“I’ve never been able to plan my life. I just lurch from indecision to indecision.” ~ Alan Rickman
What’s the most efficient and effective way you – as an investor – can increase your odds of success?
Most might answer that the best way is to pick the best stocks and get in and out at the right time (i.e. buy low, sell high).
While those things can definitely help, the reality of investing and trading is quite different. Anyone who’s been in this game for a while knows that picking the next great stock isn’t as easy as it sounds, and trying to time the inevitable twists and turns in the market will drive anyone crazy. The simple fact is that you will be wrong. And that will happen quite often.
What you really need to is put the odds of success in your favor, and the best way to do that is have a trading plan.
Why? Because it will do three very important things for you:
1) A Trading Plan Helps You Control Your Losses
Trades will go against you. That’s a fact of life. However, what happens again and again is investors either freeze and do nothing when a trade goes south. Or worse, they’ll compound the problem by adding size in hopes that they can lower their cost basis and improve their situation.
The most important thing to do is to deal with a problem trade as it develops. The specific action you take will depend on the circumstances. Does the stock slip below a key support level on a closing basis? Then it might be appropriate to simply take the loss and move on. While it sometimes seems like taking a stop is a guaranteed that the stock will immediately reverse back up, you’d be surprised at how many times support levels matter.
Does a stock you own gap sharply lower one morning? That’s a tough situation, because there’s no way to prevent emotions coming into play, but if you know that this is part of the game, then it gets a little easier to calmly reassess the situation.
If you’ve planned properly, you will be ready to react under various scenarios. You can’t prevent losses, but you can contain them.
2) A Trading Plan Helps Manage Your Gains
If there’s one aspect to trading that flummoxes even the most seasoned trader, it’s knowing when to book profits. We’ve all had trades that go the right way, but when we hold on in hopes of seeing additional upside, they reverse and our profits evaporate. Or, we see some gains on the screen, and book them because “you never go broke taking gains” only to see the stock subsequently chug along to infinity without us.
Common trading wisdom might tell us to “let our winners” run, but nothing lasts forever. Some traders swear by trailing stops, while others find that they do better by selling down positions if they get extended. Regardless of what you decide, having a plan in place will help you have an executable method to manage your gains.
3) A Trading Plan Helps You Determine Position Sizing
When you go into a trade, you need to know the amount of money you are willing to risk. Some people prefer to give trades a little more wiggle room, and that might mean taking a smaller position. Others, however, might prefer to keep stops very tight, and that provides some leeway for taking larger size. Also, do you prefer to spread out your risk by taking lots of small positions, or do you find it easier to manage your trading portfolio by holding just a few stocks? Different methods affect to overall volatility of your holdings. It just depends on what works for you.
Regardless of the methods you choose, it’s important to make a plan and stick to it. You can always revise it and make adjustments as necessary, but the process of planning and having a framework to manage your portfolio is far more important to your long-term success than just stock-picking and timing the market.
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