The picture shown below is of Donald Trump speaking at The Learning Annex. At the forum, speakers educate hopeful investors on how to become successful in real estate and in the stock market, how to protect their assets and how to start businesses. Trump has said in the past that one comment he always makes at the events is that not everybody in the room will become a successful investor. While the Learning Annex team must hate the comment, Trump makes the claim because he believes successful investors have an inherent quality that leads to their success. That quality is mindset.
Trump argues that mindset separates successful investors from unsuccessful investors and that it is an innate skill which is difficult to learn. In the stock market, mindset is especially critical to successful trading. You must have an ability to think independently when trading the stock market because forces tug regularly at your emotions. Can you imagine buying a property and subsequently turning on the TV to see analysts contend that you made the best decision of your life and others arguing that it was a very poor decision that will certainly lose money? In stock market trading, that is exactly what you have to contend with each and every day. The drain on emotional capital is too much for many to succeed.
A famous story of Warren Buffett recounts how he reacted nonchalantly to news that the 1987 crash was in full swing. He wasn’t bothered by the event in the least because he understood the value of his investments and he had internalized one of the most important trading quotes ever!
"There is nothing more important than your emotional balance" – Jesse Livermore
Emotional balance is critical to successful stock market trading. With conflicting reports released daily on most stocks in your virtual portfolio, you must have the courage of your convictions in your analyses. You must be prepared for shocks and surprises. It’s easy to think ourselves great traders when the stock market rises, but successful traders separate themselves from the crowd by knowing how to preserve capital, minimize losses and/or generate profits during downtrends.
With the stock market gyrating wildly, how can you maintain emotional balance?
The Beta Coefficient is a measure of a stock virtual portfolio in relation to the rest of the financial market. Knowing the beta values of stocks in your virtual portfolio is a first step towards maintaining emotional balance because most trader’s emotions are directly tied to account value fluctuations which originate from stock volatility.
If you tend to be a concerned trader, you should generally consider stocks that have lower beta values. For example, United Healthcare has a beta of 0.43; so you know that it won’t move nearly as much as the market moves and, in this volatile market, that knowledge can provide solace. Momentum stocks tend to have much higher beta values. Baidu, for example, has a Beta of 2.07 according to Yahoo! Finance while SunPower has a beta of 3.66!!
These momentum stocks usually garner most media attention. If you think about the job of the media, it is to boost ratings. How do you boost ratings? By discussing the most dynamic stocks in the market that move the most. If CNBC or Bloomberg discussed how UNH had risen or fallen $0.35 for the day on a regular basis, it would put most viewers to sleep. Shows like Fast Money are all designed to inject you with emotion and passion. But successful trading is about emotional balance and so, as much as possible, we want to control these emotions. The way we can control our emotions is through managing risk.
Once you have have determined that you can tolerate exaggerated stock movement or that you prefer less dramatic movement, the next step is to place hedged trades on stocks that you have performed fundamental, technical and sentimental due diligence.
This simply means applying strategies that also comply to your risk tolerance. Do you prefer high probability trades that can profit regularly or lower probability trades that can produce big payoffs? Directional trading with long calls and puts will produce much greater gains than hedged trading with credit spreads such as bull puts, bear calls and iron condors. Knowing the answers to these questions is vital to successful trading.
When you find strategies that work for you on stocks that work for you, your job is to aggregate the cumulative risk from each position. Most unsuccessful traders ignore this critical step. You might be happy with ten trades individually but, when you consider the accumulated risks, you might be very displeased should the worst-case outcome materialize!
In summary, the steps to follow are:
1/ Recognize that emotional balance is the key to successful trading
2/ Determine how risk-averse you are
3/ Control your emotions by employing judicious risk management which means
- Choose stocks with betas that conform to your risk tolerance
- Evaluate the type of strategies you prefer
- Aggregate the cumulative risks from each position to determine a virtual portfolio risk
Have a fantastic week!
OptionSage
