing strategies without using real money. Nothing is at risk and it costs nothing but time. Practice trading, if done properly, helps the trader learn the strategy he is practicing better. Nuances can be discovered without taking financial hits. The practice trader can learn, for example, how and when to adjust option positions or how and when to take profits. It can be an aid in discovering how to cut losses and let profits run unemotionally. For me, those are the primary benefits of paper trading. Though I have been trading real money for many years now, I still paper trade when I am examining a strategy with which I am not completely familiar.

However, I am in complete agreement with my broker-subscriber who says that paper trading is not the same as putting real money at risk. It isn't!!! When someone paper trades, it is not likely that the heart will beat faster or the lump will come up in the throat. There are no sweaty palms in paper trading. Real money trading is a different story and I know of no way to replicate real money emotions when paper trading. Placing real money at risk does bring fear and greed to the surface. Those emotions create the next and extremely critical battle the successful trader must face on the road to success. The goal is to trade without emotion because the emotional trader is the trader least likely to succeed. Perhaps completely unemotional trading is unattainable, but I am convinced that those traders who succeed are those who have the emotions under some control, who have tight discipline in their trading, and who discipline their money management.

I suspect that intimate knowledge of a strategy gained earlier through paper trading helps a trader control emotion though it does not win the battle. I have seen a number of successful paper traders go down in flames when it came to real money trading. When asked what happened, they have universally told me that when they started using real money they stopped doing what they had been while paper trading. They abandoned their business plan, they did not follow their exit strategy; in short, they let their emotions rule.

The ultimate goal, I believe, for the successful trader is to trade with discipline and as little emotion as possible. Paper trading can be extremely helpful, but it is only a part of the puzzle.

Bill Kraft, Editor
P.S. Bloggers! Subscribe to my Trend Trader Service at MarketFN.com and use this link for $50 PER MONTH SAVINGS!.
P.S. Bloggers! Subscribe to my Under $10 Stock Trader Service at MarketFN.com and use this link for $50 PER MONTH SAVINGS!
P.S. Bloggers! Subscribe to my Option Trader Service at MarketFN.com and use this link for $50 PER MONTH SAVINGS!.

Technorati tags: stock trading stock market investing trend trading swing trading option trading stock options stock option trading Bill Kraft Eric Aafedt

Almost every week I receive emails about the content of the Newsletter article and most of the time they are pretty friendly even when they don't agree with everything I have to say. Every once in a while, I receive a "Nastygram" as I did last week following the article about options. Here is what the dear fellow (whose name I have withheld) had to say:

"There is no academic evidence to show trading options will accumulate wealth...I have a feeling that the broker makes more cash than the trader. But show me. Give me an academic publication that proves your 'shucking and Jiving' really works. Our family has owned Citi-Corp [sic], yes that doggie since $14 a share....Just keep buying more in dividend reivestment [sic]. Let me write for your website and give traders a choice. And stop telling everyone how smart you are. after [sic] all you don't need our money....you are already wealthy."

First, if I have given the impression that I have been telling everyone how smart I am, I apologize. That is definitely not my intent. I write the Newsletter articles to try and give readers the benefits of my many mistakes as well as years of study and trading for my living. I am not the publisher of the Newsletter and get no income whatsoever for writing these articles. I do not share in advertising income paid the publisher. I write the articles for three reasons: 1. to give back in repayment for my own good fortune, 2. in the hope that the articles will get people to educate themselves before throwing money into the markets for emotional reasons, and 3. to get the occasional free subscriber to try one of my paid services (Option Trader, Trend Trader, and $10 Trader).

It is interesting to note that the free subscriber who wrote the quoted email apparently does not even know what his family does own. He refers to Citi-Corp which no longer offers stock that exists under that name, but has long traded as Citigroup (C). I think his point is that his family are buy and hold investors and there is certainly a great deal to be said about buy and hold investing. Over the long haul much buy and hold investing has been very successful and I certainly am not opposed to that strategy. I must point out, however, that blindly buying and holding definitely does not assure success. Former holders of shares in Enron and Worldcom can certainly attest to the occasional failure of the strategy.

Options can have an important place for the buy and hold strategist as well. Buying protective puts, for example, can "insure" against price drops. Our friend's Citigroup (C) stock, for example, fell from $49 in mid-September to a low of $31.05 in November. A protective put might well have significantly softened that blow. Of course, his family just holds the stock so such dramatic falls may not phase the subscriber, but I'd wager he'd be even happier if that paper loss had been offset by a big profit in some puts.

I can only assume that my email pal has a large number of shares of C now so maybe it would be worth selling some out of the money covered calls against that position to bring in some monthly income. With the stock now back in the mid-30's as I write, the Dec 40 calls could bring in 45 cents a share. If he has 5000 shares, that could be $2,250 a month in income.

The point is that various options strategies can be helpful to almost any investor. Any strategy can be rewarding and any strategy can produce losses. Buy and hold can be an excellent strategy, but it also exposes the investor to the possibility of very large losses. Options can afford some protection against such losses. Knowledge and risk awareness are keys to successful investing. Our friend evidently is wed to a single strategy and there is nothing wrong with that as long as he understands the risks of the strategy and has the knowledge to manage those risks. My question to the buy and hold strategist is: Hold until when?

With regard to the subscriber's comments about academic publications, I confess I don't know what he means by my "shucking and jiving" but neither do I know of any academic publication that devotes itself to shucking or jiving. I do know that academia does recognize option trading. I also know that some of the wealthiest investors do make use of options as do successful brokerage firms.

As that fellow wrote, I don't need his money. He is absolutely right. I don't, but I would suggest that a little more education wouldn't hurt any of us -- him included. Of course, so there is no mistake, I am not taking his money. He is a free subscriber. I wonder why he bothers to read the Newsletter.