Buying shares even 20 years ago was a lot harder than it is now. These days the internet has totally revolutionized trading the share markets and opened them right up to a wide range of global participants.
Anyone can do it, all you have to do is sign up to an online brokerage platform, choose the amount you want to, click the buy button and you're away.
But buying shares or indeed any tradeable financial instrument is the easy part, it's managing the trade where the fun really starts!
To this day it still amazes me how many traders buy shares based on a hunch or a whim. Usually it's a recommendation from a friend, some stock guru's selection, or maybe the result of some excited online forum discussion.
In most cases it seems that it is simply the fear of missing out that strongly influences people to take these kinds of hasty unplanned "trades".
There is usually little or no planning, no exit strategy, no profit targets and what it really all amounts to is really a kind of glorified online gambling session.
It could of course be argued that trading the stock markets is just another form of gambling. While technically this is true because, let's face it, all forms of investment always involve risk and a degree of speculation, it doesn't mean that buying shares has to be a straight out punt.
I believe that if you learn to read a chart properly, have a solid trading plan, and sound risk management in place, you can dramatically reduce your chance of loss and skew the odds for success in your favor.
Trading the stock markets successfully is not just being brilliant at one thing, for instance, when to buy. Its a matter of being good at taking the necessary steps tempered with patience, self control and an understanding of your emotions.
Developing a system to combine all of these things into a workable form should be your ultimate aim. By doing so you will then have a framework by which you can operate in the markets systematically and unemotionally.
So I'm going to share with you here, some of the steps that you need to implement that will help you limit your losses and become a better trader!
1. Understand What the Broader Market is Doing.
Its important before you start buying shares, to take a good look at the overall market or sector before buying. You need to be able to determine the likely direction it looks like its going in. If you can't, sit on the sidelines.
There is a saying in the markets that "A rising tide lifts all ships" and it really does ring true. The tide of course being the movements of the market or sector. It depends on your time frame.
This market tide moves up and down in the form of waves of varying sizes or degree. They are what defines the booms and busts and so you always want to make sure you are on the right side of them. That means going with them not against them.
The trend is your friend, so make sure you stay friendly with it!
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2. Look to the Larger Time frame
This should be your starting point when you are looking to find suitable candidates to build your watch list from, and I really can't stress this enough...always look to the larger time frame
This means that if you are trading a 10 minute chart, look at what's happening on the hourly chart. If you are trading hourly then you should be cross referencing the Daily action. If you are trading on a Daily, you want to be seeing some positive confirmation on the Weekly as well.
Once you start to do this you are automatically giving yourself the best possible chance of being on the right side of the trade and riding the trend in the right direction.
In most instances with my own trades I'll even go out an extra time frame. For example, I trade the Daily primarily so I'll also look for confirmation on the Weekly and the Monthly charts.
So lets have a look at exactly how this works, in the following examples.
Firstly, my scans for suitable candidates will generally start with the weekly chart and I have certain set criteria I'll scan the whole market for.
My searches for trades will generally start with the weekly chart and I have certain set criteria I'll scan the whole market for.
As you can see I keep the analysis simple, with minimal indicators. I use the larger time frame to focus on trend direction, support and resistance levels and to identify any areas of strength or weakness on the chart. The chart below shows an example of this approach.
In a lot of cases my next "port of call" will be the Monthly chart. Stepping back further and taking in the bigger picture can really help form a more solid overall view of the market.
I'll generally use it to reaffirm my weekly analysis, again the simplicity of it is demonstrated in the chart below.
Once I have positive signals on both the Weekly and Monthly I'll then look for a trade entry on the Daily. This is because I now have the confidence of the move going in my direction, from the information on the larger time frames.
This is when my next set of criteria kick in.
3. Minimize Risk and Let the Trade Come to You
So, once my larger timeframes are lined up in my favour I'll start looking for the actual trade I want to take on the Daily.
This starts with determining the entry point with the least risk. This means that I have to be able to enter the trade and have my stop loss in a sensible place. That way if the trade doesn't work out as planned, I can get out and be within the maximum % of loss allowable for that trade.
My risk allocation is always 2% of my total trading capital.
In this example below you can see how this applies and what I look for in order to determine a trades viability.
Lets say that my trading capital is $20000. If I use my 2% risk allocation rule that means I cannot lose more than $400 on a trade.
If I then enter a trade and for whatever reason it goes against me and I lose more than that amount. I have to sell and get out and take the loss. No if's or but's or hanging on hope.
I'm out... no hesitation!
Now, before I even consider putting my hard earned on the line, my stop loss placement has to allow me to take a reasonably safe position.This has to be one that gives me the least amount of loss should the trade not go my way.
This may be under a price bar that I consider important, maybe below a strong support area or even under a trend channel demand line. Everyone who uses stops has their own methods and I'll delve into it more in a separate post, because its a contentious topic that needs more than a paragraph.
If I can place my stop suitably, I then have a range of price in which I can buy. Then just like someone waiting for a bus to come along, I wait for the trade to come to me!
I never chase it, sometimes it picks me up sometimes it doesn't.
The key point here is that if I can't get the stock at the price I want under the risk conditions I am prepared to accept, then I wont take the trade.
There is always another trade.
Wow you have got this far! Well done and great work. Want to find out about more of these kinds of trading strategies? Just sign up to my newsletter and FREE 3 part trading mini-course below!
4. Buying Shares with Value in Mind
Now we come to a very important point that most traders completely forget to look at before buying shares:
Is the trade actually worth taking?
There is absolutely no point buying into something where you cannot achieve some kind of minimum profit target. For example, you don't want to be taking trades where there is strong resistance close by. Doing so potentially puts your first profit target too close to your buy in point especially if price does stall at that point.
This just increases your risk to reward
Calculating an approx profit target can usually be easily determined by using support and resistance lines on the chart, certain chart patterns have also have definite targets and P&F charts are also pretty reliable (more on this in a future blog).
As an example, if you were to use support and resistance levels, you could use these to determine where the stock might pause or stall.
When you plan your trade you can then calculate if these levels are far enough away from your buy point to give you a suitable return on investment.
For me this is has to be about 3 times my risk allocation.
5. Manage the trade
So you've planned your trade, calculated your risk to reward, bought your shares, have your stop in place and your profit target set.
Well this is the tricky bit. Nothing kills a good trade quicker than bad management and selling too early. Remember you need to cut losses short, not winners. You want to ride them as far as you can, WITHOUT letting greed take you too far.
In order to stay in the trade you need a trailing stop that allows you to ride the trend as long as you can. It must also allow for enough movement in the stock price that you don't get shaken out by normal price fluctuations.
A few suggestions of what you could use as a trailing stop loss are listed below:
- A Moving average and tweak the settings based on a previous similar move, if price then penetrates and closes below it, you sell and are out.
- Plot a trendline or trend channel and look for a break of the trend line or the channel.
- Use one of the trailing stop loss functions that are built into many charting programs these days. Most of these work quite well just be sure to test them on a prior moves first to make sure they allow a wide enough range of price movement.
- You could use an RSI crossover, where in the case of being long if it drops below the 50% line you are out.
The list goes on... there are a lot of different methods of trailing stop but at the end of the day you need to select the one that suits your own trading style.
Again this is an area that I could devote a whole post to and so I'll do just that sometime in the near future.
One thing you have to understand when buying shares, is that no matter the method you use you will rarely get out right at the top or in right at the bottom of the trend.
Your aim should be to take a nice chunk of profit from the middle of the trend in a safe and planned manner.
Hopefully from the information I have outlined in this blog you can see just how important a trading plan and a framework for managing it is, before you start buying shares.
Fail to plan and you are planning to fail, its an old line but one that really rings true in the stock markets. It is a part of the reason that so many traders burn their accounts and don't last in the game.
Do you have a set trading plan that you follow?
I'd love to hear what kinds of setups other people use. Trading styles are so diverse and its always interesting to hear differing points of view and methods.
Do you have a favorite trailing stop method?
Let me know.
If you've enjoyed this article, don't forget to share it and until next time....Bye for now!