Years ago, the only plan investors had to rely on was the good old fashioned “Buy & Hold” strategy. However, with the added volatility seen in today’s market, this strategy no longer works for the average investor, mainly because the extreme price fluctuations have caused many people to lose faith in the stock market as a safe place for them to put their money. There is no question that skyrocketing national debt and geo-political tensions are causing many investors to reconsider their investment options. Let’s face it, unless you are the type of person who is comfortable with extreme price swings, holding on to a stock portfolio these days has become much more stressful, and I simply don’t see this changing any time soon.
While traveling around the world, I’ve noticed a significant shift in the number of people who have moved away from “Buy & Hold” to a strategy that is more of a “Buy & Protect” approach. I wouldn’t say that investors are abandoning the stock market altogether, but I would say that there’s definitely an evolution taking place. Thanks to the advancement of technology, and the speed at which news is currently being disseminated, there’s never been a better time for Swing Traders than now. Swing trading incorporates a lot of the same principles as investing, especially when it comes to getting into the investment, however, the big difference between a swing trader and a conventional investor is in the way a swing trader manages the risk on the way out of a position.
Historically, investors would be willing to park their money in a company for years, as long as the fundamentals offered a respectable P/E Ratio and a reliable dividend. On the other hand, most swing traders couldn’t care less about a dividend, mainly because their plan would only require them holding on to a stock between 3 weeks to 3 months. Their main goal is to capture profits from the short-term price swings, and the main tool they use to help them do this is the Candlestick Chart.
I started trading back in 1982, which was long before computers took over the world, and long before technical analysis was even considered to be a viable form of forecasting stock prices. Back then, the floor traders had to rely on their own ability to draw the charts by hand. We used sharpened pencils and graph paper in the same way the Japanese rice traders did hundreds of years ago. The buy and sell signals were just as clear then as they are today, and I imagine traders will still be using candlestick charts 100 years from now.
Ben Franklin once said, “If you fail to plan, then you are planning to fail.”
From my experience, this bit of Franklin wisdom is extremely relevant when it comes to trading the markets. If you don’t have a plan to manage the volatility in the market, then you might as well flush your money down the toilet. In addition to that, if you do have a plan, but your plan does not incorporate some kind of risk management strategy, then that’s the same as not having a plan at all.
When you think about it, picking a stock to buy is not really that difficult. If you were to turn on your computer, to follow the news, or tune into your favorite financial program, it wouldn’t take long before some analyst started talking to you about their favorite stock. The trouble is, while that analyst might be quick to tell you which stock to buy, they are surely not going to call you up to tell you when it’s time to sell. This is one of the main reasons why we spend most of our time studying price action on the candle charts. The analyst will not tell you when to get out of a bad investment, but the candle charts will absolutely tell you when to sell, figuratively speaking of course.
Part one of your plan should involve getting familiar with the price charts. Supply and demand is easily identified once you’ve learned how to draw support and resistance lines on your chart. Support is the area where buyers come into the market, and as a result, they cause the sellers to back away. If you want to increase the odds of making money, then make sure you are positioning yourself on the side of the buyers. Another way you can look at this is to put your money in the direction of the money flow. One of the biggest mistakes people make is when they try to buy a stock while the price is dropping (Experts call this Bottom Fishing). If you have done this in the past, then you already know that this strategy doesn’t usually work out well. In fact, it’s a very bad idea to try to “catch a falling knife”, because you will most likely cut yourself in the process. If you try to buy a stock that’s being controlled by the sellers then you are doing the same thing, more or less, with your money. Resistance is the area where sellers take control of the price action, and when sellers become more aggressive than the buyers, prices usually drop. The good thing for us swing traders is that we can see when the sellers are becoming more aggressive. So, if you know when the sellers are moving into the market, then you will be less likely to buy in at that point. In addition, if you’re already holding on to a stock, this will be the best time to get out of your stock position.
Deciding how much to trade with and where the funds will come from are critical decisions you’ll have to make as you start trading. As a general rule, most people should not trade with more than about 20 percent of their overall investment portfolio. This is a very broad statement and should be adjusted for such factors as age, time until retirement, risk tolerance, and total net worth. Most brokerage firms have a minimum account balance that is required for a trading account. However, some of these minimums are as low as $500. It’s difficult to assign a threshold for funding your first trading account, however $5,000 to $10,000 is the minimum that I would recommend. I would also recommend that you not risk more than you can afford to lose on any investment, whether it be stocks, options, or even cryptocurrencies. Bottom line is: if losing the amount you put at risk in the stock market will threaten your financial condition, then don’t trade.
One of the most important things to remember, whether you are an investor or trader, is that emotions and money do NOT mix well. This is just another reason why the candle charts work so well as a tool for trading short-term trends. Once you’ve committed to following the technical signals, you leave little room for emotions to creep in to the decision-making process. It would be foolish for me to tell you that you’re not going to feel stressed every now and then, especially when one of your favorite stocks starts to move against you, but I will say that the charts make it a lot easier for you to get out when it’s time to cut your losses. Knowing when to cut the losses is the biggest challenge faced by most investors. However, if your exit price is pre-determined because you have decided to get out once a stock drops below a key support level, it will definitely help take the emotions out of your decision to limit your loss.
My biggest loss came during the crash of 1987, and at the time, I had no risk-management plan whatsoever. I was a hot-shot novice trader on Wall Street who thought he knew better than the market. Take it from me, I have a million-dollar education in this area so do yourself a favor and learn from my mistakes. Since then, I‘ve developed The 1% Rule for Managing Risk. This rule is the cornerstone from which I’ve built my financial education company, and as a result of this rule, I haven’t had a losing year since 1987. Of course, I’ve taken losses in individual trades along the way, but at the end of each year, I’ve come out ahead.
Start out by developing a plan. Learn how to read candlestick charts, secure the proper funding for your trading account, pick your entry points based on strong technical signals, and most importantly, identify your exit price before you take any new positions, so when a stock moves against you, you’ll be able to limit your risk to 1% of your trading account.
Feel free to visit The Market Guys video library where you will find a short 7-minute video that explains the 1% Rule for Managing Risk. In a nutshell, it comes down to this…It’s not how much money you make when you are right that counts, it’s how little you lose when you are wrong that matters.
By AJ Monte CMT
Chief Market Strategist
The Market Guys, Inc.