Managing the Trade Process

The last five weeks has been a mental challenge for both investors and traders alike. Why? Simply put, anytime the market becomes volatile and the trend shifts from positive to negative short term emotions are stirred. Emotions are the greatest enemy to investing and doubly so for trading. I now separate the terms trading and investing as the two have evolved into their own distinct role. Traders look short term with a time horizon of 1-52 weeks. Investors look further down the road with time horizons of of 12 -36 months. Both have their respective pluses and minuses, but both require habits developed through a defined strategy implemented and practiced over and over. Without a¬†defined approach emotions become an even bigger enemy to your portfolio, your strategy and your results.¬†I thought now would be a good time to discuss the process of managing your money with a well defined trading/investing process. Why? We bounced the last four days after a 10% peak to trough move on the downside and what you did as a reaction¬†is fresh in your mind. In fact, what you didn’t do is still fresh in your mind. Therefore, now is a good time to reflect, learn, revamp and prepare yourself for the next emotional attack on your money by you as a direct result of the markets moving against your beliefs.

The process of trading is never going to be easy… we can make it simple, but as long as there is the potential for loss it will never be easy. There are times when everything goes your way and¬†it seems easy, but therein lies the trap of the markets for investor… They confuse an up market cycle with brilliance. After thirty plus years of investing and trading money personally and professionally, I have learned one vital thing… respect the markets every day and never assume anything.

We will use a brief outline of managing the trading process. This has nothing to do with the research using fundamental, technical or quantitative strategies, this is only the process of managing your positions/trades. Why this part only? In teaching, mentoring and working with clients to manage their money it is this one vital part of the process that trips virtually everyone up. I have broken it down to the following three parts for discussion:

  1. Manage your Entries. This begins with the process of defining very clearly at what point or price you would like to own a specific asset. We must define if very clearly. For example, I want to own 1000 shares of Facebook at $24.50 per share. My research has determined that is the price I want to own the stock based on the defined strategy. The strategy will incorporate my risk tolerance, time horizon for the holding, the amount of capital I want to commit and the ‘why’ factor for ownership. What I am talking about here is the process for managing the entry or the actual purchase of the position. We can spend hours and days researching for the right stock and then never own the stock because we fail to commit to how we want to buy the stock. Define the entry process in term of price first and foremost. Then define if you want to ladder into the position or¬†buy it all at once at a predefined level? Know what price you want and define your strategy for buying the position. One key point in the entry process… Never chase the stock higher just so you can own the position. If it gaps away from you let it go… stocks are like a bus, if you miss one another one will be by in 15 minutes. If you do your homework getting into the stock should be the easiest part of the process.
  2. Manage the Exit. There are two steps potentially involved in this process. One, stop losses on positions in the event you were wrong about what you believed to be true. I know this is a very slim possibility, but you have to plan for the event just in case. Two, what do you do with the stock when you hit your target for the position? Sell, take some profit on half and let the rest run, or keep it all and manage your stop? There is no right answer, the only right answer is what you determine to do at that point of accomplishment. Having a plan in advance is always advised as greed, fear, hope or some other emotion will take over if you don’t have a predetermined exit strategy. The easy part of this process is setting your stop in the event that something goes wrong. The harder process comes when you have achieved the objective laid out when you purchased the stock. The process of sticking to your strategy has to deal with the emotions attached to money… selling parts means I may not make as much. Having a wider stop would mean giving up profit if the stock reverses direction. You get the point, emotions are an animal that when left untrained will eventually attack you when you least expect it. Define your exits and develop habits for handling the process of success.
  3. Manage the In-between this is where the emotions rule. The point between the purchase and the exit is where the news, events, fundamentals, technicals and time weigh on the investor psyche. As the old saying goes, we become more nervous than a long tail cat in a room full of rocking chairs. We start out with our conviction about the stock and then comes a news story or event that rocks the market and/or sector the stock resides in and down it moves. Unless we are prepared with a strategy (exit/stop) we will drive ourselves insane watching how it turns out and deciding if we should sell it, keep it, or buy some more. Maybe we will even buy some puts against the position or some other idea to ease the pain of ownership. Managing the in-between process is a matter of strategy, habit and focus, nothing else matters. You cannot control what others may say, do or believe. You can control what you believe and how you will act if the price breaks below a specific level. Develop good trading/investing habits, position size such that you can deal with the position logically versus emotionally. Understand that you will never be right 100% of the time. Manage the process with good habits that get you to where you want to be and accept there will be times when things do not go according to play. That is when you cut your losses and move on to the next opportunity.

The process of managing your money is not going to be easy, but the more you develop strong habits of how to manage the process of how you get into a position, get out a position and the emotions in-between you will be successful at this game of money management. When you learned to play Monopoly you first had to learn the rules, then over time you developed strategies for winning the game, and in the end it was good habits in playing the game that allowed you to win. Portfolio management is not different… learn the rules to play by, develop strategies that fit your personality and objectives, and develop strong habits to stick to what works for you. Then the next time the market corrects 10% over five weeks you will have a strategy for how to EXIT your positions, ENTER new positions and MANAGE your in-between.

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