Thursday, November 13, 2014

Concentrating on what's important

"At the end of the day, your main goal should be to make money, not to get an A in How to Read a Balance Sheet" - Richard Donchian

When you are trading, you need to focus your mind on what is important information and what isn't. Spending time looking at information that isn't critical to what you are trying to achieve is a waste of time and effort, and won't add to your bottom line.

So, what is important to you? To a degree, that will depend upon you basic ideas about trading, your timeframe, preferred holding period etc.

As a trend follower who uses hard and fast rules about when to enter and exit, what is critical to me?

Price action.

As far as I'm aware the ONLY way I can make money on a long trade is if price moves up after I have opened a position. Similarly, the only way I can lose money on a long trade is if price drops after I have entered a trade.

Simple, isn't it?

If price action starts moving against me, then I'm out of the trade. I don't hang about. I want to keep my losses as small as possible, and move onto the next trade. If, however, price moves in my favour, then I will keep the position open until that price move (trend) is over.

What help is it to you if a company seemingly has great fundamentals, yet price is falling against you? Price is fact, and is based upon what price ALL market participants are prepared to buy and sell at. The market doesn't care about your opinion on a stock - or that of anyone else. Price moves up and down based on buying and selling. End of.

Remember the dot.com bubble? Half those tech start-ups had no fundamentals or earnings! Yet they allowed traders to generate huge profits by riding those uptrends in price.

Think then about 2008. Even those stocks who were the strongest fundamentally got hit as part of a market-wide downdraft.

Having simple rules based around price action would have allowed you to benefit from such moves.

All the other pieces of information that people pore over, such as P/E ratios, balance sheet analysis, earnings reports, brokers consensus, what Cramer thinks etc., is irrelevant. True, they may be a catalyst behind a move, but as I have mentioned several times on here recently, price tends to move before underlying fundamentals become public knowledge. As an example, how many times have you seen what seems to be a positive trading update released by a company, only for price to drop, or vice versa?

Therefore, price it is for me.

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