A key to weathering – and potentially profiting from – a market correction is planning and implementation.
Take the Emotion Out of Trading
Emotions can betray you when it comes to trading securities. For instance, you may recall an instance when a rapid decline in the price of a stock left you shaken and caused you to sell too soon, missing out on future profits. Perhaps you held on to a security to avoid the pain of selling for a loss. Or you sell winners simply because they have made a profit, not because it is the right time to sell.
Once you recognize the power that emotion-based tendencies can wield over trading decisions you can begin taking steps to diminish the impact. “Establishing a trading plan with clear rules can be critical,” said Brian Bachelier, vice president of active trader strategy at Scottrade. “Then the challenge is to consistently follow that plan.”
Create a Trading Plan
The use of technical analysis, or charting a stock’s past behavior, can be an important part of a trading plan and can be a useful guide when making buy and sell decisions. But the entire plan should encompass even more. Here are some possible components:
- Establish general rules to trade by. These might work for both a trader and an investor. They may include: don’t double down, don’t buy illiquid stocks, only invest in stocks with 4 and 5 STAR S&P rankings.
- Determine tools and techniques and identify which technical patterns can be used to uncover opportunities. The relative strength index (RSI) is just one of many widely used technical indicators included on Scottrade® platforms. It can help identify an entry point when a stock is pulling back during a strong uptrend or an exit point when you might sell into rallies during strong downtrends. Other popular indicators include moving averages which track the closing price of a security over a certain period of time, and Bollinger Bands, which provide a statistical trading band based off a moving average.
- Establish firm cash management rules. Decide what percentage of your portfolio will be allocated to each trade. Set closing targets to help insure you will not lose more than a certain percentage of your portfolio on any one trade.
- Any trading plan might benefit from a review process to analyze what worked, what didn’t work and why. Rules-based trading can allow more effective performance comparisons and can lead to well-reasoned incremental improvements. However, you should not make adjustments to the plan while you’re in the middle of a trade. Those decisions tend to be based on emotions.
A Disciplined Trading Plan
A systematic trading approach that includes unambiguous, pre-designed rules is different from a discretionary model that might be based on experience-based judgement calls. That kind of systematic model can remove emotions from the trading process.
“Traders also need to understand that not every trade will be a winner,” Bachelier said. “At the same time, you should constantly analyze your trading process. You might have to make adjustments along the way.”
If you’ve devised a reasoned plan, and stick to it, you can take the emotion out of trading. It doesn’t guarantee success. But it may increase your chances. And it just might reduce your stress level.
The content provided is for informational and/or educational purposes only and should not be considered a recommendation or an endorsement of any specific investment strategy. Your choice to engage in a particular investment or investment strategy should be based solely on your own research and evaluation of the risks involved, your financial circumstances, and your investment objectives. You are fully responsible for your investment decisions.
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