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Sunday, October 11, 2009

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The Three Parameters of Stock Trading: Entry Time, Exit Time and Stock Selection

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If we were to speak strictly, all the things about stock trading boil down to only these three parameters: Entry time into the stock, Exit time out of the stock, and Selection of the stock. If a share trader knows how to find out these three parameters for any given trade, then there is nothing else to do for him/her. It is sufficient to continue doing the same trade after trade.

When stocks were traded two centuries before there were only these three things to care about for a stock trader. Since 20th century stock trading has become a common thing for many people in the United States and there came some experts that generalized principles for successful stock trading. Later some experts or institutional investors or fund managers took these even further and invented many tools like the simple moving average to the complex indicators (directional movement index).

Even when studying so-called fundamental analysis of stocks, there are too many parameters introduced from simple annual returns to complex balance sheets. The more complex tools are created the more bewildered are the stock traders.

Simplicity is the Key to Success

Like in any discipline, simplicity is the best way to succeed in stock trading. Having too many tools and analyzing them for every stock before selecting one or studying a particular stock from all its parameters only bogs you down. It is not the tools that should do the thinking it is you as a stock trader that should do all the data processing.

The simplest data to process is just the price chart of a stock. From this we need to determine the entry point and exit points. By looking at the charts of several stocks we should determine which one is the best to trade for higher chances of success.

Additionally I prefer candle stick charts for delivery based trades and line charts for intra-day trades. A simple moving average of 20 trading days is more than sufficient as an indicator. Volume is considered to be an important technical tool. But I didn’t find it a consistent tool. Sometimes it is counter indicating against the price movement or moving averages.

The simple moving average is found to be the simplest and best of all tools to use in determining the three parameters of stock trading. It is not true only one parameter is sufficient to make a profitable trade. A trade becomes successful only when all the three are right. Even Warren Buffet who is considered to be a hard core follower of fundamental analysis, always made these three parameters right. Most importantly he captured the three longest bull markets of the 20th Century in his life time with the best entry and exit times. Now you understand what it means to capture three long bull markets – it means to be the Richest Person in the world!

Entry Time

Entry time is the most important of all these three parameters. That is why I placed it first. Without a right entry time, the entire journey with the stock will be like a hell.

A good entry time makes the trade comfortable and gives you sufficient margin to place stop loss without really taking a loss in case. It also takes away the mental stress that comes when stocks do not just move as we want them to move.

You need not always make an entry at the lowest point the stock has traded. There perhaps might have been enough volume. The important thing is to make the entry so that the trade becomes profitable whether your timeframe is short term or long term.

Exit Time

Exit time is also important but as it happens only after the entry time, choosing the right entry time relieves a lot of burden in choosing the right exit time.

A good exit time is actually easier to find than a good entry time. This could be because we don’t care what happens to the stock after we quit it. A right exit time also helps cut losses short.

You need not always worry about making an exit at the highest point of the stock movement. A closer price or even a little later after that is good. We need to confirm that the trend has reversed and until then we should sit tight to make big gains.

Selection of Stock

This is the least important parameter. You can trade any stocks with few exceptions and still make good trades provided the entry and exit times are right. But a selection of stock can make all the difference between the amount of gain/loss you make in a given time frame. There are stocks that gain by about 5 times in a single year yet in the same there are others that gain about 20 times. Even during the same time there can be stocks that fall to 1/10th of their value.

Knowing how to find these three parameters can help make best trades consistently. Consistently is what makes a good share trader. If you can trade consistently right even a single bull market can make you a millionaire if not a billionaire (Warren Buffet in three bull markets).

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