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The Most Important Question You Need to Ask Yourself Today

By Ben Morris, editor, DailyWealth Trader
Thursday, January 26, 2017

I want to ask you an important question...
 
You may not have an answer right now. But by the end of the day, I hope that you do...
 
It will help you avoid making useless trading mistakes... and throwing away hundreds, thousands, or even tens of thousands of dollars.
 
The question is, "What's your plan?"
 
You can take that question a lot of different ways. But here's what I'm asking you today. It involves two parts...
 
First, do you have a short-, intermediate-, or long-term outlook on the markets you're involved in... like stocks, bonds, and commodities? How about the specific sectors within those asset classes... and even the individual stocks or commodities themselves?
 
You don't need an answer for every market or asset across every time frame... But you should have an answer for each, for at least one time frame.
 
After all, why would you own an asset if you don't think it's going to rise over some period of time?
 
Review your portfolio today. I suggest you immediately close out any positions for which you don't have a good answer. That's part one.
 
Second, does your exit strategy line up with your outlook? By this, I mean your stop loss. This should be the core of your trading plan...
 
A stop loss is a predetermined point at which you'll sell a position... no questions asked. Stop losses are designed to limit risk and to remove emotions from your trading decisions.
 
You can use a lot of different types of stop losses... But two of the most common – which I like to use in my DailyWealth Trader (DWT) service – are "trailing stops" and "hard stops." A trailing stop is calculated as a percentage below an asset's highest price since you've owned it. A hard stop is chosen before entering a trade and remains fixed.
 
Each has benefits and drawbacks. But whichever you chose, make sure your stop aligns with your outlook...
 
For example, let's say you strongly believe that shares of XYZ Holdings (XYZ) – a medium-sized company with growing sales and earnings – will rise by at least 75% over the next three years.
 
If you want to weather the stock's volatility for three years, you're not going to use a 10% trailing stop. You'll get knocked out too quickly. You're also probably not going to use a 50% trailing stop. The 50% risk isn't worth a possible 75% reward.
 
Maybe a 25%-30% trailing stop would be appropriate. This way, your reward is at least 2.5 times your risk (75% divided by 30% = 2.5)... And you're giving XYZ "wiggle room" for normal volatility.
 
These details are important. But it's even more important that you stick to them...
 
One of the biggest mistakes that both investors and traders make is that they get caught up in emotions and throw their stop losses out the window. Here's why you need to have both a time frame and a specific stop loss in mind when you open a position...
 
Let's say XYZ makes a big, 30% move higher in the first three months that you hold it. On top of that, the stock market in general jumps 15%. You get worried that there could be a correction over the next month... and that XYZ could fall 15% or 20%.
 
This is where most people say, "30% in three months is great. I'll sell now and buy back if there's a correction."
 
This may not sound so bad. But it's a huge mistake. First of all, you risked 25%-30% on this position... because you believed there was 75% upside. If you sell now, your position just went from a reward-to-risk ratio of 2.5:1 to about 1:1. You likely wouldn't have made that trade to start.
 
Plus, this is a three-year position. It doesn't make sense to close it out based on a possible one-month move. The time frames that guide your actions should match up with your expected time in a position.
 
Folks who sell in these scenarios often don't get back in. They miss out on a great opportunity to make 75%... one that was already going their way.
 
If you sell XYZ after a 30% gain, then place a similar trade that goes against you, your loss will nearly wipe out your entire gain on XYZ.
 
Over time, this is a losing behavior...
 
With many investment and trading strategies, your win rate isn't going to be much more than 50% or 60%... And that's if you're doing well. If you close out a trade when your gain equals your initial risk (like in the XYZ example), you're condemning yourself to terrible long-term returns.
 
In order to make big profits in the market, you need to follow the golden rule of trading: Cut your losers and let your winners ride.
 
Having a clear plan from the get-go – with your time frame in mind and your stop loss set – allows you to follow that rule.
 
Plan your trades. And trade your plans. You'll save yourself from making big mistakes... And your investment account will thank you.
 
Good trading,
 
Ben Morris




Further Reading:

In his timeless essay, Kim Iskyan outlined three questions that will help you make a plan for your investments. It sounds simple. But if you ask yourself these questions before you invest, you can control your emotions... and avoid making expensive mistakes. Read more here: How to Never Make a Bad Investment Decision Again.
 
Too many investors rely on "trust your gut" decisions that only lose money... They cut their winners too early, and ride their losers all the way to the bottom. In this classic piece, Dr. David Eifrig explains how to avoid "gambling" with your portfolio. Read more here: How to Trade Like You Have a Sixth Sense.

Market Notes


THIS COMPANY IS RIDING THE BIG MOBILE-PAYMENTS TREND...

Today's chart highlights a behind-the-scenes company that makes the checkout line a breeze. It's as easy as pressing a button and walking away...
 
If you have braved a brick-and-mortar store recently, you know we're talking about mobile payments. The technology is spreading rapidly... According to Cisco, an additional 700 million people will use smartphones by 2020. That's 15% more people in only three years.
 
Regular readers know one of our favorite ways to profit off any trend is through "picks and shovels." These are the companies that provide the tools, products, and services vital to the success of long-term trends. One such company, Vantiv (VNTV), specializes in mobile, in-store, and online payment processing. And business is booming...
 
Shares of Vantiv have thrived over the past year, recently hitting new all-time highs. As more people ditch their wallets and grab their cellphones, Vantiv's business should continue to grow...
 

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