Wall Street Craps – 2012 Global Ebook Finance Award-Winner

KNOW THE PROPER TIME FOR ENTERTAINMENT: Don’t trade the stock market for the sake of fulfilling your entertainment needs. Your goal in trading is to make fast money and then get out. The time to entertain yourself with the stock market is when you’re on the sidelines anticipating your next big move.

If it’s the thrill of “action” that you crave, then you would be better off taking a gambling trip to Las Vegas or Atlantic City. At least you can get free drinks for playing recklessly with wild betting schemes, when you’re at these places of entertainment. It’s much more appropriate to think of the stock market as a place for making serious money with disciplined thinking, rather than a place for receiving instant gratification with just plain luck.

Comment: Trading the stock market is very much akin to playing chess. Over the long haul of a person’s investing life, the outcome will ultimately be determined by consistent smart moves in terms of market tactics and money management. All of a person’s side issues regarding such things as the need to be right, the need for action, the need to feel special, etc. will only serve to undermine your trading and investing success. When it comes to playing the market for serious money, know that when you are holding trading positions, it’s all business and not necessarily for pleasure.

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“A successful trader is rational, analytical, able to control emotions, practical, and profit oriented.”

Monroe Trout ~ Trader and hedge fund manager

“TO SELL OR NOT TO SELL? THAT IS THE QUESTION!”: When you follow the price of stocks that you own, it is tempting to calculate how much money you have gained or lost up to that point. But this calculation is only relative to the stock price at which you bought your stocks.

Since buying and selling are essentially independent decisions to make, the captured buying price of a stock should not be a factor at all in determining when to sell it. By keeping the purchase price of a stock fixed in your mind, it will only serve to cloud your thinking and result in making an unwise trading decision to sell or not to sell.

This means that you will likely do two things when you regularly calculate your paper profits:

1. sell too early in an upward moving market and thereby miss out on potential profits, or
2. sell too late in a downward trending market and end up taking unnecessary large losses.

In both of these cases, the unwise decision to sell or not to sell is based on the investor’s fear. And that fear is the amateur’s avoidance of any emotional pain associated to taking a financial loss and, more importantly, admitting that he or she was wrong.

If you are not willing to take a loss and admit that you can be wrong, then you have no business trading or investing in today’s volatile stock market.

Comment: This doesn’t mean that you can’t play the stock market. It just means that trading the market over the shorter-term based on extremes in the underlying indicators is not suited for your temperament. What you can do is play the longer term in your “growth funds” and “security assets” portions of your portfolio in more value and income-oriented buy candidates.

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“If you can’t take a small loss, sooner or later you will take the mother of all losses.”

Jack D. Schwager ~ Author of The New Market Wizards (1992)

DON’T COUNT YOUR CHIPS WHILE YOU’RE PLAYING: Don’t count your gains and losses while you have positions in the stock market. This natural tendency will most likely cause you to trade based on the prices of your stocks instead of the underlying market indicators.

In order to reap large gains in the stock market, you must be able to hold a portion of your winning position longer than you’re emotionally inclined. And conversely, in order to avoid large losses in the stock market, you must be able to sell out of losing positions quicker than you normally would like. In both cases, it’s usually the practice of watching the price of the stocks they own that causes investors to sell at the less desirable time.

Comment: Always remember the masses exclusively follow price while the savvy players pay more attention to volume and breadth when it comes to the technicals. And in terms of sentiment, the masses love plenty of company to reassure them of what to do while the savvy players do the opposite of what the masses do at key turning points or extremes in the market.

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“Avoid ‘jogging in place’ with your portfolio. Failure to decide is, in effect, a decision. If you would not care to buy each holding in your portfolio each day, you should sell it (barring tax considerations).”

Bennett W. Goodspeed ~ Author of The Tao Jones Averages (1983)

DON’T PARTY WHEN YOU PLAY: The market doesn’t care if you’re on vacation or goofing off somewhere. You must either get out of your positions before you leave or else monitor stock market action after the close of every day while you’re away at play. And if the latter is the case, you must also have the presence of mind to take clear decisive action when necessary.

Not everyone has the experience or discipline to play the market correctly while their mind is somewhere else. Therefore, cashing out or lightning up your positions before you take a real or mental vacation might be the smart way to handle this situation. Otherwise, your play time may end up costing you more than you ever imagined beforehand.

Comment: I know this first-hand from the days before the Internet and when I used to take cruise vacations every October. Back then I couldn’t make trading decisions while I was away on a cruiseship. And the stock market had a not-so-funny habit of always crashing with me aboard every October.

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“If a speculator is correct half of the time, he is hitting a good average. Even being right three or four times out of 10 should yield a person a fortune if he has the sense to cut his losses quickly on the ventures where he has been wrong.”

Bernard Baruch ~ Legendary investor (1870-1965)

FOCUS WHILE YOU ARE PLAYING: When you hold positions in the stock market, refrain from as many distractions as you possibly can. Make it a daily practice while you’re in the market to know how the major indexes and underlying indicators performed at the end of each trading day. You never know when the stock market will give you an unexpected gift in the form of a spectacular one-day gain.

That’s why it is so important to pay attention to the market every single day when you’re holding stock positions. It could turn out that your window of opportunity to sell at a great price will be quite small when unexpected news-driven market events occur. As seasoned market players can attest, it’s not uncommon for a big up day caused by investor euphoria to be followed immediately by a sobering big down day. (Note: Never forget a Wall Street adage that reads: “Take windfall profits when you have them.” Sometimes the smartest move you can make is to simply “take the money and run.”

Comment: Always remember that the stock market doesn’t know when you bought your stocks. That means that you should be ready to sell at any time. Pay attention to the stock market whenever you hold positions in your “play money” trading account. Otherwise, you may find yourself selling on the market’s term instead of yours.

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“If there is a well-defined movement on at the close, it is more than an even bet that the next day’s market is to be a speedy one, for the closing movement usually carries on in greater strength and for a longer duration than the movements which develop and pass out again during the course of the usual day’s trading.”

Richard W. Schabacker ~ Author of Stock Market Profits (1934)

CATCH A HOT STREAK & RIDE IT: A stock market rally is more about longevity than it is about price. When it comes time to sell, accept whatever price the market gives you. Discipline yourself to sell out before the rally runs out of time.

Most amateur players only concern themselves with the price of the stocks they own. But when you buy investment vehicles like broad-based Exchange-Traded Funds, you’ll know that when the market is up, your stock value will be up and, conversely, when the market is down, your stock value will be down.

If the market gets on a hot roll, be content to take your profits on the way up no matter what the actual quoted price is. An obsession with meeting predetermined price objectives for individual stocks is what keeps many amateur players from selling when the time is right. A major key to trading success is the ability to maintain the mental discipline to buy and sell according to time rather than price.

Comment: When time becomes your determining factor in buying and selling, it is normal to occasionally be a day early and/or a day late. But you will be more likely to participate in a major move rather than be left behind by trying to wait for the perfect price to come in for you.

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“If you are in the right thing at the wrong time, you may be right but have a long wait; at least you are better off than coming late to the party. You don’t want to be on the dance floor when the music stops.”

Adam Smith ~ Author of The Money Game (1967)

FINE-TUNE YOUR BETTING STRATEGY: After you have gained valuable experience in trading, you can adjust your betting strategy to suit your own individual preferences.

For example: In my own trading account, I find it easier to buy three times over a three to five day period. This means that I don’t necessarily buy every day during the period of time that I identify as a bottom area. I will also make my first bet only one unit. I do this in order to eliminate the tendency to miss moves by wanting to time the market perfectly. Then I’ll make my second and third bets equal to two units, bringing my total for any one position to five betting units.

This strategy works for me because I’ve found that the hardest bet to make is always the first one. This 1-2-2 betting strategy also makes it easier to sell effectively if I choose to leave this particular market position in the same gradual progression. (Note: The 1-2-2 progression appeals to our basic antsy, fear-based behavior when it comes to trading the stock market. On the buying side, we are often afraid of missing out on an opportunity but scared of being too early. On the selling side, we can be fearful of losing a profit and having it turn into a loss. But at the same time, we are afraid of selling too early and losing out on the potential for further profits.)

Comment: If all of this seems a little confusing, then simply make of your bets small ones. I call these the “$5 Bets.” This is the smallest denomination of a betting unit and is one that any player with a $100 bankroll can feel comfortable about playing. Remember that the key to playing freely lies in not being afraid to lose – hence the $5 bet.

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“To obtain better than average investment results over a long pull requires a policy of selection or operation possessing a twofold merit: (1) It must meet objective or rational tests of underlying soundness; and (2) it must be different from the policy followed by most investors or speculators.”

Benjamin Graham ~ Economist & Professional Investor (1894-1976)

MANAGE YOUR CHIPS WISELY: Spread your money evenly over a targeted three to five day buying period. Always keep plenty of your money in reserve so you can maintain peace of mind and clear thinking. Only losers bet their last dollar.

Remember that the market has the ability to do anything at any given moment. The proper way to invest in the stock market is to respect its power and play the percentages wisely. By spreading your money gradually over a specific period of time, you are taking calculated risks. At the same time, you’re respecting the possibility that market conditions could change. Making even-sized bets will also help you sell less emotionally; you won’t be favoring your big bets over your small bets.

As a helpful reminder, your objective is not to be “perfect” in your decisions. Your objective is to play a smart game in terms of prudent risk/reward trading opportunities and wise money management. (Note: Sometimes rapid overnight developments in a news-driven stock market environment like the European debt crisis of 2011 will reduce your normal three to five day window of opportunity down to only two or three trading days.)

Comment: Resist the urge to go “all in” like in a game of poker. The gradual accumulation method will keep yourself in check just in case your market analysis proves to be wrong. My experience also shows that it’s okay to be a day early from a long-term perspective. A day early only is a problem when that bet is too large.

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“In order to make a success trading in the stock market, the trader must have definite rules and follow them – Divide your capital into 10 equal parts and never risk more than one-tenth of your capital on any one trade.”

William D. Gann ~ Author of Truth of the Stock Tape (1923)

CHECK FOR SWEATY PALMS: The best entry points in the stock market are often the times when it feels the scariest. This is because the media has an uncanny way of causing negative investor sentiment with a barrage of relentless bad news at stock market bottoms. Recognize that key turning points in the market are usually counterintuitive.

The hardest, yet best time to buy is often when everyone else is selling and no one else is buying. Conversely, the most comfortable, yet worst, time to buy is usually when no one is selling and everyone else is buying. If your palms aren’t sweaty and you’re not afraid to buy, you’re probably not at a good stock-market bottom. Always remember that having sweaty palms caused by media-induced fear is one of the key prerequisites to buying into the stock market at an optimal time.

Comment: Find several ways to monitor fear, worry, and apathy in the stock market. Notice the outspoken people who are notoriously wrong at key turning points in the market. While I like to notice whether I have sweaty palms or not, I also notice when the clamor of worry or the confidence of short-sellers becomes excessively loud in volume or number.

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“Nobody rings a bell at the market bottom.”

Wall Street Adage

DON’T GET ANTSY & JUMP IN: Don’t let low rates of return on cash equivalents be your sole reason for buying. The market will reward your patience and discipline with solid double-digit returns.

Many investors assume that their money must be “at work” all of the time. But there may be times when the best values for your liquid assets are not to be found in the equity or fixed income markets. Instead, the best use of your money at these unique moments may be in paying off debt, buying items of value for personal use, increasing your insurance needs, or simply protecting it from risk.

There’s something good to remind yourself about when low returns on cash equivalents cause you to start feeling antsy to trade: it’s much better to earn a positive risk-free rate of 1%, than it is to suffer through a negative 25% return in a downward trending stock market.

Comment: It’s perfectly okay to sit in a cash position for extended periods of time even when it is yielding less than 1%. Don’t let salespeople talk you into going after higher yields when it comes to your short-term and intermediate-term money. The extra yield over a year or two is less significant than keeping your powder dry for a market that is setting up for an eventual big move in either stocks or bonds.

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“Bet big when the odds are in your favor, bet small when you’re less convinced, and don’t bet at all if you’re not sure.”

Jim Cramer ~ Host of CNBC’s Mad Money