The most common mistake that I see traders make is that they approach trading as a single transaction. They make one buy and then hope to lock in a gain with a single sale. If the trade doesn't work, then they take their losses and move on. They make little effort to use strategies or tactics to increase their potential for success. They simply hope that their timing is right and it will pay off.
This loss-cutting approach can work, but you can greatly increase your chances for profits if you treat a trade as a living, breathing thing that is evolving as conditions change. Your confidence level should start to build if the price action is favorable and allows you to put more capital to work in a favored stock. When the early buys don't work, your risk is limited, and you can cut back exposure and avoid substantial losses.
The goal of "probing buys" is to gain confidence in a trade as we watch a situation develops. It also allows us to consider other issues such as the overall health of the market and new fundamental development. Conditions are always changing, so it makes sense to constantly change your level of exposure as a trade develops.
Jesse Livermore is considered one of the greatest traders of all time, but he still went broke three times before age 30. He was known on Wall Street as the "Boy Plunger," because he would "plunge in" to a situation and take huge positions. When they worked, he made a fortune. When they didn't work, he was wiped out.
What was particularly frustrating for Livermore was that many of his major losing trades would have eventually worked extremely well if his timing had been just a little different. He built his position too big and too fast and couldn't stay with them when they didn't immediately work.
Eventually, Livermore dealt with this problem of timing by developing a method he called "probing." Rather than jump right in immediately, he would probe the market by making small buys that would help him gain a sense of the price action. If he liked what he saw, he would add to the position and start to pyramid it as it moved in his favor.
He likened this approach to a military officer sending out a reconnaissance patrol to spy on the enemy and gather intelligence. The knowledge gained by this probing would allow him to attack aggressively at the right time.
The probing method has several benefits. First, it helps to keep emotions under control when you start small and keep risk limited. You will find that your view of a stock will often change very fast once you actually own some. I often find that I will avoid a chart that at first glance seems too technically extended, but after I make a small initial buy and then watch the action, my attitude about it will shift as I follow the price action more closely and gain a sense of the stock's personality. Rather than just dismiss it as a missed trade, I am now focused on looking for an opportunity to press as the chart develops.
A second benefit of the probing approach is that it allows for a much higher level of aggressiveness when you trade incremental. Since you can manage risk more closely, it is possible to take bigger conditions as you monitor the situation.
Livermore had two key conditions to his probing buys. First, he made sure to determine the size he ultimately intended to hold, should the stock develop in the manner he liked. He had a plan in advance and didn't just add shares randomly. His initial probing buy would generally be about 20% of the total. The idea here is to have a plan and not be tempted to modify it as your emotions kick in as the price action develops.
This first rule goes hand-in-hand with the second, which is that you only add to the trade if it is acting in a positive matter. You don't try to lower your basis because you hope that the market will eventually appreciate the positive fundamentals of this stock. What you do is add to your position as the price action proves that the market is discovering the merits of the situation. That is what helps you improve your timing. You aren't trying to guess when a stock will move. You are embracing it as it moves and does what it is supposed to do.
Much of the movement in a stock is just random and doesn't have much meaning. You can take advantage of that as you watch the situation and consider it in context with overall market conditions.
One variation that I add to the probing approach is trading part of the position with shorter timeframes. Rather than treat it as one big trade that is established incrementally, I will think of it as several trades with different time periods. This has many of the same benefits as the probing approach but helps to mitigate risk when there are some quick flips as you build a position.
It can be quite easy to let inertia set in as you seek the perfect trade. There will always be negatives and uncertainties, but if you don't put money to work, you won't have a chance to profit. Taking small initial "probing" positions forces you to act and keeps you focused on finding good opportunities. Your insight into a trade will grow quickly once you have a stake and learn its behavior. All it takes is a very small buy to turn theory into practice.