My Rules for Trading
Over the course of an investing lifetime we’re all tempted to make trades. It might be a hot stock or sector in the news, a stock tip you got at the golf course, or your neighbour bragging about huge profits in the markets. One way another, we want to “take a shot” and make a trade.
Here are my rules for trading whenever a client, prospect, friend or family member asks me about the idea.
- Set a Limit: If you want to trade, you need to set a target allocation – such as 10% of the Portfolio.
I am reminded of the old lottery slogan – “know your limit, play within it”.Set a percentage of your Assets that you are willing to “play” with and do not go beyond that.
- Use Rules (and stick with them): I have found the hardest decision when trading is deciding when to sell.
My recommendation is to set ground rules up front. The simpler the better.
I often say to clients – post the rules by your computer and check them every night before you go to bed.
I recommend using rules based on closing prices, so you don’t have to be obsessed with the stock market all day.
Two examples of rules I recommend:
- Sell when the stock closes below the 20-day Moving Average: In many cases folks want to buy stocks because they are “trending”. They are in a hot sector and have been outperforming the market.
You can check every night after the Market Closes to compare that day’s closing price to the 20-day Moving Average. If the closing price is lower, this means the stock is starting to “roll over” (and may be headed significantly lower).
This rule would be to sell the next morning at the open.
- Use a Trailing Stop: Set a limit for the most you are willing to lose on the investment. For example, you could set a stop at 10% below the price you paid.
If the shares trend higher, you raise the stop loss price to 10% below the new, higher price. Over time, this will change from limiting your loss to locking in a profit.
The amount you are willing to lose is a personal decision. The more “room” you leave for the stock to fall before you sell, the more you will lose if the price drops. On the other hand, you also give the stock more leeway to rebound and potentially go higher.
Whatever rule you choose, the discipline comes from creating the game plan up front and sticking with it.
- Focus on what you can control:
No rule is perfect, and there will be times when you make “a mistake” and sell “too early”.
In my experience, there is as much of a chance you will make “a mistake” and lose money.
We cannot control the Market.
What we can control is our emotions by creating rules and sticking by them.
If you follow these rules, I am certain you will have a better experience when trading stocks.
Please feel free to reach out directly with any questions about these rules and/or anything on your mind at 416.231.6528 or jeff.ker@rbc.com.