A trader recently asked me what the best way is to increase his profits. It is a daunting question, and I’m in the process of writing a book to more completely answer that question. Better stock selection is the most obvious solution, but trade execution will likely have the most impact on trade results.
The first thing I would suggest is that instead of thinking of a trade as a single buy and then a single sale, traders plan to enter and exit each trade with multiple purchases and sales. Rather than buy at price X and sell at price Y, think of a trade as a developing relationship that will grow and change based on how the stock acts and overall market conditions.
One of the most common complaints traders have is that their carefully selected stocks always seem to drop immediately. The ideal entry point turns out not to be so perfect. The emotions surrounding a trade suddenly shift when the stock fails to perform immediately in the manner that we had hoped. Even if the conditions are equally good or even better, that initial entry points drives our emotions about the trade.
When it comes time to take some profits, we can be sure that our timing will prove to be less than precise. We will sell too early or too late about 95% of the time and will often miss out on substantial profits.
The single buy and sell approach assumes a level of precision that just doesn’t exist in the market. It sounds good to say I’m going to buy at the 50-day simple moving average or the exact point that a gap is filled. It is logical and easy to execute, but it rarely works out. If it were that simple, we’d just program our computers and lounge on our yacht.
The better approach is to harness the imprecision of the market and use the inevitable volatility to arrive at better overall entry and exit points. The dynamic of a trade changes quite a bit if you plan on your entry point being less than perfect. It is very empowering when you start to look forward to the opportunity to buy even lower after your initial entry rather than focus on your poor timing. Embracing this mindset relieves some of the timing pressure. You can put a stock on your screen and then watch for the opportunity to improve your entry points and build the position. You might average up or down. It doesn’t matter. The important thing is that you are working the trade and developing a feel for how the stock acts.
One of the significant advantages of this approach is that it helps you cultivate patience. You have the luxury of time when you are making a series of entries and exits. Too often, a trader will jump into a trade too big and too fast and then take a quick loss when the stock doesn’t go straight up as planned. The single buy and sale approach is a recipe for impatience. When you plan on working a trade with multiple purchases and sales over a period of time, you are forced to be more patient and let things develop.
There are many other considerations when using a multiple buy and sale approach to trade management. The best way to start is to experiment. Next time you identify a stock you would like to buy, make a plan to break down the entry into three or four separate entries over a specific time frame. See how that approach shifts your thinking, strategies, and emotions.
Stocks are never going to do precisely what we hope they will do. The best way to deal with that is to develop a trading system that embraces imperfection.