The Biggest Issue for Traders Isn’t the Market’s Direction

I often think that trading is mostly common sense.

Strategies such as running profits and cutting losses are like second nature to me.

But it wasn’t always like this.

I began trading shares when I was 15. My strategy was to buy speculative mining stocks. I still recall a few of the names: North East Gold, Transcontinental Mining, and Clifford Resources.

Can you guess how I’d trade these stocks?

Well, I didn’t do things by halves…

My approach was to go ‘all in’ with the little capital I had. There was no thought about risk or exit plans. My goal was pure and simple: make a lot of money, quickly.

Naturally, it was a disaster. I don’t think I had a single winning trade. A few stocks would surge higher. But I’d never sell. I’d eventually ride them all the way back down.

However, that wasn’t my biggest problem.

You see, I thought trading was just about buying and selling. Strategies to maximise profits, limit losses, and spread risk didn’t enter my mind. I was totally clueless, and I didn’t know it.

It wasn’t until 1992 that I began learning to trade. My job at Bankers Trust put me alongside some of the best traders in the land. I was lucky. Few people get this opportunity.

This week, I’m going to tell you about a trader who hasn’t been as fortunate. His trading style reminds me a lot of my own early ways. And I suspect the outcome will be just as poor.

The problem for many traders isn’t the market’s direction — it’s the strategies they use.

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Doubling-down will not always pay off

I was talking to an aspiring trader recently. Greg is a leasing broker at a large commercial property firm. He’s good at what he does, but his ambition is to be a stock trader.

Greg was asking me how I trade. You can probably guess what I said. I told him that I spread risk, buy into strength, let profits run, and cut my losses — basically, Quant Trader 101.

This was Greg’s response: ‘Seriously, that’s how you make money?’

You see, Greg tells me he does the exact opposite. He trades big, buys as prices fall, bags a quick profit, and doggedly holds when a stock is in the red.

Greg gave me an example of one of his trades — Ramelius Resources Ltd [ASX:RMS].

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Source: BigCharts

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Greg made his first purchase in mid-August, at 47 cents. His reasoning was the shares were ‘down nicely’ from the recent high. He says this is the best time to trade speculative stocks.

You see, Greg’s a believer in buying the dip. This is a classic bargain-hunting strategy. Many traders successfully use this entry method. The key is to have an exit plan if the shares keep falling.

But Greg doesn’t have such a plan…

He tells me he’ll only sell at a higher price. I asked, ‘What if the shares keep falling?’. He confidently told me that shares always recover — it’s just a matter of waiting.

RMS is down around 20% from Greg’s entry. But he isn’t planning on selling.

In fact, Greg is so confident that prices will rebound that he plans to buy more. He believes doubling-down will get him into the black even faster. The stock’s recent sell-off is of little concern.

Sure, many shares do recover. Holding your nerve often pays off.

But the problem lies with the stocks that don’t bounce back. These are the ones that can ruin your portfolio. Traders who fail to understand this are bound to struggle year after year.

Most traders fail to manage risk

There’s one more aspect to Greg’s strategy that I want to mention — position size.

I told Greg that my strategy involves many relatively small trades. This limits the impact of any single loss. It also increases my odds of buying several of the best performing stocks.

But Greg doesn’t agree…

You see, small trades are a waste of time in his view. Greg believes that in order to win big, you need to bet big. He says that’s the only way you can really make a lot of money.

And do you know what?

He’s not alone — many traders share this view.

One of the biggest problems I see is a gambler’s mindset. People often approach trading like they would a day at the races. Winning big is their overriding priority.

But in chasing the big win, they often lose sight of the risks.

Maybe RMS will recover, maybe it won’t. We’ll only know in hindsight.

But I do know this: Bold traders eventually lose their capital — I’ve seen it happen time and time again. Respecting risk is one of the most important things I can tell you.

Until next week,

Jason McIntosh,
Editor, Quant Trader

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Jason McIntosh is a professional quantitative analyst. Before he graduated in 1991 he joined Bankers Trust — a Wall Street investment bank — to be a trader. After Bankers Trust was taken over in 1999, Jason, already financially independent, co-founded a stock market advisory and funds management business called Fat Prophets. At 37 he sold his part of that business and retired. These days, he’s a private trader and system developer. In 2014 he launched the wildly successful trading service: Quant Trader.


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