Risk Tolerance. Wrong.

I remember when my 5 year old wanted to drive the car. I put him in my lap and off we went. Of course, my hands were on the wheel too, but he felt what it was like to drive the car, even though his feet couldn’t reach the peddles. Letting your 5 year old drive the car all by himself? That’s risky. Add a decade or two of training and practice, much less risky. The same is with the stock market.

This is a terrible question. Everyone’s risk tolerance should be the same. None. You shouldn’t have to tolerate risk. You should eliminate it or at least reduce it to next to nothing. This is done solely with training and practice, just like driving a car.

When a financial adviser tells you an investment depends on your risk tolerance, he’s just asking “how much do you mind losing”, because they don’t know what we are doing or they haven’t had enough practice to learn how.

Another terrible question. That’s like saying I can only make right turns because I’ve practiced that and don’t know how to make left turns. You should have training and practice in both directions. When to buy, when to sell, when to hold, and what to buy are the most basic skills to learn. These decisions are not based on your risk tolerance (how much to mind losing), but are based on your skill level, your level of certainty of what will “probably” happen.

Know the difference and don’t fool yourself. Possibility is for 5 year olds. Probability means you have good level of certainty and you have a plan B, and maybe even a plan C. Important: Knowledge is not information. Knowledge is Certainty.

I’m not going to cover here how to pick a stock nor how to determine a trend. You probably have your methods. I just want you to know what you’re doing. Increase your level of certainty and not confuse yourself with all the possibilities.

Buying a stock at a bargain and waiting for it to go up, is a completely different activity than buying with the intention of selling to make a short term profit. Buying and holding a security gives you security. Ha. It may go down or up over the years but at least you own a piece of the company, and maybe with dividends. You don’t fool with it often. Maybe just add to it periodically. It will probably go up over time, if only because the dollar is getting worth less over time.

Trading a stock or option takes a completely different mindset. It’s the mindset of every business activity. Buy at a price lower than what you will sell it for. If you’ve ever sold something you didn’t make yourself, that’s the same as trading stock. A store might be happy making a 10% profit. Grocery chains are happy to make 2%. A lot of businesses run on very slim percentages. Trading stocks give you a better mark-up and you don’t have to deal with people.

When you decide to make a trade, determine where you expect the stock to go and in how much time it will take to move there. Then and there, decide when to get out. You can use your indicators, and then look at where the price has been, and figure out how much of a move it will make. I reduce that estimate by a little bit because I want to get out before it gets to my estimated top. If I expect to make less than 10%, I usually pass and look at the next one my list.

I rarely buy stocks to trade. Stocks are for buy and hold. With options, you have options. Ha, again. I follow these rules to protect my money when doing short term option trades:

By short term, I mean I expect to exit the trade in a few days to a few weeks. I can’t see the medium term of many weeks very clearly because “Wars and rumors of wars” have distorted reality, too much.

I do know for certain what the will happen in the long term. Stocks will go up and stocks will go down. So I buy calls that are 4-6 months out when the stock market is down, and I buy puts that are 4-6 months out when the stock market is up. These I consider are traps that I set. Since they are out so far in the future, I’m “certain” I can get in and out at profitable times. I can just set them, and once in a while check back to take what I’ve caught. Today I caught SPY, QQQ, and IWM for a combined profit of over 20%. They were Jan, Feb, and March puts. IWM did over 50%. Maybe small businesses are screwed these days? Anyway, 20% in 14 days is a good mark up on my “products”.

Who knows what the future will hold, but I am Certain, you need to have your Options.