How To Avoid Embarassing, Costly Trading Mistakes

Everyone makes trading mistakes and some of the most costly include:
1)Trading too large in size.
2)Holding onto a stock against the strategy of stopping out.
3)Missing an exit.
4)Missing an entry point
5)Being Under or Over invested
6)Many others

One of the more important things I am working on is systematizing my trading and automating a trading strategy wherever possible. If you can learn how to simplify your trading strategies to a set of rules, you can set up safeguards and routines that keep you from making mistakes.

Money Management And Portfolio Management:

 

The ideal money management strategy is a complicated topic. I tried to approximate the "maximal growth" strategy for multiple correlated investments using a series of formulas and assumptions. This allowed me to come up with a maximum for a system I have.
It's something like:
No more than 20 "active" option positions
Standard 1% position size
max of 5 2% exceptions
max of 2 3% exceptions
max of 1 4% exception.
max 5 exceptions total.

max 10% per stock position
max 50% stock allocation.
10% income allocation. Only sell as needed to avoid margin, and repurchase as you can.
1-5% asset allocation (reviewed monthly)
A few more nuances than listed here.
Maximizing growth is probably way more aggressive than I want, so I may cut these in half. Still, it's very unlikely I'll be anywhere close to every single maximum all at once.

Trade Management:
I also have a few rules about trade management:
minimum 3:1 reward to risk prior to entry.
Clear entry trigger priority list.
Clearly defined stops and targets prior to trading
Exit near close if stock remains below your stop.
Don't sell short of target
After target have clear criteria for exiting that gives the stock a chance to run (such as selling on a close below the target or a close below the prior day low. or 3 day low or prior week low)

Using A Spreadsheet to track decisions:

You can set up formulas using excel to display a message if a stock is above or below a particular price. This can also allow you to also let you know if a stock has the minimum risk/reward to purchase. The idea is to input a watchlist into this list and have a way to automatically update prices (or to press a button or copy and paste a price quote) and not have to think too hard tracking your decisions.

The routine:
You should fall into a routine or habit rather than being emotional or thinking or worrying about your decision process.
1)Build watchlist. (I have a separate spreadsheet to mostly automate this)
2)Input watchlist plus add stops and targets
3)Check portfolio rules to determine how much of a particular position you can accumulate according to rules.
4)Look for confirmed buys if you can do so within established guidelines/rules of both portfolio and following buy checklist.
5)Purchase.
6)Input purchases in spreadsheet with stops and targets.
7)Review positions near the end of the day

You shouldn't really need to check your own positions more than once a day and the process of buying should only require you check your watchlist 5 times for a couple minutes per time. Perhaps once an hour after the first 2 hours of trading is over plus the last 5 minutes of trading.

One exception to checking your position might be on the Friday if you have any options that expire. You should probably use a 30m chart and check once per hour. Look for a close below in either of the prior 30m candles or a failure to take out the prior high in 2 candles... Otherwise sell or roll the option over to a later expiration date an hour before expiry.

If you need a checklist to remind you of this process and/or a timer system to alert you to make the checks that's fine.

Watchlist Creation:
As I've said, I've mostly automated the process. I have a much more complicated set of formulas that allow me to quickly categorize the stock and rank them and I'll go through maybe 400 stocks just glancing at the charts for a particular visual look I'm looking for and I'll come up with a watchlist of maybe 20-60 names from that list. It only takes me maybe 15 minutes. I could probably come up with more strict formulas to only look at 100 names and still get 1-2 dozen names for the watchlist but I like looking for the best setups. I can do this after market close and use the list the following day.

Watchlist importing:
This also is probably best done after the close. List the stock, identify approximate stop and target (I use measure rule to measure the pattern) and repeat for all. This may be a little more time consuming but will probably enhance my decision making and makes sure I don't miss anything obvious.

Options Tracking:
Probably the most challenging thing to automate is options tracking. it's not easy to automatically get option quotes for every price and have formulas based upon your stock target to convert it to a risk and reward. You may be able to approximate the option cost if you know the implied volatility and days left or come up with a formula that calculates it... but the implied volatility varies too often between stock and even among a stock it varies over time. However, if you list a strike price and target price, you can have a calculation of what the intrinsic value of the option at expiration is. There may be an extrinsic value added on if you buy more time than you need which can complicate the strategy if you are planning on rolling the option well before expiry.

You can also reverse engineer so you have the required price to give you the 3:1 reward to risk based upon the intrinsic value at expiration at the target price. You might just pick a strike price or 3 for a stock and check the quote early on and see the risk reward and where it needs to be and then set a limit order based upon what it should be at the price. That would take an options calculator or you approximating it (you can develop this skill over time). I'm not sure what the best way is to quickly optimize strike price selection and options selection. This function needs work. For now I'm just using the stock's risk/reward as a proxy and I'll go down the line of those on my watchlist and make sure the option trade also has a 3:1 reward to risk.

Tracking the option once you trade it should be tracking the intrinsic value only which isn't too difficult as long as you input the strike price. The "stop" for an option should probably be zero but you may try to salvage half in certain circumstances when you use options as stock replacement, but that's another topic.

So for now this is a system that you can use to have a spreadsheet literally tell you in words what to do with an option, a checklist you go through before you buy, monitoring key metrics as they occur and so on.

Another thing you may want to do is avoid trading earnings. as long as you have data inputs coming in when earnings are you can set up a formula what today's date is and then one to alert you if a stock is within X days of earnings date.

All of this can help you avoid virtually every mistake you can think of ahead of time as long as you create a plan and rule for it and method to ensure you avoid it.