Bill Gates and Warren Buffett both agree that Charlie Munger is the most intelligent person they now. Charlie Munger once said: “Problems frequently become easier to solve if you turn them around in reverse. Unless you’re more gifted than Einstein, inversion will help you solve problems.”
Now let’s use a little bit of inversion to solve your trading problems. Around ninety percent of traders lose money so what we have to do is ask what are ninety percent of these traders are doing.
- First, they buy breakouts and then sell breakdowns. Yes, they are literally chasing the stock price around.
- Second, they all try to cut their losses short and let the winners run. This idea sounds great in theory, but it just doesn’t work.
- Third – way too big position sizes. Have you ever heard the saying “don’t overtrade, focus on the best setup, and increase your size on the good ones”? There’s some merit to increasing in size during periods of better opportunity but don’t overdo it or eventually you’ll be wiped out of the game.
- Traders are afraid of reducing their cost basis because they might be capping their potential profits. For example, selling a covered call reduces your cost basis but also reduces potential gains. Unlimited profit potential is a mystical creature.
Now that you see these four wrong things traders do, why do they do them?
Well, some of that human psychology is because of what traders were taught by investment education websites: “Trade breakouts. Cut losses, let winners run, and have unlimited profits!”. Those websites tell traders what will make them spend money. But now think about it: how appealing does “cut your losses smaller and let your winners run” sound? Sure, it sounds great, exactly what you want to hear, but anyone teaching this concept has either never traded before or they are just lying. However, it does not mean that you must have massive losses and tiny profits. If you are trading and implement the right strategies, this shouldn’t even happen or be an issue.
Let’s use a bit of inversion and flip these points around. In the following rows, we are going to discuss a new and efficient trading strategy.
1. Buy into weakness and sell into strength
Why? Because it is precisely the opposite of what most traders do. Now you might be saying “how do I know if a sell-off is over?”. The answer is simple: you don’t, nobody does. It doesn’t matter if you are Warren Buffett or Bill Gates. You don’t know whether the stock is going up, down, sideways or in circles, but ultimately is the human emotion that drives market news. So don’t just fall victim to your emotions.
2. Book your profits and be patient with losing trades
With a high profitability trading strategy, almost all losing trades will become winning trades at some point. If you are cutting your losses small, you are going to choke out a lot of good trades, and if you are trying to let your winners run, you are going to be very disappointed when they don’t run like they were supposed to.
3. Keep your position sizes small
This allows you to make decisions based on logic rather than emotions. The only way to be patient with positions is if you size them correctly. If they are too big, then the day-to-day fluctuations in your account balance would cause you to make bad decisions and acquire gray hair at a very young age.
4. Reduce your cost basis
You can do it by placing trades with a defined profit strategy. These are strategies with limited profit potential, but they have a very high probability of success. Consistently reducing your cost basis will pay you far more than that home run that you might hit. If you swing for the fence, you’re probably going to strike out.
5. Trade during the weekends
Weekends are no longer considered short breaks before weekday trading. As after hours trading has increasingly become popular among professional investors, you can make good money investing during weekends. If you trade during the weekends, you will find it a really lucrative strategy because you can buy or sell binary options in a short timeframe when the markets are closed, as well you can benefit from a more robust and appealing portfolio. When Monday hits and markets open, your profits could be higher.
Following these simple guidelines, you will save you many headaches, time, and money.