This week’s Stockscores Market Minutes video looks at how to use the Stockscores Market Scan tool to find trading opportunities plus my regular market analysis. Watch it by clicking here.

I have spent my summer writing a book about trading, look for “The Mindless Investor” this Fall!

Here are 10 things that every trade should keep in mind,

1. Know that not every trade is profitable.
Since the stock market can not be predicted, every trader needs to accept that they will be wrong some of the time. What separates good traders from the rest is their ability to throw in the towel when the market proves them wrong and take the loss.

Doing this allows them to maintain their financial and emotional capital. Don’t leave money in a loser that is more likely to continue to be a loser, it is too deflating and expensive.

2. Know what your tolerance for risk is.
Traders who are able to make smart decisions can beat the market. However, the greatest hurdle to doing so is overcoming the emotional traps that cause traders to make bad decisions.

The reason we succumb to our emotions is because we are afraid of losing. It is the risk we take that creates emotion; take too much risk and you are likely to make bad decisions.

Therefore, you need to know what your limits are. What dollar amount of risk causes you anxiety? If you can not make a trade with out fear then you are taking too much risk. For some, that means never trading since they simply can not handle the risk of financial loss. However, over time and with success you will begin to build up your tolerance for risk, just take it one step at a time.

3. Know who is in control of the stock you are trading.
Never ever buy a stock that is going down. Stocks in downward trends are controlled by the sellers and they will continue to go down until the sellers lose control. While it is tempting to get a deal on a stock, to try and buy it at bargain prices, the actual act of doing so is very challenging. The market is not always rational and the bottom is difficult to predict because we do not know what is motivating the sellers to act.

Making money is simple. Buy stocks that are going up, short stocks that are going down. If the stock chart has rising bottoms, the buyers are in control. If the tops are falling, the sellers are in control.

4. Know who is in control of the overall market or sector.
A big factor in a stock’s performance is the performance of the overall market or the stock’s sector. If the oil industry is strong, individual oil companies will be able to do better.

Any trader who has a hold time frame beyond a few days should first consider the sector and focus their attention on the sectors that are outperforming the market. Strong stocks in weak sectors are not as likely to do well as a moderate stock in a strong sector.

5. Know the price point where the market proves you wrong.
If we accept that we can not be right all of the time then we need to have a plan for what we will do when we are wrong. Arbitrary stop loss orders are not effective, they must be based on past opinions of the market.

Remember that the stock market’s job is to put a price on fundamentals. This is difficult since fundamentals are always changing but we do find that the market is good at putting upper and lower boundaries on the fundamentals over a period of time. The lower boundary of fundamental value shows up on a stock chart as a price floor while the upper boundary will be a high price point that acts as a ceiling. Breaks through these price ceilings are caused by a change in the perception of fundamental value. So too with price floors, if a stock closes below a well established price floor then we can guess that the market has found a fundamental reason to accept lower prices.

So, when you buy a stock, understand where the price floor is. Look for well established low price points and plan to exit a buy if the stock closes below that low point. The reasoning is simple; if a stock closes below a psychological floor then it is likely that investor perception of company fundamentals has changed.

6. Know what the expected value of the trade is.
Good traders do not fly by the seat of their pants. They develop a set of rules and then test those rules to determine the expected value of trades using that strategy.

The expected value of a trading strategy is the probability of being right times the average profitability when you are right minus the probability of being wrong times the average loss when you are wrong. Using this equation you should see that success trading is not just about whether you are right or wrong but how much you make or lose when you are right or wrong.

A trader can make a lot of money only being right 10% of the time if they capture very large gains when they are right and only small losses when they are wrong. In the same way, a trader can lose money even if they are right 80% of the time if they have big losses on individual trades.

7. Know that the media knows nothing of value.
While there may be entertainment value in the media, using it as an information source is doomed for a couple of reasons.

First, the media tends to react rather than predict. Trading the stock market well is far more lucrative than reporting on it so it should be difficult to trust the analysis provided by financial reporters.

However, to be fair, there are some financial reporters who are able to uncover valuable information that could be lucrative if only you and a few friends knew about it. The reality is that the media is speaking to a large audience which means the information that they distribute will be priced in to the stock almost immediately.

It may be interesting to hear some like CNBC’s David Faber report on a merger of two companies but capturing the value of the trade around that transaction will be difficult because the market will move so fast once he announces his discovery. The market is efficient, making the media’s voice merely entertainment.

8. Know that the market never lies. 
I have met so many liars in the stock market business over the past 20 years. I think that many of them actually believe what they are saying but, the truth is, people’s judgment is clouded by greed.

The stock market is a giant polling mechanism allowing people to cast their opinion with their money. If you think the stock market is going up, you buy. If you are right, you make money. It is a simple and powerful machine that determines value and, since no one wants to lose money, it is very efficient at telling the truth.

The truth may change from one moment to the next but one thing will not change. Arguing against the market is a fast way to lose money.

9. Know the difference between pullbacks and reversals. 
The profit is in the patience. Very few stocks go up day after day after day; with all strong trends there are pull backs against the trend. These pull backs are important because they shake out weak hands and recharge buyer interest. So long as the pull back is not an indication of a change in the perception of fundamentals.

Stocks do not go up forever; there will come a time when the trend must reverse as money moves out of the stock. Learning to know the difference between a pull back and a trend reversal is important if you want to maximize your overall profitability.

Generally a reversal comes when a trend line or important area of support is broken. Allow for the short pullbacks so long as the primary trend remains intact.

10. Know yourself. 
If you do not know yourself you can not know success as a trader. Trading well is a matter of mastery over emotion. While very simple, trading is hard because our emotions get in the way and we succumb to fear and greed. If you know what motivates you and understand how you react to risk and reward you can begin to succeed as a trader.

The market is very slow right now, partly because it is the tail end of the summer when most traders would rather be enjoying the weather than sitting in front of a screen and partly because the market is waiting to see what the US Federal Reserve does in terms of monetary stimulus. The market expects some sort of action by the September meeting of the Fed, much of the strength over the past few weeks has been pricing in that expectation. Now that the market has speculated on QE3 happening, investors want to see the proof. That is why stocks have stalled at resistance.

That means it is harder to find Alpha stocks, those that move faster than the market. One sector of the market that has been strengthening and looks to be in the early stages of a long term turnaround is the US Housing market. Consider the XHB ETF to participate in the recovery of the US Housing market.

1. XHB

XHB is making a break on the long term monthly chart this August, it should continue higher in the months, and perhaps years, to come.

References

• Get the Stockscore on any of over 20,000 North American stocks.
• Background on the theories used by Stockscores.
• Strategies that can help you find new opportunities.
• Scan the market using extensive filter criteria.
• Build a portfolio of stocks and view a slide show of their charts.
• See which sectors are leading the market, and their components.

  Disclaimer
  This is not an investment advisory, and should not be used to make investment decisions. Information in Stockscores Perspectives is often opinionated and should be considered for information purposes only. No stock exchange anywhere has approved or disapproved of the information contained herein. There is no express or implied solicitation to buy or sell securities. The writers and editors of Perspectives may have positions in the stocks discussed above and may trade in the stocks mentioned. Don’t consider buying or selling any stock without conducting your own due diligence.