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Stock Market Investing

The Smart Profits Report: Issue #374
Wednesday, November 29, 2006

Stock Market Investing: 3 Things Investors Must Master To Improve Their Trading
By D.R. Barton, Jr.
Quantitative Analyst, Mt. Vernon Research

Poker champion Puggy Pearson once said: “Ain’t only three things to gamblin’: Knowing the 60/40 end of a proposition… money management… and knowing yourself.” Truer words were never spoken. And in fact, if you substitute the word “tradin’” for “gamblin’,” the same logic is true within stock market investing.

Back in 2004, I gave a keynote address at a conference, entitled, “The Three Pillars of Investment Success,” which were the same three areas listed in Puggy’s quote above. But Puggy puts it much more eloquently and succinctly than I did!

Pearson was a world champion poker player and the father of the modern poker tournament format. (So you have him to blame for the fact that you can’t turn on the TV today without seeing a No Limit game!)

He obviously understood the critical aspects of the game well - aspects that can also be applied to the investment world. There are three things investors must master - so let’s look at them today and see what specific things you can do in each area to improve your trading and investing profits now.

Master These 3 Core Concepts to Maximize Your Profits

In school, learning the “three R’s” has always formed the basis of a solid education. Until you learn readin’, writin’ and ‘rithmetic, there’s no use working on much else. The same is true in trading. These are the three most important core concepts. And it’s vital that you nail them in order to maximize your profits:

  • Know The 60/40 End Of The Proposition: You have to have an edge - but what exactly is your edge in each trade? So many people enter a trade or investment without knowing and understanding exactly why the odds are tilted in their favor. But if you know your edge, you can have the confidence to stick with an individual trade or with the trades within a system - even when things aren’t going well.

What To Do Today: Revisit your trading system or trading plan. Identify the market conditions where the system should be very strong, and the conditions where it might not perform so well. With this key information, you can approach every trade with more understanding and confidence.

  • Understand Your Money Management Strategy: You have to be able to protect your money long enough to realize your edge and take advantage of the times when you’re doing well. But many traders don’t have a money management strategy. They trade the same number of shares or contracts, regardless of the trade’s risk profile.

What To Do Today: Define a strategy that allows you to allocate your risk equally for each trade. This means that you trade more contracts or shares when the risk of loss per share is lower (meaning that your stop-loss point is closer) and trade fewer shares or contracts when the risk of loss per share or contract is higher.

  • Commit To Working On Your Personal Trading Psychology: Every great poker player, golfer and trader knows the link between knowing their personal psychology and performance. And great traders have always stated that 60% to 90% of trading is knowing and understanding your own psychology. But there are a huge number of people who believe that if they just find the right system or newsletter, then they won’t have to worry about anything else. Unfortunately, nothing could be further from the truth. Trading is such a counter-intuitive game that almost everyone who studies it concludes that success is 60% to 90% related to mastering your personal psychology.

What To Do Today: Find a good set of resources to help you develop your trading. My personal favorite is Dr. Van Tharp’s “Peak Performance Home Study Course,” find more information about this here.

Like every savvy speculator, we need to pay attention to each of the three key areas of trading in order to get the most from our investments.

Great trading,

D. R. Barton, Jr.

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Today’s Smart Profits Cribsheet

  • Once you’ve read over the three core concepts of investing, you might want to check out another issue I wrote about how to avoid three common investment mistakes in Smart Profits #371, Asset Protection Plan: How To Avoid 3 Mistakes That Could Cripple Your Investment Account.

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The Chart of the Week

Archer-Daniels-Midland (NYSE:ADM) vs. Corn Futures

This chart shows the relationship between 100 shares of Archer-Daniels-Midland (NYSE: ADM) and contract of corn futures. In August, I recommended shorting this ratio, because of the fervor over ethanol and how it was only being reflected in the distillers’ price, while the corn farmers were getting the short end of the stick.

As predicted, this ratio continues to drop - and is now reaching a stretch point on the other side. With the continued demand (artificially induced or not) for ethanol, I think this ratio is set for a bounce to the upside. My good friend and fellow Smart Profits Report analyst and commodities expert Lee Lowell agrees (at least on the corn side of the equation) and is bearish on corn for the short- to intermediate-term.

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