Mitigate  Risk

Every trader looks like a genius when the market supports all of their positions but for me, the smartest traders are those that come up with a system that eliminates their risk variables.  

All too often, traders will focus only on their profit target and overlook properly setting up a contingency plan for when things start moving in the wrong direction.  I believe any trader can benefit from a refresh on the basics so today, we're going to look at some core elements of a good exit plan.  

Work off of the $1 loss to $3 profit ratio

One of the worst mistakes you can make is to think of the profit to loss ratio only from the profit side.  Let's use our imaginary friend, Terry The Trader, to highlight an example.

Terry feels really good about taking a position on a particular stock.  All of the charts look solid and the profit target is clearly defined.  The overall market has been soaring for weeks.  To top it off, recently all of Terry's moves have benefitted from the Midas touch so what's to lose?  Time to pull the trigger and start looking for the next golden goose, right?

Wrong!  

What Terry couldn't anticipate was the upcoming earnings report and how the institutions would react to it.  As a real example that I had to face recently was with  $BBBY.  Earnings was reported April 14th Wednesday.  Stock dropped off  -16.88%  within 2 days between the day before and the day after earnings release.  This is one of the reasons why one must not hold onto the stock through the earnings season.  It's always a good idea to trim the position and harvest some profits prior to earnings release.  Mitigating earnings risk is something that should be a part of the Trade Plan.   

Situations like this have confronted every trader out there but they're completely avoidable if you take the extra steps needed to plan out a loss threshold.  

Stop second guessing your plan

Any time you take a position, you need to place an order for a contingent stop loss right afterwards.  Don't put this off for any amount of time - act immediately before your emotions and biases can enter into the mix.  Just make this a part of your routine for every single position you take.  By the 3rd time, you will have formed a new habit!

It's also important to monitor your position after you've taken it.  In my experience, the 34 day EMA (exponential moving average) can be an early indicator that a stock is going against your profit plan.  If you see a sudden increase in the selling side of the Volume, that's a danger sign as well.  

Focus on emerging opportunities

You can spend days spinning your wheels in analysis paralysis after a position goes against you.  Unfortunately, throwing a pity party sucks up all of your energy and leads to missing the boat on new opportunities.  

When a position goes against you it's important to have your stock watch list on hand.  Building an actionable stock watchlist one needs to make sure to:

• Look at stocks in the same industry group as your profitable positions.
• Avoid stocks that have surpassed their buy point.
• For an early indicator of a stocks momentum, review the 21 day exponential moving average and the relative strength line.  

If you aren't already aware, relative strength line is your best indication of a stocks value against all of the other stocks in that particular industry group.  That's a key metric that you don't want to overlook!

Keep in mind that IBD® is a tremendous resource when you're putting together a growth stock watch list.  If your list creation process is solid, you might even be able to identify stocks before they crack the IBD® 50 .  The earlier you can identify an opportunity, the more prepared you can be to pounce when a buy point hits. 

I hope this information helps you get into the habit of establishing a proper loss threshold for a position.  

As always, keep the comments and emails coming!

Amin Hemani

investorspotlight@gmail.com