The Deipnosophist

Where the science of investing becomes an art of living

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Location: Summerlin, Nevada, United States

A private investor for 20+ years, I manage private portfolios and write about investing. You can read my market musings on three different sites: 1) The Deipnosophist, dedicated to teaching the market's processes and mechanics; 2) Investment Poetry, a subscription site dedicated to real time investment recommendations; and 3) Seeking Alpha, a combination of the other two sites with a mix of reprints from this site and all-original content. See you here, there, or the other site!

10 April 2007

Lessons to be a better short term trader

Dorsey Wright always offers excellent insights in each communiqué; this very brief snippet from today's edition is but one example...
The nature of the risk involved in short-term trading is not understood by most people. As a trader, you really are not risking your entire investment on a particular deal as you will be out of the stock as soon as it looks even remotely weak. The real risk lies in the fact that, while a short term trader cuts his losses, he also cuts his profits. To be successful at this sort of thing, you are going to have to pick stocks that are going up and going up now; otherwise, you will spend half your fortune and most of your time chasing your tail. Here are some helpful hints:
1. To be sure of a breakout, buy after the stock has pulled back. This will give you a better risk-reward ratio and a tighter stop loss as well. You need every edge in this endeavor.
2. Sell immediately if the stock turns sour. Sell it if it drops a point or two below support. The idea is not to let it head south like a migrating bird. Violation of the support line is a strong warning.
3. Have in mind a fairly precise short-term target. The vertical count would be very effective. If the stock moves up, move the stop loss up below it until you are finally stopped out.
4. Construct a trend line as soon as possible. If this [trend line] is violated, sell the stock.
5. A stock in an up trend may be purchased as it hits the bottom of the trend line in hopes it will reach the top parallel line. If not, then you have a close stop loss.

To become an expert short-term trader takes a great deal of work, experience, know-how, and money. It is most difficult and most dangerous. The old saying, "you never go broke taking a profit," is only partially true. If you're protecting against losses, as you should be, you should not at the same time be protecting against big gains. Obviously, it is better to let a good stock run. This is very hard to do when you are trading in and out as it is too easy to get shaken out.

© Dorsey Wright & Associates
These 5 "rules" are not as easy as they look...
#1 foils most investors for lack of the ability or intestinal fortitude to purchase pullbacks;
#2 is a purely mechanical exercise, but most investors believe his or her intelligence is greater than that, so they rely on their perceived intuition... to their repeated dismay;
#3, like #1, is difficult: "What, sell strength? But it is going higher in price! Why sell now?!"
#4 also foils most investors. For a primer on the proper construction of trend lines, please see my "Trend Lines Primer" in the sidebar to the left;
I have attempted to teach #5 for nigh a decade, to no success.

Despite my caveats, you can achieve success. Heck, if I could do it, anyone can!
-- David M Gordon / The Deipnosophist


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