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Apprenticed Investor: The Zen of Trading

    9. Learn to Short/Hedge Stocks: Short is not a four-letter word. Successful traders learn to play both sides of the fence. That's less controversial today than it was as the market was first falling apart, but it is no less true.

    When a particular strategy isn't working, the market is telling you something. Thoughtful traders must consider whether there are bigger issues than their own trading mechanics when they enter a losing streak.

    In Law School, students learn they have to be ready to argue either side of a case. You never truly knew a case until you could argue both for and against it. Only when you were able to see its warts could you truly appreciate the beauty.

    The trading corollary is that you should never own a stock unless you know what makes it an attractive short. Each buy and sell decision should be an argument pro and con.

    The market is cyclical; count on a bear market every four years or so. Unless you plan on sitting out for 18 to 24 months once or twice each decade -- as much as four years out of 10 -- you better learn to either short stocks or hedge long positions.

    10. Understand Sector Strength and Market Trend: This rule generates the most "pushback" of any on the list, because it's so counter-intuitive: Stock selection matters less than you think.

    Studies have convincingly demonstrated that about 30% of a stock's progress is determined by the company itself; a stock's sector is equal to at least another 30% (if not more). The overall direction of the market is an even bigger factor, counting for some 40%.

    If you own the best company in the wrong sector, or buy the greatest stock when the broader market is going the other way -- both positions are likely to be losers. But if you see a strong sector, the market trend will help out even the weakest stock in the bunch.

So that's the 10 rules I call the "Zen of Trading."

Investing skills are worthless without a broader framework in which to practice them. The above rules will provide you with that frame of reference. They were as true 100 years ago as they will be true 100 years from now. Those who develop a plan and an investment philosophy are on the path to achieving trading success.

1. Expect to Be Wrong 2. Your Fault, Reader
3. The Wrong Crowd 4. Bull or Bear? Neither
5. Know Thyself 6. Prepare for Battle
7. Bite Your Tongue 8. Don't Speak, Part 2
9. The Zen of Trading 10. The Folly of Forecasting
11. Lose the News 12. Tracking Elephants, Pt 1
13. Tracking Elephants, Pt 2 14. Nothing Doing
15. Surviving Silly Season
Check back for more of Barry Ritholtz's
Apprenticed Investor series

Barry Ritholtz is chief market strategist for Maxim Group, where his research and market analysis are used by the firm's portfolio managers and clients in the U.S., Europe and Japan. He also publishes The Big Picture, his macro perspectives on the economy and geopolitics, entertainment and technology industries, and is a member of the board of directors of Burst.com, a streaming media software company. At the time of publication, Ritholtz had no position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ritholtz appreciates your feedback; click here to send him an email.

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