Rule #3 & #4 of My 10 Investing Rules

By Chris Rowe May 1, 2015 Facebook Logo Twitter Logo Email Logo LinkedIn Logo


Last week I posted the first 2 of my 10 favorite rules.


As promised, here are the next two trading rules.

Please enjoy Rule 3 & 4, below...


Rule #3: Ignore Outside Influences.

Outside influences are virtually guaranteed to take you off your game.  There's a reason I stressed the word 'your'.

It's because, at the end of the day, you and you alone are responsible for your buying and selling decision.  If you rely too much on outside influences, you run the risk of detaching yourself from those decisions.

You'll find yourself trying to morph into the type of investor that you are NOT.  You have your own goals, temperament, and tolerance for risk.  The best investing strategies are the ones that fit most comfortably into the kind of investor you naturally are.

What's more, outside influences -- the news networks, self-interested brokers, even well-meaning family and friends -- can inject needless emotion into your trading decisions.

And I can't say it enough: When it comes to trading... emotion is the enemy.  I defy you to find a single interview with a Jesse Livermore... or a Warren Buffet... or a Jim Rogers...

... where they say, "You know, this trade was going against me. But then I got really angry/happy/fearful... And it all turned out!"

So, tune out the media, analysts, corporate executive comments and any financial advisor.  None of them are motivated to make you money.

And, in addition to the drawbacks listed above, they can all take precious time away from you studying (and seeing!) the market in front of you.

If you're like most people, you'll be most tempted to turn to outsiders immediately after a setback... or during a losing streak.  (And they darn well know it.  Believe me, they're lying in wait.)

Look, You will go through losing streaks.  Everyone does.  That doesn’t mean you should allow yourself to be influenced by others.

As long as you manage your risk correctly, you will be able to withstand losing streaks both mentally and financially.

Which brings us to...

Rule #4: Identify Your Maximum Risk.

Before entering any trade, know exactly where you would exit the trade and take the loss.  Identify the point at which you would cut your losses.

I know that sounds like the most "Well... D'uh!" piece of advice ever offered...

But you actually have to do it!

You'd be shocked at the number of folks I speak with who actually don't practice rudimentary risk management.

So, make sure you never enter a trade until you're sure you know your downside risks.  And there's more to it.  You also need to make sure the reward far outweighs the risk.

You see, risk doesn't exist in a vacuum.  Risk and reward are the two faces of investing.  It is possible to make a massive fortune on some thousand-to-one shot.  Trouble is, the odds are stacked so massively against you that you might as well take your money and burn it.

Smart trading means stacking the odds in your favor.  (Or, as a very wise investor put it: "The real risk is not knowing what you're doing.")

Above all, follow through and exit your position when your max risk limit is reached.  Don’t make excuses to stay in the trade.  (Bonus question: What do you think would drive you to make those excuses?  If you answered "Emotion", give yourself a gold star.)

Max risk doesn’t have to be a particular percentage loss.  It can be based on technical factors.  (For example, the price level an up trend line is at increases every day.)

The way professional traders trade, and the way you should too, is:

  1. Decide where you would exit a trade based on technical patterns –  not some static rule like: "sell at a 7% loss every time".  People teach other people to exit a trade at a fixed percentage loss, because it’s a quick and easy way to train you to jettison a loser.  It’s a method for people who don’t want to spend the time that your investing and trading education deserves.
  2. Decide on your POSITION SIZE based on the DOLLAR AMOUNT you are willing to risk on a trade – not using some static dollar or share amount on every trade.

FIRST decide how much money you are willing to lose if you are wrong.  Consider that you might be wrong on 6 – 10 trades in a row.  It happens.

Using step 1, above, you should figure out, using technical patterns... chart formations... support and resistance levels... where you would enter or exit a trade.

Once you know the price at which you would exit at a loss, then you can easily figure out how much money you would invest into a trade.

For example:  With a $50k account you might be willing to risk 1%, or $500.00 on a trade.  If your stop loss (in points) is two points (you’ll sell at a loss if the stock declines two points), then you know you can buy 250 shares.

250 shares x 2 points stop loss = $500.00 loss.

If it’s a $50.00 stock, that’s a $12,500.00 investment.

If it’s a $20.00 stock, that’s a $5,000.00 investment.

If it’s a $10.00 stock, that’s a $2,500.00 investment.

If you use this method, you will find that you are able to invest more in some ideas and less in others.  If you trade any other way, you’re almost certain to spin out.

An additional way to significantly reduce risk is by using option contracts.  My Options Soup course (which I created with Costas Bocelli) shows you how to make money using option contracts.

We also have a section on how to use options to take much smaller risk while at the same time positioning yourself to make much larger profits than a typical ETF or stock position.  I’ve had hundreds of people tell me this strategy changed their lives.

That may sound unrealistic to many people.  That’s because those people have been trained to think the wrong way.  This is very real.  And major investors, including Warren Buffett use options to trade/invest.  Don’t let your financial professional convince you they can only add risk.

Option contracts are like a new Ferrari.  It’s only as dangerous as the person driving the car.  I would think letting a 17-year old drive a Ferrari is riskier than letting a 60-year old drive one.

But... the new Ferrari is much safer than the 30-year old Toyota with bad alignment and bald break pads.

Thanks for reading, and I'll see you soon.