It will get you every time. If you fail to plan, plan on failing, especially when it comes to stock trading.
The stock market is an expensive place to learn how you react under pressure. When there is money on the line, people's ability to make sound, rational decisions oftentimes becomes clouded in the heat of the moment.
Ask yourself what you would do if you had recently bought a stock in a company and soon after the Securities and Exchange Commission announced an investigation into the companies 10k form?
Or what if a terrorist group successfully denoted a bomb on an aircraft; would you sell your airline stocks or buy more?
What would you do if a company that produces organic beverages announced that they recently discovered that their major product line was tainted with E-coli?
These are the type of questions that all successful traders have an answer to – even before scenarios like these happen.
What type of trader are you? Do you buy or sell short a stop and not use a protective stop order to exit the position should it go against you? Or do you have a well defined plan that includes a "worse case" scenario, takes partial profits at well defined exit points, and trails a exit stop to maximize profits?
I am going to suggest that if you are not in the latter group that you consider changing your trading habits – or give up trading all together. Let's face it, you are a potential trading casualty in the trading arena without a solid trading plan. I am not saying that the well prepared trader is not also a candidate to completely lose everything. I am saying that the prepared trader has a better chance of profiting and keeping profits then the "trading cowboy".
Let's define a trading plan, one designed to keep in you in the game ready to pick up the winners while minimizing the losers.
1) Know at what price you will exit, even before you enter a position, in case the position goes against you. Know how much money you are willing to lose, whether that amount is a percentage of your portfolio or a fixed dollar amount helps keep your precious trading capital in tact and ready to win.
2) Use stop orders for protection against catastrophic losses. Have a good-till-cancel order running at all times to protect yourself from trades going beyond your loss threshold. Realize that just because you have a stop order at a certain price does not mean that you will get that price if your stock is moving against you. Bad – or good – news has a way of moving a stock price rather quickly. My preference is to use a straight stop order and not a stop order with a limit. Understand what types of orders your broker provides and how to use them.
3) Exit a position after a certain time if your position has not moved favorably even if your stop price has not been hit. Think about it, if you entered a stock based on the idea that it would move in your favor and it does not – what does that tell you? You might be wrong about the direction of the stock's price. Consider it a chance to get out before something unprofitable happens. Grow up and get over the idea that you have to be right to make money trading stocks.
4) Take profits on at least part of your position if the stock moves in your favor. Do not be greedy.
5) Once you have taken profits, work on keeping the position open as long as possible. This assumes the stock does not give back a good portion of the profits. Look for significant highs and lows to place an exit stop.
6) Remove trading profits from your account. Have a plan to invest your profits elsewhere – in a long term investment mutual fund, or real estate, or pay off your debts.
Traders with the discipline to plan out their traders are likely to keep and grow their trading accounts. Be one of those traders.