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Newbie traders and experience pros alike need to heed one word of advice to avoid catastrophe: Always have a plan before the trade is made. Otherwise, traders are simply throwing themselves at the mercy of their own emotions.
That's what Stephen "Sarge" Guilfoyle, president of Sarge986 LLC, said at the latest Yahoo Finance Premium webinar, where he broke down some key tenets of risk management. "What did Mike Tyson say? Everyone has a plan until they get punched in the face. In the infantry, we used to say, everyone has a plan until you make first contact. Here, you need a plan. And you need to stick to it ... Your plan can change. But you can't forget you have a plan once you get into trouble, because that's the only way to keep emotion, as best you can, out of the equation," he said.
During the webinar on Wednesday, the Nasdaq Composite (^IXIC) was selling off, with software and chip stocks getting hit hard. While fielding a question, Sarge looked at his trading screen and felt obliged to take action on one of his long-term bullish holdings, Advanced Micro Devices (AMD).
"[Y]ou know what I'm going to do right now? ... I'm going to sell a little AMD right now, which is one of my favorite stocks ... [I'm going to] take off about 20% of my position — just so that I don't make the fool's mistake of giving away money I've already made, because I have a big profit in this name. But it's been on a way south a little bit lately," said Sarge.
He then walks through his reasoning for taking some profits in AMD, defining the terms he uses in the course of his trading. AMD had hit his "panic point" of $82, which is the theoretical level at which he may need to take action to preserve his capital — in other words, it's a sell stop for at least part of the position. But despite the phrase's namesake, there's no need to "panic" at this level — he simply pays attention and assesses his plan.
"I don't have to sell it all there. In fact, I will never sell all my stock or buy all the stock I intend to buy at the same price. But I'm going to ... take something of a profit here, because, hey, this stock was a $99 stock. I've already lost out on some of my profits. I don't want to give them all away. So I take something off. I reassess. And by tonight, I'll have a new panic point," said Sarge.
Breaking down key concepts
Also key to the discussion are the terms "pivot point" and "cost basis." Sarge defines the pivot point as the price level that provokes action on the trade entry.