Phil Wallach

My first taste of trading the stock market was both disastrous and sudden.  Obviously the markets are full of all those people my mother tried to warn me about.  Forget about getting a good job, finding a nice girl and wearing clean underwear.  This is what I wish my mother had told me all those years ago, if only I’d been listening.

#1 Preserve Your Capital

Most people start trading with the expectation of making a large fortune in a small period of time.  Good luck to you if you do.  The reality for 80% of traders is the loss of their trading capital.  Don’t join them.

Always keep in mind how much you can lose, not how much you can make.  While you are new to the markets, never put money into the market that you cannot afford to lose.  To do so is to ask for trouble.

Given the above, your primary goal is to hang on to your capital.  And there are plenty of people trying to get their hands on it.

The keys to preserving your capital are:

• Cut your losses and let your profits run.  While this sounds reasonable, most new (and not so new) traders do exactly the opposite.  They take profits quickly before they evaporate (often to watch the stock continue even higher) and they hold onto their losers waiting desperately for them to get back to break-even (at which point they promise to get out) while the price sinks lower and lower.
• Use stop loss orders.  The easiest way to cut those losses is to set automatic stop loss orders that close out your position automatically if a certain price level is breached.  This allows you to limit your downside exposure to a known amount.
• Use risk management.  Risk management is a vast and complex area, but for the beginner the simplest rule is probably the 2% rule.  The rules states that you cannot risk more than 2% of your capital (the risk being given by your stop loss order) on any one trade.

#2 Follow a trading system (but don’t buy a system)

Trading is not a game, nor is it an exercise in seat-of-the-pants intuition, gutsy decisions and plain good luck.  If you believe any of that guff you should just hand over your money now.

Having some sort of trading system is essential for success in the markets.  Without a system you will have no consistent basis for your actions, which means that successes cannot be repeated, and mistakes cannot be corrected.

Your trading system should follow a do-review-modify cycle.

• Your system will help you research and plan your actions, which you must diligently and meticulously execute.
• All your actions must be recorded, so you can review the performance of your system.
• This may lead you to (occasionally) modify your trading system.

The only caveat is do not buy a black-box trading system.  These are normally very expensive computer programs which spit out buy and sell instructions, often for high risk markets (e.g. futures, options, warrants).  They often come with “proof” of exceptional returns and high-pressure sales techniques at “free” seminars.  Avoid these at all costs.  They are simple computer programs that produce their amazing results by optimizing their heuristics over historical data (i.e. curve-fitting).

#3 Don’t listen, learn

“Give a man a fish; you have fed him for today.  Teach a man to fish; and you have fed him for a lifetime”—Author unknown

Don’t listen to the many newspapers, magazines, newsletters, spam emails, and so on that tell you what stocks are hot and what are not.  While such missives often seem to be carefully researched and well reasoned, they are in fact a trap for the unwary (or lazy) trader.  The problem is related to #2 above; if you are not buying as part of a trading system, then you cannot repeat successes and avoid failures.  You are doomed to go about your trading without ever really knowing what you are doing.

On the other hand, I would embrace all the books, magazines, seminars, websites and so on, that do not tell you what to sell and buy, but instead teach you how to trade for yourself.  The only path to being a more successful trader is to become a better trader.  It is better to lose money paying for valuable education, than to lose money in the market because you didn’t know any better.