Are you coming?

Risk is the price of a ticket to the stock market dance.
When you learn how to dance properly, you’ll get a discount.

Seriously, managing risk is nothing more than a discipline rather than being overly clever or smart. This relates to our opening article of the Radar Newsletter May 2020; know you have biases and that you need to be intellectually humble. Thus, we make the choice of managing riskthrough objectivity rather than subjectivity. Plan over mind, rules over ego, system over intellect. Trading is a very serious challenge to mind control.

If we take a step back and understand the reality of what we are doing the article below may slow down your need to pour over numbers and strategies trying to unseat a trading revelation or ‘secret sauce’ that will let you succeed at every market corner. Let me tell you there isn’t one. But really you know that don’t you?

Let’s just pretend for now that we don’t know what stocks are going to do. Of course, you do but let’s just pretend for now.

We can all jump on stocks and ride the trends higher because trends occur with amazing regularity on the stock market, but there are two very important things we must do if we are to then actually make money from those trends.

Firstly, on the odd occasion we get it wrong, knowing full well that of course you don’t ever get it wrong, but for this exercise let’s just say the impossible happens and you do, why not use a risk management strategy that aims at capping any loss, at around say 15%. Yes, there could be slippage and there are wild and dangerous markets and that’s the game we play but it is a sensible target to try and achieve. It certainly will negate the 40%, 50% 60% you might have swirling around in your minds right now or might have experienced in the past! That becomes the maximum target for you to lose – ever. Now that is a comforting thought. I will sleep well at night knowing my strategy is wrapped in care and I will wake up bright and chipper every morning ready for the new market challenge every day brings hopefully without the calamity of a big loss hanging over my head.

If we learn how to cut big losses, we don’t take them. It is that simple.

Secondly, the other aspect of risk is keeping what you’ve already earned. We don’t want to throw our hard-earned profits away. Unfortunately, our ego’s trick us into thinking we should be smart enough to know when to get out (near the top) but alas that simply isn’t true. It’s got more to do with having objective systematic responses to price action than any unique predictive powers.

I do know you all are not it that group and can all get out at the top because of course you all know exactly where the high will be. But again, let’s just assume for this example you don’t. God forbid. Let’s then implement a trading strategy whereby you use a little thing called a trailing stop. It says when price retreats, say 10-15%, from a defined level you exit and lock in your profit. That’s it. You then walk away totally unaffected by subsequent events. You’ve done your job correctly. The big benefit is that you will never ride a stock all the way back down and let your profits evaporate – ever. I know that never happens but we’re just pretending aren’t we. Just as we need to limit losses we need to learn when to lock in our profits – come what may.

Profits are relatively easy to come by

it’s the hanging on to them that’s important.

It’s another choice we make when we trade.

If we learn how to protect profits, we keep them. It’s that simple.

We all try let profits run and cap losses. It’s how we get there that is different.

Trading is a tough game to play especially when you’re reeling from one of the fastest drops is history which may, or may not, not be over yet. However, we don’t know that – we’re just scared (of losing more money) and that’s understandable. But it’s also where the tough get going and those that follow their methods will soon show us why. Buying the fear is a hard ask. But that’s not exactly what you do. I’ll explain shortly but first……

Yes, in many cases our 15% stop loss target was exceeded in the recent drop.  But that’s not the point all markets are different as are the strategies we employ. To take one example as a case against a strategy is not the way to test it or evaluate it. If we are to engage the market successfully and with proper risk management, it is over time that we want to succeed.

Our success in the GFC was solid, easing out into the rise and banking cash at 8%, but our success in 2020 was not such a happy experience. The elevator straps broke, and now cash pays nothing apart from stability and limited risk. I guess that’s a bonus and not to be ignored. Reality. To survive a drop of this speed required Houdini like escape artistry. And congratulations to those that did. But then of course the challenge doesn’t stop there, does it. What’s next – another challenge. In fact, every trading week is a new challenge.

So now with prices lower again the opportunities beckon to recoup. Are you ready to play again? Yes, we’re gun shy, as we were in 2009, but that is a natural state. When the market recovers and is going up then we say, if only, we’d taken those signals when they came, because we know out of despair the stock(s) rise again. That is a good traders well known secret.

Back to buying the fear…. At Stockradar the approach is that we don’t pick a ‘market’ bottom we pick off stocks one by one in a game of cat and mouse with some careening ahead and some failing at the first post. That’s the risk management aspect. It’s the game we play and if we’re in it to win it, we play the best we can which is not without ‘managed’ risk and loss.

There aren’t many stock picks yet from my 166-stock list-only 12! But I’m carefully evaluating and looking for other targets. Over recent weeks I’ve banged on about safety and caution and to avoid reckless buying. (See this week’s Micro view on Consumer Discretionary stocks) That’s important because in this environment fear can quickly take hold again. But you will notice looking through the fear there are always some stocks that appear to have a certain degree of immunity. It’s like paying a game of Where’s Wally!

You don’t just buy the (market) fear you buy it
using careful process driven systematic selection.

We try and gain clarity and perspective from where we sit. We look at price action and volume levels. We evaluate and try to shift the odds into our corner. It’s hard work, mentally challenging and exhausting in this somewhat fragile psychological environment. We can take the easy route and just say I’m not playing now, as many have. I’m not sure that’s the right way to play such a market. It’s a gun-shy approach. You won’t lose any money, yes, but you’ll miss good opportunities and that what this market is about now. You’ll be the one saying – if only! Opportunities. If we play this game, we need to play it right, otherwise don’t dance.

Money as we know is a strange master because it does drive us all to do strange things. So, in the stock market where money is made and lost at lightning fast speed, we can’t let it master us or we fail, we need to master it and take control.

The many nuances of stock market trading are a challenge to us all – constantly – that will never change end every moment and challenge is different. Exhausting, but also exhilarating.