3 Things You Can Do to Improve Your Trading Right Now

You want to kick up your trading a notch?

Fine. But before you put a single dollar on another stock, there’s something important you need to understand.

The stock market doesn’t care about you. It doesn’t care what kind of fancy degree you have. It doesn’t care how many years of trading experience you have or how many complex techniques you use to pick your investments.

If you want to succeed in the market, you need to adopt that same spirit of indifference. You need to forget about your emotions and hunches.

In fact, if you approach the market with a trader’s mindset, you will instantly cut your losing trades in half and grow your account faster than you ever imagined.

But first, you must change the way you think about the markets. And once you know how, you’ll be able to drastically improve your returns while protecting your portfolio from crippling losses.

All you need to do is learn these three unbreakable trading rules.

Follow these three simple rules and you’ll quickly set yourself up for trading success. It doesn’t matter if you’re trading every week or just picking up a couple of plays a month to supplement your long-term portfolio. Stick to these rules and the market will reward you handsomely.

Here’s what you need to know:

1. Price Is King

Price action will tell you everything you need to know about the markets. The financial news, rumors, gurus — all the rest of this crap is just noise.

There’s no place for emotions, hunches or astrology here. OK?

The minute you allow your analysis to drift away from price, Mr. Market’s going to suck you into bad decisions that will cost you money. You have to toss your beliefs aside and obey the market’s signals — even when they run contrary to common sense.

Let’s say you believe the markets will correct soon because valuations are just too high. If you cling to that belief when the market begins to move against you, you’re going to run into trouble. Instead of obeying price action, you insist your analysis is correct.

But 9 times out of 10, the need to be “right” will end up costing you big bucks. Price is your judge, jury and — if you disobey the rules — executioner. If the market tells you you’re wrong, sell your investment or trade and move on to your next opportunity. There are always others. Always remember, it’s infinitely better to admit you were wrong and lose a little than to insist the market is wrong and lose a lot.

As I said, the market doesn’t care what you think. All that matters is how much you pay for a stock and how much you sell it for. Period.

2. Don’t “Bottom Fish”

Sometimes, you’ll see a down and out stock rocket higher due to a positive earnings surprise or some other news event. That’s when you discover how much self-discipline you have, because your greed glands will scream buy, buy, buy the next time you come across a stock you like that’s stuck in a nasty downtrend.

Everyone likes a deal. So it’s no surprise that fundamental investors love stocks that are cheap relative to earnings, sales or book value. After all, why wouldn’t you want to buy a cheap, out-of-favor stock and hold it until its true value is realized?

In theory, it sounds like a smart idea. But as you probably know by now, the realities of the market can easily derail your plans. Instead of buying any old “cheap” stock you come across, you need to exclude any names that might trap you in a losing position.

Here’s how you do it:

First, avoid buying stocks at or near 52-week lows. I know it might be tempting. After all, the stock is cheaper than it’s been all year. The typical investor logic here is that shares shouldn’t trade much lower.

But they can. And they probably will. Just because a stock hits a new low does not mean that it has found a bottom. Stocks move in trends — up, down or sideways. If a stock is moving lower, you must assume it will continue to do so until the price tells you otherwise.

3. Don’t Let a Trade Turn into an Investment

Here’s another overlooked rule you need to know…

Never buy a stock without first defining your trading goals. Place your potential trades into two categories: quick trades and core holdings (these are your short-term and long-term trades, respectfully).

A quick trade is just that — a stock you plan to hold for a few days to a few weeks. On the other hand, a core holding can be a play on a much larger trend, such as the death of brick-and-mortar retail or the small-cap rally (which are two big themes we’ve discussed here at the Rude lately).

If you have defined goals for your trades that you stick to, you’re less likely to let a quick trade turn into a long-term hold — or take gains off the table too quickly with a potential longer-term play. These are two mistakes that can ruin your returns.

Trades in these respective categories come with their own set of rules. For example, they have different stop loss levels…

You’ll tolerate more price swings with longer-term trades than with short-term ones. With short-term trades, you simply don’t have the luxury of waiting around for prices to recover.

Longer-term trades provide you with more flexibility, so you can loosen up your stop loss levels. Make sure you know which one applies before buying any stock.

Let this be your new trading mantra. Write it down and memorize it:

Don’t ever let a short-term trade turn into a long-term disaster. If it doesn’t work out, cut it loose. 

As legendary trader Jesse Livermore put it, “Cut your losses quickly, without hesitation. Don’t waste time. When a stock moves below a mental-stop, sell it immediately.”

Sincerely,

Greg Guenthner
for The Daily Reckoning

The Daily Reckoning