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Risks of Buy and Hold

2009-07-18T07:33:00.000-06:00

In the article last weekend, I discussed the concept of trying to catch falling knives and, quite predictably, I received some comments from readers justifying their own actions in buying falling stocks. One contributor set forth a very thoughtful plan through which he buys falling stocks with which he has had success, but was careful to note that the strategy is very risky. I agree completely and commend him for the construction and use of his plan that is set out in last week's blog. Another commentator defended his practice of buying GE as it was falling on the theory that it is a great company. I have a little more trouble with that one and liken it to a fellow who was upset with me a couple of years ago when I criticized elements of buy and hold because he and his family had been holding what he referred to as "that old doggie" Citigroup (C) since it was only $14. Citigroup is trading under $3 as I write this article.

First, I want to say that I have no problem with people trading GE. It is, indeed, a great company, and even in very significant downtrends such as GE has experienced in its fall from about $37.50 last year to its current level under $12, there have been several trading opportunities both to the upside and the downside. The key, in my view, is to have an exit strategy in place since we can always be wrong on direction. We also need to be mindful that GE, though a great company, has not been a great stock over the last 9 years. It traded near $60 in 2000 and if I had bought it then and held it until now, I don't think I would be very happy. It is not alone. Other great companies like Coca Cola (KO) have seen significant drops over that time as well. If a buy and hold advocate just bought the Dow near the high in 2000 he would be down approximately 3400 points as I write today.

The point I am trying to make is that a buy and hold approach with no exit strategy is extremely risky. To start, buying a stock is one of the riskiest things we can do in the market because, without stops or protective puts or some hedge, the risk is the whole investment. Great companies have failed and disappeared. There was a time when investors would have laughed at the suggestion that the great Pennsylvania Railroad could ever fail, but I watched as my own father, then a Federal District Court Judge, signed Order No. 1 in the Pennsylvania Railroad bankruptcy proceeding. Bankruptcy of General Motors was unthinkable not so long ago but we just saw it happen. The list of once great companies that failed is long, indeed. Those who were buyers and holders of those companies doubtlessly suffered. According to "Yahoo answers" American companies have been going into bankruptcy at a rate of 500 a week! Obviously most of those are not publicly traded, but publicly traded companies like GM definitely are to the great pain of shareholders.

I have little doubt that many will remain unconvinced, but buy and forget or buy and hold with no exit strategy is fraught with great danger. What if we bought at a top and have need for the money when there is a significant decline such as the one we have recently been witnessing or the one following the 2000 high? My suggestion to the buy and hold investor is to be aware that there is risk, sometimes enormous risk, and ask yourself the question: Hold until when? Why would you not want to have an exit strategy? If you exit and then the stock turns back up, you can always buy it again. Sure you may have to pay a capital gains tax (currently at a low rate) on the gain, but isn't it better to do that than to see your investment go down the tubes completely or suffer a large loss?

by Bill Kraft, Editor
Copyright 2009, Makin' Hay, Inc.
All Rights Reserved

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Catching Falling Knives

2009-07-11T08:24:00.001-06:00

During the past week, the Dow, S&P 500, and Nasdaq Composite each broke down below the neckline of head and shoulders chart formations. Such a break is generally thought to be a fairly strong bearish signal, particularly when combined with weak fundamentals such as in the overall economy including things like high unemployment and low consumer sentiment. While no chart formation or, for that matter anything else, is ever a guarantee of market direction, it can be something that may be helpful if we are aware. I write that because when I make directional trades in a stock, I try to make entries that are consistent with the market and sector direction. The idea, for me, is to try to give myself an edge since obviously when a market is rising most stocks can also be expected to be rising and, naturally, the same is true with respect to sectors. The opposite would also be true in that we could expect most stocks to be down when the market is down. In that circumstance, of course, my bias for directional plays would be bearish.

One of the things I have seen with many traders is that they are so anxious to buy a stock that they make their entry when the price is on the way down. That phenomenon is affectionately known as trying to catch a falling knife. The problem they face is that no one knows how far "down" actually is. For stocks like Bear Stearns or Enron or Lehman Brothers or a host of others "down" wound up being zero. Back in February or March a friend asked me what I thought about buying General Motors and I shook my head from side to side. But it's GM, he said, it won't go under; it has to come back. We have to remember that simply because it was a good company or simply because a company is good now doesn't mean that the stock price will go up. All too often we confuse a good company with a good stock and the two do not necessarily go together. General Electric (GE), for example, has long been a good, even great, company that traded in the $30 and $40 area. This past March it hit under $6 a share. Those who bought at $25, $20, or $15 on the way down were trying to catch that falling knife. I can hear them saying: "It'll come back." Maybe. Probably. But when?

Instead of catching that falling knife, if we like the fundamentals and like the company, why not exercise a little patience and wait until not only it signals a return to an upward move, but also wait until the market and sector head the right way as well? That movement may miss catching the absolute bottom, but it is just fine in my book to take a bite out of the middle once the market, sector and stock suggest that you have a little edge.

I certainly won't argue with those who try to catch those falling knives because at times their timing is near perfect and among the scars on their hands will fall the knife handle just before things turn. However, a very successful and very experienced trader once told me that we only get one perfect high exit and one perfect low entry in our lives and I know I've had mine so, for me, taking a bite out of the middle is just fine.

by Bill Kraft, Editor
Copyright 2009, Makin' Hay, Inc.
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Qualities of Success

2009-07-04T07:03:00.000-06:00

I recently read a biography of Warren Buffet and it reinforced a thought that people who achieve the highest levels of success in their chosen fields have several important attributes in common. I don't mean to arrive at a judgment whether they are "good" people or "bad" people, only that they seem to share the same qualities in rising to pinnacles in specific categories. For example, just because a man becomes a great athlete or great statesman does not necessarily mean that he is also a good husband or father although he may well be. I only intend to look to those qualities that seem to coalesce with regard to the specific area in which a person has attained greatness and suggest that those same qualities are important in becoming a good, better, or even great trader.

The qualities I see that seem to be most important are (not necessarily in any order) passion, focus, determination, the creation of a plan, and patience, and some form of giving back. Is there any doubt, for example, that Tiger Woods on a golf course is focused and determined? Obviously he is passionate about the game as he has devoted his life to becoming the best there ever has been at golf. He demonstrates patience in that he rarely does anything foolish to try to force a result, but, instead, takes full advantage of opportunities once presented.

If we apply the same characteristics that Tiger has on a golf course to our trading is there any question that we are not likely to become better? I don't mean to suggest that each of us is capable of such passion, focus, determination, patience, etc. but only that an increase in those areas is likely to lead to an increasing chance of greater success. If we look at the flip side, how likely are we to trade well if we don't have a plan or if we fail to focus or try to force trades through impatience?

Recently in response to a questionnaire I sent to a prospective coaching student I received a reply that he enjoyed nothing about trading and considered it a necessary evil and something that he had to do. I replied saying that I thought he should reconsider the idea of retaining me to coach him because I believe it is essential to have passion for trading in order for there to be any likelihood of success. In my view that approach is true in almost all endeavors. So many of us go through the motions of life without a love for what we are doing and, at least as a partial consequence, may never rise to the heights we are truly capable of reaching.

I discovered trading relatively late in life, after age 50. It grabbed me and I have been passionate about it ever since. When I began, I had no other source of income, and not a lot of money, but I knew it was what I wanted to do. I studied trading at least six hours a day and often more. I loved learning about it and it became my focus. Even today, after many years of trading, I continue to study; I read, attend seminars, watch DVDs and do whatever I can to add to my trading knowledge. I do those things because I am passionate about trading. I do not contend that I am anywhere near being the world's best trader, but I continue to try to be and I know that requires effort. For me, trading is fun and the effort well worth it.

While it probably is not necessary to devote as much time and energy as I have to be a success in trading, I do believe it is necessary to have passion, focus, and determination to succeed in the business of trading. Patience may take a while as it did in my own case. In later articles, I'll try to discuss each of these characteristics in more detail as we continue to try to elevate our chances to succeed as traders and investors.

I hope you have a wonderful Independence Day and realize that an ability to trade is one of the wonderful things that can, indeed, let us be independent.

by Bill Kraft, Editor
Copyright 2009, Makin' Hay, Inc.
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This Half Year

2009-06-27T06:47:00.001-06:00

As far as I am concerned, it is definitely true that the older you get the faster time seems to pass. I just looked at the calendar and suddenly realized that 2009 is almost half gone. That observation gave me pause to look back on the year so far. It has been quite a year for trading. The Dow 30 Industrials fell almost 2600 points from the first of the year until the March low and then climbed back just over 2400 points to the highs in the first third of this month. Similar violent action occurred on the S&P 500 and the Nasdaq Composite. The S&P fell from a January high of 943.85 to a March low of 666.79 only to rebound to a new high of 956.23 on June 11th. Though volatility as measured by the VIX failed to attain the all time heights achieved in late 2008, they remained uncharacteristically high as the markets fell to the March lows. In short, this year has seen a pretty wild market; one that resulted in very substantial losses for many from January to March.

During that descent, I attempted to trade very cautiously, only to become more aggressive during the run-up. Most recently I pulled back as the market looked like it was turning over. In the alert services I edited, I probably have made fewer trades than in other years. As I write this article on Tuesday, June 23rd, I checked the Trade Tables to see what my percentage of winners has been for trades closed in 2009. I was pleasantly surprised to see that the overall percentage of winners in all the services I edit combined (Option Trader, Trend Trader, and $10 Trader) was 82.8%. Broken down, $10 Trader achieved a winning percentage of closed trades of 86%, Trend Trader 83%, and Option Trader 75%. Those statistics were particularly interesting because both Trend Trader and $10 Trader are essentially designed as bullish services in which I am illustrating situations where I open a position by buying a stock and closing the position by selling. Option Trader uses a variety of strategies designed to attempt to profit on bearish and neutral trades as well as bullish trades.

In the last six months, I was also very fortunate to have my new book, "Smart Investors Money Machine," published and my new DVD "Trading for Keeps" released. I discussed the book in some detail in the article last week. I am really pleased by the DVD that was produced by traderslibrary.com and includes subjects like trend line use, principles of disciplined trading, how to let profits run, the use of collars and protective puts, and the effective use of stop losses. All of those are subjects with which I have dealt in many private coaching sessions as well as in my own trading.

One of the sad things I have noted over the past 6 months is the number of folks who have contacted me regarding coaching sessions who have lost very significant amounts of money in the most recent crash and who are looking for ways to stop the bleeding. In past articles, I have written about concepts that I consider to be critical to successful trading. They include things like money management, establishing exit strategies before entering positions, recognizing reward to risk potential, educating themselves about trading, and having a trading plan in place. Most of those who called about coaching because they had suffered severe losses were unaware of those concepts or failed to put them into practice. Whether they signed on for coaching or not, I encouraged the callers to learn and apply those concepts. In trading and investing ready, fire, aim is definitely not the way to go.

No one, including me, knows what the next six months will bring in the markets. As is often said, we can only trade the right hand side of the chart, but to do so successfully, we must prepare ourselves and we must continue our trading education. As all too many learned in the disastrous market fall from October 2007 until the March low this year, buy and ignore is simply a dangerous strategy. I wish you all good trading and hasten to add that the "luckiest" traders are generally those who work the hardest at learning the craft.

by Bill Kraft, Editor
Copyright 2009, Makin' Hay, Inc.
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Picking A Strategy

2009-06-20T04:51:00.000-06:00

I recently wrote a little about picking a stock and mentioned a few of the myriad ways in which an investor or trader might go about selecting a candidate. In my own trading life, as I review stocks, I find that the process becomes much more one of elimination than selection. As I look at a chart, for example, I can see that good old XYZ may have just reached up to a resistance and is turning down. A quick fundamental review may show that earnings have dipped due to some new competition, debt is considerably higher than other stocks in the sector, and a potentially large lawsuit has just been commenced against the company. If all this is occurring in a bull market, XYZ is not a buy for me; it is eliminated as a potential bullish addition to my portfolio since I know there are other better candidates out there. Does that mean that as a trader I am not interested in the stock? Definitely not. Though I have quickly rejected it as a buy I may give further consideration to XYZ as a bearish candidate. I may look at a different strategy that looks like it might have a greater chance of success with XYZ. Does it fit my parameters to short the stock, or to buy puts, or maybe put on a bear put debit spread or a bear call credit spread? I can see how those strategies might be a better choice given the information I have about XYZ and its price performance.

A majority of investors and retail traders may pass right over XYZ since their bias is bullish and they are only looking for stocks to buy. Those investors may only really consider one strategy; buy the stock first and sell it later. In so doing they easily may miss the apparent opportunity the XYZ scenario offers to an investor armed with more than one strategy. There are many ways to making money in the markets, and the utilization of various strategies can add income streams and profits to the trader or investor who gains understanding.

How we invest or trade is a personal decision. The decision is influenced by how much time we have, how much cash we have to invest, our age, our family situation, our risk tolerance, our interest and a variety of other factors. No matter who you may be, if you have the interest to read this article, there is almost certainly a strategy that will fit your situation and comfort level. I devoted my new book to this subject. "Smart Investors Money Machine" is designed for investors as well as traders. In "Smart Investors Money Machine," I have tried to consider a wide variety of investors and traders using examples of a young single person, a growing family, and a couple reaching retirement to show numerous ways each might select a strategy that fits them and their lifestyle and at the same time will provide them with more income. The book isn't limited to option strategies though it does discuss some. The scope of "Smart Investors Money Machine" encompasses a variety of strategies from buy and hold to dividend capture to writing covered calls, to specific sectors that offer exceptionally high yields and includes a basic primer on bond investing and annuities, and even explains a little about reverse mortgages. With each strategy, I not only describe the strategy but also show how people in differing times and stations of life might use it to bring in more income to lighten their daily load.

The point is there are lots of ways to create streams of income. Some of them require a lot of time and some very little time. Some are very risky and offer higher potential rewards while others are accompanied by a lesser risk but offer a lesser potential reward. There are plenty of ways to do it and some of those ways are likely to fit your specific circumstances. In my view, it is definitely worth the trouble to explore the possibilities and see what you like and what can work for you.

Almost assuredly there are strategies for you. What I often see is people trying to be traders rather than investors when they have neither the time, the knowledge, the capital, nor the risk tolerance to really be traders. My advice to them universally is it is great to be a trader, but first you need to acquire the knowledge. In the meantime, there is no reason why they shouldn't be generating additional income using other strategies that may be less complex, less time consuming, require less attention (in some cases even no attention), and still add a stream or streams of income.

The strategies we utilize are critically important to our success and choosing what strategy we will employ may be as important, and sometimes even more important than the specific XYZ we select.

by Bill Kraft, Editor
Copyright 2009, Makin' Hay, Inc.
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Selecting a Stock

2009-06-13T08:19:00.000-06:00

The most common question I am asked about trading is how I select what stock to trade. There are probably as many ways to select a stock as there are people searching for candidates. Systems of selection may be as simple as a friend told me about the company or as complex as an algorhythm created by a group of Nobel Prize winners. Actually, such an effort by some Nobel Prize winners almost literally destroyed the markets when it failed in practice. Some traders or investors may be wed to a fundamental approach while others may choose a technical tactic. It is not unusual to see a combination of fundamental research accompanied by a technical entry. No method yet devised is perfect and any chosen stock can go the wrong way so the best we can do in my estimation is attempt to give ourselves an edge.

There are some relatively simple devices to help in the selection process. For example, there is an old saying among traders: “don’t try to catch a falling knife.” Freely translated, that adage suggests that it may not be prudent to buy a falling stock since there is no way to tell where the fall will end. Companies like Lehman Brothers, Enron, and General Motors bear witness to the dangers of trying to catch a falling knife. Someone one much wiser than I once told me that a trader only gets one top and one bottom in his life, and while that may be an overstatement, it is something to keep in the back of our minds.

If buying while a stock is falling or trying to pick a bottom doesn’t give us the edge we may seek, what alternatives do we have? One thing I always talk about with coaching students is to try to trade the direction of the market. If a market is generally bearish, are we better making bullish plays or bearish plays? As a very general rule of thumb, if a market is bearish, we could estimate very roughly that about 70% or 80% of the stocks in that market are bearish as well -- otherwise, the market would not be bearish. If 70% or more of the potential candidates are bearish, how are our odds when we decide to make a bullish play? Undoubtedly, even in a bear market, some stocks will move up, but if 70% or 80% can be expected to move down is it a smart choice to pick against those odds?

Personally, I would prefer to have the odds on my side so if 80% of the stocks in a market are moving down, I am more likely to choose a bearish candidate and make a bearish play like selling a stock short or buying puts or putting on a bearish call spread than I am to buy a stock. I don’t mean that I would never buy a stock in a bearish market, I simply mean that the preponderance of my trades in a bearish market will be bearish.

Naturally, the opposite is true when the market is bullish. If most stocks are moving up, that seems to me a better time to buy stocks than when they are moving down. I understand and respect the thought of contrarians who say the best time to buy a stock is when the market is going down. Sometimes they achieve excellent results and are just proof of my earlier statement that there are probably as many ways to select a stock as there are people selecting. I just prefer to put the odds in my favor.

If a bullish market is a criteria for selecting a stock to buy, so, too, would be an advancing sector. One of the things I often look for is an advancing stock in an advancing market in an advancing sector. I am perfectly happy to take profit out of the middle of a move instead of trying to catch a bottom to buy. Having written that, I should quickly note that I also use technical analysis in an effort to catch a good entry. Just buying a stock because the market, sector, and it are rising does not solve the problem. I also want an entry suggested by technicals that also provides a nearby exit in the event I am mistaken about the direction. As an example, in a bullish market and sector, I might choose a stock that has just broken above the 30 day moving average. Essentially as long as it remains above that moving average it is going my way. A break down through that same moving average would be a signal that the price may be reversing and could well be a reason to exit the position.

In the previous paragraph, I illustrated a way to select a stock based solely on a technical event, i.e., a stock crossing a moving average. In that example, there were no fundamental considerations whatsoever. In some instances, when I want to combine the fundamental with the technical, I might look for a company paying a high dividend that has low debt and a price to book ratio less than 1. In my own trading, though those fundamental factors could generally be considered to be “good,” that would not necessarily be enough to satisfy me that I should buy the stock. What is missing in that scenario is my exit strategy. Although I like those fundamentals, I would still demand a good technical entry and a nearby exit in case the stock price went the wrong way.

These thoughts are just some of the innumerable combinations and permutations a trader might consider when attempting to select a stock. In my view, the planning must come first. What are you seeking in your trade or investment? Are you looking for a company that appears undervalued while paying strong dividends? Do you want something that is optionable? What exit strategy will you use? Have you considered what the upside appears to be and how does that compare to the risk you are taking? A key is to think about what you intend to do before you do it. Have a plan in place. In my first book, "Trade Your Way to Wealth," I devote several pages to the importance of a plan and then devote several more pages to how an individual can create a plan that suits his style, risk tolerance, strategy preference, and account size as well as a number of other significant factors.

by Bill Kraft, Editor
Copyright 2009, Makin' Hay, Inc.
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A Couple of Answers

2009-06-06T08:06:00.001-06:00

This weekend I am going to discuss a couple of topics. The first deals with some trading issues raised by an email from a subscriber to one of the alerts and the second with a suggestion by a blog contributor that I provide some information about the differences between my two books, "Trade Your Way to Wealth" and "Smart Investors Money Machine". I'll provide the information about the books toward the end of the article.

This past week, on one of my subscription services, I sent an alert indicating that I was buying shares of a stock that had been trending up and that had just broken above a resistance. The sector was also trending up. The company was reducing debt and the stock had also recently been upgraded to "outperform." Those were salient facts of which I was aware when I bought the stock in my own account. After market hours, the company announced that it would be paying fairly generous dividends on certain classes of preferred shares. The following morning, the stock price fell. I received a couple of emails from subscribers evidencing concern evidently because I had not immediately pulled the plug as the stock began to fall.

One email labeled the trade as stupid because I bought at a high and failed to wait for a dip. Since I am still in the position as I am writing this article, I can't yet agree or disagree as to how bright or stupid it may have been. I do confess, however, that every trade I make isn't great, and I do have losers on occasion. As I write in the next paragraph, both entry and exit strategy for this trade were in place before entry. The facts of the market are that prices do go up and down and can reverse unexpectedly and on a dime. Until a price reverses down, we can't know what the high actually became. In this situation, I did not know that my entry would prove to be at a near term high until it was followed the next morning by a turn down. The entry could only be said to be at or near a high after the price dropped the following day. I should mention that my entry in the stock in the example was nowhere near the high for the year, but was near a recent short term high.

Actually I do like new highs in many situations, but that was not the reason for my entry in this trade. The specific reason for entry in the example was that the price had broken up through a resistance or ceiling. My exit strategy was to sell if and when the stock broke down through the uptrend line since I am aware that often a stock that breaks resistance may take some time to deal with that level. In both entry and exit, the strategy was controlled by a technical discipline -- i.e. enter on the break above resistance, exit on a break down through the trend. As with any strategy, the one I employed in this situation can result in a loss. Some trades lose; it is that simple. The best way I know to trade is to utilize a discipline that is designed to cut losses and let profits run. That was the idea in the example trade. The loss would be cut when the stock no longer remained in the uptrend, but as long as it was trending up, I would not exit in spite of normal fluctuations in price that do occur every day.

One readily apparent reason for the dip in the stock was the after-hours announcement of dividend payments. Whenever dividends are paid, cash is going out of the company and, theoretically, at least, the value of the company is reduced by the amount of the dividends paid. It is not unusual to see a stock price dip on such announcements only to be followed by another upswing. As long as the stock does not violate my pre-determined exit and remains in a trend in the direction I want, I want to avoid pulling the plug out of panic. All too often, it is panic that motivates action with retail traders and it is a significant enemy.

Some important lessons here, I suggest, are that 1) not all trades win; 2) day to day prices fluctuate, often as a result of unpredictable events; 3) one should have an exit strategy in place and stick to it; 4) trading should not be ruled by panic; and, 5) as traders we need to rely on something other than our emotions in pursuing our trading business.

Thanks to the blogger who asked me to explain the differences between my two books. First, I suspect that the new book, "Smart Investors Money Machine", is designed to and probably does have appeal to a broader audience. "Smart Investors Money Machine" is premised upon the idea that most of us have one major source of income -- our job, but that having more income would definitely be helpful. This book details many ways in which we can add additional sources of income to enhance our finances if we only chose to do so. Using examples of young unmarrieds, growing families, and folks near retirement, I show a wide variety of ways in which almost anyone can add more income each month. I discuss a wide array of devices and methods including (but not limited to) things as diverse as dividend capture, bonds, MLPs, writing covered calls on stock you already own, even reverse mortgages and annuities to show how people can add streams of income and I discuss how much (or how little) effort may be necessary to achieve a better quality of financial life. This is a book that can help nearly anyone, no matter how much or how little time they have and no matter how much or little money they have, to add some income to their lives by having money work for them instead of the other way around.

"Trade Your Way to Wealth", on the other hand, is more focused on people who have an interest in trading. In my view, trading should be treated as a business (whether full time or part time) in order to achieve success. "Trade Your Way to Wealth" sets out critical elements of a trader's business plan and takes the reader through a step-by-step process of how to create a personal business that is specific to his requirements. In "Trade Your Way to Wealth", I then set out at least 15 specific stock and option strategies that can help traders achieve large profits with varying levels of risk. Since I have seen so many traders fail to understand and appreciate the risks they are taking, I try to emphasize the risk in each strategy and show specific methods to reduce and, in some situations, even eliminate risk in trading. In addition to explaining the strategies in detail, I discuss the relative rewards each offers in relation to the risk the trader may undertake. This is a book that is meant to help people from novice to relatively experienced add to their trading knowledge.

by Bill Kraft, Editor
Copyright 2009, Makin' Hay, Inc.
All Rights Reserved

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What Do We Really Want?

2009-05-30T07:50:00.000-06:00

I remember my start in trading more than a decade ago. It began with a book I read that just hooked me. It talked about some amazing returns and exposed me to strategies that previously had been unknown to me; strategies like writing covered calls and buying LEAPS calls and selling naked puts. I suppose it was the amazing returns that first attracted my attention, but it was only after trading a few years that I realized that the returns the author used to illustrate his points were annualized, not annual, returns. He would show a trade that produced a 30% return in a month and then discuss it as an annualized return of 360%. Some of the examples as I recall even referred to annualized returns over 3000%! Definitely, that kind of trading was for me so I embarked upon my career as a trader.

At that time, the market was a roaring bull and the tech bubble was expanding. Quite frankly, it was pretty hard to make a very bad trade as long as I entered a bullish position. Though I felt like I was doing pretty well, I could not get annual returns anywhere near the 1000% mark. My naivety was rapidly crushed when I learned that trades could actually lose as well as win, especially when the market turned over and rocketed downward. At that point I understood that if I intended to continue as a trader I needed to do a few more things: I needed to learn how to trade a down market and I needed to set aside the greed factor as much as possible and figure out what I really was trying to do.

Figuring out what I was trying to do was not quite as easy as it sounds. Obviously, the goal was to make money, but underlying that were questions of what expectations were reasonable, what rewards would I seek, what risks would I be willing to trade off in exchange, and how would I go about it? Later, in talking with many seminar attendees and private coaching students, I learned that most people fail to take those things into consideration at first just as was the case with me. Most jump into trading because they see the marvelous potential, but learn as they go forward that though it may be simple it definitely isn't easy.

One of the questions is whether a trader is in it for the big hit or whether he is willing to play the game steadily, being satisfied with a relatively steady advance. I find that those seeking the big payday only rarely achieve it and often take themselves out of the trading business without ever achieving success through inattention to things like reward to risk awareness and money management flaws.

My personal conclusion, and the decisions are personal to each of us, is to treat the market as I would eat an elephant -- one bite at a time. In other words, my primary focus is on regular, steady production of income and increase of assets through a variety of strategies. My secondary focus to which I devote less time, energy, and money is to seek big hits. Those huge returns do come on occasion, but in my experience they are relatively rare and are not frequent enough to satisfy my financial needs and wants.

It is my sincere belief that almost all of us would be well served to establish a variety of streams of income in addition to our own labors. That is the reason I wrote the material I discuss in my new book, "Smart Investors Money Machine." Most of us have differing abilities and differing requirements, but we share a desire if not a need to increase our assets. Before "Smart Investors Money Machine" was released, some self-anointed critic on the blog suggested that the book was just about diversifying, but he is wrong. While diverse methods to create streams of income are an important part of the book, it goes beyond that concept to illustrate how various methods and strategies can be employed by people at various stages in life and with varying amounts of time to devote. It is designed specifically to show the individual reader how he or she might improve their financial lot using investing and trading methods and devices that work best in their own lives. In other words, "Smart Investors Money Machine" was written to help interested readers decide not only what they really want, but also how to get it.

by Bill Kraft, Editor
Copyright 2009, Makin' Hay, Inc.
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Reaction and Over-reaction

2009-05-23T08:25:00.000-06:00

One seeming constant I have observed over my more than a decade of trading for my living is how the markets tend to react and often over-react to various events and news. Have you noticed, for example, how often a stock price will dip following an earnings announcement even when the announcement is good? Sometimes, we see the price of a stock literally plummet when it misses predicted earnings by a penny or two. What causes these sharp moves?

At least in the shorter term, it is no secret that market movement is a gret deal more psychological than logical. Have you ever attended a home owners' association meeting where the subject may affect property values and seen the raw emotion evidenced by the crowd? How about the audience reaction at a governmental meeting where a zoning change is discussed, or a half-way house is trying to open in a community. Manners and civility are forgotten and a mob mentality prevails. All I need do in one of these articles is take any position regarding something like taxation or social security and the battle is waged. The blog is filled not only with varying opinions but also with vitriolic verbiage. Emotions simply take over and often seem to overshadow reason.

I suggest the same kind of psychology often prevails in response to stock market related events and news. A stock "misses earnings" by a couple of cents and share prices fall $5 or $10. Does that make logical sense? In some cases it may, but in most, it is an over-reaction fueled by fear that the company isn't doing well.

If we take a moment to stop and think about it, what does missing earnings really mean? In general, it simply means that an analyst or a bunch of analysts were wrong in their guess. Truth is, they are often wrong. The same is true about the predictions of economists. They predict so many things including retail sales, unemployment numbers, GNP, inflation, and on and on and, it seems to me are correct about as often as the weather man. Rationally, we know it is impossible to predict these things with complete accuracy, but the irrational, emotional side of us often over-reacts when these predictions (that we know from experience are often mistaken) turn out to be wrong.

Who can predict tomorrow? If I as a trader say I think the market will go up tomorrow and it doesn't, would that be a surprise? Of course, it wouldn't. World events, a war breaking out, a terrorist attack, a company failing unexpectedly, a corporate officer being charged with a crime all could influence the market movement.

As traders, I believe it is important for us to be aware that the markets react and over-react emotionally when a prediction of the unpredictable fails to hit the mark. Though we may rationally conclude that the failure of a prediction should not be unexpected, we can be aware that it nevertheless can result in a market consequence. That awareness can help us gain an edge in our own trades. In short, the knowledgeable can position themselves to take advantage of the over-reactions of the emotional.

Thanks to those of you who have been buying the new book, "Smart Investors Money Machine," and to those of you who have ordered my TradersLibrary.com DVD. I sincerely hope both add to your investment successes.

by Bill Kraft, Editor
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Motivation

2009-05-16T08:34:00.000-06:00

In recent articles, I have touched upon issues relating to the idea of knowing oneself as a trader; the necessity of careful self-analysis. One important area I believe many traders gloss over is the concept of motivation. Obviously, on the most apparent level, we are all motivated by the desire to make a profit, but I suggest it might be prudent to dig a little deeper in recognizing additional factors that may motivate us.

Over the years, particularly in the seminar setting, I have run across a significant number of people who look upon trading as a get rich quick endeavor that requires little effort. While I concede that almost anyone can occasionally land a big return with a lucky play, it is the trader who treats his efforts as a business that is more likely to succeed. Let's face it, we all have some level of greed; it is a part of our humanity. But greed unchecked can be one of the greatest dangers any trader faces. It encourages us to take foolish risks. I have often related the story of a seminar student who began trading very well. He was trading directional options and had several consecutive winners. Each day he would call me reporting on how much he had made but then the phone went dead. I thought he might be vacationing on his profits. After a few weeks I called him only to find that he had lost it all. Instead of managing his money, he, in essence, "bet it all on black." He bought short term out of the money directional options before an earnings announcement and on the announcement (even though it was positive) the stock gapped down and with little time remaining to expiration, he was wiped out.

When I tell people that story, the reaction is "how foolish" that would never happen to me. I'm sure the subject of my anecdote thought exactly the same thing -- that it could never happen to him, but it did. He was, and undoubtedly still is, a very bright man whose greed and impatience sucked him into making one foolish decision with catastrophic results.

Two major premises of my book, "Trade Your Way to Wealth," are the importance of appreciating risk as well as focusing upon reward and the necessity of treating trading as a business. In my view, many unsuccessful traders focus only on the positive possibilities when entering a trade. They fail or refuse to see and understand the risk until it is too late. I suggest it is better to look at the risk first and decide how to handle it before ever entering a position. Sure, losses will be incurred, but we can still be just fine if they are controlled.

A second element often found in our motivation is impatience. We are looking for the quick buck. Those kinds of trades definitely do occur, but I personally prefer the "get rich steady" over the "get rich quick" approach. Please don't get me wrong, getting rich quickly is fine, but, in general, that isn't so likely. In my new book, "Smart Investors Money Machine," I discuss a variety of ways to create numerous streams of income. Most of us need income to pay our bills each month and if we can utilize strategies in addition to a job to add to our income, it seems we can be better off financially. In "Smart Investors Money Machine," I try to show the reader a variety of ways that can be accomplished using different techniques and differing investments while pointing out those that require less effort as well as those that may require a fairly high level of monitoring. These are ways almost anyone can add income to their lives, but which few bother to do.

Ultimately it comes down to motivation. What steps are you willing to take to improve your financial lot?

by Bill Kraft, Editor
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How We Learn

2009-05-09T08:40:00.000-06:00

After last weekend's article, a subscriber wrote an important and thought provoking note on the blog. He indicated that he was unable to learn very well by reading books or watching DVDs and believed the only way he could learn to trade was by actually doing it. I guess the smart alec in me is grateful that this fellow didn't decide to be a pilot, but learning to trade through trading real money may be nearly equally dangerous. What struck me as so important about the posting was that the writer recognized that learning through reading or watching and listening to someone else just did not work well for him. He had learned that he grasps new information most successfully with a hands on approach. I sincerely believe the writer should congratulate himself on understanding where both his strengths and weaknesses lay with regard to learning. Once he achieved that understanding he can embark on a course of education specifically dedicated to his personal learning skills even without putting real cash at risk.

In the seminars I have given and in the coaching sessions I have conducted, it is apparent that each of us learn in different ways. Some may be auditory learners while others are visual and some do best reading a book. Though I probably shouldn't be, I am often amazed at how the "light goes on" for a student when they are first exposed to a chart of price and volume after they had great difficulty in picturing a trend or understanding how they might use Japanese candlesticks to set stops. Most of us seem to learn best using a combination of methods from attending seminars to reading books to watching DVDs to practice trading. Again, most of us seem to have at least an intuitive feel for how we can best study and understand information.

If we really want to commit to becoming better traders, I suspect it is worthwhile for each of us take a little time to focus on how best we learn then formulate a plan by which we can add to our trading knowledge and abilities. If, like our friend, we can only learn by doing, I urgently suggest it not be done by risking real money at first. One can learn a great deal about methods and strategies by paper trading, for example. When we paper trade, we can see how things work and when we might want to enter a position and under what circumstances we might want to exit. We can test strategies and practice adjustments to trades, but we don't have to worry about losing the farm while we practice. Please understand, I advocate paper trading as a way to gain knowledge about trading and about ourselves. It is not the same as trading real money. When we do put real money on the line, our emotions will be much different than they are with a paper trade and at that point we may have reached the point where we have no choice but to learn by actually doing and, perhaps, using a coach to help us through some of the emotionally driven issues we may face when real money is at risk.

If you learn well by reading, you may want to check out "Trade Your Way to Wealth" or my new book, "Smart Investors Money Machine." If you like to learn using videos, you might want to take a look at the DVD that was made of my presentation in Chicago before a live audience for Traders Library that is about to be released. Of course, while I'd love to see you get my books or DVDs, there are a number of great tools available beyond what I have done. Dr. Alexander Elder's "Trading for a Living" is an excellent book for those who want reading material as is Charles Kirkpatrick and Julie Dahlquist's "Technical Analysis." Many brokerages offer free webinars to those who prefer a visual presentation, and seminar companies abound. Trading software companies also often put on presentations and I have found it is quite worthwhile to attend seminars put on at events like Traders Expo.

Most of us can improve only with study and practice. Trading education generally must be self-directed since few institutions yet offer courses and even if they did, I'm not too sure that I'd want a purely academic approach in any event. As has long been my mantra in this area, if you really want to be a good trader I believe commitment to study and practice are essential.

by Bill Kraft, Editor
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What Are You Willing to Do to Become a Successful Trader?

2009-05-02T08:49:00.000-06:00

Over the last couple of weeks, I have written about taking personal inventory and making the evaluations necessary to choose where you want to be as a trader. In this article, I would like to invite your attention to what you may or may not be willing to do to become a successful trader. Trading can be done successfully on a part time or on a full time basis, but it is critical to understand it is a serious business. Anyone who trades their own money is putting it at risk.

If I am going to put my money at risk, it seems to me that the question then becomes what am I willing to do to try to make the risk worthwhile. Beyond all else, I would suggest that a real commitment is necessary. The trader who wants to succeed must first commit to his trading as a business. InvestorWords.com defines "business" as: "A commercial activity engaged in as a means of livelihood or profit, or an entity which engages in such activities." Clearly, that is what the trader is attempting to do and his activities should be treated as he would any other business.

First, I would suggest that the trader commit time to the operation of his business and next he should carefully formulate a business plan specific to his own goals, needs, and current abilities understanding that the plan can be expected to evolve as he does as a trader. In my book, "Trade Your Way to Wealth," I have set out elements of a business plan and discussed how a trader might construct his personal plan. Rarely does a business succeed without a plan and trading is no exception.

Next, I would suggest that the trader commit himself to learning his business. Trading can be simple and it can be fun, but at the same time it requires effort and knowledge. Trading knowledge is not necessarily easy to procure. Most successful traders have undertaken to educate themselves. They read extensively, attend seminars, watch DVDs, obtain coaching and are willing to pay what it costs in terms of their time, effort, and money. Failure to take at least some of those steps can result in a very expensive learning experience.

The trader must achieve an understanding of the strategies he is using and particularly of the risks attendant to the strategy. He must formulate an exit strategy for every trade and, in my view, that is best done before the trade is ever entered. He must become acutely self-aware and exercise extreme discipline. He must understand that many trades may result in losses and that most of the profits result from as little as 3% of his trades. He would be wise to keep careful records and a journal of trades to which he refers regularly to keep himself on track and assure that he is following his plan.

Focus, commitment, and discipline are key ingredients to successful trading. Without them, the trader is not giving himself the best chance to achieve his goals. As I have written before, money management, risk awareness, exit strategy, and discipline are requirements and though each may be relatively simple to understand intellectually, they are not necessarily easy to put into practice when confronting a fast moving market.

If you are willing to create a business plan, exercise stern discipline over your trades, plan each trade, learn how to cut losses and equally importantly let profits run, and have a money management plan, you are giving yourself a chance. As with so many things, it is in your hands. Your level of commitment will go far in determining how you fare.

This is a business and it can be very rewarding, but it requires work, study, and practice. It may be simple (buy low, sell high), but that does not mean it is easy. As I suggested in the first of this series of articles, it is helpful to take a self-inventory. See where you have been, carefully consider where you want your trading to take you and finally have a serious discussion with yourself to decide whether you are willing to commit to becoming a good trader or whether something else is for you.

by Bill Kraft, Editor
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Where Would You Like Your Trading to Go?

2009-04-25T07:54:00.001-06:00

In the article last weekend, I suggested some serious introspection and self-evaluation to determine how you were doing with your trading. To me that means going well beyond whether I am making a profit or loss. It means I need to understand how I behaved in a trade to determine what influence my action or inaction had on the ultimate outcome of the trade. Obviously, I can't control a market and I can't make a stock do what I want it to do, but I can act to do things like cut losses by placing stop loss orders or by buying protective puts and I can decide not to pull the plug when something is still going my way. Recognition of how I acted and reacted can profoundly affect my future trading as can failure to understand why I've acted in certain ways.

There are probably as many answers to the question "where would you like your trading to go" as there are people answering the question. Certainly everyone would like to see their trading be profitable and most, at least, would like their trading to be safe. But answers will begin to differ when we ask: how profitable? or how safe? Are we satisfied if we make 1% in a year or do we need to make 15% or 50% to be satisfied. What is safety in a trade, and what reward can we reasonably expect relative to the "safety" we want?

Recently, a coaching student wrote reminding that most people seek high rewards, safety, and liquidity. Unfortunately, though we may find two out of three in a trade, it would be exceedingly rare to find all three in one specific investment. From the outset it is important to recognize that almost all trades and all trading involves compromise of one sort or another. For example, often when looking for a large reward we may need to take on high risk. Conversely if we set up a trade that is relatively safe, we may find that we may need to limit the potential reward to achieve the safety.

As each of us decides where we want our trading to go, we must both understand and make compromises that can lead us to the results we seek. In next weekend's article, I'll discuss some of the things I believe are essential for a trader to do in order to achieve success. For now, however, the first step is to decide where you want your trading to go. Is it to be a gambling venture where you buy a stock that someone mentioned at a cocktail party with the hope it will go up or do you want it to be your full time occupation? Do you want your trading to provide a regular stream of income as I discuss in my new book "Smart Investors Money Machine," or is it sufficient to dabble occasionally with the hope of snatching a profit here and there?

All the choices are yours. I only suggest that you not be too cavalier in deciding your approach to your trading. Trading can offer very significant possibilities to enhance financial success and it can leave you broke. Either of these possibilities carry serious consequences deserving of careful consideration. Those who may be unlearned or unsophisticated in trading may believe that I have put too much emphasis on this self-analysis, but I am confident that self-knowledge is an absolute necessity for anyone who intends to achieve regular success in the markets. We are often our own worst enemies in entering and exiting our trades. If we start with a specific understanding of where we want our trading to go, I believe we have a good beginning. If we don't have that specific understanding, it might be good to go back to square one and make the effort to understand ourselves and what we are willing to do to become better traders.

by Bill Kraft, Editor
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What Have You Been Doing?

2009-04-18T08:46:00.001-06:00

This article is the first in a series of three where I will raise the questions of where have you been with your trading, where would you like to be, and what are you willing to do to become a better trader.

In recent articles, we have looked at some issues relating to risk and to some of the psychological factors involved in trading. We have seen a market that crashed and we have seen a sharp rally. I find it interesting that I was receiving quite a large number of inquiries about my coaching sessions as the market was falling, but not nearly as many during the rise. The calls were often from prospective new clients who reported large losses and were looking for ways to stop the bleeding and to attempt to regain lost ground. Sadly, steep losses had already occurred before help was sought. It seems clear that less help is sought as markets move up, but one wonders whether that is a symptom of the old condition of confusing brains with a bull market.

The fact that we have seen an upturn in the market following the March lows certainly does not mean that it can't turn back down. The question is whether the trader knows how to protect himself in the event of another decline or whether he has already forgotten his recent pain. Hopefully, it is the former and the trader has taken steps to understand ways to cut losses, hedge positions, or even insure a portfolio.

No matter who we may be or where we are in our trading, I would suggest it is a valuable exercise to take a personal inventory about our approach to trading and make an evaluation of how well or poorly it has served us. Some of the folks to whom I have spoken told me that they just threw away their account statements unopened because they knew they would be bad. While I can sympathize with their feelings, I don't see how this "ostrich approach" can be helpful. In a sharply declining market, that approach does nothing to cut losses nor does it assist in learning ways to profit from downward moves. Others have simply pulled out of the market either because they have abandoned hope or to cut losses and await the next bullish move. Finally, a small few have had great success.

Now is as good a time as any to recognize where you fall on the spectrum of trading. Did you throw away your statements or did you have exit strategies in place that saved the bacon? Did you know what to do and when to do it or did you just hang on for dear life hoping "it'll come back?" At this point, whatever you did or didn't do can teach important lessons for the future.

Self-evaluation may help avoid costly errors in the future and may help even the most successful improve their trading. I would suggest that each of us look at positions we have entered and/or exited in the last year and a half and try to recognize why we entered a play, ascertain whether we had planned the trade before we entered it and if so whether we followed our plan, and determine what strategy were we attempting to use and ask ourselves whether we actually followed through with our strategy. Did we succumb to the "little voice in our heads" saying something like: "I'll just let it go down another 50 cents before I get out." Did we get out then or did we let it go even farther down? We need to analyze why we made those decisions. Was it a fear of losing? Did we give up because we just didn't know what to do? Did we stay in positions because we consider ourselves to be buy and hold investors? Precisely what led to our decisions or indecisions.

In trading, as in many things in life, it is important in determining where we are going to know where we have been and what influenced or controlled our decisions. The introspection can be extremely helpful in heading us or keeping us in the right direction. If I can understand my behavior with respect to a trade or to my trading in general, I am armed with ammunition that can help me become better than I have been in the past. Failure to come to such an understanding can easily result in repeating the same performance. As has been said, "The definition of insanity is repeating the same thing over and over and expecting a different result."

by Bill Kraft, Editor
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An Impediment to Profitable Trading

2009-04-11T09:00:00.001-06:00

When we trade the markets, we have many hurdles to overcome if we are ultimately to be successful. Underlying all trades, for example, is the necessity to have knowledge. We need to know what we are doing and we need to know the specific risk(s) we are assuming. We need to understand the strategy we are employing and we should have an exit strategy. We are well served when we have a plan for our trade and utilize a money management system. All those factors can help us achieve an edge in our trading that can lead us where we want to go.

One of the most critical elements, however, is one that traders often ignore and that is our own psychological trading profile. I am convinced that certain of our individual psychological traits are the greatest impediments to success that we face. Long ago, a trader came to me seeking help. He had lost a great deal of money when the tech bubble burst and the market turned over in the early part of this decade. He had a fair amount of money and no job and wanted to get back to trading for his living. When I met with him, I learned that he had no specific business or trading plan so I began to go through the elements of a basic trading plan as I later set them out in "Trade Your Way to Wealth".

When we came to the section where he would set his trading hours, he absolutely refused to set hours. I prodded him by suggesting that if he were to open any other business he would likely have hours, but he persistently refused, creating one excuse after another as to why he could not set the hours he would devote. I reminded him that his plan is always a work in progress so once set he could always make a change. Even that didn't help convince him to include hours in his plan. His resistance was adamant and seemed irrational to me. Suddenly it occurred to me that refusal to complete the plan may be a way for him to avoid trading altogether so I changed gears.

I asked this fellow whether buying stock was a strategy he believed he understood well and he agreed it was. At the time of our meeting, the market was bullish so I suggested we find a stock that looked ripe for an entry and that had a nearby exit in the event it turned down. In a short time we found a candidate that we both agreed looked bullish and that might afford a good entry. I asked the student how much money he had in his account and learned it was in the mid six figures. The stock we found was trading for around $30 a share. I suggested he buy one (1) share. Immediately he refused, he literally began to shake and offered many reasons why he needed to do further research before committing. I pointed out that even if we were wrong on direction and the company immediately announced a bankruptcy after he bought the share he would lose only $30 and the commission. Tears filled his eyes as he claimed a need to do more research, gain more knowledge about the fundamentals, and await confirmation.

He never made the trade. Undoubtedly this situation illustrates an extreme case, but it does illustrate a psychological barrier that absolutely prevented this fellow from becoming a successful trader. He is a poster-child example of how perfectionism (in his case resulting from fear) can stifle good trading. Perfectionism in trading can lead to paralysis of analysis. The perfectionist seeks every bit of information he can possibly find and then seeks confirmation of the information. Meanwhile, he is likely to miss the trade. He is so interested in being right that he fails to pull the trigger until after the target is gone.

One of the problems with the perfectionist approach is that it fails to recognize that even once as much information is gathered as is humanly possible there is still no guarantee that it will remain the same the moment after the trade is entered. Perfectionism does not guarantee the trade even though the perfectionist may, indeed, be seeking the perfect trade. A perfectionist generally does what he does to insure complete safety, but in reality there is no such thing.

Many years have passed and the fellow about whom I wrote in the anecdote above continues to try to create a perfect algorithm to find the perfect trade. Unless we can perfectly predict the future there can be no such algorithm. Unexpected attacks occur; cataclysmic natural events occur; fundamentals can turn on a dime -- any of those kinds of things can and do alter predicted outcomes.

Those who are perfectionists can help themselves in their trading, I believe, if they are aware of the trait and temper it with the knowledge that no matter how hard they try, complete safety cannot be achieved. Learn to make reasonable efforts, understand that all cannot be known and even if all current facts are known it does not guarantee the next moment. Try not to let the trade get away, but realize that it will have risk. Work to manage the risk.

by Bill Kraft, Editor
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How Can a Trader Make Market Cliches Work?

2009-04-04T08:18:00.000-06:00

One of the many enjoyable things for me in learning about and trading the markets is the variety of colorful cliches that point out some little piece of wisdom (mostly) or other. "You can't go broke makin' a profit," for example, can remind us that it may be a better idea to take profits at some time before they turn into losses. But how does that fit with "cut your losses and let your profits run?" The key in both instances seems to me to be the undefined "when" that signals the time to take the profits. Even if we can't go broke makin' a profit, it is certainly better to let those profits run as long as they actually are becoming increasingly profitable.

In my dealings with coaching students and with other traders, I have seen that traders may learn relatively quickly to cut losses, but have a little more trouble letting profits run. There also seems to be a tendency to take profits relatively quickly as well. Naturally, if that is what we are doing, we can't go broke -- UNLESS our losses outweigh the profits. Both the sayings are important in that they invite our attention to what we should be doing. The how and the when are what deserve our study.

As with many things in trading, there are a number of ways to achieve the goals of not going broke, cutting our losses, and letting our profits run. Unfortunately, it is too often the case that the trader listens to the little voice in his head (the emotions) to make trading decisions. I have seen that the voice in the head method regularly can lead to cutting profits and letting losses run. It seems clear to me that something else is needed. The key here is discipline and one way to establish discipline is to use a line on a chart. For example, if we take any chart of the movement of a stock price and overlay a moving average we can visualize a disciplined entry and exit strategy. Suppose we choose a 20 day exponential moving average and we decide that we will enter a bullish position when the price crosses above the moving average and that we will exit when the price crosses below the moving average. Now we have a simple discipline. Does it work? Take a look at any chart with a moving average overlaid yourself and you will see that the method catches many nice uptrends and if you also play bearish many nice downtrends. In between, you may also see several areas where you would be whipsawed in and out of a trade incurring, perhaps, a number of commissions. One weakness of the methodology is the risk of whipsaws while a strength is that the method keeps us in the game while the position continues in the favorable direction. In any event, you can get an idea of how such a technical discipline using a moving average may be more helpful than the voice in the head method.

Actually, moving averages are forms of trend lines. We can also draw lines depicting the trends ourselves and use them in similar fashion to enter and exit positions. By learning to utilize devices such as these we may be able to enjoy the benefits of another old market cliche, to wit: "the trend is your friend." Simply put, if we can find a trend we may be able to jump on and ride it until it is broken. That, at least, may be one way to let our profits run.

I suppose we can improve our trading when we come upon some of these cliches by giving them some thought instead of just letting them go by. There is wisdom in many of them if we can find a way to accomplish what they suggest. Perhaps the most important one of all to remember as we trade may be: "Bulls make money, bears make money, but hogs get slaughtered."

by Bill Kraft, Editor
Copyright 2009, Makin' Hay, Inc.
All Rights Reserved

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The Issue of Safety

2009-03-28T09:03:00.000-06:00

Last weekend I wrote a little about what I consider to be the importance of establishing streams of income. I included the statement: "I believe that creation of diverse streams of income can be a critical element in assuring financial comfort." One anonymous blogger apparently mentally added the word "safe" to my statement when he (or she?) wrote: "Safe income streams that should be part of every ones portfolio has now become a myth exactly like the buy and hold strategy. That strategy has really been a myth for as long as I can remember. Not even the safest of all investments, Money Market funds, are immune to loss."

No one, least of all I, suggested that any specific income stream was completely safe. In fact, as far as I can tell, nothing in this world is safe. Breathing can be dangerous depending upon what is in the air we breathe; looking both ways when we cross the street doesn't absolutely insure that we won't get run over; putting helmets on our kids when they are engaging in activities may reduce the likelihood, but it doesn't prevent head injuries. Risk is everywhere and it is certainly present in trading and investing. I wrote "Trade Your Way to Wealth," in part, at least to show readers where the risk is and ways to reduce or manage risk in their investments.

In my new book, "Smart Investors Money Machine," I demonstrate a wide variety of ways we can create streams of income, but I also try to discuss risks associated with each strategy. In my view, one of the important ingredients in successful investing is knowledge of and management of risk. If the anonymous blogger was under the impression that I think simple diversification makes for safety, I failed to make myself clear. Diverse streams of income, like the helmet on a child, may reduce risk, but they do not remove it. Nothing removes all risk.

Recently a neighbor asked for some coaching as he was re-entering the investment world. He told me he wanted something safe with a very high income flow. I said I thought that is probably what everyone wants, but the combination is very difficult, if not impossible, to find. As a generality, the higher the potential reward the higher the potential risk and vice versa. Only by gaining knowledge can we make decisions and implement plans that help us manage the risk no matter what we are doing.

by Bill Kraft, Editor
Copyright 2009, Makin' Hay, Inc.
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Investment Philosophies

2009-03-21T08:38:00.000-06:00

The classic investment philosophy taught to preceding generations has been "buy and hold." There is little question that "buy and hold" worked well over long periods of time and those who bought stocks and held them for 20, 30, or 40 years often had a decent gain, even after inflation. Today, however, we might be hard pressed to convince a 60-year old who has just seen his 401(k) or other portfolio drop by 40% or 50% in the past year that buy and hold is the way to go. Undoubtedly, someone will say just hang on, it will come back, but the fact is it won't if the investments were in Washington Mutual, or Bear Stearns, or Lehman Brothers, or the like. That money is gone forever and many times with it the quality of a retirement.

I don't mean to say that I am completely against the buy and hold approach to investing as long as the investor has an answer to the question: Hold until when? I personally use a technical approach as the trigger to exit a position, but whatever an investor is going to use as an exit strategy, I believe anything is better than hold until I die. Unfortunately those brokers who have sold the public on the buy and hold strategy rarely include any strategy to get out when things turn south -- and at some times, the markets always do turn south.

Among my objections to buy and hold are the possibilities that a stock can go to zero, that an investor may have an important need for his money at a time (like now) when stocks are depressed, that a drop of 50% means a position must move back up 100% just to get back to even (and that doesn't usually happen very fast), and that the investor who holds until death may never enjoy the qualities of life that any gains may help provide (though his heirs probably will).

Having lived long enough to watch a lot of people live their lives, I am convinced that more folks need additional streams of income so they can pay their bills each month than need to have buy and hold positions that may or may not show great gains at some time in the future when the money is needed. If we just look at someone today who is about to retire and who had relied upon investments in a 401(k) to get him through his retirement years we can easily see how he would be better off having created additional streams of income instead of having been resigned to a buy and hold investment. Social Security may provide a stream, but we know that at the very best it can provide only a small portion of the solution for the new retiree whose investments in both equities and real estate have been devastated.

My personal investment philosophy does have a place for a modified buy and hold strategy. The modification is that I have an exit plan when the market begins a move against me. Perhaps even more importantly, however, I believe that creation of diverse streams of income from different sources can be a critical element in assuring financial comfort. My new book, "Smart Investors Money Machine" (Wiley & Sons 2009), that is scheduled for release shortly addresses many of the ways almost any of us can create these streams of income with just a little effort. Most of us need money now, at the end of the month, so we can pay our bills, but few of us have streams of income besides our jobs to enable us to pay those bills. The fact is, as I demonstrate in "Smart Investors Money Machine," that there are many ways we can create added streams of income that bring in regular cash without a great deal of time and effort. Generally the most time and effort required to add these streams of income is expended in learning what to do and how to do it. As I explain in the book, the methods can be relatively easy to learn and can be very rewarding in terms of enhanced lifestyle and permitting more time for the things we enjoy.

Bottom line for me is that I'd much prefer enjoying a number of income streams than agonizing over losses in a 401(k). Who wouldn't? The fact is, that nearly everyone can add streams of income in their lives once they have the know-how.

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Catching a Falling Knife?

2009-03-14T13:44:00.001-06:00

Trying to pick a bottom on a falling stock or index can be a very difficult proposition and, in the trading business, has been likened to trying to catch a falling knife. Last Tuesday, when the Dow rocketed up almost 380 points, there was a lot of excitement and speculation about whether we had finally seen a bottom. Much of that particular move was evidently sparked by an announcement that Citigroup (C) had made a profit for the first two months of the year. The fact that a company has made a profit, particularly after major government intervention, is great, but one has to wonder whether it is earth shaking news. Often, the markets exhibit a tendency to overreact to a news event and though the news was certainly a positive in a market that has been filled with negatives one has to wonder whether the big spike was an overreaction or the start of a reversal.

In my individual coaching sessions, I always suggest that my students try to trade in the direction that gives them an edge. If the market, sector, and stock are all going down, for example, why take a long position? Who or what is to say that it is going to turn up and even if we say it is going to turn up, the question becomes when will it do that? Couldn't the stock just keep going down? Recent history has, once again, taught us that zero is truly a level to which some equities can descend.

While it may be very tempting to jump on board when prices are at such low levels as they have been lately (e.g. GM at $1.50, GE under $8), we need to remember that there is still room below. When markets, sectors and stocks are bearish, my view is that it is best to make bearish plays or simply stand aside. Wait for the actual bullish turn rather than trying to predict. As I suggested in a recent article, no one can predict with certainty. If we think we can, we just need ask ourselves what will the news be tomorrow.

The Dow has been in a downtrend since the latter part of 2007 and it will remain in that downtrend unless and until it breaks up through the downtrend line. The same is true for the Nasdaq Composite and the S&P 500. That is not to say that there cannot be rallies in a bear market, but they are exactly that -- bear market rallies. They are to be expected, but it remains important that we understand the difference between a rally within a bear market and a break in the downtrend that actually can signal a return to the bull. Otherwise, we may find ourselves trying to catch that falling knife (or piano).

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What Does It Look Like

2009-03-07T08:02:00.001-07:00

Perhaps the second most frequent question I am asked (right after how do I find a stock) is what do I think the market is going to do. When I answer, I want to avoid rudeness yet the simple fact is that whatever I may think the market is going to do is completely irrelevant at least in the sense that the market simply does not care what I think. If I think it is going up, that doesn't mean it will go up and if I think it will go down, it doesn't mean it will go down. Of course, the phenomenon doesn't apply just to me. It applies across the board. I am fascinated by how often I hear diametrically opposed opinions from various talking heads on the TV stock market shows. Their opinions may make for wonderful entertainment, but they should not be relied upon as trading gospel. It is not unusual for one prognosticator to predict a specific stock is set to move up while 15 minutes later an equally credentialed guru is adamant that it will move in the opposite direction.

Years ago, I remember an exercise on a TV show where a chimpanzee picked stocks against an analyst and actually did marginally better. Is all this to say that success in trading is luck alone? Certainly not. There are a number of principles that can lead to success even when what we may think might happen doesn't. As an example, take the old saw: "the trend is your friend." Anyone who traded based upon that adage and made bearish plays since the latter part of 2007 probably did quite well. Anyone who traded and didn't pay attention to the market direction probably has suffered significant losses.

I am primarily a technical trader so I rely upon what I am seeing the market do. Part of my plan is to try to trade the direction of the market, the sector, and/or the stock. I do not pay as much attention to fundamentals as many investors might since I have learned that simply because it is a good company does not necessarily mean it is a good stock. General Electric (GE) may be a great company, for example, but its stock has fallen from $60 in 2000 to under $7 in March of 2009. I don't mean to suggest that there aren't fundamental reasons for the dive -- there are. What I mean to say is that I can look at a chart of GE and see how it broke below major support (what used to be a floor) back in early 2008 and signaled a time to get out to technical traders. Could I have been wrong? Of course, but if I followed the signal and got out I could always have gotten back in if it broke back up through resistance (the new ceiling).

The point of the last paragraph is that traders and investors need discipline and self-imposed discipline is very difficult without some device to guide us. I use lines on a chart. I don't contend they are perfect because they aren't, but they definitely work better than that little voice in my head that may say hold on a little longer, it will come back.

Predicting is a highly improbable road to success in trading and investing as so many have found out in these difficult times. Discipline, money management, exit strategy, a trading plan, and the acquisition of knowledge are much more likely to lead to success.

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Priorities in Trading

2009-02-28T08:05:00.001-07:00

In the years that I have been trading, teaching trading, and writing about trading, probably the question I am most frequently asked is how do I find what stock to trade. While that obviously can be quite important, there are a number of other factors that, to my mind, are at least as important. As anyone who has undergone private coaching with me will tell you, there is much greater emphasis on formulating an overall plan, formulating a plan for a specific trade, money management, reward to risk analysis, exit strategy, and discipline. Even if we aren't a particularly great stock picker, those other elements can serve to save the day and make a trader profitable if used properly.

In my book, "Trade Your Way to Wealth," for example, I go over those elements in some detail, and emphasize the importance of risk awareness and risk management. Shortly, my new book, "Smart Investors Money Machine," will be released, and in it I emphasize the need to create multiple streams of income and discuss quite a number of ways to do just that. Some individuals have suggested that my approach may not lead to fast wealth. I won't dispute that although I will say that some of the strategies I use and about which I write definitely can and do lead to wealth when used appropriately. I am a firm believer, however, that first we need to look to protect capital. There are many ways to do that, but I fear that most retail traders fail to make that a top priority.

Sadly, many of the calls I get inquiring about coaching are from people who have already lost large sums and are looking for ways to stop the bleeding. While "better late than never" is certainly apropos, I earnestly suggest that traders and investors make it an early priority to gain the knowledge of how to protect against catastrophic loss and how to minimize losses in their trading before heading off to put their money at risk. I don't mean you have to call me or hire me for coaching. There is plenty of information available on the internet, in books, and in DVDs that will help in that regard.

So many of us jump in with the hope and expectation of accumulating riches only to have our dreams dashed because we forget that trades can lose as well as win. We have no plan or strategy to protect us if things go the wrong way. We fail to employ a discipline or realize that we must expect that a fair number of trades are going to go the other way. What we need to understand is that we can still make money even when a significant number of trades are losers as long as we pay attention to important things like money management and reward to risk ratios.

I have often said, and I'll say it again, what we need to do to succeed is take our eye off the money and concentrate on making good trades. A good trade can actually lose money if we have followed our plan, employed a reasonable reward to risk ratio, and followed a pre-determined exit strategy to cut losses. A trade that makes money can actually be a not-so-good trade if we fail to follow our plan and cut our profits prematurely because we didn't utilize discipline, but rather followed our emotions.

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How Long Will My Trade Be?

2009-02-21T08:59:00.000-07:00

Recently, a subscriber to the Option Trader service wrote to ask why I bought LEAPS (that expire a year to three years out) when I only planned to be in a trade from 1 to 3 months. That is definitely a great question that raises what I consider to be some very important issues about all trading, whether stock or options.

The first answer with regard to my own trading is that I do not employ an exit strategy based upon how long I plan to be in a trade. In other words, when I enter a position, the length of time is not going to be the reason for my exit (unless, of course, it is an option that expires). I try to remain in a position depending upon the price behavior of the stock. Why, for example, would I want to exit a bullish position when the stock is continuing to move up? That action would serve to cut my profits and that is something I want to avoid. Similarly, if a position turns against me, I want to get out. I want to cut my losses and let my profits run.

Unfortunately, and all too often, investors have no exit strategy. Witness so many in the most recent bear market who have seen their portfolios drop 40% or 50% or more. Many times they remain in positions because they are "investing for the long term." Sadly, that has not worked for those holding stock in companies like Enron, Lehman Brothers, Bear Stearns, or Washington Mutual. An exit strategy that is only defined by time can result in some very serious losses.

Instead of defining my exit strategy solely by time, I try to use a specific discipline that I pre-determine before I enter the trade. I might use a break through a moving average or a break through a trend or the crossover of two moving averages. The choice can vary from play to play, but it is based on some discipline other than the passage of time.

Specifically relating to the subscribers question, when I buy call options, I buy a lot of time. Generally, if I remain in the position it is either because the stock price is continuing to move up or because I want to use the position as an underlying against which I can bring in income by selling other options. Additionally, buying long term options or LEAPS (technically Long Term Equity Anticipation Securities) the time decay portion of the premium initially does not run against me as quickly and I often can find a better delta than I would at the same strike price with a nearer term expiration.

I would add one thought and that is some successful traders do use a time stop to exit positions quickly if the play does not begin to run in their favor relatively quickly. For example, even if I were using a price support as an exit, I may have decided in advance to exit my position if the stock doesn't move my way within 2 or 3 days.

Bottom line, for me, is to let the stock price movement make the decision for me when to get out rather than to use a purely time-based exit.

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Keeping Records

2009-02-14T10:28:00.000-07:00

One often neglected part of trading is record keeping. Active traders probably know that the IRS requires us to file a Schedule D-1 with our tax returns detailing both short term and long term capital gains and losses and including the date acquired, the date sold, the cost or other basis, the sales price and the gain or loss. When I began trading many years ago, I was unaware of the need for this schedule and wound up spending several days going through confirmations of literally hundreds of option trades to fulfill the requirement. Now, of course, things are easier and we have programs like Excel and services like Gainskeeper that can take a great deal of the drudge work out of the process.

Putting aside the important implications of record keeping for tax returns, I also believe it is critically important and incredibly helpful to keep careful records of our own relating to our trades. I have become a serious believer in the value of some form of comprehensive trading journal or diary. The journal can be kept in many different forms such as notes made within a charting program, in a brokerage account site where available, or on individual pages devoted to specific trades. How it is done is a matter of personal preference, but whether it is done should not be an issue.

Amazingly I have witnessed some traders who had great difficulty going through sloppy records just trying to ascertain what positions they held. Little wonder that they were not successful. If we are going to become better traders, we must be attentive to what we are doing, have a plan and follow it. How can we analyze our mistakes and avoid repeating them if we don't have some way to evaluate what we have done and are doing?

In addition to recording what we are trading, before we even enter the trade, I think it is helpful to set out the reason for that entry into a position, the reason we are choosing a particular strategy (e.g. why are we buying the stock as opposed to buying a call or selling a naked put), the size of the position, how we assess the reward to risk at entry, and our exit strategy. At the conclusion of the trade, it seems equally important to record how we did. Did we follow our original exit strategy, for example, and if not, why not. Did we cut losses as intended? Did we let profits run? What gain or loss did we experience and how did that fit in our money management plan? In some fashion, we may even want to give the trade a grade like those we got in school.

Does all that seem like a lot of work? It really isn't, particularly if we take a step back and realize that trading and investing is a business unto itself even if we are not doing it full time. It is our money we are talking about here and I, at least, believe it is worth the effort to pay attention to what we are doing with it.

I am primarily a technical trader and use the discipline provided by things like moving averages, trend lines, MACD crossovers and the like so I use the chart as the underpinning for my own journal. When I enter a trade, I make a copy of the chart as it exists at the time of my entry and note on the chart what I did, why I did it, and my exit strategy. I then place that page in a 3 ring binder so it is facing like the left-hand page of a book. When the trade has been completed, I make a copy of the chart at that time and note on the copy how it closed and the profit or loss realized. I then put that page as a right-hand page in the 3 ring binder and review the two pages side by side to see how well I followed my plan and how well it worked and so I can grade myself. In this fashion, it is fairly easy to see mistakes so that I can attempt to avoid them in the future.

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Avoiding Impulse Trades

2009-02-07T08:48:00.000-07:00

Last weekend, the Newsletter article began with the following paragraph:

"When we trade we need to make many decisions. What stock will I choose? What strategy will I use? When will I enter? Am I bullish or bearish? What is my exit strategy? Will I set a stop to buy? Will I set a stop loss once I have entered? What reward to risk do I seek to attain with the trade? Will I bother to create a trading plan? These are just a few of the decisions we must make as traders."

I then went on to explain how important I believe it is to make decisions and how difficult it is for so many to make those decisions themselves. Somehow, at least one subscriber interpreted the article to suggest that I was advocating making trades on impulse. Exactly the opposite is true and I thought I better write this weekend's article to clarify my thoughts just in case any other subscribers may have reached the same mistaken conclusions.

Each of the elements in the quoted paragraph require a decision. We specifically should decide what stock we choose, if any. Part of that specific decision will be based upon whether we are bullish or bearish. If we are bearish, for example, we may just decide to stay in cash or choose an ETF (Exchange Traded Fund) or option strategy to play the downside. We then would want to decide on an entry point and an exit strategy. After all, the trade is not over until the exit and that exit strategy, in my view, needs to incorporate both a way to cut losses and a way to let profits run. These are decisions that should be made in advance of entry into any trade. We may then decide to implement the decision using a stop loss order or a trailing stop loss or an alert that is sent us once a specific price is reached. Deciding on a specific minimum reward to risk ratio before ever making a trade can make the difference between being a winner overall or a loser.

Anyone who has read my book, "Trade Your Way to Wealth," has seen that my philosophy is definitely NOT to trade on impulse, but rather to create a plan that is specific to each individual trader or investor. In the book, I set out elements I believe should be incorporated into each traders plan and discuss how a trader might decide to implement those specific elements. Trading without a plan is often the equivalent of trading by impulse and sets the trader or investor up for failure. So there is no mistake and in order to be crystal clear, I absolutely believe a trading plan is essential. Creation of a plan requires that the investor make decisions and it is that decision making process that I discussed last weekend. The decisions should not be made on impulse, but rather with careful consideration, but they should be made. Again, as I discuss in my book, I believe all trading decisions should be made out of the heat of battle and at a time when emotions are not ruling the decision making process. Only in that way, I would suggest, can we avoid making trades on impulse.

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Decision Making

2009-01-31T07:56:00.000-07:00

When we trade we need to make many decisions. What stock will I choose? What strategy will I use? When will I enter? Am I bullish or bearish? What is my exit strategy? Will I set a stop to buy? Will I set a stop loss once I have entered? What reward to risk do I seek to attain with the trade? Will I bother to create a trading plan? These are just a few of the decisions we must make as traders.

As I have often said and occasionally written, one of the best pieces of advice I ever got was from a colleague regarding decision making. We were talking about the difficulty so many people have making decisions and my friend said that it is often more important to make the decision than what the decision actually is. "Naturally," he said, "the decision may be wrong, but then all we have to do is make another decision and fix it." So often, I have seen traders (and other people) absolutely agonize over making a decision. They try to gather every fact relevant to the decision and then worry over it for prolonged lengths of time only to find once they have finally made the decision that some fact changes immediately after they have decided and it makes the decision wrong or inappropriate.

Should I buy XYZ? It was going up, but it just took a dip. Earnings have been good, but the next earnings are set to be released in a month. I like the CEO, but there is a rumor he might be leaving. Their product is super, but rumor has it that the ABC company might be releasing an improved product in the next six months. There is almost always a "but" in any analysis we make. We simply can't know what a stock or the market will do tomorrow.

The only time we can make a decision is now. As Dr. Ari Kiev wrote in "Trading to Win" (John Wiley & Sons, 1998), "Waiting for the right answer before you act is a trap. You may think you are doing something when you are deciding on the right way to go or the right path to follow, when in fact you actually are mired in your own thinking. The issue is to choose or not to choose, not choose the right answer."

If we buy a stock, for example, we can be right or wrong. The issue for us is to decide what to do when we see we are wrong or when we see we have been right. In my view, that is what an exit strategy is all about. If we are wrong, we should get out, that is what cutting losses is all about. If we are right, we should stay in until the play turns against us. That is how we let profits run. In either event, we need to make the decision now.

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