Connors’ Weekly Battle Plan

Well, I survived the weekend of player assessments for my daughter’s softball
league and then on Labor Day, I got the chance to draft my team. For those of
you who have managed a team before, you know that drafting the kids is obviously
important. But there’s one thing even more important: Drafting the parents! I
want to win as bad as anybody, but I sure as hell don’t want to deal with too
many mothers and fathers who believe I’m the only thing blocking the path to
their daughter becoming the Barry Bonds of Little League softball. So my
strategy was three-fold: draft the two girls who are among the best pitchers in
the league; get nothing but hitters (fielding can be taught quickly, plus if my
pitchers do their job, it’s minimal-event); and most importantly, CHOOSE THE
KIDS WHOSE PARENTS ARE NOT PAINS IN THE ASS!

First, if you’re expecting some magical formula as to how to sell at every high
and cover your shorts at every low, you’ll not find it here. It doesn’t
exist (though I’ll probably spend at least another 20 years of my life looking
for it). Trading is a game that always changes and there is no way of
knowing ahead of time if the stock you just sold won’t rise 200% over the next
few months. And on the opposite end of the spectrum, how many times have you
watched a stock — which you had a healthy profit in — move lower
instead of continuing its rise? These are common situations that play themselves
out thousands of times a day, every day in the real world of trading. But, there
are some general rules you can follow that hopefully will make you better at
capturing gains when they exist. Here are some things for you to think about and
next weekend I plan on looking at specific trades in order to dive deeper into
this subject:

1. You Need To Lock Pieces In

This means taking profits along the way. And the more aggressive you are here
the better. In my opinion, many traders leave more money on the table because
they are looking for home-runs. You, nor anyone else in the world knows ahead
of time if a trade is going to rise 10 cents or 10 points. Accept this fact
and you will immediately learn the importance of scaling out of a trade. This
can be done many many ways. Fixed points, support and resistance, fib zones,
etc., but lock ’em in.

For example, you’re long 2000 shares of XYZ. Let’s assume you’re a short-term
trader. You buy at 49 and your stop is at 47.50. When risk equals reward (meaning
50.50), you should be taking a piece off. What’s a piece? Your call, but 20-25%
of the position may not be bad. You then raise your stop to break-even on the
remaining shares, and unless something crazy happens overnight you now have a
profitable trade. Now let’s assume the stock continues to rise. As it’s moving
higher, you keep taking small pieces off and aggressively raising your stop. If
the stock pulls back and hits your stop, you take your profits and move on. Yes,
you will hate life if they find you and then the stock explodes higher. But
guess what? It happens to EVERY successful trader. You just need to accept this.
If your stop is not hit and the stock continues to move higher, you have some
profits locked in plus the opportunity to participate in further gains on your
remaining piece.

This is not rocket science stuff. It is simply buying wholesale and selling
retail. Trading desks call this “moving inventory” and that’s why so many of
them are so successful. I suspect most don’t go home at night second-guessing
themselves on every trade that went higher after they sold. It’s not their job.
Their job is to take stock in cheaply and piece it out at higher prices. So is
yours.

2. Know Your Time Frame

If you are an intermediate-term trader, you should be looking to make many
points on your trades. If you swing trade, the goal is a few points (on
average). If you day trade, it’s usually in the 20 cent-$1.00 range. This is
standard. Yet, many traders grab profits on their entire position much too soon!

For example, many traders like to refer to themselves as swing traders. That is,
until they have a gain of 50 cents which then drops to 30 cents. Instead of
standing pat and waiting the potential upside move to work it’s way through the
many wiggles it will encounter, they panic and exit the entire position. They’re
just happy to lock in any gain no matter how small it is. Instead of
letting the move play itself out, they become “scared money” and exit. This is
not a contradiction to number one above. Number one says scale out of positions
on a “systematic basis”, not a panicky, quick trigger basis.

Doing this correctly requires you to know what the average successful move will
likely be. And most times, this average move will be dictated by the amount of
time you stay in a trade. If it’s a few days, which means you are looking for a
few points, you don’t bail out of everything because you are up a few cents. If
the holding period is longer and the potential gains are higher, you need to
allow more room and time for the gains to occur. Taking 30 cents while risking
1-1 1/2 points is not the path to riches. It’s the path to losing for sure.

3. Get Aggressive at Extremes

This means that the more overbought the market becomes, the more aggressive you
should be in locking in long gains. And the more oversold the market becomes,
the more aggressive you become in locking in short gains. We have done numerous
studies on this and they all point to the same thing. The more OB/OS the market
becomes, the closer and more likely the market is to reversing. It’s next to
impossible to know if this is the 3 or 4 times a year that the market is going
to go on a tear, but I’d rather have locked in gains and missed a few big moves
than to lose profits time after time because the market reversed. This one
concept alone will likely dramatically improve your trading results, especially
if you stay disciplined in acknowledging that “the market moves stocks”, not
vice versa. Next week we’ll look at some chart examples in order to gain a
further understanding of these three profit-taking strategies.