The famous investor Stanley Druckenmiller explains the essence of stock trading best: “It’s not whether you’re right or wrong that’s important, but how much you make when you’re right and how much you lose when you’re wrong.”


He’s basically talking about managing your risk and reward—which is always top of mind for the MarketSmith team.


When we get a follow-through day in the major indexes, we react to the positive news and purchase a stock. Follow-through days do not always lead to a longer term change in market direction, but we put money to work—not a lot—knowing that one of these follow-through days will mark the beginning of a major uptrend in the market. At those major directional shifts, we have greatest potential for gains—if we have stayed in tune with the market and invested in stocks with leadership characteristics.


By wading in slowly with small “pilot” positions, we can gain exposure and allow the market to prove itself while still limiting risk. If the follow-through day fails, we simply get stopped out of our positions for small losses, but if it succeeds, we can pyramid into positions to allow for bigger gains. 


Remember, some of the market’s strongest uptrends have begun when the news was negative and market sentiment poor. We cannot discount a follow-through day simply because it does not feel right. Over the short term, taking small losses can be frustrating, but we must remember that the end goal is to have big winners and small losers, not a high hit rate. In fact, if risk is managed properly, you can have quite a low winning percentage and still be very successful in your portfolio. 


 

Best Returns,


Andrew Rocco,

The MarketSmith Team