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3 Dos and Don’ts Most Traders Learn the Hard Way

January 21, 2014



The following article is an excerpt from Trade Like a Stock Market Wizard: How to Achieve Super Performance in Stocks in Any Market by Mark Minervini with permission from McGraw Hill Publishing.

 

How to Handle a Losing Streak

 

A losing streak usually means it’s time for an assessment. If you find yourself getting stopped out of your positions over and over, there can only be two things wrong:

 

1. Your stock selection criteria are flawed.

2. The general market environment is hostile.

 

Broad losses across your portfolio after a winning record could signal an approaching correction in a bull market or the advent of a bear market. Leading stocks often break down before the general market declines. If you’re using sound criteria with regard to fundamentals and timing, your stock picks should work for you, but if the market is entering a correction or a bear market, even good selection criteria can show poor results. It’s not time to buy; it’s time to sell or even possibly go short. Keep yourself in tune with your portfolio, and when you start experiencing abnormal behavior, watch out. Jesse Livermore said, “I’m never afraid of normal behavior but abnormal behavior.”

 

If you’re experiencing a heavy number of losses in a strong market, maybe your timing is off. Perhaps your stock-selection criteria are missing a key factor. If you experience an abnormal losing streak, first scale down your exposure. Don’t try to trade larger to recoup your losses fast; that can lead to much bigger losses. Instead, cut down your position sizes; for example, if you normally trade 5,000-share lots, trade 2,000 shares. If you continue to have trouble, cut back again, maybe to 1,000 shares. If it continues, cut back again. When your trading plan is working well, do the opposite and pyramid back up.

 

Following this strategy will help keep you from trading yourself into the ground when things turn sour, which they definitely will at some point. When you take a large loss or get hit repeatedly, there’s a tendency to get angry and try to get it back quickly by trading larger. This is a major mistake many traders make and is the complete opposite of what should be done. Don’t do it; trade smaller, not bigger. If you keep trading the same size over and over, even making small mistakes can lead to a death by a thousand cuts. Instead, scale back your trading size and raise the cash position in your portfolio.

 

A Practice That Will Guarantee Disaster

 

It would be bad enough to sit and watch your wealth disappear and do nothing to protect yourself by not using a stop loss, but it is even worse to put more money into a losing investment. Throwing good money after bad is one of the quickest ways to the poorhouse. This is called averaging down.

 

Brokers often talk their clients into buying more shares of a stock that shows a loss in an effort to sell more stock or rationalize the poor recommendations they made in the first place. They tell the client that it will lower their cost basis. If you liked it at $50, you’re going to love it at $40, right? Double up at $40 and your average price is now $45. Wow, what a deal! You now own twice the amount of stock, and you’ve doubled your risk. Your loss is still the same; you didn’t gain anything except maybe a double-size loss if the stock keeps sliding. How about buying at $30, then $20, and then $10? How ridiculous! There is no shame in losing money on a stock trade, but to hold on to a loss and let it get bigger and bigger or, even worse, to buy more is amateurish and self-destructive.

 

High-growth stocks that fall in value after you purchase them at a correct buy point do not become more attractive; they become less attractive. The more they fall, the less attractive they are. The fact that a stock is not responding positively is a red flag that the market is ignoring the stock; perception is not going in your direction. Maybe the general market is headed into a correction or, even worse, a major bear market.

 

For many traders, it’s tempting to buy a pullback because you feel you’re getting a bargain compared with where the stock was trading previously. However, averaging down is for losers, plain and simple. If this is the type of advice you’re getting, I suggest you get a new broker or advisor. This is simply the worst possible advice you can receive. Remember that only losers average losers.

 

Learn to Pace Yourself

 

When I come out of a 100 percent cash position, generally after a bear market or intermediate-term correction, I rarely jump right in with both feet. I think of each trading year as the opener of a twelve-inning game. There’s plenty of time to reach my goal. Early on, I take it slow with my main focus on avoiding major errors and finding the market’s theme. This is like an athlete warming up and assessing the competitive environment.

 

Themes can come in the form of how prices are acting in general, industry group leadership, overall market tone, and economic and political influences. I try to establish a rhythm and set my pace during this time. Like a golfer who has found his swing groove, once I find a theme and establish my trading rhythm, then and only then do I step up my exposure significantly. I wait patiently for the right opportunity while guarding my account. When the opportunity presents itself with the least chance of loss, I’m ready to strike. Patience is the key. My goal is to trade effortlessly.

 

If your trading is causing you difficulty or stress, something is wrong with your criteria or timing or you’re trading too large.

 

To trade with ease, you must learn to wait patiently until the wind is at your back. If you were going sailing, you wouldn’t go out on a dead calm and sit there floating in the water all day waiting for the wind to pick up. Why not just wait for a breezy day to set sail?

 

 

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