It Takes More Than Just Being Able to Pick Good Stocks

The objective of trading is to make a profit. Success is measured by whether or not gains are achieved consistently over time. But early on, when explaining the stock market basics, which is the objective of this website, it must be pointed out that some losing trades will occur.

This article, and the chart of a specific trade shown below, is meant to inform the beginning trader about how and why losses occur, or potential gains are diminished, by negative news events that are often not directly associated with the underlying stock.

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To succeed as a short term trader takes more than just being able to pick good stocks to trade – although it does start with that ability of course. But after taking a position in a stock, unforeseen events often occur that interrupt the expected flow of events — from the moment of eagerly buying stocks in anticipation to selling them with a happy profitable ending.

Losses will occur, not always because of poor stock choices
The unexpected events I refer to may, at best, merely delay the move to a profitable outcome but can, in some cases, lead to a more distressing exit. The point I want to make is that losses will occur and have to be accepted without flinching (too much) and if there is anything to be learned when a loss occurs then that just might provide a benefit for the future. We are always looking to the future, to the next trade, we are speculators, our trading philosophy does not permit a buy-and-hold approach but instead is based on a fairly short time horizon that allows us to be in and out of a trade in short order.

An example of an extended trade delayed by unforeseen events
At the end of this article, to illustrate the type of interruptions in a likely profitable upward movement — due to unforeseen events as referred to above, a chart is shown of a recent trade that probably should have been closed by now but instead is approaching a new possibly “critical” moment, in this case earnings and future prospects are about to be announced.

But first, let’s mention some styles of trading
There are several forms of short term trading, there’s day trading, swing trading, momentum trading, position trading and probably others, titled and described variously, depending on their strategic objectives and methodology. Those can be described in more detail elsewhere on this site at a later time.

Whatever the method of trading, after taking into account the winners and losers, all styles of trading can be profitable — if you can stay the course through those wins and losses. Remember the remarks of Bernard Baruch, the great trader from the early days of Wall Street, who said:

“Even being right only three or four times out of ten should yield a fortune to a person who has the sense to cut their losses quickly”

About price targets and exit dates

The stock market basics site follows mainly the approach of a position trader with a typical target stock holding period of about 3 or 4 months. When taking a position, part of the process is to establish the price target and an exit date. The “exit by” date is often determined by the unofficial rule of not holding a stock position through earnings announcement dates if possible.

An exit might also be necessary if the expected potential stock action has not materialized, possibly because of a loss occurring or perhaps because the stock has stalled with no or little gain having been achieved and seemingly with little hope for improvement. For example:

• In the case of a loss, an exit is triggered by following the unofficial rule to cut losses at a given percentage.
• When no loss has occurred but the stock is not moving up or down as expected – we might exit the position and buy stocks that appear to have better prospects, rather than losing time by staying with a non-moving trade.

Let’s coin the phrase “Unexpected Event” to use for the following:

A further comment on when a significant “unexpected event” occurs
A trader will likely have several stocks in play at any one time (my suggestion is to try for 8 to 10 positions to provide some diversity and enough action to stay engaged but not too many to monitor and manage easily). When a significant “unexpected event” occurs it can effect every stock in a portfolio, compounding the loss, especially since stocks can drop 5 or 10% or more in just a few days.

Unexpected Events also compound the problem if any of the affected stocks in the portfolio are reaching their pre-determined sell dates – perhaps based on earnings dates – in some cases an Unexpected Event might not allow time for recovery before the sell date has been reached.

Examples of recent Unexpected Events:

• Geo-political unrest in the middle east – in Tunisia, Egypt, Libya and other countries.
• Followed shortly after by the earthquake and tsunami in Japan and the near melt down of the nuclear in that country
• Serious financial problems in Portugal and other EU countries
• Just a few days ago trading was negatively affected by the concerns over the US budget deficit and the credit rating agency suggesting the the U.S. Could lose it’s AAA rating.

Here is how the above Unexpected Events played out on a given stock, MO (Altria Group Inc.)

There are probably better examples than this one shown here, but what I wish to illustrate is a stock, in this case MO (Altria) reacting to bad news, even though it did resume its upward motion after the initial setback.

MO was moving steadily up for quite a while until about March 10th, when at level “A”, it fell back after news of the Middle East political troubles took hold, and that news was followed by the sad situation in Japan after the Earthquake there.

MO then recovered and resumed its upward move until around about position “B” when it again faltered and traded sideways for a while after more serious troubles were encountered in the Japanese nuclear plants.

Again MO moved up until at position “C” there was another reversal, starting Monday, on the market reaction to the U.S. deficit problems and the comment about the country’s AAA credit rating being suspect and could be downgraded.

What next?
Our current dilemma is that earnings announcements on this company are due to be released tomorrow, April 19 — meaning we have broken our rule to exit positions, where it makes sense to do so, prior to earnings announcements — will that be a costly mistake? Tomorrow we will know.

Related posts:

1. Yes, Indexes Signal It’s Time for Buying Stocks
2. You Can Win or Lose When Buying Stocks, Know When to Exit
3. About Stock Market Courses and Learning How to Trade Stocks
4. Stocks for Our New Watch List
5. Buying stocks — But First, Before We Start
6. Finding Stocks for Stock Market Basics Paper Trading
7. The Stock Market Basics Approach to Buying Stocks

Filed under: Stock Market Basics

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