Stock Market Index Trading Strategy

The Smart Profits Report: Issue #380
Thursday, December 21, 2006

Stock Market Index Trading Strategy: A 2-Step Approach To A Successful Trading System
By D.R. Barton, Jr.
Quantitative Analyst, Mt. Vernon Research

Everyone loves getting gifts. Sure, we all know some old curmudgeon who has become jaded by the season. After all, Charles Dickens didn’t invent Scrooge out of thin air! But I’m talking about the part of us that’s still like a little kid and gets excited about receiving a gift. When we get one, the moment is “pregnant with possibility.” It could be anything. It puts us in a hopeful state. The hope that it’s what we want and will thrill us.

Then we open the package. And the moment that was just filled with the unknown turns into a finite reality. It becomes something. Hope becomes certainty. Expecting becomes knowing. And what was once our heart’s desire can’t help but degrade into a slight disappointment in that transition. I’ve seen this in my children and in adults, as well.

And it happens in the investment world, too - and is one of the biggest trading problems that I believe we all face, whether it’s within a stock market index trading strategy or a trading system. So what do we do when tough reality sets in and our exciting “anythings” get turned into mundane “somethings?”

How Investors Get Burned by “Christmas Present Syndrome”

Hundreds of people have shared with me their feelings of moving from excitement and anticipation to disappointment once they started looking at both the promise and the flaws of any given stock market index trading strategy or investment system.

I call this the “Christmas Present Syndrome” because whether we’re unwrapping a gift or digging into a new trading system or idea, we’re confronted with a difficult emotional and intellectual transition: We move from a world filled with hope and unlimited expectation into a world of definitive knowledge, filled with the reality that flaws exist and that it may not work as well as it did on TV.

During the holidays, having our gifts turn from eager possibility into harsh reality can cause a bit of post-celebration disappointment. With a trading system, it can cause us to toss out good, useful ideas.

But wait! There are steps you can take to prepare and objectively evaluate that new stock market index trading strategy or trading system! Here’s how the top traders that I know and work with approach new investment ideas and strategies:

Set Expectations For Your Stock Market Index Trading Strategy

Setting expectations for your stock market index trading strategy or trading system is one of the most overlooked aspects of the process of developing a trading plan. And managing your expectations is really a very concrete exercise.

It all begins with setting goals for your trading. Developing your trading goals and objectives is a critical first step - but also the part of trading that most people want to skip. While goal-setting can follow a prescribed format, it is inherently personal (no one else can tell you what’s right for you). And it requires thought. In my good friend Dr. Van Tharp’s first book Trade Your Way to Financial Freedom, Tom Basso (a successful money manager and a market wizard himself) said that when developing a system, one should spend 50% of the time on determining objectives.

Let that sink in for a moment. If you’re serious about managing your expectations for your next trading system, spend some serious quality time on developing your trading objectives - before you take the proverbial wrapper off of that new trading idea.

Determine The Objective Of Your Trading System

The best tool I know of for setting goals or objectives for trading is also one of the cheapest! The third chapter of Trade Your Way to Financial Freedom (mentioned above) has a great objective-setting section for traders and investors.

If you don’t have this book on your shelf, check out the Smart Options Cribsheet below to see how to get a copy of the new revised edition. Go through Chapter 3 in intimate detail. I obviously can’t go into the depth that the book provides in this short space - but here are some areas to consider (while the book is in the mail!)

How much equity do you have to invest?

What percentage returns do you hope to achieve?

How much of your equity are you willing to risk (in the form of drawdowns) in order to achieve your rate of return?

How much time do you have available to spend on developing your stock market index trading strategy or system?

How many hours a week will you apply to execute the trading strategy?

How are you at working and strategizing by yourself? Do you need others to help in strategy development or for accountability and feedback?

Many traders and investors throw out great trading ideas when they discover the first imperfection within any trading system or strategy. Understanding that no stock market index trading trading strategy is perfect and knowing how to use a system within the framework of your overall objectives will be a great help as you evaluate any new investment strategy.

Great trading,

D. R. Barton, Jr.

Today’s Smart Profits Cribsheet

Are you looking for an options strategy for protecting your portfolio against a new investment paradigm that could pose a threat to your wealth? Our Mt. Vernon Research Investment Director, Karim Rahemtulla, offers detailed strategies in Smart Profits #375, Option Strategies: The Solution To The Most Dangerous Investment Paradigm Today.

My good friend Dr. Van Tharp wrote what many people consider to be one of the best trading books of all time in his classic Trade Your Way To Financial Freedom. But he has now revised and updated this classic - and the second addition is now available. You’ll also see a section from yours truly on swing trading in the new edition. Every serious trader and investor should read this book! To get it - and six great bonuses, this link has more information.

Our resident expert in futures commodities, Lee Lowell, of Mt. Vernon Research gives a quick and easy breakdown of 3 different options strategies while seeking to answer the ultimate investment question in Smart Profits #377, Investing In Options: 3 Powerful Option Strategies That Make More Sense Than Stocks.

Related Articles:

Risk Management and Position Sizing: Three Ways To Give Your Trades A Tune-Up
Asset Protection Plan: How To Avoid 3 Mistakes That Will Cripple Your Investment Account
Stock Market Investing: 3 Things Investors Must Master To Improve Their Trading

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