My Recipe for Success When Trading Stocks

One of the most widely held misconceptions about the stock market and investing is that success is primarily a function of predicting the future. The majority of reporting and commentary in the business media about the stock market is focused on various experts predicting what will happen next. Those that market good calls are celebrated even if they don’t produce very good returns.

The reality is that great stock market success isn’t about predicting the future. It is about managing the present. Insightful predictions about stocks and the market can be very helpful in our quest for good ideas, but what will ultimately determine our level of success is how we handle those stocks in the short term as we wait for the long-term celebration.

The great challenge of the stock market is timing. Finding good stocks and ideas isn’t that difficult, but if you don’t time your entries and exits effectively, it won’t matter much if you pick good stocks. What will determine your level of success is timing. If you go big at the right time it will be huge, but if you go big at the wrong time, the frustration will often drive you to take a loss as your emotions overwhelm your logic.

The only way to get the timing right with some degree of precision is to manage the action that is occurring right now in front of your face.

The biggest mistake that many market players make is that they just keep on buying their favorite stocks regardless of the price action. They add on strength, they add on pullbacks, and they never reduce positions into volatility. This is a recipe for disaster because even the best stocks are going to go through some nasty corrections as they develop. When your position size is too large at the wrong time, then the reflexive move is to call the stock pick a failure and give up on it.

If you are holding a smaller position in a favorite name as it acts poorly, then your mindset is completely different. You will look for the opportunity that is being created rather than focus on the pain of poor action.

Short-term management of long-term holdings is not an easy task. It requires constant work but the combination of a very short-term trading approach along with a long-term view is a very potent weapon. I trade some of my favorite names on a nearly daily basis. They have sufficient volatility for day trading, but my long-term view of the stock helps to give me additional confidence that the trades will pay off.

This past week I discussed one such favorite on Real Money. I’ve been holding some Aurinia Pharmaceuticals (AUPH) for a long time as I’m confident that it will eventually be a winner, but it has acted very poorly for a long time. Rather than just buy-and-hold the stock and hope that it will pay off nicely at some distant time, I trade it quite often. When I see a technical pattern, I like I will jump in and try to take some short-term profits while I continue to wait for the big move. At some point, the stock will start to put together a sustained move, and I’ll be looking to ramp up my positions quickly as that occurs.

Quite often, the stocks I like long term will look quite poor in the short term. I view those charts as offering good trading as they improve. As long as my overall thesis on a stock remains positive, I will keep looking for new trading opportunities.

The essence of this approach to trading is to able to view a single stock in multiple time frames. The way it is traded short term might be the exact opposite of what you do long term.

The key to my market success is to identify stocks that I think will do well long term and then trade them aggressively in the short term while I wait. Rather than try to predict when my great ideas will eventually be recognized, I try to take advantage of the short-term volatility and inefficient pricing. My entry and exit points may not be the best, but the important thing is that I’m controlling my risk levels. The goal is to take the most risk when conditions look best and reduce it when things look most dangerous.

Good predictions and stock selection are quite beneficial in producing strong returns, but it managing short term volatility and being aggressive at the right time makes the difference between good results and great results.