Back in college I remember a professor starting a lecture by saying "A good teacher will always start a class by reviewing material covered in the previous class before moving on." That same principle of review holds tremendous value for traders. As tax season rolls around once again, I spent the weekend reviewing each and every position in my virtual portfolio in 2007 and I encourage you to do the same. In fact, I dare you to do so!
While the process is tedious, it is possibly one of the most valuable exercises you can conduct. Although last year was, in many respects, an easy year to profit given so many stocks had enormous bullish runs, you will almost certainly find – as I did – positions that make you want to kick yourself!
So how do you conduct this review process?
Each position should be analyzed from a number of perspectives. The first is the technical perspective. When you examine a position, do so with a technical chart open so you can see how stocks in question trended before you entered positions and how they trended afterwards. The most common result most traders find from this analysis is that too often they entered bullish positions near resistance levels and entered bearish positions near support levels. The result of these actions is typically to end up on the wrong side of trades and take losses time and again. If you find this occured in your trading, stop repeating the same mistake again and again!! To improve we must learn from failure!
Another potential landmine many traders experience is relatively big losses in the months of January, April, July and October. Why might that be? Earnings season takes place in those months. If you take nothing else from this article, remember earnings season can move a stock in ANY direction. You can listen to pure technicians all day long but they won’t help you whatsoever when earnings season comes around because fundamental news events can quickly and substantially derail a technical trend. The lesson to take if you discover this in your review is:
1) Take note of when companies are reporting earnings and
2) Add further hedging during earnings season.
Another factor to consider is losses. If you consider yourself a good trader and good at timing the market but are disappointed that you either lost money or didn’t make more, examine the magnitude of your losses very carefully! You may find you have ten great trades but only one has a huge loss. That single losing trade can offset many of your winners. Cutting losses early is CRITICAL to long-term success. Or if you don’t cut losses early, hedge quickly.
If none of the above factors caught you out last year, it’s time to celebrate, you are way ahead of the game! But the big one is still to come…and it’s potentially worse than all the others put together!
Potentially the most dangerous mistake you can make in trading (and I can’t over-emphasize this point) is failing to employ judicious risk management. Even KKR this past week (historically a hugely successful private equity firm) suffered margin calls because of over-leveraging (another way of saying they employed poor risk management). In general, no position should dominate your virtual portfolio (there are ways to hedge signficantly and allow this to be the case but it requires sophisticated understanding of hedging). Personally, I don’t like any position to exceed 5% of my virtual portfolio these days but if you have a $10,000 virtual portfolio that won’t make much sense so make sure to read past articles on virtual portfolio management where various virtual portfolio sizes are considered.
A final point worth noting, and one that catches most novices out is commissions. Brokers that offer fixed commission rates or discounted rates are very attractive for traders with large accounts. For smaller accounts, those same commissions are a much bigger percentage of a position size. If you ever find your account is spinning its wheels, a closer analysis may actually reveal that you are a pretty good trader. You may simply be trading too much and making your broker rich! To mitigate against this occurring, it is imperative that you perform the analysis mentioned above to ensure that you learn how to filter out losing positions and to ensure that transactions costs are paid on winning transactions!
During the next year, you will likely spend countless hours reading economic reports, quarterly reports, analyzing charts, discussing positions, and performing research. Most, if not all of it, is done with the intent of postulating what will happen in the future and how best to take advantage of it. Perhaps an equally valuable investment of your time will involve looking to the past. Invest wisely!
