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One of the narratives for investors the past few months has been that US interest rates would be falling into the end of 2024 and beyond. Lower inflation and rate cuts around the world seem to guarantee that the US Fed would cut rates.

However, if the US bond market is to be believed, the rate cuts may not be as profound as was hoped. While there is an 89% chance that we will see a 0.25 point rate cut in November and a 66% chance of another 0.25 rate cut in December, the pace of cuts is not as aggressive as the market had hoped a month ago. We have seen the bond market fall, raising interest rates and hindering the broader market of stocks. The leaders continue to be a handful of the largest companies in the major market indexes.

I have noticed a significant pick up in the trading action over the past two weeks. It is typical at this time of year to see more stock speculation as traders come back from the summer ready for action. There have been a number of stocks each day making very significant gains.

The key for traders is to focus on the very abnormal, liquid stocks that surprise with the strength. Don’t chase the strength higher, buy the breaks of pullbacks as long as the upward trend remains intact.

This Week’s Market Minutes Video – How I Picked a 3000%+ Gainer This Week

On Monday, I highlighted a stock in my weekly Stockscores email that I thought could do well. It ultimately went up more than 3000% in the days that followed. In this week's video, I explain what I liked about this stock, then provide my weekly analysis of the stock, commodity, currency and bond markets. Finally, my trade of the week on DRUG.

Click Here to Watch this week's video

https://youtu.be/15WmUlAqXbU

Commentary – Do You Have a Trading Plan?

Would you build a house without a plan? How about start a business, would you do that without putting a plan down on paper? Most people will recognize the importance of having a plan for these things and yet very few people have a written plan for how they trade the stock market. This fact is just one more reason why most people do not consistently beat the stock market. For most investors, their forays in to the market are a lot like stepping into a Casino.

It is more important than ever to approach investing with a solid trading plan. The markets are more volatile, faster moving and seemingly irrational than ever before. They are not necessarily harder to trade but they do require a well thought out approach that takes advantage of the way the modern market behaves. If you try to apply a traditional approach to the market, you will probably make a visit to the poor house. Your approach to investing has to reflect the market that we have, not the one that we had.

Your trading plan does not have be long or complex, it is actually best to keep it concise and simple. There are a number of key functional areas that the plan should have, including these will help you to do better in the market.

Rules for Entry

What are your requirements for making a trade? Most investors do not clearly define these and instead make investments that make sense to them. The investment might be based on something they read, a recommendation from a friend or a method they read about in a book. The problem with doing what makes sense rarely works, here is why.

Our brains tend to make references to something that has happened in the past when trying to predict the future. What happened in the most recent past tends to sit at the top of our consciousness, influencing our future decisions. The result in investing is we will focus on the characteristics of a past stock market winner and try to find something similar. This usually leads to a misguided correlation.

If you watch a stock move up 100% in 3 months it is likely you will look for another stock that has the same characteristics. If you know that the winning stock was a gold exploration company with operations in Ghana, would you go out and try to find another one with a similar business.

If you are a normal person, there is a good chance that you would, or at least follow the same thought process. The problem is that there is likely no strong correlation between gold exploration companies in Ghana and winning stocks. The one winner that caught your attention was more likely to be rare than it is to be the norm.

It is important to test whatever you use as your rules for entry and measure the expected value for trades that follow those rules. This test must be done over a large sample size so you can accurately determine if the rules yield positive results over time.

Your rules can be simple, you might say that you only want to buy stocks that have a PE Ratio less than the industry average or buy stocks when their 50 day moving average crosses over the 200 day moving average. Rules do not need to be complex but they do need to be tested so you can identify how often they are right and how much they make when they are right versus how much they lose when they are wrong.

The strategies that I have developed tend to have 3 to 7 different rules for entry. I will use different strategies for different market conditions but I don’t tend to apply more than 2 strategies at any one time.

Your trading plan should have a rules check list. It is easy to get caught up in the emotion of making a trade and lose sight of what your rules are. Having the check list will help you adhere to your plan.

Risk Management

Most investors recognize that it is not possible to be right all of the time but few have a plan for what to do when they are wrong. You must first define what it means to be wrong and then come up with a plan to control risk for those inevitable wrong decisions in the market.

Any time I make a trade, I also define that price point where the market will have proven me wrong. I go in to the trade knowing that if the price falls to that trigger point, I will exit the trade and take the small loss.

Doing this allows me to control the amount of capital I have at risk. Good traders know that they go out of business if they run out of capital so controlling the size of your losses is crucial for success.

Rather than buy the number of shares that you can afford, your position size should be based on how much you can afford to lose. If you are buying a stock at $10 and plan to take a loss if the stock falls to $9, the risk per share is $1. If you are willing to lose $500 on any one trade then, in this case, you would buy 500 shares.

When judging your success, don’t look solely at how much you make or lose on each trade but instead, look at how much you make relative to the risk you took. Making $3000 when you risked $500 is a good trade because you made six times your risk. Making $500 by risking $1000 is not a great trade because it requires a much higher success rate.

The Risk Management portion of your trading plan should define how you will know when to exit a trade at a loss and what your risk tolerance is in dollar terms. It is also a good idea to define your loss limits before you take a mandatory break from trading.

Rules for Exit

Just as you need well tested rules for entry in to a trade you should also have well tested rules for exiting. Obviously, our aim is to maximize profits and minimize losses but you should not approach this aim one trade at a time. Instead, you should come up with a set of exit rules that maximizes your gains over a large number of trades.

Suppose you have a strategy that tends to be profitable 70% of the time. Testing of your strategy finds that three out of 10 times you lose $500, 6 out of 10 times you make $1000 and 1 out of 10 you make $10,000. What if I give you two choices for an exit strategy? First, sell all winners once they have $1000 profit. Second, only sell a winner if it achieves a $10,000 profit but sell any stock that shows a $1000 profit and then falls back to break even.

The first rule will make you $1000 7 out of 10 times and lose $500 three out of 10 times for a total profit of $5500 every 10 trades. The second rule will make you $10,000 one out of 10 times, breakeven 6 out of 10 times and lose $500 three out of 10 times but make a total profit of $8500 every 10 trades. This second exit strategy makes you more money even though it is only profitable 10% of the time.

The lesson here is that the focus is not on success rate but on profit maximization. Use the rules that make you the most money and not the ones that are right more than they are wrong.

Process

Trading requires discipline so it is a good idea to include in your trading plan the process you will go through to research, identify and carry out your trades. Making a detailed, step by step process will make it easier to follow your plan and improve your likelihood of success.

Schedule when you intend to look for trading opportunities and the steps you will take to find trades. Also define how you will follow your open trades and what tools you will use. Be very specific but keep it simple. You are more likely to follow your plan if it is easy to do so.

Emotional Control

Normal people are pre-disposed to fail in the stock market because normal people have an emotional attachment to money. This emotional attachment causes us to break our rules even if our testing has shown that they are effective. Most traders have a very hard time following their rules.

Having a fear of losing money is the biggest reason why investors break their trading discipline. Therefore, it is important to include in your plan a way to stay on track and be disciplined. It is helpful to have leverage over your emotions, perhaps have your spouse or friend check your trades on a regular basis to make sure you are following your rules.

Most importantly, don’t take more risk than you are comfortable with. If you are not scared of losing the amount you risk on a trade then you are more likely to follow the rules.

In the emotional control section of your trading plan, make a list of the things you will do to control your emotions. Think about what gets your emotions involved in your trade and the come up with ways to overcome those obstacles.

This week, I ran a Market Scan for stocks with a Sentiment Stockscore of at least 60, an abnormal day up, abnormal volume and at least 1000 trades. Here are two that I like.

1. WWR
WWR came alive today with abnormal buying, breaking it out of a trading range. Position trade with support at 0.49.

2. GRRR
GRRR broke out of a pennant pattern today with increased volume, position trade with support at $3.90.

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References

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Disclaimer
This is not an investment advisory, and should not be used to make investment decisions. Information in Stockscores Foundation is often opinionated and should be considered for information purposes only. No stock exchange anywhere has approved or disapproved of the information contained herein. There is no express or implied solicitation to buy or sell securities. The writers and editors of this newsletter may have positions in the stocks discussed above and may trade in the stocks mentioned. Don't consider buying or selling any stock without conducting your own due diligence.

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Do You Have a Trading Plan? - Stockscores Perspectives for Oct 21 2024