This column was originally published on RealMoney on Jan. 23 at 10:11 a.m. EST. It's being republished as a bonus for TheStreet.com readers.
Discipline -- every good trader has it. In fact, every good businessman has it. Irrespective of the type of business you are in, there are times when it's easy to make money and times where it's a bit tougher. A good businessman knows how to cash in during the fat years and keep the business intact during the lean ones.
If you chart the progress of a well-run business, it will look like an ascending staircase -- a series of rising steps representing strong profits. The top of each step is level -- representing a period of consolidation within the business cycle.
On the other hand, a poorly run business looks more like a sine curve -- a series of peaks and valleys that, when added together, equal zero. They're just marking time rather than going anywhere.
I know a real estate developer like this. I've seen the guy go from rags to riches to rags for the past 20 years. As the real estate market gets hotter and hotter, he loads up with more and more land as his profits soar. But when the market cools off (as it always does), he's loaded up on land that he must sell at a discount. All his profits evaporate and he just hangs on ... trying to keep from defaulting on his loans.
Eventually, the real estate market perks up again. As the market heats up, his profits rise. Several years into the cycle, he is close to where he was during the last bull market. But he repeats the same sin, buying from sellers who are cashing out.
Does this sound like your trading? Do bull markets reveal your inner genius to the same degree that choppy markets hide it? If so, you probably need to work on your discipline. And the precursor to good discipline is managing expectations of yourself and of the market.
Markets change constantly. At times they are more user-friendly and profits come easy. Other times, they are difficult. This is where discipline comes into the picture.
During difficult times, are you taking on more and more risk because profits are tough to come by, or are you focusing on preserving your capital until the next favorable environment? The answer to this question tells you whether you are walking up a staircase, or just marking time.
Now let's look at some charts:
(GOOG - Get Report)
(PBR - Get Report)
S&P Small Cap 600 iShares
If Google is going to remain in this uptrend, the selloff needs to be contained by the support line above. My note says "potential" trend line because it takes at least three distinct points to form a valid trend line. So far, there are only two. So if the bears take it below this line, my bet is that $300 is in play. The next catalyst for Google will be on Jan. 31, when Google announces earnings. "Sell on the rumor, buy on the news, anyone?"
This oil & gas driller has been on a tear for quite a while, and its weekly chart shows a series of successively higher lows on both absolute (price) and relative (within Bollinger Bands) terms. This is what strong stocks do. At the same time, we can see stochastics putting in successively higher lows. I am showing stochastics on this chart to illustrate a point I've made many times before: strong stocks become overbought and remain that way for quite a while. Avoid overbought stocks and you avoid profits.
The trick is the entry. If you buy as profit-takers are reaping excessive gains you risk buying at a peak in the uptrend, which often leads to selling for a loss when the stock pulls back in its natural ebb and flow. Discipline goes both ways. You need discipline on entries and exits. Every uptrend presents low-risk buying opportunities. Buy a dip at the first sign of firmness, then set your stop close to avoid excessive losses if the dip turns out to be a falling knife. You can see where the next buy point is on PBR, when it drops back toward the middle Bollinger Band. Pick any spot on this strong chart and you'll see that patience is almost always rewarded as each advance tends to be followed by a sharp pullback that offers a second chance. Wait for it here.
GlobalSantaFe looks a lot like PBR. The stock is in a strong uptrend that is gradually picking up steam. I've highlighted the most recent volatility squeeze. After a few months of trading sideways, GSF has exploded upward now. The best entry is in your rear-view mirror. I'd wait for the stock to cool off a bit, and hope for a pullback near $50 sometime in the next month or two. That's where I'd buy.
S&P Small-Cap 600 iShares
I wrote about using trend lines in a different way, suggesting traders use resistance as a basis for assessing the strength of an uptrend. When a peak no longer extends far enough to tag an established resistance line, you know the trend is losing momentum, despite otherwise strong technicals. This weekly chart of IJR illustrates this point nicely. The stock is in an undeniable uptrend. It's a "buy on dips" stock. However, the resistance line is pretty well established. If IJR rolls over before tagging it, be extra patient because downside risk is rising as upside potential is falling. Frankly, I'd love to see IJR churn for a while, like it did during much of 2004.
Be careful out there.