One of my most important New Year's resolutions is to finish a book I have been working on for a while. It is tentatively titled "Trade Secrets: How You Can Master the Market." The focus of the book is to provide a framework for understanding how the market operates and to help investors and traders develop a unique approach that allows them to produce optimal results.
There is quite a bit of material in the book but I want to distill seven key ideas that will greatly improve your trading results if you understand them, internalize them, and work at making them part of your trading and investing.
I will greatly expand on all these concepts in my book but here are the seven key ones:
1. Predictions and Forecasts Are a Waste of Time
In the many years I've traded, I've heard an uncountable number of predictions and forecasts. The vast majority have been wrong or so poorly timed as to be useless. Wall Street loves predictions and forecasts because that is basically what they sell. They convince customers that they can predict the future better than you can and therefore you should pay them for their guesses about the future.
The market situation in 2020 was one of the best examples ever of the futility of forecasting. No one anticipated what happened: a major pandemic, the worst economy in a century, a crazy political situation, and the stock market flying higher despite the news.
Predictions and forecasts are interesting and can help us prepare for volatility ahead, but it is the reaction to changing events that is the most important. Moving to the sidelines as a downtrend emerges will protect you better than any prediction or forecast. It is reacting decisively that works far better than predictions and forecasts.
Don't focus on anticipation and predictions. Focus on vigilance and reaction.
2. Compound Your Profits by Keeping Your Accounts as Close to Highs as Possible
Nothing is more counterproductive than making up losses. If you lose half of your money, you must double it to just return to even. If you are zealous at keeping your accounts near highs, you will outperform over the longer term.
Long-term buy-and-hold investing is often promoted because it allows you to compound your money and that it is what makes investors such as Warren Buffett so successful. However, you can also compound results when you keep your accounts at highs and continue to produce returns. It is not necessary to hold a single stock and hope that it is "the one" that will make you rich. You can engage in aggressive trading as you look for the best stocks and still benefit from the power of compounding by keeping your accounts near their highs.
Compounding fails to work when you suffer big drawdowns and losses. This happens to both long-term investors and short-term traders that fail to protect their gains. The key is to address it and not just sit there. If you err on the side of not suffering large losses, you will produce substantially better returns as you compound your capital.
Charts are often dismissed as voodoo by the same people confident in their ability to predict macroeconomic events.
3. Profits Occur Sporadically
The market is, and always will be, cyclical. It goes through ups and downs of various magnitudes on an irregular basis. Newer traders likely have a very unrealistic view of the bigger market picture. The style of trading that is working right now will not last forever and if you do not appreciate that fact, then your career in trading will be short-lived.
Traders should be mindful of the 80/20 rule. Most traders will typically produce 80% of their profits in 20% of the time. The other 80% of the time they make little progress. New traders that have immediate success will have a tough time dealing with this fact as the market shifts. Many have been spoiled recently by a fantastic market and they will give back much of their profits and eventually give up in defeat because they are not prepared for the inevitable shifts the market will undergo.
The problem with the 80/20 rule is that we never know when that period of peak productivity will occur. We must be constantly vigilant and ready to spring into action when favorable conditions occur. When they do occur, we have to ramp up our aggressiveness and profit while we can.
One trait effective traders share is the ability to be patient and do little for long periods, and then move suddenly and decisively when the time is right. Shifting from a patient state of mind to a more active one is not easy and becoming more cautious when conditions change is the key to holding onto gains.
4. Use Charts
Charts are often dismissed as voodoo by the same people who are confident of their ability to predict macroeconomic events, but they miss the main point. Charts are useful because they provide a framework for discipline. There are millions of ways to use charts, but at the heart of every method is cutting losses and letting profits run.
Don't think of charts as a way to predict the future. Think of charts as a way to manage your existing trades. The charts will help you when to buy and when to sell, but they won't tell you what is going to happen in the future. Charts are the best tool you have for developing the discipline you need to be a successful trader over the long haul.
5. No Trading Approach Is Inherently Superior
The best approach to the market is highly subjective. Some people do very well with trend-following and momentum. Others do equally well with value plays and fundamentals. What works best will depend on how you view the market and the methodology you use to protect capital and find new stocks to buy.
Work on developing a style that makes sense to you. If it doesn't work as well as you'd like, keep modifying it. The market is constantly changing, which means what works best will shift all the time. Just make sure you keep in mind the discussion about how profits tend to occur sporadically.
6. Trade Incrementally and in Multiple Time Frames
Most people think of the trading and investing process as being a single buy and then an eventual sale. They decide that this is a good stock, buy it, and then sit there and hope that it works out well. There is no strategy involved in this sort of market approach. You lose your power to control the situation when you trade in this manner.
The better approach is to move incrementally. Take an initial position and watch the action. Perhaps your opinion of the stock was wrong, or the market shifts. You can then quickly escape the situation with little loss. However, if the stock continues to develop well, then you can build the trade and become more aggressive.
As a good trade develops, you can focus on navigating it in a variety of time frames. Maybe keep a core position for weeks, months, or years while trading a portion as the inevitable ups and downs occur. Some of the best long-term buys also provide for great day trading. If you have a good stock pick, then why not trade it in multiples.
This strategic approach to trading and investing is key, and I spend a great amount of time expanding on this topic.
7. Trading Is Hard, Which Is Why It Can Make You Rich
If you read social media, it is easy to develop the impression that thousands of people make a huge amount of money with a steady diet of great stock picks.
The reality is that trading is tough and that even the best traders have substantial losses along the way. The very best traders are those that embrace the inevitable of poor trades and make them part of their process. No matter how good you are at trading, you will have losing streaks and be hit by tremendous bad luck at times. It is the nature of the beast.
However, it is because trading is so hard that it has the potential to reward you so greatly. It is trite to say, but it is true, "nothing good comes easy." It may feel easy at times, but long-term market success is a daily slog that requires hard work and will often be disappointing. Rather than be discouraged, take heart because if it was easy, you couldn't get rich doing it.
I wish you the best in 2021.