Sunday, February 12, 2006

Finger On The Speculation Trigger

You always pull the trigger without having complete information.

An Investment is a long term bet based on incomplete information.

A speculation is an indeterminate term bet based on incomplete information.

Information will always be incomplete - even after the fact.

With an investment you first discover an opportunity that you think exists. Next you may discuss it with a broker to find a good way to put money behind your conviction. Then you wait and watch as your chosen vehicle raises and falls.

With a speculation, when you pull the trigger and enter the trade - you have a good idea of when and how you will exit the trade. If the trade does not work as anticipated - if there is a loss - you will probably get out quickly.

With an investment it is buy and hold. Most investors will hold until their emotions get too high. They will either sell when the price drops enough to seriously depress them or has risen enough for them to feel good about a victory. With this emotional criteria they tend to let losses run and grab at small profits - they lose overall.

A speculator should understand before they enter how they will know if they were wrong about the market or the timing. Speculators seek to protect themselves from large losses by pulling the exit trigger quickly. The other side is to hold on to profitable positions - giving themselves maximum opportunity for large gains.

When you hear of a big winner in a speculation - it was not that one speculation that made them successful. If they stay successful they will cut losses short and let profits run. This is done most frequently by planning your exit points before you enter.

That large speculation win is the symbol of many victories comprised of cutting losses short. Protecting your chips so you can win big when you are right is a major victory also.

The exit point does not have to be a number, in fact for profits it probably won't be a number.

  • Pull the trigger to enter your speculation only when you have a way to judge quickly if you were wrong
  • Pull the trigger to exit the speculation as soon as you know your reason for entering was an error.
  • Stay in a profitable speculation as long as the reason to pull the trigger in the first place remains valid. If that changes - consider exiting the trade.
  • Pull the trigger and exit when your target for the move is complete - and - your analysis shows the trend is about to end.
  • Buy the book before the speculation - know the rules and tricks relevant to that particular market before you commit.

If pulling the trigger is determined by emotions, the investor has probably made a mistake.

Our emotions tend to reflect the emotions of the herd. The herd is right for short periods in the middle of a trend - but emotions are not high there.

The herd is wrong at extremes - emotions will be high - wrong choices will be made. The defense to emotions is to, as much as possible, eliminate emotions as a trading criteria.

An old speculation rule states this quite well.

Plan your trade - Trade your plan.



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