TRADER'S CHECK LIST "The best way to predict the future is to invent it." -- Alan Kay "Too burdensome. The smartest way to profit from the future is to accurately predict it [sans labor of inventing]." -- T.K. Lin The following check list is provided for your information only and by no means exhaustive. It is presented to help you avoid potential mistakes and to improve your performance and profitability in the stock, futures, index and derivative markets. 1. Without accurate forecasts, the clich‚ "cut your losses but let your profits run" is only an illusory rule because it presupposes that you already know whether price is headed lower or higher. Without reliable timing (i.e. price forecasting), it is impossible to know if one is cutting losses (or profits), or letting profits (or losses) run. Diversification without timing is a placebo for ignorance. Unless one is born lucky, an effective timing system is an essential pre-requisite to winning in the market. Sound strategy and risk management are also very important. 2. Risk only what you can truly afford to lose. Always have reserve buying power and always start by buying only a fraction of what you can afford in opening a position. Always start small. Whatever the amount of cash you wish to commit to a position, divide it by an integer greater than 1. Then divide it again into multiple trades, and gradually build up your position. It is not a bad idea to risk no more than 5% of your risk capital in any one market or industry. If you do not have sufficient capital to fully implement your trading plans, then you are not quite ready to begin. You either must wait until you have accumulated the necessary amount of risk capital, or you must forsake even the "very good" trades and wait until you have the "extremely and exceptionally good" ones, when the situation is overwhelmingly in your favor. Otherwise, one setback will take you out of the market. In either case, patience and preparation are your best friends. 3. Learn to avoid, prevent, or minimize potential losses before worrying about maximizing profits. Take care of potential problems and the profits will take care of themselves. Think through each potential trade thoroughly and have ready plans to handle different contingencies. Those who use a good timing system should also use a time stop. If prices are not moving sufficiently within the time you allocated, be prepared to begin liquidation. Write your ideas and plans down before you initiate your trade. Review and reevaluate them to find ways of improving your approach. This will help you progress rapidly in your trading effectiveness. Don't average your losers, unless superb timing dictates otherwise. Avoid and prevent double-digit losses like the plague, through discipline and loss control. 4. Always limit your losses. Note that this is different from cutting your losses. Limiting losses does not presuppose the ability to forecast prices. Even those who have no idea where prices are headed can limit their losses by using a stop order (mental or otherwise). Remember that it is easy to recover from 10% loss (requires only a comparable 11% gain) or less. Where losses are severe, e.g. 50% or more, it can be very difficult to recover (requires 100% or more gain). The proper way to limit losses is not to set a tight stop, but to limit the total dollar commitment to any position. Set a stop sufficiently large such that if it is approached or triggered, it is an indication to you that your position is wrong, i.e. your price forecast is in error. It may occasionally be OK to use limit orders to open a new position, but it can be deadly to use limit orders to close out an unfavorable one. Sooner or later, a limit order will cause you to miss the market and your failure to close out an unfavorable position may lead to very substantial and avoidable losses. 5. Trade only when the odds are overwhelmingly in your favor. Patience in waiting to open a position is often a virtue in the financial arena. Patience in holding on to a losing position in the hope that time will eventually bail you out of a bad decision is not. Therefore the rule: "Be reluctant to open a new position, but be quick to close an unfavorable position." Do not overtrade. Wait for a very clearly advantageous opportunity when the odds are overwhelmingly in your favor, before you risk your capital. Even if you trade infrequently, remember that a gain as small as 20% to 30% will eventually make you millions. Safety must always overrule greed. Patience must always take precedence over rigid percentage goals. In financial markets, fortune favors the prepared and the patient, not the bold. Boldness must be the result of foreknowledge, ability and skill, or it's suicidal. Ironically, in financial markets, the impatient and the anxious regularly lose because they violate the important rules presented here. Remember, as an individual you cannot, do not and must not create trading opportunities and markets on your own -- it's just too expensive and fraught with risks, as the Hunt brothers learned after losing $billions in silver. You can however be fully prepared to take advantage of the opportunities of price peaks and bottoms as the market or other billion-dollar players present them. That's the safest and most profitable way to be. Since the market moves on greed and fear, you should remain detached from such emotions in order to take advantage of it. To have peak performance, you yourself must be stress free. 6. There are no true "defensive stocks" to buy long in a bear market; either go short or stay in cash. The best defense is to be able to aggressively take advantage of a bearish situation after potential losses are limited with appropriate investment strategy. Even when you are right and prices are moving in your favor, you should have a realistic price goal which, if reached or approached, will cause you to begin profit- taking. If you do not have clear cut price objectives for liquidating your planned position, then you are not ready to open it. 7. Be prepared to go short (but protect with a call option) in a bear market. To try to make money going long in a bear market is harder than finding needles in a haystack. Always trade in harmony with the prevailing trend. Never have an emotional preference for either long or short positions. Your bias or preference should be the result of market condition, based on reliable price forecasts, not personal habit, belief or other emotional attachments. 8. Avoid qualitative (dis)information. The more rumor you allow to enter into your thinking, the worse you're likely to perform. Remember that you are among the last to hear of any "news" and the price has already reflected that. Never invest on hope or wishful thinking, for the results will depress you. Make sure that you have done your homework and that you are totally calm and unperturbed emotionally before you trade or you might act impulsively, which in the long run may lead to financial ruin. 9. Learn to be courageously independent in your conviction (backed by solid, objective forecasts), particularly when your view differs from the overwhelming majority. Remember, at major price turning points (though not necessarily prior), the overwhelming majority is always wrong. In financial markets, loneliness and profitability tend to be cousins. Track your equity, if it is not trending up, it is warning that your timing or/and strategy is/are off, and it is time to cut back or get out of the market altogether for a reevaluation and a fresh start later. When uncomfortable or in doubt, cut back, or liquidate. The market is always there when you are ready to start with a clean slate. 10. Unless you have a knack of buying at bottoms and selling at tops, do not trade illiquid markets. 11. Be flexible. Be open-minded and objective. And be prepared to make changes and improve your approach. All great traders are seekers of truth and intellectually scrupulously honest with themselves. You should be too. Always trade with the attitude that you are still learning, and that you should learn something new or valuable from each trade. Always consider yourself a student rather than a master, that way, you'll tend to trade small and conservatively, particularly when uncertainties exist. Become better by improving on this Check List. We'll be glad to receive your feedback and suggestions for improvements. Send your letters to: R.M.C., P.O.Box 60842, Sunnyvale, CA 94088-0842, U.S.A. Copyright (C) 1990-1994 by R.M.C. All rights reserved.