This Week’s Battle Plan

Well, my daughter’s softball season just came to a close and Coach
Mike’s and Water Boy Larry’s…errr I keep making that mistake…Assistant
Coach Larry’s team won the City Championship with a 14-1-1 record.
Coach Mike was very proud at the end of the season and well he should
be. Most of our games were never even close, and we were by far the
superior team in the league. But, you’d think he’d lighten up a bit,
especially as the season was winding down and a championship was all
but assured.

But that’s not Coach Mike’s style. In our next-to-last game of the
year, we entered the bottom of the last inning leading 15-0. Before
the girls took the field he told them how proud he was and how they
were the best team he ever coached. That love-fest lasted only about 4
1/2 minutes, though. With one out in the inning (remember it was 15-0)
our shortstop mishandled a routine ground ball and then rushed the
throw which went over our first baseman’s head. Before you know it,
everyone in the stands got to witness a grown man running onto the
field (I’ll let you guess who that was) with his hands in the air
screaming “You girls are going to put me in an early grave!
That’s right. An early grave!” Well, thank goodness we got the
next two outs — I’m squeamish even when it comes to blood — so the
sight of a dead man on a softball field would likely haunt me for many
years to come (not to mention how it might impact a bunch of 9- and
10-year olds).

We’re now going to play in one tournament and that will wrap things
up. Sadly, I’ll probably never be with Coach Mike again. My daughter
is probably going to move up to travel ball and Coach Mike is going to
coach his younger daughter’s team next year. Even though I won’t miss
playing ball boy for an entire season I will miss the man’s passion.
For the other coaches in the league, it’s just 9-10 girls ball and
they are there for the kids to have fun. But for Coach Mike, it’s a
bit different. It’s life and death. And even though he may be a
“bit” extreme at times, he’s taught 10 girls what it takes
to win and that’s something they’ll take with them for the rest of
their lives. I’ve always been attracted to people who have passion for
what they do, and for the past four months I’ve been lucky enough to
be around one of those guys.

I usually like to focus on the positive aspects of learning to trade.
But, this weekend, I think it makes sense to look at what I believe to
be the reason why every year some traders have substantial losses. For
some, the losses are the size of their trading account. For others,
its in the magnitude of what happened to Long Term Capital. And from
their mistakes, we can learn and we can make sure we avoid those exact
same mistakes.

Mistake 1: Too Much Leverage Or Concentration
In One Market

We all know somebody who became “paper rich” by owning a lot
of stock in one company in the late 1990’s. They concentrated the
majority of their money in one stock, probably a technology stock, and
then didn’t sell a share. In fact, they probably bought more. Their
paper profits were staggering. No need to use stops, no need for
risk control and proper management control. They just loaded up
and greed took over. This happened to layman, it happened to doctors,
it happened to people in the high-tech industry, and guess what? Go
pick up the latest issue of Fortune magazine. It even happened
to Ted Turner. And what was the end result over and over again? Staggering
losses. Time after time these people lost it. Ted Turner, in fact,
lost over $8 billion dollars because he loaded up and didn’t lock
things in as prices started to drop.

The key is obviously not to put all your money into any one stock.
Trade multiple positions, and keep the risk low. Only use a percentage
of your portfolio in any one security. That way, if you’re wrong, your
maximum loss is limited to what you risked. We usually take positions
with maximum overnight risk of 7 1/2%-15% in any one position (our
intraday risk is much much less than that). For us to lose that much,
a stock that we went long would have to go to zero overnight (it’s
never happened…not even close). That means our risk is far less. It
means we will never concentrate our money in any one stock, which
means we will likely never get badly hurt even if we are very wrong.

You should decide ahead of time how much of your portfolio you will
tie up in any one position. If you risk too little, it will be tough
to make healthy gains. If you risk too much, you make more when you
are right, but you will lose more when you are wrong. Moderation
and balance here is the key.

Mistake 2: Going Into The Fetal Position

That means freezing when a position moves against you. A  friend
of mine runs a trading desk for a large futures firm. A
well-capitalized trader was on the wrong side of a large S&P
position and the market was plunging against him. My friend had him on
the phone because margin calls were getting triggered. He kept asking
this gentleman “what do you what to do?” The problem was he
couldn’t get an answer. The guy on the other line wouldn’t answer.
Why? He was vomiting. And each time my friend asked “what
do you want to do?” all he heard was …well, I think you can
figure it out. True story; real world. The guy blew out. He was a
successful businessman who tried his hand at trading and blew out. He
had no plan. He was winging it. And when the gun went to his head,
he simply fell apart.

One of my favorite sayings is “Price Over-rules Your
Opinion.” But, for people who blow out, their ego has
over-ruled price. Yes, we all have opinions and we all have
“gut feels” for where the market will likely go. And
selective memory reminds us of being right more often than wrong. But,
you will never maximize your returns until you live by the following
philosophy: “It’s not about being right or wrong. It’s about
making money. And before you can make money, you need to be damn
sure you do not lose substantial money.” The market moves
against you, you’re out. You take the loss. And you take the hit to
your ego. Get over it, because it happens to EVERY SINGLE GREAT TRADER
NEARLY EVERY DAY! When you take a loss, you get to join this elite
club.

Last week I was talking with a batting coach who got a four-year ride
to a major college and would have likely had a shot at playing
big-league ball had he not had a family situation that affected his
life for a few years. He told me something interesting. He said he saw
guys (and still sees guys) who have all the tools to make it as
professional players. All the tools are there, except for one thing.
They can’t handle failure. They can’t accept the fact that they will
fail 7 out of 10 times at bat (and with those statistics, they’d
probably become millionaires).

Well, the same goes for trading. Most traders can’t take handle the
losses. A few trades in a row that go against them and they begin to
get unglued. Add a few more to that and they are changing their
system, skipping trades and completely unwinding a truly valid trading
system or methodology.

No one likes to lose. But no one is profitable on every trade or even nearly
every trade. Learn to handle failure. My guess is that if you have a
methodology with an edge, and your stops and profit taking techniques
are solid, you can “fail” 50% of the time and still make one
heck of a living and be a wonderful trader. But learning to accept
losses goes a long way to achieving your success.

Crushing These 3 Mistakes and Creating A
Winning Plan Of Attack

Most of the above is common sense and simply requires the discipline
to execute. Going forward, you will use a fixed position size for
every trade which does not put you and your family at risk and does
not put you on the cover of Fortune magazine telling the world
what a dummy you are to have lost 8 billion dollars (Ted is no dummy,
he was brilliant enough to make it, but you get my point).

Second, you should have a plan in place in case of a margin call. But,
if you do get a margin call, you were likely taking too much risk.
Either the position size needs to be lessened or the stops need to be
tightened. And, a plan must be in place in case a large unexpected
move does occur. Markets occasionally move fast, and losing one’s
lunch is not an appropriate response to the question “what do you
want to do?”

2. Kevin Haggerty is again holding his annual seminar June 20-22. This
year, instead of having to travel to a hotel, you can participate in
the seminar from the comfort of your home via the Internet. Kevin will
also be introducing new material he’s never taught before. And his
seminar remains one of the premier events of the year. You can find
all the details here.

Have a great week trading (and in case you’re interested, Coach Mike
has an opening next season for a Water Boy…err, I mean Assistant
Coach)!