Last week, Toni Turner of TrendStar Trading Group, Inc., discussed the importance for traders to find an approach that fit all aspects of their lifestyle and priorities. Striking the proper balance between schedules, finances and the demands of everyday life can be the difference between success and failure in the stock market.
We asked Toni to share some of her thoughts on ways traders and investors can evaluate themselves when they prepare to play the market, as well as some advice and common pitfalls she's observed through her experiences as a trader and financial educator.
EQ: Why is it important for traders to understand their own level of risk tolerance?
Turner: Traders and investors alike need to be able to identify their own personal risk tolerance. I don't know if we can actually choose our ability to handle risk in an emotional way because I've read in scientific journals that to a great degree, each and every one of us is born with an aversion to—or tolerance for-- risk. Of course, risk is inherent to the stock market. When we plunk our money on the line and buy shares of a stock or other financial instrument, whether we intend to hold it for two minutes or two years, there is risk inherent in that action because it can produce a loss in funds. There's high reward but there's also high risk. Being able to handle that is a trait or characteristic that is actually built into us, and each and every person is different. So if the thought of losing any money at all makes you sit up in bed at night, then the stock market may not be the correct place for you.
EQ: Is there a rule of thumb when determining a good trade size as measured by the percentage of your buying power/portfolio?
Turner: There are varying degrees of opinion on that. A single position can range from no more than 10 percent of your capital, to no more than 25 percent of your capital. I would tend to stick to no more than15 percent, and that does not include margin. These markets can turn volatile in a heartbeat. If the bottom falls out of the market in any given day--which happens every now and then like we saw in the Flash Crash in May 2010--we don't want to be wiped out in a single trade. So I believe no more than 15 percent of anyone's account assigned to a single trade is a wise portion to adhere to. But you have to factor risk into that as well, which can all be done mathematically. You never want to risk more than 2 percent of the capital, excluding margin, in your account on any one trade. Of course, by risk, I am referring to the spread between the entry price and your protective stop.
EQ: How do you use news and technicals for your trade setups?
Turner: In Toni's Market Club, we do earnings plays every quarter. So about three weeks before companies are set to report earnings, I will go in and check out a list of stocks to target. For each stock, I look at their chart first and then if I find any attractive setups, I will look at their prior fundamentals. I'll see if they're expected to report earnings better than the prior quarter and what their chances are of doing so. If the technicals are correct and the fundamentals are correct, then we many enter to the long side. We advise exiting the trade before the actual earnings announcement comes through. You know, “buy the rumor, sell the news.”
One big mistake that new traders make is that they hear a talking head on CNBC or other financial network say, "This company is great, and traders should buy it right now." That is often a big mistake to buy it at that point in time because the stock is usually run up, and that's exactly when the shorts come in to take it down. To just buy a stock because someone on TV advises it, can turn into a bad trade. Traders and investors should do their own homework and research before entering any position.
EQ: How do you trade on breaking news or developments that are more immediate?
Turner: One way a lot of people look at stocks that they think are about to jump is by looking at the options of the underlying stock. If you see a tremendous amount of options activity around a certain stock, then you can ascertain whether that action is positive or negative. Many times, news can be predicted if you're sharp and you're good at analyzing the actions around options. Otherwise, by the time a stock appears in the news, it's too late. Too many people know about it by then.
EQ: Can you talk about the importance of entry and exit points and how they help traders stay disciplined?
Turner: Traders should plan their trades before they get into the trade, not as they're getting into the trade. Every trader knows this, and investors should as well. You should know the best current entry point before you get into the trade, so when you enter, you are disciplined and you don't get tempted to chase the stock. Undisciplined traders tend to chase stocks, and they'll chase it higher and higher. A stock may be moving up on good news, and by the time they get in, the shorts have jumped in and they're pounding it lower. In those kinds of situations, new traders get hurt all the time.
The discipline comes in when we go through multiple charts and stocks to we find a setup that looks good. We then sit down and figure out the best entry point, the best stop target, and then the initial profit target. Those three numbers are the initial foundation of every trade. For me, I like the risk-to-reward ratio to be about one part risk to two or three parts reward. Then we have to have the discipline to stick to it and not to enter late, and not to ignore our stops. And in my opinion, it is never OK to chase a trade. If you are consistently a disciplined trader, your odds are very good of having consistently winning trades. So the discipline should weave into every action we take in the market.
EQ: Keeping a trade log is important, but what are some other tips on self-evaluating one's trading performance?
Turner: One tip on evaluating your own performance is to compare groups of trades with each other. For example, record your next 15 trades and see what the profits or losses are, and then evaluate your next 15 trades and see how they compare to your last 15 trades. So you compare groups of trades rather than just single trades against each other, and that's a great way to see whether you're moving forward and getting to be a more skilled trader.
There are three major bricks in my foundation of trading that I teach. They are knowledge, discipline and experience. You have to get the knowledge in order to execute the trades. When you execute the trades, you absolutely have to get disciplined, and if you can take your knowledge and discipline and make them work together, you will gather the experience you need to will even sharpen your skill set more. If you can work on all three of these so called "bricks" of a foundation, and you should become a better and better trader.
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