Friday, August 17th, 2012
By George Leong, B.Comm. for Profit Confidential
This is an exciting time of the year, as we near the end of the baseball season with the race to the playoffs heating up. Success in baseball swirls around the abundant statistics, as is the case in trading stocks, but there are major and subtle differences. In fact, the key to achieving stock market success is more akin to pitching than batting.
Let me explain. In baseball, the ultimate goal for every batter would likely be to hit over .300?that is three hits for every 10 at bat for you baseball neophytes. Of course, there are exceptions for the home-run hitters like Willie Mays?one of the top baseball players in history. In trading, stock market success doesn?t equate to winning in only 30% of your trades; this would actually send you to the sidelines or poorhouse quickly.
Stock market success is more like pitching. A pitcher who wins 65% of his starts would win about 21 games based on 32 starts. Winning at a 70% win-rate would equate to 22 games and a possible Cy Young award (top pitcher) for the mantelpiece. In trading, if your win rate was 65%?70% and you cut your losers, you would likely achieve stock market success.
The key to stock picking and stock market success is simple?make sure you make more money than you lose. To do this, you need to make sure you cut your losses and, at the same time, ride the winners.
Many inexperienced traders often get caught-up in the emotional roller coaster by taking profits on the top stocks, while keeping the poor performers and refusing to admit a mistake was made, which does not bode well for stock market success.
At this time, stocks are facing chart resistance, as evidenced by the S&P 500 at 1,400. The bullish investor sentiment in the stock market continues to ad support for stocks, but I?m seeing some stalling on the charts. The lack of strong volume is a red flag.
You need to understand that being prudent is important for stock market success just like it is in baseball. Let?s assume the bases are loaded. The batter in this situation doesn?t necessarily try to hit a home run, but aims for a hit to drive in runners. This is called playing ?small ball.?
The same goes for trading. Aiming for a home run with each trade is fruitless and doesn?t mean stock market success. I would rather play small ball and drive in runs, albeit hitting that occasional long ball over the fences would be a bonus.
Risk management drives stock market success as it does in baseball.
It would be unlikely that a pitcher would throw a fastball down the middle of the plate on a 0-2 count?instead, perhaps he would offer up a curveball, splitter, or change up.
The key with both baseball and trading stocks is monitoring your pitches and situation.
When the price of a stock trends higher, you should think about a potential exit strategy for overall stock market success. This does not mean liquidating profitable trades; it?s more like protecting your unrealized gains. Take the current stock market rally as an opportunity to take some profits. Trust me, you?ll feel better about it if stocks slide.
Another stock market strategy that needs to be considered is the use of mental or physical stop-loss limits. But you need to be careful when the volatility increases and wild swings in the stock market materialize that could take you out of your position prematurely.
And for those of you familiar with options, you can employ put options to help minimize the downside loss in the stock market. (Read ?Stock Market Success: It?s About How You Manage Your Risk.?)
Babe Ruth was arguably the best baseball player in history, while Warren Buffett is widely considered one of the top long-term investors. As these men have proven, the key to success in both baseball and trading is to understand the situation, know the risk, and have an exit strategy.
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