Mistake Proofing, Poka-Yoke Style

Ken Calhoun |

Keeping the cost of your stop losses to an absolute minimum is one key to successful trading and investing. It’s useful to prevent trading mistakes before they happen. A key Japanese manufacturing concept known as “poka-yoke” or fool-proofing, can be adapted to help your trading approach as well.

Prior to getting into trading over 15 years ago, the author was a widely-published total quality management consultant -- adapting tools like flowcharts and “poka-yoke” to active trading has proven especially effective. In this series of articles we’ll look for ways to improve your trading processes as well, using easy-to-understand proven improvement techniques.

Error-Proofing for Profits

A good example in real life of “poka-yoke” is a USB cable; they’re designed to plug in only one way. Or, to help you remember to take your cell phone with you the next time you leave your house, put it into one of your shoes (not a table or counter), to ensure you remember it and don’t misplace it.

Similarly, you should seek opportunities to mistake-proof your trading as well. There’s several techniques that you can use to help reduce errors when trading:

a) Sell ½ your position at a close exit target, use a break-even stop on the remaining shares: For example when you enter a new swing trade in a stock in the $30-$50/share range, you may want to sell half the position once it’s moved 5 points in your favor, and use a trailing or breakeven stop on the remaining shares.

For day trading, my favorite ‘poka-yoke’ I designed for my live room members is to automatically close half the trade once it moves twenty cents or more in your favor, and then use a breakeven stop on the remaining shares. This mistake-proofing strategy is perfect for when a trade starts off successful, then pivots back against you; it’s a ‘trade saving’ technique designed to minimize the cost of stops and false breakouts.

b) Use pilot trades: Instead of all-or-nothing large size trades (100-500 shares), use a more cautious approach and enter small positions of less than 100 shares, to minimize upfront risk. It’s much smarter to trade a diverse group of 5-7 strong breakouts using small initial trades than to over-bet 1 or 2 charts and hope for a large win (which seldom works).

c) Enter using dual entries and exits: Fine-tune your trading approach by breaking your entries and exits into two separate actions, spaced at least two points apart. So instead of using for example a buy-stop order of 100 shares at $33/share, use one buy stop for 50 shares at $33 and a second buy stop at $35. This helps mistake-proof your trade by keeping the cost of a stop loss half as much, in case the first entry doesn’t work out for you.

Use Visual Reminders to Mistake-Proof Your Trades

Finally, I’d recommend you use visual reminders placed near your monitors to help you remember what to do next, when taking action. For example I have a small shipping label taped to the edge of one of my monitors with the words “Small Stops” written in black marker ink, to remind me.

You may want to also develop a brief flowchart to outline key decision steps in your trades. Once you figure out “poka-yoke” type safeguards that protect and grow your trading account, be sure to document them briefly, and post illustrations near your workspace to help remind you of successful actions to take every time you trade.

In upcoming articles we’ll continue to explore additional quality improvement trading strategies used by professional traders.

Recommended resource: For more on using this and other trading strategies, see the author’s complimentary Saturday “Trading Week Ahead’ webinar events at http://TradeMastery.com/free/ .

Ken Calhoun is a trading professional who has traded millions of dollars of equities since the 1990s, and is the producer of multiple award-winning trading courses and video-based training systems for active traders. He is a UCLA alumnus, MoneyShow speaker and founder of TradeMastery.com and StockTradingSuccess.com (with Steve Nison), popular online educational sites that reach tens of thousands of active traders worldwide.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer


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