Emotion is the Enemy
Stockscores Foundation for the week ending August 21, 2018
In this week's issue:
In This Week’s Issue:
- Stockscores’ Market Minutes Video – Don’t Trust Your Gut
- Stockscores Trader Training – Emotion is the Enemy
- Stock Features of the Week – Stockscores Abnormal Breaks
Stockscores Market Minutes – Don’t Trust Your Gut
“Gut instinct” is driven by our emotions, making it a bad thing to trust when making trading decisions. I discuss this concept, provide my weekly market analysis and the trade of the week on JWN.
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Trader Training – Emotion is the Enemy
Emotion is the enemy of every trader.
Our emotional attachment to money is what causes us to lose our discipline, to take big losses, to not let our strong and profitable trades run higher. It causes us to own too many stocks in one sector or fall in love with a stock that will only hurt us. Letting emotion in to our trading decisions is a fast way to insomnia.
The perception is that the stock market is too risky, many investors don't like the potential for a sharp selloff that can destroy their portfolio in a very short time period. The collapse of the stock market in 2008 has given many a form of post-traumatic stress disorder, leaving them on the sidelines when it has not made sense to do so.
The stock market may be volatile at times but that is not what determines risk. Risk is how you respond to the volatility, how you manage the potential size of your losses. The stock market is not risky, the people that play it are. It is how you deal with price volatility that determines risk.
If you want to sleep well while invested in stocks, you need to have a plan for managing risk. The notion that you can buy some "good" companies and forget about them is outdated and reckless.
Here are my essentials to being invested in the stocks and sleeping well:
Plan to lose. When you buy a stock, know the price level where the stock market will have proven you wrong. Learn how to determine where a stock's support price is and if the stock closes below that level, realize that the market is telling you that something is probably wrong at the company. Get out.
Know your tolerance for risk. How much are you willing to lose on any one stock trade? If you risk more than this amount, you will get emotional. Take the difference between the entry price and the stop loss price and divide that in to your risk tolerance to determine how many shares to buy. If you are buying a stock at $10 with a stop loss point at $9 and you are willing to lose $500 on any one trade then you should buy 500 shares.
Don't obsess. You don't need to watch your stocks constantly, if you are position trading then only look at the once a day or even once a week. You only need to check to see if your stock has given an exit signal, obsessing over every gyration will make you emotional and lead you to make mistakes.
Have a written plan. You must write down your trading rules. When will you buy, when will you sell, how will you manage risk and how will you review your positions. Keep the plan simple but concise enough that there is no room for interpretation.
Stick to your plan. Your plan should be based on strategies that you have tested and believe in. Deviating from the plan means you are going in to areas that have not been tested and that puts you closer to being a gambler. Gambling traders may win in the short term but in the long term they lose.
Remember that trading stocks is as risky as you make it. Not having a plan with rules for limiting the size of your losses leaves you exposed to big losses if the market corrects sharply. With loss limits and discipline, you should never be the victim of a major market correction.
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The Stockscores Abnormal Breaks scan looks for stocks making abnormal gains through resistance. I like to run this scan daily and then inspect the charts for breaks from predictive chart patterns. Here is one stock with a decent set up today:
TOL is breaking its downward trend line today with strong volume, giving a good signal of a long term trend reversal. Position trade with support at $34.50.
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