About Closing Trades

[David Randolph]

This is an excerpt from  the book Trading Rules, by William F. Eng:

«Traders spend a good portion of their waking hours analyzing the markets. They try to determine how they can enter the markets correctly, yet they spend very little time planning what to do if their analysis is wrong. They also don't predetermine points where they can take profits.

Initiating a trade is only one part of the total process. There are really three parts to a trade: 1) decision making, 2) execution, and 3) management. Each part is critical to successful trading, and each part must follow in sequence. However the only part that makes money is the management part.

The first part of the trade is decision making. Most traders learn techniques of fundamental and technical analysis to help them decide wether they should go long or short in a trade. It takes a long time to gain knowledge in this area, and the learning curve is steep. Hence, this part of the trade makes no money for the trader.

In fundamental analysis the trader analyzes the balance sheets and income statements of companies to predict future price movements of the stocks. The analyst tries to predict future trends in past assets, earnings, sales, products, management, markets, and other indicators. He or she assesses wether a particular stock or group of stocks is undervalued or overvalued at the current market price. The fundamentalist analyzes commodities, interest rates, and foreign currencies with these tools.

The technical analyst, on the other hand, looks at supply and demand in terms of price, time, and volume action. The analyst tries to discover repeatable patterns by charting these types of data. Once the analyst classifies price, time, or volume action into repeatable patterns, he or she can then forecast future patterns.

Traders cannot learn fundamental or technical analysis overnight. From my own experience, it takes several years to become proficient with these tools. The time spent learning the analytical tools causes many traders to overemphasize this portion of a trade.

The second part of a trade is execution. Although this part of the trade can be learned within a month, it also does not make the trader any money; at best, it will reduce price skids on trades. After the trader has decided to either buy or sell, there is a spectrum of approaches to executing the trade. The trader can enter a trade at the market price or at a limit price; he can enter a long position with a stop buy order or a short position with a stop sell order; he can close out a position at the market with a stop on close only; he can place contingency orders; he can buy at noon and sell 15 minutes before the close, etc.

Sometimes traders confuse the decision-making tools with the trade execution tools and begin to view the execution part of the trade to be the same as the decision-making part. These traders end up trading more often than they should and for much less profit than they can get.

The third part of the trade is the management of the position. This part makes all the money. It is the most critical part of a successful trade. Successful traders handle this part very well. Unsuccessful traders are unaware that this portion of a trade exists.

When the trade turns into a profit, the unsuccessful trader takes his profits; the winning trader tries to determine whether or not the trade will continue to show more profits. If it shows promise of more profits, the trader allows it to run its course.

Losing trades don't start as large losses, but as controllable small losses. When unsuccessful traders have a small loss, they allow it to expand. If they want to move into the winners' class, they must learn to manage their trades correctly.

Of the three parts of a trade, position management requires the least amount of study, for there is nothing to study, yet it is the only part that can make the profit. The part that does require study is the study of yourself and your own personality traits. You must know how comfortable you are with yourself as a winner, how you cope with failure, and how you handle disagreements in life.

It is difficult not to lump the three parts of a trade together because the decision-making process takes the longest time to learn. However, a trader who becomes consumed by the act of deciding doesn't know what to do with the trade once it is executed. If the decision to enter the trade is correct, the trader does not know how to manage the position. He or she sells out too soon and prevents the profits from accruing.

When you learn the process of making a trade over several years, the three parts to a trade appear to overlap to the point where you cannot see their demarcations. The next time you want to make a trade, decide what you want to do based on fundamental analysis, technical analysis, or a combination; then execute the trade. Finally, bring out your desire to make a profit: Manage the position correctly. Remember that when you start a trade, you are only partially on the way on the road to wealth !»

[Jimbo]

David,

I would like to thank you and Frederick for the fantastic site you've created. I found about 3SOF about two weeks ago and since then I've been following all your posts. There was no question that I should join the premium service. I'm new to the trading world and that is a big time experience for me. There is no doubt that I'll learn a lot from you guys.

Since this is a knowledge topic and you mentioned some trading rules from the book Trading Rules, by William F. Eng. I would like to ask you for some recommendations of a good trading books. There are so many books in the market and a newbie like me gets easily confused.
So far I found :
1."Technical Analysis of the Financial Markets" by John Murphy
2."Technical Analysis of Stock Trends" by John Magee, Robert D. Edwards

I appreciate any help

[Ramsburg]

David,

I would like to thank you and Frederick for the fantastic site you've created. I found about 3SOF about two weeks ago and since then I've been following all your posts. There was no question that I should join the premium service. I'm new to the trading world and that is a big time experience for me. There is no doubt that I'll learn a lot from you guys.

Since this is a knowledge topic and you mentioned some trading rules from the book Trading Rules, by William F. Eng. I would like to ask you for some recommendations of a good trading books. There are so many books in the market and a newbie like me gets easily confused.
So far I found :
1."Technical Analysis of the Financial Markets" by John Murphy
2."Technical Analysis of Stock Trends" by John Magee, Robert D. Edwards

I appreciate any help

Hi Jimbo,

Thanks for your feedback ! You're welcome !

There are some great books about the market, I'll give you my personal TOP3:

1 - Reminiscences of a Stock Operator


2 - Trading for a Living


3 - Encyclopedia of Chart Patterns


best regards !

[Jimbo]

Thanks Frederick,
 
I've ordered them.    BTW here is a great site for online shopping  - it's cheaper 10% than Amazon.com. 


http://www.buy.com/


Keep up the great work!