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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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Strategies for Making Money Even If You Guess Wrong. If you wish to increase your investment, do itStrategies for Making Money Even If You Guess Wrong A nimble sixpence is better than a slow shilling.Old English Proverb Tools, knowledge of market procedure, and economics will help you increase your percentage of right guesses. But, whether you make money at all, or, more importantly, dont lose much when you guess wrong, depends purely on the tactics you use. Practically every tool and piece of knowledge you acquire about the market will give cues of when to buy or sell, or short (i.e., take a position), but only a few give you cues of when to sell or cover your short (i.e., get out of your position). That depends entirely on the tactics you use; and profits are only paper profits until you close the transaction. This method (which works in both bear and bull swings) is notoriously simple, as most great truths are. Even if technical tools or fundamentals fail you, your tactics can save you. And, in conjunction with other things, your tactics can make you tremendous profits. At worst, proper tactics can preserve your capital. PROFIT FORMULA GIVEN To illustrate, assume were in a bear market. You decide its time to sell short. You need a stock that is moving with the trend (in this case a downtrend). You study the volume leader list published daily. You select a stock that is moving down on heavy volume. You look at its chart. If its in a suitable downtrend and has some weak fundamentals (lower earnings), and its short interest is not extra large (versus its usual short interest and versus its floating supply of stock), then you place an order to short sell it at a price where it would be rising slightly to touch its downtrend line (unless it happens to be touching it on the day you look at its chart, in which case a market order to sell short would be appropriate). WATCH THE CHART If you are not a chart reader and do not have the time or desire to become one, you can probably use this method with the help of a friend or broker who has a knowledge of charts. But, for the purpose of this approach, only the simplest of chart techniques is necessary. I suggest you make your own chart on the stock in which you take a position. A single chart will take only 60 seconds a day to keep up. One caution. Before you sell it short, be sure the stock chart does not show a reversal pattern, such as an inverse head and shoulders, or a falling wedge, or a double bottom. Ideally, one tries and hopes to find a chart pattern showing a bear pattern, like a rising wedge, head and shoulders top, double top or the like, from which a downside break has taken place on volume. If you dont yet know what these patterns are, ask someone who does. Or read the books on charting recommended in the Resources chapter of this book. THE ALL-IMPORTANT TREND LINE Well assume you took a position and are now short. At this point, you should place a stop-loss order the same day. Day traders use day orders (to expire at the close of the same market day). But most use GTC (good till canceled) or good till the end of the week or month. You may want to place the order about one or two points above the downtrend line so that when the stock breaks its downtrend you want out of your short at once, not caring if its a so-called false break or a genuine reversal. If you do that, make it a stop-close-only order, so you dont get stopped out on a fluke intra-day spurt. Basis the close is safer. CHANGE STOP One key to the success of the plan is to change the stop-loss order as needed, based on the new level of the trend line, which is never the same two days in a row in any stock with a steep trend line, and based on the stock price change. Hopefully the price drops, if so youll place your stop-loss order a bit lower than the prior level. Keep repeating this process as necessary, whether for days, weeks, months, or years. If the price stands still but the trend line angle makes the last stop look too high or low, change the stop. Thus, you seal in your profit. It never gets away from you. A loss never takes place unless it occurs in the first few days after you take a position, in which case you are out quickly and with a minimum loss, so you can try another. You cant be right in stock selection more than perhaps 6, 7, or maybe 8 times in 10. Even if you are right only 4 or 5 times, but on those occasions let your profits mount, you should still come out ahead. NO METHOD PERFECT There will be cases where your stock hits its stop-loss order and then reverses. That cant be helped. You bought insurance against bigger losses with your stop and you must be content with that knowledge. If you start your action under this formula very late in a movement, youll find you get stopped out rather soon in most of your picks. This cant be helped either. But, when you see it happening, step out awhile to see if the trend is not indeed slowly changing, in which case youll now want to begin using the same method on the long side, buying stocks instead of shorting. ONE STOCK ONLY The best way to begin using this method is to use it for a single stock at a time. Its extremely difficult for most people to watch two or three positions at the same time successfully. Unless youre one of those rare people who can literally do two things at once, stay away from two or more positions when you first follow this formula. One stock gives you the advantage of total concentration. If you wish to increase your investment, do it in the same stock, adding to your holding, but only as it moves favorably for you. ODD LOTS VERSUS ROUND LOTS To maximize profits, try to deal only in round lots (100 shares) even though it may mean you have to deal in cheaper stocks. The fraction of a point lost in buying and reselling an odd lot (under 100 shares) forces you to be that bit more right and cuts into your profit or makes the loss larger. DONT TRY TO OUTGUESS THE MARKET Under this approach, you never try to anticipate what the market or your stock is going to do next. You act as though you didnt care. You just keep moving that stop each day or so, and nothing else interests you. You need not decide to sell out or cover. You just allow yourself to be stopped out. The only partial exception to this is, as mentioned before, when your studies show a reversal is taking place in the market averages. Then, you may wish to bring your stop orders (up or down) very close, so that the slightest move of your stock against you takes you out. MORE ON STOCK SELECTION When you are using this formula, there are a few extra hints that may help in taking your initial position. Avoid taking a position if you are in grave doubt about the market as a whole. Wait until you feel a trend is under way. This doesnt mean a trend is established so thoroughly that everyone can see it or so old that reversal is in the air. But it should be a confirmed trend, as qualified by lower lows and lower highs in the DJIA (for short positions), or higher highs and higher lows (for long positions). Usually avoid cheap stocks (stocks selling under $5). Favor stocks in new high ground for the year if going long, or new low ground if going short. Favor stocks with relatively few shares only if the short interest in the stock is not unfavorable to your position. Favor stocks with a big short interest as compared to total shares out if buying long, or a small short interest if selling short. STOCK SHORT INTEREST RATIO A long-time favorite indicator of mine is the individual stock short interest ratio. Here, you take the stocks total number of shares outstanding and subtract all the shares you know to be held by funds and institutions (this information is available in Barrons, Standard & Poors, etc.). Then, divide the latest short interest figure in that stock (multiplied by 100) by the remaining shares outstanding. For example, lets say you wish to calculate the ratio for ZIP Corp. It has 1,000,000 shares out. Institutions and funds hold 500,000. Maybe you learn also (from its S&P sheet) that the president and officers own 250,000 shares. This leaves 250,000 rather freely floating so far as you can see. You look up the short interest in Barrons or the Wall Street Journal or elsewhere. It shows 60,000 shares short. You divide 6,000,000 (60,000 multiplied by 100) by 250,000. The answer shows a ratio of 24%, very high indeed and a good stock to buy long perhaps, but not one to short. The relationship between shorts and shares out is too high for a short, since the number of shorts to longs constitutes a quarter of the stock out. A short squeeze is highly probable in such a case. If the ratio were as low as, say, 7%, you could consider the short interest as negligible, and freely short the stock in question. Although there is no guarantee of success simply because of its ratio, at least you are assured of avoiding a trap, and you take a position with the stock, not against it. A DOUBLE-CHECK An extra measure of safety can be added if you compare the weekly volume of trading for your stock (information available in Barrons or weekend newspapers) with the stocks short interest. As a loose rule of thumb, if the stock is trading less shares in a week than its short interest, the gearing is powerfully bullish. Conversely, if the trading volume is, for example, 50,000 for the weeks total and the short interest in the stock is only 9,000, then its bearish. There is no technical support in the stock from its short interest in this example, and its a suitable candidate for shorting consideration. This double-check may, in a pinch, be used instead of the previously discussed short interest ratio, if you have difficulty getting the data. CONSIDER THE INDUSTRY This is also of importance and can add much to the strength of your position. By picking a stock that is part of an upward (or downward if you are shorting) moving group, you get the odds working for you to a considerably higher degree. Industries take turns at being in or out of fashion, usually based on earnings or prospects of earnings. But some stocks are difficult to place in an industry group. Others are in two groups at once. Those who think industry groups are the most important selection factor often end up in the right group but pick the wrong stock. Thus, I feel that industry consciousness is only helpful if you select your stock by chart analysis. LONG OR SHORT I wish to emphasize again that this technique is equally applicable to buying stocks or selling them short. Some variations of this method are occasionally seen on the long side, but one rarely sees it done on the short side in bear markets. Yet you can see that the principle is the same for either type of market. ATTITUDE IS VITAL I would remind you again that your attitude is critical in making money, and, with this or any method, attitude will determine your degree of success. To make profits consistently, you must be more interested in making money and cutting losses short than in being right. Newcomers may find this strange and many old-timers would be reluctant to admit it, but many people in the market subconsciously feel its more important to be right than to make money. They think both are important. But pride is such an important factor that they refuse to admit mistakes (thus hanging on to falling stocks) and wait too long for the market to move around to prove their feeling about it was right. To make money, you must have no pride of opinion. You must care only about making profits and not hesitate for one second to admit you made a mistake, and reverse your direction from forward to back or back to forward. By the way, its easier to admit mistakes to yourself if you dont tell friends or family about your positionsas you hate to lose face in their eyes. So keep quiet! SUMMARYSTICK TO YOUR RULES To summarize this relatively safe trading method: Select a high volume stock with a sharp trend line. Stick to one stock. Stay in it until stopped out. And change stop-loss orders as necessarybased on the trend line and price. Trade short or long depending on the trend. When in doubt, stay out. Check the short interest. Forget pride of opinion. I can think of no better incentive for you to set some kind of trading tactics or rules (such as those outlined in the next chapter) than to quote this: A bookkeeper (in a brokerage office) kept 5,000 accounts, and he only knew of one mans account that showed a profit. This was written by E.E. Hooker, Jr in You Cant Win in Wall Street, 1927. The odds are against the undisciplined in the stock market. If you, like me, cant leave it alone, then increasing your know-how is your only hope of gain and survival. You should run scared as a habit. But if you follow a sound set of rules, your tactics will be your salvation. The principal reason people lose money in the market is their lack of a full set of simple rules for every situation, or, more commonly, not following them. What do you hear more often in this business than someone saying, I knew I should have sold it when it hit 125, but . . . So, set some rules and stick with them. |
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