On weeknights Jeff Macke of CNBC's Fast Money has, on more than one occassion, commented that traders should "Sell until you can sleep!" when markets are volatile. This is valuable advice for traders who are long the market and cannot tolerate wild swings and excessive volatility.
Volatililty is an inherent part of trading the stock market and so we must learn to manage our perspective towards it. The stock market is traded by a herd of humans who are emotional beings, and, creating panic among them, shakes out the weak holders from time to time which is an important and necessary process before the market makes a move to higher ground.
If you were to ask most amateur traders how they are sleeping during periods of high volatility and they tell you that they are sleeping like a baby, they may not mean that they are sleeping solidly through the night but rather that they are waking up every two hours and crying for 20 minutes before falling back to sleep!
This is NOT a situation you ever want to find yourself in and yet the bold and brave often find themselves reduced to tears quickly in the stock market because of their inability to manage their own emotions when volatility increases. In order to control emotions, it is imperative that we learn to manage risk.
Trading the stock market rewards the tried and tested more so than the bold, brave and reckless. History has taught us this lesson many times. Brian Hunter of Amaranth was an infamous example. He speculated on highly leveraged and insufficiently hedged bets in 2006, just as he had done in 2005. While in 2005, the bets led to reputed earnings of $100,000,000, the bets unraveled in 2006 leading to the closure of the fund!
Another famous example from history is that of Victor Niederhoffer. Niederhoffer rose to fame in the 1990s. In 1997 "The Education of a Speculator" was published and acclaimed Niederhoffer – who just a year earlier had been ranked the #1 Hedge Fund Manager in the world!
In the book, Niederhoffer regales the reader with stories of near disaster and his escapes that ensured he survived another day. He amassed great wealth in the process. Niederhoffer proudly boasted that he "never used stops". He regularly violated one of the primary rules of the book "Reminiscences of a Stock Operator" – Do not average down on a losing position.
Soon after the book was published, George Soros's warning that a tide might 'overwhelm' Niederdhoffer became prophetic, when bets on the Thai currency market went against him causing huge losses that forced brokers to issue margin calls against him. Although hours later the positions had returned sufficiently that he would have been just fine, the triggers had been pulled and it was too late for his fund. The damage was so extensive he was forced to re-mortgage his home and he effectively lost everything.
How do the lessons from the past help us trade the future? They should cause us to reflect upon our existing positions and determine how much risk we have assigned to each position. Many of us enter positions, cognizant and comfortable with the risk of a single position but fail to sum the risks of all our positions and account for our virtual portfolio risk.
When the damage has been done to an account, it can be very hard to fix it. As Phil likes to say it's almost like going to a train station after the train has left and asking "How can I catch the 11AM train now that it's midday?". It doesn't matter how fast you are told to run, you are not catching the train!
So, think long and hard about each position in the account BEFORE an event happens. This is precisely why at Phil'st Stock World we know how we are going to exit a trade BEFORE WE ENTER IT.
Trends are accounted for ahead of time so, no matter which way a stock moves, we have determined that we are comfortable with the risk and reward of the position. Most importantly, we are comfortable with the capital at risk in the trade and what % that capital is relative to our virtual portfolio size.
We encourage you to prioritize risk management above all else in the stock market. As Jim Cramer wisely points out: "It is the only free lunch" in the stock market. Perhaps the flipside of that is that if you abandon it you may not have any lunch money at all!
Be careful out there and trade safely. We are here to help and will do all we can to offer to teach you our guiding principles and, as you have already seen, a few winning trades too!
Have a fantastic week!
OptionSage
