The 1,2,3-method of trading
Today I want to explain in more detail what I mean by my 1,2,3-method when it comes to trading.
How come some people always seem to be able to put a cooler on their nerves and consistently make money trading?
Is it because they have special abilities that you don’t have and never will have? Or is it because they are unbelievably lucky when it comes to trading and always bet on the right horse?
No. It’s because behind successful trading there are rules that they strictly adhere to.
These rules don’t come out of the blue, and have in fact often been learned the hard way by people in the business.
It may seem easy to stick to a number of rules, but I can tell you from my own experience that it is not.
This is why I’m writing this article. So that you don’t have to make the same mistakes as I have throughout the years and can start right away being what you really want to become – a successful trader.
I call my method the 1,2,3-method.
By adhering to my rules you can completely remove the emotions that inevitably surround the business of trading and focus on identifying the right moments to enter and get out of a trade instead.
The method is modified from Quint Tatro’s trading method which he has shown to be very successful in his career.
In this post I will lay out the fundamentals of a successful trading strategy and show you how you can consistently make money in the market.
What do you need?
As a minimum you need an internet connection, a trading account and some money on that account.
The trading account does not need to be advanced. The only thing required is an account that automatically buys and sells your stock at a given price level.
How much money you have is up to you, but I would advice against trading with less than $200,000.
If you have less than that you can still trade, but it’s difficult to use the economies of scale that present themselves when you have those $200,000 in your account.
In other words, you can trade for fun with less than $200,000, but not for a living.
You then need to use software that represent the different charts that you will use as a basis for your trading.
The best free software that I have found is called FreeStockCharts.com and that allows you to customize the charts in a way that best suits you.
They also have a paid version which obviously is better, but if you are just starting out you don’t need anything else than the free version.
So what is the method really?
In essence it’s about quantifying your risk.
Let’s say that I’m prepared to lose $500 on each trade.
Then I look at the chart and identify the price level where I want to get in as well as the point where I deem my trade to be a failure.
That is where I put my stop.
I then buy exactly so many stocks that my final loss will be $500 if things go bad.
That way I know before hand how much money I will lose if things don’t turn out the way that I want.
That means that I have mentally prepared myself for a loss of $500.
It’s the equivalent of betting on the race track, because if the horse that I have bet on will not win, my money is lost.
That is one of the advantages betting on the race track has over trading the market.
1, 2, and 3
If the stock goes the other way (which it should given the odds), I take a third off the table when prices have advanced 1 x the risk.
For example, if I get in at $10.00 and my stop is at $9.00, then 1 x is at $11.00.
The second third, I take off the table at $12.00 and the final third at $13.00.
By knowing beforehand when and where I will leave the trading, I don’t have to play with my own emotions.
Trading is difficult enough as it is. Don’t let yourself be your worst enemy.
That’s it. Enjoy your trading.
This post is a follow up on my guide on how to use technical analysis in trading.
Conclusion:
Today I’ve tried to explain how I personally approach trading and I do it with a method that I call the 1,2,3-method of trading.
It’s about recognizing that you are your own biggest enemy and that you have to manage your own risk.
You do that by taking the emotion out of your trades.
First I identify where my trade is no longer regarded a success. That is where i exit.
If Warren Buffett had to start today, could he still reach his current level of wealth?
Absolutely. To invest successfully you need to manage risk, not avoid it. Warren Buffett has understood every aspect of this and made a lot of money executing the idea.
By focusing on good companies with steady cash flows and high return on equity, he has been able to increase his wealth even at the worst of times.
This is in sharp contrast to resource investing where a mediocre year may be followed by an excellent year – all depending on commodity prices.
The question then becomes “How did Warren Buffett manage the risk?”
Some of his holdings may have seen exceptionally big in respect to his whole portfolio at times, and you would be forgiven to believe that he was putting all his money at risk. But then you realize that he wasn’t gambling at all.
He could at all times liquidate his holdings in American Express, Coca-Cola or Wells Fargo and at least get what he paid for them back. In this sense it has been clear that Buffet has been taking very little financial risk.
The environment in which he made his money was every bit as uncertain as the one that we have today. Yet, he was able to steer clear and make a lot of money.
Today there is rapid credit growth, quantitative easing by the central banks and a potential bubble in China to worry about. When Warren Buffett started investing in the sixties and seventies, the worries were different but no less severe.
You often hear things like “Financial markets don’t like uncertainty”, but that is only half-right. Financial markets may not like uncertainty, but good investors thrive.
That all sounds very good, but what is the best thing that I can do with my money?
When you read this you may think that it is only to invest in a few good stocks and you’re ready to go off and settle on the beach, but it also takes a lot of psychological strength to be able to go with just a few stocks like Warren Buffet has done.
The strategy that we recommend is to diversify your portfolio in order to spread the risk.
If you don’t consider yourself to be a Master of investing who turn all that he touches into gold, to diversify your holdings would seem to be the most prudent strategy.
Conclusion:
Today we have been talking about the success of Warren Buffett and how he has managed to make a lot of money even when times were rough.
He did so not by investing in the fastest growing companies, but in companies that had the safest cash flows.
We have also talked about diversifying your portfolio if you haven’t identified stocks with good cash flows at the exact good time point to invest.
The reason why we recommend you to do this is that it spreads the risk that you run from owning just a few companies.
If you have read this whole text, we would appreciate it if you downloaded our primer on our Three Favorite Gold Stocks.
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Published on the 1’st of September 2016