Taking emotion out of stock trading
EQUITIES trading is all about getting the timing of transactions right. Successful traders are those who are mentally tuned to make an exit when facing losses.
At the same time, they need to adopt a strategy on when to exit a trade when they are in the money.
Years ago, professional trainer in stock trading Kathlyn Teo saw her Intel stock options plummet to a fifth of their value before learning how to cut her losses.
The lesson is at the forefront of her mind when coaching others on how to handle their emotions when trading stocks.
Dealing with losses is an integral part of an investor’s trading strategy, says Teo, who is a founding director and chief trainer at Beyond Insights Sdn Bhd, an award-winning investment and trading education centre.
“Success is mostly achieved through investor psychology and money management. There is no way to get it 100% right,” she says with regard to learning when to bite the bullet.
A key strategy is in employing a numbers-driven method towards minimising losses through the timing of trades, while similarly maximising gains.
“We teach beginner investors how to minimise risk so that even if one trade goes wrong it’s only 1% of the capital. Say you invest RM2,000 in five stocks each; even when a stock goes down we cut-loss at 5%, which is only 1% of the capital. Even if there is systemic risk such as when Donald Trump announced tariffs and the overall market goes down, that is still only 5% risk,” she says.
To this effect, Teo espouses the golden rule of never risking more than 2% of your capital in a single trade, and utilising leverage instruments such as options, contract for difference (CFD) and futures to trade with less capital.
She has another rule, and that is to employ a risk-reward ratio of two times the reward versus the risk.
“I look at what is a safe stop-loss level and I look at the potential of reward based on what the technical chart tells me. One win covers two losses, so my break even is a one-third success rate and if I’m half right I will make money.”
Teo specialises in trading on the US equity markets. Speaking to StarBizWeek during Wall Street’s corporate earnings season, she says she likes healthcare stocks and services, and acknowledges that tech counters are weak at present given the negative news flow.
“I’ve never really liked bank stocks,” she adds, explaining that they tend to have low margins. She notes that Citigroup posted better-than-expected first quarter earnings recently but its share price slid lower on the announcement.
Technical approach
Teo fosters a trading methodology of screening a company’s fundamentals for profitability, sustainability and future growth, as well as timing transactions with a technical approach.
“Trade at a strong support and resistance, not in-between,” says Teo, offering her advice on technical trading during current periods of volatility.
This is coupled with a reminder to take caution and trade conservatively.
She also recommends intra-day trading to move in and out of the market and mitigate the risk of wild price fluctuations that could happen on a day-to-day basis.
Teo is wary of investment strategies that promise high success rates. “When you make money using a high success rate system, you make a little but you stand to lose a lot.
“Even when the 10% of losses happen, it can wipe out the 90% you’ve accumulated previously. High success rates are what people want but some seminars don’t tell them what can actually happen.”
Teo believes in allowing time for success to happen, saying that it takes about three years for investors to develop a consistency in their trading approach.
In the same vein, she believes that people who need certainty in their income may not be suited for full-time trading. “Don’t expect to make money every month consistently like at your job. You have to understand this to become comfortable with trading.”
Teo found that some inexperienced investors make just three losing trades in succession before they begin doubting their methodology.
However, she cites a 2001 interview with SAC Capital’s Steve Cohen where he revealed that his best trader was only right 63% of the time, while most traders made money in the 50% to 55% success range.
“At Beyond Insights, we measure success in 100 trades. You can lose several trades in a row, but in one hundred trades based on our methodology, if you’re half right (50 trades) you will make money.”
Teo, who started Beyond Insights with husband Terence Teoh in 2008, first cut her teeth on the stock market by trading in Intel stock options while an employee in the tech firm.
Given her profession, she naturally gravitated to other tech counters such as Microsoft, IBM and Cisco. This paved the way for a harsh lesson during the dotcom crash in 2001.
“From US$70-plus, Intel stock dropped to US$30. I asked my senior colleague what I should do and his advice was that as the stock was half price, I should buy more or at least hold on to the shares.”
Unfortunately for Teo, Intel’s share price wouldn’t bottom out until it hit US$13.46 apiece in October 2002.
“That cost me a lot,” she says. “If I knew a fraction of what I know today I would have sold the Intel shares after it broke the trend line.”
In addition, Teo says it is important to have the right expectations when trading so as not to get too easily discouraged when losses do occur.
“If you were trading in 2017, which was a good year for stocks, you would have been optimistic. But if you are trading in 2018, it would be a good test of whether you can stay on as a trader.”