Important Lessons and Reminders for Every Investor and Trader

Published on November 14, 2017 @ 8:05am

More volatility continues to plague short-term charts of all of the major indices. Remember though, volatility to us isn't necessarily always down - it's big swings back and forth, and that's how the averages continue to behave for the time being.

Following another gap lower yesterday, the NASDAQ Composite fought back yet again. However, the markets have opened lower again this morning. All pretty normal right now considering just how extended these markets have gotten - ever since bottoming out in June of last year.

As a matter of fact, when you take a step back and look at the monthly chart of the NASDAQ, you can see not once since June of last year has the index managed to find its way below its 3X3 DMA (blue line), which currently sits at 6,305.

Not only is that extremely bullish on a long-term basis, it's enough to make any potential short seller pretty darn nervous. Yet, hedge funds and traders continue to test these markets on a short-term basis.

Believe it or not, based on this monthly chart of the NASDAQ here, the index could sell off almost 500 points and the strong bullish thrusting activity we've seen for almost a year and a half would still be fully intact. Why? Because the 3X3 DMA still will not have been breached.

Further, a move to 6,305 on the NASDAQ would represent about a 6% pullback. If that were to happen, we'd likely start hearing the financial media talking about the possibility of the bull market coming to an end. Anything is possible, but in our opinion that couldn't be farther from the truth.

The bottom line is the further and further the NASDAQ gets away from its 3X3 DMA on its monthly chart, the more and more the risk for a reversal increases, but it won't necessarily end up meaning the bull market has come to an end. Why? Because every single stock or index will ALWAYS come back to its 3X3 DMA at some point - it's just a matter of when. Everything always comes back to a mean of sorts. It's important to remember though, displaced moving averages - just like simple moving averages - do just that, they move.

So why do we bring this type of analysis up? Because the single most important aspect to achieving your goals when it comes to investing in stocks, is to know your time-frames, strategies, goals and risk tolerance. In other words, if you're a strong buy and hold investor, you've got to be willing to accept unrealized losses and returns on a long-term basis, while knowing good company fundamentals will always win in the end.

On the flip side, if you have no interest in buying and holding much of anything for an extended period of time, then it's important you take profits in ideas when they're there. We're not referring to 2% - 5% here and there, but something more along the lines of 10% to 30% when the opportunity arises.

We get the question all of the time, where do you set a protective stop loss in an idea? That's an extremely loaded question - one that is entirely predicated on your timelines, strategies, risk tolerance and goals. However, there are a few pretty good rules of thumb.

First, smaller stocks must be given more wiggle room, because their moves in both directions are usually far more volatile than those bigger companies out there. In other words, a protective stop of 15% on a small cap is not out of the norm, while a protective stop of 10% on large and mega-caps can sometimes even be a little too much.

Your trading or investing strategy is also very important when trying to determine your stop loss levels. Meaning, are you in the idea for the short-term or the long-term? If it's the latter, you may not even want to set a protective stop. However, if you're short-term trading, then you need to understand preservation of capital is just as important as being in the right ideas.

Then, when it comes to risk tolerance, everyone always wants to make a lot of money, but the reality is the bigger the potential returns the higher the risk. So, rather than only focusing on what you want to make on an idea, it's probably a better idea to figure out what you're willing to lose in an idea first, before you ever decide to enter the idea in question.

The bottom line is the single most important aspect of becoming a great trader or investor is to plan the trade and trade the plan based on your OWN INDIVIDUAL timelines, goals, strategies and risk tolerance. Everyone is different - investors vary in age and income - which is why it's probably not a good idea to just buy or short something without first figuring out what your goals are with the idea in question.

Lastly, if there's one big belief we've adopted over the years that can be applied to anyone - regardless of individual preferences - it's that entries and exits are usually better served when a contrarian mentality is adopted. Meaning, when you're looking at a quality company or a short-term trading opportunity, treading lightly on running ideas, and getting more aggressive when they've backed off a bit, will usually prove more prudent in the end.

How much an idea has ran or backed off though is also predicated on one's own timelines, goals and strategies. So, as you can see, the only real golden rules when it comes to being a successful trader or investor is to know who you are - your timelines, goals, strategies, and risk tolerance.

Once someone understands the above, they've got far more discipline than 90% of the rest of the investing world out there, and more importantly are far more likely to achieve their goals - whatever those goals might be.