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Nadeem Walayat Financial Markets Analysiis and Trend Forecasts

Patience, An Investors Virtue

InvestorEducation / Learning to Invest Jun 07, 2007 - 06:15 PM GMT

By: Hans_Wagner

InvestorEducation Patience is one of the most difficult skills to learn as an investor and trader. The best investors and traders understand the importance of patience. One of Warren Buffett's rules of investing is


 “ The Stock Market is designed to transfer money from the Active to the Patient." The best returns come from those who wait for the best opportunity to show it self before making a commitment. Those that chase the current hot stock are destined to loose more than they gain. Remain active in your analysis looking for quality companies at discounted prices, but be patient waiting for them to reach their discounted price before buying. 

Dennis Gartman, a highly successful trader and publisher of  “The Gartman Letter” as well as Rules of Trading has this to say about the value of Patience:

“Be Patient with good positions.  If you miss an entry trade, wait until a correction occurs before entering.” Often the price will return to its breakout point, so you do not have to chase the price.  Also, your technical charts show support and resistance levels to help identify good entry points.  Volume expansion and contraction also provides a good indication.

“Be patient with good positions.  Once a trade is entered, give it time to develop .” Set your targets and stops and then let it perform.  As the price moves up toward your first target, move the stop up to the next clear support level.  When your first target is hit sell according to your plan and the market (1/2 of your position in a bull market, 3/4 of your position in a flat market).   This creates capital for further investments and trades.  Adjust your stops up to new support levels.  Review your 2nd target and adjust if strength continues.  The real money is made by letting your best positions to continue to perform.  Taking small profits unnecessarily will not create wealth and most likely will lead to ultimate loss.

Proper patience is needed throughout the life cycle of the trade, at entry, while holding and when you exit.

Waiting for Your Entry Point

You have done your homework, including identifying the entry point for a promising stock. Now you are waiting with anticipation for the price to reach your entry point. Instead of pulling back the price lunges upward. You panic, entering an order that is higher than your entry point. Now you have given away some of your potential profit and violated your risk reward of the trade. You even knew it was a mistake to make this trade, yet you let your emotions rule the day. Later it pulls back to your entry point. If only you had be more patient. Now you are faced with another decision: Do you buy more or do you wait to see what happens next? 

An impatient investor who violates their discipline starts down the path to ruin. Following the rules is what keeps the emotional side of trading and investing at bay. Patience in investing is similar to patience while fishing. There are many fish in the lake and it isn't necessary to catch every fish that swims by in order to be successful. In fact, it's only necessary to catch those few that bite. There are always many opportunities, even in a tough stock market. The difficulty is not so much finding trading opportunities but choosing among them. There will always be trades. Don't concern yourself with that. Concern yourself with getting good entry points. If a stock doesn't want to bite, then don't worry about it. Be patient. If it is meant to be, the stock will provide the setup that allows one to enter the trade. If it doesn't, then pursue the other trades that are available because the risk/reward doesn't favor the missed trade as much as the other trades that do meet your criteria.

And if you find that you have lost control and entered a stock before its time, there are two possible actions you can take. First, you can exit the position and return to your discipline. In most cases where one has made an emotional trade, it is best to exit the position and return to your discipline. Admit the mistake and take the punishment, the loss before it gets works. This makes the most sense when the price is not near your well thought out entry level.

On the other hand, you can reevaluate the company and the trade to decide if it is worth holding or exiting. This approach helps you return to your discipline to make decisions your emotion. This step makes the most sense when the price is at or very close to the entry price you originally set. In this case you entered early and now have to adjust your homework accordingly. For example, since you already have a position, buying more might not meet your capital management discipline. After all holding too much of one stock may violate your diversification rules. Keep in mind that since you bought early, your risk-reward tradeoff will be less, most likely resulting in a smaller gain or larger loss than originally envisioned.

Waiting for the right entry point is an essential characteristic of every successful investor and trader. If you finding yourself tempted to enter an order before its time, step away and go over the reasons you selected the entry point again. Then remind yourself following your discipline is what makes you a great investor. 

Giving the Position enough Time to Develop

One of the stocks you have been following hits your entry point and you pull the trigger. You enter a good-till-cancelled bracketed order with the target and trailing stop. Now you wait for the expected move to happen. It starts its move up and you have a profitable trade. However, according to the original plan it still has more room to run. Then it un-expectantly retreats and falls below your original entry point, but has not hit you trailing stop. You panic and sell with a small loss. Then the price moves up again and reaches your target, only you are not participating. You're well thought plan was right, only you let your fear of a loss get in the way of the trade proceeding as expected.

Rest assured, this is a common trait among many investors and traders. Exhibiting patience with a good trade setup is a difficult task. It requires confidence in your research and in your system. While no one is infallible, the best investors trust their discipline to make them successful. They do not vary from their trailing stop methodology, letting the trade play out. Most of the time, it will produce close to your expected profit. If it incurs a loss then they capture all the relevant information to assess what went right and what went wrong. If their discipline needs to change then so be it. However, do not let your emotion take control. It enviably leads to losses.

Keep in mind that losses are part of investing and trading. It is your discipline with good entry points, trailing stops and exit targets that lead to consistent profits and keep you from incurring unwarranted losses. Stay patient and let your process go to work. Again if you are tempted to exit prematurely, step away and go over the reasons you set the stop where you did. Then remind yourself that your discipline is what makes you a great investor.

Knowing When to Sell a Position

There are times when you followed your discipline faithfully and the price barely moves. You have been patient and followed the rules. Now what do you do? It is pretty simple. Go back and re-examine your analysis of the company. Take a fresh look and try to find if anything has changed. If it has, does your new analysis change the original reason for entering the trade? If the rationale for the trade has changed, does your analysis call for you to avoid the stock at this price? If you should not be in the stock, then sell it immediately. On the other hand, if your analysis indicates that this stock meets all your criteria to own and the entry point is very close then it makes sense to continue to hold it.

In many cases the price of your stock will approach your target. Being patient has worked out well for you. Now comes the time when you need to close out your position. You can continue to be patient, waiting till the price hits your target or your trailing stop. On the other hand you could tighten up your stop seeking to capture additional profits. In either case it is time to reward your patience with a profitable trade.

There is another reason to sell out of a position before it makes its move. While doing your homework you have uncovered several good prospects. Unfortunately, you do not have sufficient capital available to add the best one to your portfolio, since your capital is tied up in the stock that has yet to move sufficiently. Since the original trade has not met your expectations it is logical to close out the position to make money available for more promising opportunities. 

Summary

In summary, so much of trading is psychological. To use an overused phrase, patience is indeed a virtue for investors. Exhibiting patience when entering a trade and having patience while a trade develops are integral parts to trading and investing successfully. However, allowing patience to turn into stubbornness is something you must always guard against. Consistently exiting a trade according to predefined criteria is one of the best methods of improving ones success in trading.

By Hans Wagner
tradingonlinemarkets.com

My Name is Hans Wagner and as a long time investor, I was fortunate to retire at 55. I believe you can employ simple investment principles to find and evaluate companies before committing one's hard earned money. Recently, after my children and their friends graduated from college, I found my self helping them to learn about the stock market and investing in stocks. As a result I created a website that provides a growing set of information on many investing topics along with sample portfolios that consistently beat the market at http://www.tradingonlinemarkets.com/


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