Last New Year’s Eve, I gave one final prediction for 2011 in this post. Here is the text:
“There Will Be Head Fakes”
Accordingly, please use caution headed into the next several weeks. There is nothing wrong with taking a wait-and-see approach to start the year.
HAPPY NEW YEAR
Given my style as a technically-driven trader who is best at reacting to price and momentum, it is tough for me to make bold predictions seriously. I was having a bit of fun in that post above, but my sense was that 2011 would, in fact, be a difficult year for just about all market participants. Your style may very well be different from mine in terms of making bold predictions, and that is fine by me. I just try to stick to what I do best.
We have a little more than a month to go in 2011, and there have indeed been plenty of head fakes in both directions at various points throughout the year. Although it sounds, and can most certainly be, boring to say and do, protecting capital has been the far more important discipline to practice this year than growing it. Usually, that means staying in heavy cash and keeping a tight leash on positions.
And that brings me to my next point: The most important and least discussed aspect of trading is bankroll management.
“How do you pay the bills while in heavy cash?” is a question I often see on the Twitter stream from traders who believe they must trade all day, every single day. First and foremost, if you are an active day trader then you are going to, naturally, be more active than I am as a predominant swing trader. Beyond that, though, if you trade full-time then you should have, at the very least, six-to-nine months of living expenses set aside in the event you are trading lightly or are on a nasty losing streak. To state the obvious, unlike other jobs where you are an employee working for a salary or hourly paycheck, in the market you are risking capital each and every time you try to make money.
If you think about it, anyone can label themselves a full-time stock trader. It is only when you deal with the inevitable losses, especially the ones that come quickly and throw you for a loop, that you find out if you are a true professional. In addition to temperament, i.e. not going on tilt, being properly bankrolled is a must if you are going to trade full-time. Not gambling with the rent money is one of those old axioms that will never become obsolete, given how many will be forced to find religion through the school of hard knocks in the market.
There are plenty of talented traders out there who blow up their accounts not because they got outmaneuvered by the guy (or robot) on the other side of their trade, but because they were simply not bankrolled properly and felt compelled to overtrade in poor market conditions to try to “pay the bills.” Well, I have news for you: If you need to trade to pay your electric bill and utilities, then you are in the wrong profession. Being properly bankrolled also gives you the peace of mind that you do not have to, in fact, trade all day, every day. Trading is gambling, although your definition of gambling may differ from mine. The market owes you nothing, and society has exactly zero sympathy for those who have the capital to trade/invest and lose it all (unless you are a giant bank, in which case you can rely on a bailout from Uncle Sam).
If you do not have those six-to-nine months, at a minimum, of money set aside, then no amount of technical or fundamental analysis will keep your back from soon being up against the wall. In addition, position sizing is an important subset of bankroll management, which I will discuss in another post. In easier, trending markets, mistakes are easily forgiven by Mr. Market. But those markets eventually morph into nastier ones, where there is much more of a premium placed on details and discipline. We all make bad trades and stray from our discipline at times. The key is quickly re-focusing and striving to improve.
However, failing to adhere to bankroll management is worse than a mere blunder in a chess game–It often amounts to leaving your King exposed to get checkmated by the market. And that will ultimately be the take-home lesson for most traders from the market as the year 2011 comes to a close.