Great trading and investing consists of just two basic steps: stock selection and trade management. That isn't particularly profound, but that is what it is all about. Nothing else really matters but what is often overlooked by market participants is that trade management is much more important than stock selection.
Picking great stocks makes life much easier, but if you count on that alone to produce superior returns, you will have some problems. No matter how good you might be, you will pick many duds along the way. The best traders expect failure rates as high as 50%, but they can still do well due to superior trade management.
If you are a long-term buy-and-hold investor there is a tremendous cost if you buy what you think is an outstanding stock and then do nothing to manage the situation if you happen to make a mistake
Even if you are a fantastic stock picker it is still necessary to deal with overall market conditions. An excellent stock pick in a lousy market has a low chance of success. I often write about how indices drive some markets, and some are driven by stock picking. If you fail to recognize that fact, you are going to have a hard time if you focus on stock selection rather than trade management.
The business media reinforce the idea that market success is all about stock picking. If you are writing stories and headlines to attract readers, talking about individual stocks rather than strategy and tactics has much broader appeal. A good example this past week was the news coverage of the earnings reports from big-cap technology names like Apple (AAPL) , Facebook (FB) , and Amazon (AMZN) . The stories were all about whether the earnings reports were good or bad. There was little discussion of psychology, 'sell the news' reactions or the potential for rotation. Those are the things that are the most important for traders, but they aren't exciting from a journalistic standpoint.
Trade management is the key to producing excellent results. Good stock selection helps, but George Soros sums up the issue exceptionally well with the following statement:
"It's not whether you're right or wrong, but how much money you make when you're right and how much you lose when you're wrong."
This concept is so essential that I have this quote printed out and taped to a monitor. It reminds me that no matter how hard I may work to find good stock picks, the far more critical issue is how I trade them. I can't just sit there and assume that the stock market is going to eventually appreciate the brilliance of my research. The price action is going to tell me if I'm right or wrong, and when that happens, then I have to be prepared to act.
The point here is a straightforward one - put more emphasis on trade management. Too many traders justify inaction by believing that they are holding a 'good' stock and, therefore, it will eventually produce great results. Maybe it will, but that doesn't relieve you of the responsibility of trading it effectively while you wait. Focus on maximizing gains where you are right and cutting the losses when you are wrong.
Good money management is such a powerful tool that traders should be able to make money even when stock selection is entirely random. They will have great results if they can add value to the process through stock selection.
If you want to be a better trader, focus more on those money management skills and don't rely as much on stock selection.