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Why Today's Market Is Perfect for TradersBy Tom Dyson, editor, S&A Penny TrendsMonday, May 4, 2009 Stock prices are moving up and down at great speed and in extreme price swings. This is because no one knows where the next bankruptcy will strike or what the government will do next.
In other words, "we're back in the 1970s."
The 1970s were the Wild West of stock markets. The government was intervening like crazy, there were big oil spikes, economies were weak, and we were in the middle of a long bear market. The commodity and stock markets spent the whole decade soaring and plunging.
There's only one way to make a fortune in crazy markets like these: Forget predictions.
Predictions are worthless in this market. You have to be a trend trader, rooting out the profits like a pig digs out truffles from the dirt. If you're on to something, keep digging. But if nothing's there, move on quickly. Do more of what's working and less of what's not. It's as simple as that.
Most people hate traders' markets. That's because most people are investors. Investors like boring markets that go up 10% a year for years at a time. Their money is stable, and they make a decent return. This isn't the right market for that approach. There's too much chaos. Instead, we need to buy when something starts rising and sell when it starts falling. If we're wrong, we move on... If we're right, we make a fortune.
Investors try to predict the future. Traders do not. We simply trade on the side of the trend and ride giant moves. That's our first big advantage over investors. But we have another big advantage... our proper money management principles.
Investors often think the more something goes down, the more attractive it is. This makes them want to buy more on the way down (known as "averaging down"). But we know letting your losses run is the worst "amateur" mistake you can make... It'll bankrupt you in no time.
Thousands upon thousands of people learned this lesson the hard way in 2000. They learned it again in 2008.
The lesson brings to mind a quote from legendary trader Paul Tudor Jones. Jones was so against averaging down that he had a sign on the wall of his office saying "Losers average losers." I encourage you to keep this quote in mind.
Another "money management" technique to keep in mind: Use simple math to tell you how much of a stock to buy. You can't see into the future, so bet the same amount every time. And define the size of the loss you are willing to take before you make the bet. This way, you know exactly how much you stand to lose at all times.
Of course, you can use your own money-management system to suit your purposes. But a good rule of thumb here is to always put 4% of your total trading capital into each idea and use a 25% trailing stop. This will limit your loss to approximately 1% of your account if a position goes against you.
And in today's market, you should consider cutting your position size down to 2%. With a 25% trailing stop, you won't lose more than 0.5% of your capital.
This is your protection on the way down. On the way up, don't limit your profits. The trailing stop loss lets profits run as far as they can, and frees up capital quickly.
Good investing,
Tom Dyson
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