In volatile markets most investors ignore simple tools and strategies  for staying focused.

So how do you stay calm about your investments when the market seems to be going crazy?

With a nervous market and economy, it's a good time for a refresher in one of the most basic but helpful practices an investor can do for themselves.

Before buying an investment, think of all the reasons for buying it . Even pull out a sheet of paper and write down all of the factors that were important in your decision.

Effectively, you are articulating everything you like, as well as what you expect the investment to deliver in terms of performance and volatility.

So if you are looking at a mutual fund, you will have a variety of characteristics to write down. It might get good ratings from Morningstar, past performance over short- and long-term periods, a minimum initial investment you can afford, etc.

In stocks, it's all of the basic characteristics you’re looking for. It might be a solid balance sheet, no debt, earnings stability, a leading position in its sector and industry. It might also be the bullish recommendation of an expert or analyst or the diversification that the investment adds to your portfolio.

Want to do it like the pros?

Most pros look at 8 fundamental factors:
 

-         Positive earnings

-         Positive earnings surprises

-         Increasing sales growth

-         Expanding operating margins

-         Strong cash flow

-         Earnings growth

-         Positive earnings momentum

-         High return on equity.

For a stock to be worth buying, five of those eight characteristics need to be present; when a stock changes over time and it falls below that minimum threshold, it gets sold.

For options, the above is not that crucial because you can also profit from a down market. Here it is important to look at the overall trend of the broad market and the underlying stock for a specific option before you decide what options to buy, either calls or puts.

Whereas stocks and mutual funds have an unlimited lifetime, unless of course the company goes broke, options do have a limited life because they expire after some time. So that’s why, if you buy options, never go against the trend because “the trend is your friend”! With stocks and mutual funds you can always sit out a crash or a bear market. But with options it becomes more and more difficult the longer the market trend goes in the opposite direction of your trade.

Laying out the selection criteria lets you know specifically what's in place, and what's not.

At the end of the day, writing down your reasons for making an investment also cements your feelings about the money you are putting into it. If you start the process and then feel like the reasons are stupid then perhaps it's time to change your investment strategy or selection criteria.

If, on the other hand, what you wrote down on your sheet is a good representation of your thinking and demonstrates that you have reasonable expectations and reinforces your belief that your methodology will stand up over time, then you can go ahead and make the purchase.

But what do we do if we're still nervous? Try to recall your thinking at the time of purchase, and come up with conditions that would have you buying the investment again today. If you can't convince yourself that you would buy it again, you have a clear sign that you shouldn't be quite so calm about your investments, because something is not quite right and it's time to make a change.

Another thing one should always do. And I mean ALWAYS (!!!) especially if you are an options and short-term trader! Always set a trailing stop!

A trailing stop is a stop order than can be placed with % or $ limits. The limit slides up with the stock. So if you set a $1 trail when you buy a stock at $50 the exit takes place automatically at $49. If the stock moves up to $55 then the exit would automatically be at $54 protecting a $4 profit that you've made should the market consolidate or even crash.

The other way around would be if you bought a stock just before the market goes down which

is always annoying! Then, taking the above example, your stock would get sold at $49 making you only a loss of $1 per stock instead of a lot more.

So in other words, if the price gets to the trigger (trail price), it activates the trade and then gets you out at the then market price.  A trailing stop is a disaster averter and protects against major losses. A trailing stop also does not limit upside profits, because it follows the price of the option premium.

At the latest, as your trade makes profits, use a trailing stop. By doing so, you should look at an approximate 20-25% trailing stop. 

And if all else fails and you’re still not sure whether to trade or not, then don’t! Don’t make the same mistakes hundreds and thousands of traders and investors do every day falling into the same pitfalls as many before them.

Just sit back and relax because market storms provide many new opportunities after the dust has settled. They are also a good time to pull in the sails and make for port.

In volatile markets I always back off to see if the waves of panic will settle down before making new trading commitments whether short on long.

Yours in Successful Trading

Ricky Schmidt

www.tradingpitfalls.com