Setting Your Own Objectives - Part 2:Defining Your Objectives

Continuation of the 'Setting Your Objectives' work from 'Trade Your Way to Financial Freedom.'

What is your advantage or edge in trading? What is the particular concept that you are trading that gives you an advantage?

• My advantage is that I trade a proven methodology - the CAN SLIM method. This system has worked for countless investors, so I know that if I'm willing to put in the effort it can and will work for me. I've studied many of the traders whose ideas and methods built the foundation for the CAN SLIM system. I'm willing and able to adjust the system to mitigate my shortcomings and take advantage of my strengths. I will not blindly follow the method, but instead will practice it earnestly and adapt it to fit me where it's appropriate to do so.
• CAN SLIM could be generalized as trend following, as much as the author of the system would rather it's not. My adaption of the system is particularly so. I've seen poor fundamental stocks rise in price and solid fundamental stocks fall, so although I target 'high quality' stocks, I'm willing to forgive some 'CAN SLIM criteria' when I see a great chart on a stock. I don't mind an ROE of 10%, for example (CAN SLIM specifies 17% as the minimum), if most other fundamentals are solid and there is evidence in a stock chart that the company is under heavy accumulation. I believe the laws of supply and demand govern the direction of a stock price, nothing else.

How much money do you have personally? How much of that money could you afford to lose? How much risk can you afford to take on a given trade?

• I won't disclose publicly my personal financial matters, but my trading account is small enough to be considered insignificant. Of course, I hope to change that by trading successfully.
• I could lose my entire trading capital and it would not affect our day to day finances.
• On any given trade I attempt to limit my exposure to 2% or less of my total capital. As small as my account is now, sometimes my risk on a given trade is slightly greater. If my capital grows to a substantial sum, I would try to reduce my risk to 1% of total capital on any single trade. It should be noted that I limit risk not by the size of my purchase but with predefined sell stop orders.

How much money do you need to make each year? Do you need to live off that money?

• I'm years away from living off the proceeds of my trading, but that is my ultimate goal. If and when I near that point, I will need to revisit this question and my overall trading plan.

What if you don't make enough to live off it? Can you make more than you need to live off of so that your trading capital can grow? Can you stand regular withdrawals from your trading capital to pay your monthly bills?

• Recent market history should make anyone planning to live off the proceeds of investments seriously consider these questions. My plan is the same now as it was two years ago, but was reinforced by the recent stock market crash. I would need to follow one of two paths in order to live off of trading. I would either set aside enough cash to live off of for three years without making a penny and trade the remainder, or I would invest enough in some fixed income product that delivered enough income to live on and trade the remainder. Both are very conservative approaches, will take longer as they require a great deal of capital, but will afford me peace of mind.

Are you being realistic, or are you expecting to trade like the best trader in the world? For example, suppose you have a very good system that is right half the time and gives you profits that are twice as large as your losses. In that system, just by chance, you could still easily have ten losses in a row. Your system is still working as expected, but you could easily have ten losses in a row. Could you tolerate that?

• When I first began trading I had visions that I would be a prodigy. I was certain that it wouldn't take me nearly the time to become a success that it had take other great traders. As with many before me, the market has humbled me and I believe my aspirations are now indeed realistic. My current objective is to beat the market and finish with a profit each year, after fees and commissions.
• Because my system is not fully mechanical, and at it's very nature follows the trend, I would not tolerate ten losses in a row. After three losses in a row, I put myself in the 'penalty box' where I cannot trade for three weeks. If I came from that and had another three losing trades in a row, I would have to take a very serious look at what the problem was - myself, the market, or more likely both. I probably logged ten losses in a row early in my career, and that's the motivation for me to develop a formal system - to avoid future failures like that.

Do you have the time to trade short term?

• No, and I don't have the interest either.

How much social contact do you need?

• I enjoy spending time with friends in my free time, but I don't need to be around people during working hours. I'm a bit of a lone wolf, and appreciate time I have alone at home.

Can you work by yourself day after day? Do you need one or two other people around, or do you need a lot of other people around? How much do those other people influence you?

• As stated above, I can take or leave social contact during business hours. I'd prefer not to have anyone around when I'm trading so that I'm sure the decisions I make are not influenced by them.

In summary, what do you expect to make each year as a percentage of your trading capital?

• I expect my expectations to grow with my experience. At this point, I'd like to make a 50% gain the first year that we get a new bull market (I don't know when this will come).

What risk level are you willing to tolerate in order to achieve that?

• I've covered this above, I try to risk no more than two percent of my capital on any given trade. If the market is going well, I would not be opposed to trading on margin. Therefore just using rough numbers, I think if I ever went 'all in' and the market took a fantastic dive I could potentially lose 10% of my capital at one time - this is the worst case scenario as I see it.

What is the largest peak-to-trough drawdown you are willing to tolerate?

• I'm not sure I fully understand this question. On an individual stock basis, I will not lose more than 7% on any one stock purchase.

How will you know your plan is working, and how will you know when it's not working? What do you expect from your system in various kinds of markets? Trending? Consolidating? Highly volatile?

• When the plan is working I will be right (profitable) on 40-50% of my purchases with an average profit around 20%, and an average loss of about 5% on the incorrect trades. I'll know it's not working if I have three losses in a row, at which time I will take a three week break from trading.
• The system works in an uptrending market, and other market requires me to go to cash.