HOW TO KEEP YOUR NEST-EGG SAFE AND SOUND
by Mike Lally
Simple but not simplistic
Does it require mathematical prowess to become a good risk manager?
Is trading only meant for those people who are highly intelligent or the fortunate types who would generally succeed at anything they turn their hands to?
Is it a complicated game where only the super smart can expect to prevail? No! No! No!
I am continually asked – should you trade using technical analysis or fundamental analysis?
Is it better to play the piano with one hand or two?
It is important to use both fundamental and technical analysis.
Fundamental analysis can tell you what to buy or sell.
Technical analysis can tell you when to buy or sell.
We have no real idea what will happen tomorrow.
In fact prices can do absolutely anything tomorrow, without so much as a by your leave.
In life, few people can forecast or guarantee anything.
When it comes to the markets, nobody can, at least on a regular basis.
Gurus manage it for a little while, then they suddenly become mortal once again.
The market eventually cuts everybody down to size.
Markets have a mind of their own.
To prosper you need a firm idea of how you intend to profit from the market.
You need a plan.
This will give you an important trading edge.
Without a plan and hence an edge you will lose your money.
It’s that simple.
Some of the irrefutable canons of successful investing and trading:
Always trade with the trend.
Always determine the risk based on probabilities.
Know how to position size.
Trade with a stop-loss.
Always enter a trade knowing how much you are willing to lose.
Always enter a trade with a profit target.
Always invest with a margin of safety.
Monitor the progress of the trade very carefully.
Take action if the trade fails – do rely on crossing your fingers – this is a failed strategy.
In other words, trade with plan.
Your mission is to preserve your capital.
This means paying obsessive attention to risk.
Without capital the game has ended at least until your piggy-bank has been rejuvenated.
It is capital alone that generates capital gains and dividends.
So you have no choice, you must cut your losses before they become so large
they damage your ability to continue investing.
Any large loss will have a frightening effect on your psyche.
Many people once a loss grows so large understanably feel that they cannot afford to sell.
Hope springs eternal but rarely in trading.
They hang on. Feverishly.
The reason this happens is because many investors do not have a clear idea of where or when the investment actually went wrong.
This is not altogether surprising.
If you only have the vaguest notion of why you made the investment in the first place, it makes it virtually impossible to decide at what price a point of failure has occured.
THE HARDEST LESSONS TO LEARN ARE THE SIMPLEST
The simple lessons are:
Before making any investment, you must know where your analysis is wrong.
This is commonly known as your stop-loss level.
It may sound trite to suggest that you only make a capital gain on an investment if it is upwardly trending. We need higher prices.
If price stops trending up, or begins to trend down, you should take immediate action – sell it. If your stop-loss level is hit, you should also sell without hesitation at whatever price the market will accept.
Three situations which you must obey and act without faltering are:
If a stock stops trending up – sell it.
If a stock breaks below a significant trading range – sell it.
If a stock is trending down – don’t buy it.
It is tempting for many beginners to get sidetracked by the numerous fancy indicators.
They are weapons of mass distraction!
Never fail to analyse the price chart.
Remember it is price alone that determines the trend.
A painful example which affected many Australian Mum and Dad investors was Telstra.
Telstra after a prolonged uptrend then commenced a period of range trading.
Price then broke below the significant trading range.
This was the clear, unambiguous signal to sell.
Most people didn’t – the rest is history.
YOU MUST FOLLOW THE THREE RULES!