Alexander Elder
Within the past four months, Apple (AAPL Quote - Cramer on AAPL - Stock Picks) traded higher than $200 a share, collapsed to below $120 and levitated higher than $190 again, before its recent softness. This rollercoaster ride, so common among stocks, offered multiple opportunities to buy, sell and sell short.
We buy when we feel optimistic -- or are afraid of missing a good thing. Perhaps you read a story about a new product or heard rumors of a merger. Maybe you ran a technical scan or found a promising chart pattern on the screen. You had some money in your account and called your broker (or went online) to place a buy order.
You've received a confirmation -- now you own this stock. That's when the stress begins. If the stock stays flat and goes nowhere you feel restless. Did you pick a wrong one again?! Others are going up -- should you sell yours?
If your stock begins to rise, it creates a different kind of anxiety. Should you take profits now, add to your position, or do nothing? Doing nothing is hard, especially for men, who are trained from childhood on "don't just stand there, do something!"
When your stock drops, the anxiety becomes mixed with pain - "I'll sell as soon as it comes back to even."
Amazingly, the most psychologically comfortable position for most traders is a slight decline in their stock. It is not sharp enough to be painful, and with the stock near your entry price there is probably not much reason to sell. With no action required, you have a perfect excuse to sit back and do nothing. It feels good not to have to make any decisions. That is how a small loss can gradually become a bigger and badder loss.
If you throw a frog into a pot of hot water, it will jump, but if you heat it slowly, you can cook it alive. Traders with no clear selling plans can end up boiled alive.
The worst time for making any decision, including the one to sell, is when you feel under the gun. This is the reason why I urge you to write down a trading plan, as shown below, before you put on a trade. A good plan must outline your reasons for entering a trade, define your entry price, include a protective stop, and a profit target. Setting stop and target levels means making a decision to sell. Making those decisions before you enter a trade allows you to use your brain instead of jumping in response to heat like some poor frog.
Psychologists have proven that the quality of decisions we make under stress is lower than those we make in a peaceful and relaxed frame of mind. You are likely to make better decisions, increase your profits and reduce your losses if you write down your selling plan before you buy that stock.
A written trading plan accomplishes an amazing feat -- it increases your profits and reduces losses!
So, why not do it?
Two reasons. First of all, most traders have never been taught what you have just read. Beginners and outsiders simply do not have the knowledge.
The other reason is that people like to dream. A written plan cuts into their sweet daydreaming business. It feels nice to lean back and drift into a vague fantasy of riches. Sitting up straight on a hard-back chair and writing down your specific goals as well as a contingency plan robs you of that vague daydream.
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