Contents

Foreword by David Bowden ...................................................................................... 2 About Safety in the Market ........................................................................................ 4 Introduction .................................................................................................................. 6 What is a Trading System ............................................................................................ 8 Step 1 Never Put All of Your Eggs in One Basket ................................................... 10 A Tale of Two Traders ............................................................................................. 11 Step 2 Cut the Losers with Stops ............................................................................ 15 A Tale of Two Traders Trade 2 ............................................................................. 18 Step 3 Always Know Your Destination ................................................................... 21 A Tale of Two Traders Trade 3 ............................................................................. 23 Step 4 Never Let a Profit Turn into a Loss .............................................................. 26 A Tale of Two Traders Trade 4 .................................................................................. 28 Step 5 Turn the Odds in Your Favour ...................................................................... 31 A Tale of Two Traders Trade 5 ............................................................................. 34 Step 6 Make Your Own Decisions ........................................................................... 37 A Tale of Two Traders Trade 6 ............................................................................. 39 Step 7 Play it by the Numbers ................................................................................. 41 A Tale of Two Traders Debrief .............................................................................. 43 Conclusion What Does it All Mean? ........................................................................ 45 So What Next? ............................................................................................................ 45 What our students are saying .................................................................................... 46

Foreword by David Bowden

Let me start by congratulating you on taking the first step towards becoming a successful trader by picking up this book and potentially changing your lifestyle forever. You are already well ahead of the vast majority of people who try and fail at trading simply because they believe they can be a successful investor without any real plan. If you only take one thing away from reading this book, be sure it is this you must have a plan and know how you are going to achieve that plan before you start trading. In my career as a trader and later as an educator, I have helped thousands of people become successful traders by following a trading plan. Understanding the markets and having a plan are essential skills for any successful trader. I began my trading career the way many people do. I saw a successful trader and decided I wanted to be like him. Fortunately though, I knew nothing about trading and so I set about educating myself. It was during my early days that I was introduced to the works of W.D. Gann. The fact that Gann was reputed to have made more than US$50 million from trading stocks and commodities certainly attracted my attention. However, I was soon to learn that the basic principles that Gann followed were founded on solid mathematical principles that I could apply to the markets. Gann is generally misunderstood by the general public. He did not teach or think in a complicated way. I believe he loved
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simplicity, yet he wrote in a complicated style so as to make his students think to make them work for his wisdom. After mastering the lessons of Gann, I set out to simplify his lessons and teach them to those people who had a genuine desire to learn. It was from here that Safety in the Market was born. Through Safety in the Market we have taught people across the globe how to understand and profit from the markets. Although I retired from active duty back in 2001, I still get a kick out of catching up with traders as I travel around the country following my other passion of cars and motor racing. It never ceases to amaze me, the stories I hear from people who have worked with the team at Safety in the Market and how the knowledge they have gained has made an enormous difference to their lives. I am immensely proud of the work the team continues to do to help people who are willing to gain the knowledge and skill it takes to profit consistently from the markets. If learning to make money through trading is something youre serious about, this book is a great place to start.

David Bowden

About Safety in the Market

Safety in the Market is Australias longest running and most respected trading and stock market education organisation. Established in 1989, Safety in the Market has taught thousands of Australians how they can trade the financial markets safely. Our longstanding success is based on a methodology that tracks down trading opportunities with the highest probability of success while steadfastly protecting your capital. Its a step-by step approach that has allowed many of our students to achieve trading success. Safety in the Market was established by David E. Bowden, whose life story is a testament to the effectiveness of Safety in the Market. After undertaking an extensive study of the complex theories of famed American investor W.D. Gann, David made a series of remarkably accurate market forecasts naming and publishing the date of major market turns up to a year in advance. Ganns work had long defied clear interpretation. Davids efforts were an astonishing display of insight and forward-looking analysis from a man of humble beginnings who had endured his share of business misfortune. After establishing his own personal wealth through his mastery of Gannbased techniques, David embarked on what he came to consider his true lifes calling passing on his knowledge. David turned his unique grasp of Ganns difficult writings into a clear and precise trading methodology for everyday traders. Since 1989, it has been applied successfully to a full range of markets in both bear and bull conditions. Today, David is regarded as the leading international authority on the strategies of W.D. Gann. Since Davids initial seminars, Safety in the Market has developed into a structured series of home study, live education and software tools, all of which include ready access to a support team of trading and technical experts. Its an educational model that has profoundly affected the lives of over 25,000 dedicated Safety in the Market students and practitioners.

inveSTMenT Know-how
Investment

7 STepS To inveSTing wiTh A plAn

Know-How
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Introduction
Why is it that some people are successful investors? After all, they cant be that much different from everyone else, so what is it that allows them to choose investments that are profitable? Imagine if you were to ask this question to ordinary people you met on the street. No doubt youd get a range of different answers. Typically people believe that others are more successful investors because they are rich or because they have inside information on which shares are going up. Some will tell you that its because they are smarter than the average person while others write it off to some investors just being plain lucky. All of these answers are wrong. In reality, the reason some people are successful investors is that these people know how to invest. When you think about it, it makes sense. So how do you get investment know-how? Investment know-how comes from two things. A) Education Investing is like anything else. You have to learn how to do it. B) Experience Once you have learnt the theory you still dont have investment know-how until youve put it into practice for a while...and probably made a few mistakes along the way. So, the short story is that you can get investment know-how but youve got to be prepared to spend some time educating yourself and gaining some experience.

What this Book is About

This book has been written to give you an insight into some of the principles of investing. In particular, it is very important that you have a system or a plan when you start investing and by the end of this book you should have a good understanding of what this involves. So, if you want to be successful and you want to have investment knowhow, youll soon come to realise that its all about your trading system. The following chapters illustrate some of the key principles that youll need to include in your trading system.
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Throughout this book we will be talking about shares but the principles can be equally applied to any financial market investment including managed funds, options, futures or foreign exchange.

Active Investors vs Passive Investors

There are two types of investors active investors and passive investors. A passive investor is someone who owns investments in the sharemarket but who doesnt actively follow the performance of their investments or buy and sell on a regular basis. With compulsory superannuation, most of us are actually passive investors, with our investments managed by our superannuation fund. Many people also have some additional investments in managed funds or shares. This book is designed for people who are interested in self-directed investment. By this, we mean someone who is interested in managing some or all of their own investments. In other words, if you want to do some of the buying and selling of shares yourself. Active investors are also sometimes known as traders and thats what well call them in this book.

What is a Trading System?

A trading system is a collection of rules that define everything you may do before, and more importantly, after you buy any share or investment. It is a planned approach that provides structure to your investment activity in the market. The trading system is basically a plan that not only says how you are going to trade successfully but what you are going to do if things go wrong. Building wealth is just like building a house. You wouldnt build a house without a plan and neither should you attempt to build wealth through trading without a solid trading system.

Three Very Important Questions

Your trading strategy needs to include very clear rules that answer the following three questions: 1. When and why will you buy a share? 2. If you start making a loss, at what point will you sell the share? 3. If you start making a profit, at what point will you sell the share? Lets consider each of these questions.

When and why will you buy a share?

This is the easiest question. You could use just about any method, from throwing darts at the financial pages of the newspaper to using a sophisticated computer system to pick which stock you will buy. The important point is that you are consistent in your method so that youll be able to look back and see if its working or not.

If you start making a loss, at what point will you sell the share?
This is the most important question. If you think you will trade and never make a loss, youre better off putting your money into managed funds or in the bank. There is always a risk with any investment and no one ever gets it right all of the time. What differentiates the successful traders is that they admit when they got it wrong and get out quickly rather than hanging on and hoping the stock goes up again. It is important to define the level of risk you are prepared to accept and then stick to this rigidly. The disciplined use of stop losses is a common characteristic of successful traders and well cover this in detail later on.
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If you start making a profit, at what point will you sell the share? The idea that what goes up, must come down can be frequently applied to the share market. The law of gravity still applies. Too many investors have seen dollar signs as a share they own races upwards, only to then watch it plunge back down to below its purchase price. So just as it is important to know how much of a loss you are prepared to take, it is equally important to have a profit strategy and to stick to it. After all, a small profit you have is better than a large profit you might have had.

Believing in Your Strategy

Once you have a strategy that will answer the questions above, it is important to convert it into a specific plan that you can use to make decisions. Making decisions with confidence means operating under a set of rules that you believe will work for you. The only way to really gain this confidence is to put your system to the test. The more you can learn about yourself and your investment behaviour and tendencies, the better your decisions will be. It is important to keep realistic goals when developing your system. Many inexperienced traders enter the markets with high expectations of what they can achieve. But in trading, slow and steady wins the race you cant expect to become rich overnight.

You Cant Be Right All The Time Or Can You?

Most of us think that it is good to be right and bad to be wrong. This is only natural because since the time we were children, we have been told that we are good when you did the right thing and bad when we did the wrong thing. The problem is, when it comes to investing, this is not how it works. Most people would consider they were right if they made a winning trade. But there is no way that you will be right every time you buy a stock. Sometimes you will be wrong. Sometimes you will lose money. So how can we be right all of the time? The way to do this is to adjust our definition of right. Instead of thinking that it is right to make a winning trade, lets say that being right means following our trading plan precisely every time we take a trade regardless if its a winner or a loser. In this way we can be right all the time.

Step 1

Never Put All of Your Eggs in One Basket

The most important rule of investing properly is not to lose the money that youve started with! This might seem obvious, but it is amazing how many peoples trading strategies dont look at ways of managing risks. There is some form of risk involved in every kind of investment. Risk management means taking action that will significantly reduce the likelihood that you could lose the money you have invested. One of the first things that you can do to reduce your risk is diversify. You may be familiar with the term diversification. When talking about investment, this really means spreading the risk. If you have all of your money in one stock you have more possibility of losing it all. Imagine if that one stock unexpectedly goes down. Even before you could sell the shares you own, you may have lost a major portion of your investment. On the other hand if you had taken the same amount of money and spread it over four different stocks, it is unlikely that all four shares will fall dramatically at the same time. This is especially true if you make sure that the stocks are in different industries. So how can you put this idea into practice? By creating a simple first rule in your trading plan that limits the amount of investment capital that you will risk in any one investment. For example, if you have $10,000 to invest, then you may wish to create a rule whereby you never put more than 10% into any one share. This means that you would not invest any more than $1,000. That way if a particular stock goes bad, the most you can lose is $1,000. Whether you know it or not, you have just introduced the concept of money management into your trading plan. Money management means using rules to protect your money regardless of whether the stock market goes up or down. Well learn more about money management in the next few chapters but for now we can summarise by repeating our first step: Never put all your eggs in one basket.
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A Tale of Two Traders

At this point, we would like to introduce you to a couple of friends. This is a tale of two investors or traders as they often like to be called once they start doing it a lot. Both of these gentlemen have saved a bit of money and both of them have decided that they can afford to put aside $10,000 for trading on the stock market. While this is a significant amount of money for both of them, they are able to put it aside for investing without jeopardising their current financial position. This is important because it is well known that you should never risk money that you cannot afford to lose. The first of these traders is Michael. Most of his friends call him Mick. Our second trader is Neville or better known as Nifty Nev. The only difference between these two investors is that Michael has decided that he will spend some time learning about the stock market before he starts. He decides to buy an investment course for $1,000. While this does represent 10% of his money, he figures that he will be able to do better with $9,000 if he knows what he is doing than he would with $10,000 if he does not. Nev on the other hand figures that he has always been good at these types of things. He reckons that hes just a lucky type of guy, and besides he has a few friends in the industry that often give his other mates tips and they tell him they are doing well. So before we begin, lets have a look at their investment accounts.

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One of the first things that Michael learnt in the investment course he attended was some of the principles of money management. Only good money management allows you to protect your capital and hang onto any gains you make.

Trade #1
Both Mick and Nev have been following a stock called XYZ and are looking to take a trade. Our traders have identified that XYZ has dropped down $2.00 since the beginning of January. You can see this on the chart below.

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Both the traders reasoned that since the share price of XYZ had fallen so sharply that it would probably be a good buy. Neville jumped right in and bought 1,000 shares at $6.50 costing him a total of $6,500. On the other hand Michael was still studying his stock market course and knew that he probably had more to learn, however he couldnt resist taking the trade, which he felt was a good one. Michael had however learnt some lessons already and he knew that he should not commit such a large portion of his money to one trade. He made sure that he stayed within a limit of 10% of his capital. Consequently Michael bought only 130 shares at $6.50, which cost him $845. This was equal to less than 10% of the $9000 he had in his account. As it turned out the price of XYZ shares did start to move up, but only briefly. The stock was actually in a down trend and after moving up $1.00 it quickly reversed and moved down to $4.50 within a couple of weeks.

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Both Michael and Nev knew that they had made a mistake and sold their shares in XYZ at $4.50. Nev had lost $2,000 but Michael had lost only $260 because he had limited his risk. Even though Michael had lost some money he was pleased that he had used the first money principle that he had learnt and it had worked! He felt that his stock market course had already paid for itself by saving him from losing money. Lets look at the trading accounts of our two traders after their first trade.

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Step 2

Cut the Losers with Stops

Assuming that we dont know anything about the stock market we are faced with a simple choice - buy a stock or dont buy a stock. Youre probably reading this book because you want to know more about investing so lets assume that you choose to get involved and buy a stock. There are two things that can happen. A - The stock can go up B - The stock can go down In other words its a 50/50 bet. We have an even chance that the stock could go either way. For the moment we arent really worried about picking winning stocks because we want to focus on the idea of money management. As we discussed earlier, money management is about protecting your initial investment while limiting your losses and making the most of profits. So lets go back to our 50% chance. If we were to go about buying stocks on this basis, we could reasonably expect to make no money. It would be like betting on the toss of a coin. On average half our shares would be winners and the other half would be losers. Without knowing more about the stocks, what could we possibly do to improve our results? One solution would be to pick better stocks so we have more winners and fewer losers. Yes this will work, and well discuss that later, but for the moment lets assume that we have no way of working out which are the better stocks. Therefore we need a different way to improve our results. The answer is cutting the losers. If we can work out a way to make our losses smaller than our wins then we will still make money overall, even if we still have the same number of winners and losers overall.
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In order to do this, well need to say that if the market moves against us well get out and if it goes up well keep it. It sounds simple but it works. Imagine that we take 10 trades. Lets say that in 5 trades the stock goes up and in 5 trades the stock goes down. We can make a rule in your system that says if a stock goes down more than 5% after we have bought it, well see it and take the 5% loss. On the other hand, if the stock goes up, we will hold onto it until it goes up 10% and then sell it. Using these rules, and assuming we are spending $1,000 on each security, our results are as follows: 5 Trades x 5% Loss ($50) 5 Trades x 10% Profit ($100) = Total Loss of $250 = Total Profit of $500

Therefore by using a simple money management technique the total result from our 10 trades is a profit of $250 even if we only have a 50% chance of winning. So remember to add a rule to your trading plan that cuts off your losing trades and makes them little losses before they turn into big losses.

What About Stops

Experiencing your first major loss can be very stressful. For most people the money is hard earned and so protecting your investment capital is very important. One way of minimising the losses is by setting stops. A stop is a predetermined point in the market which, if the share price reaches this point, you will sell your holding. This might be a 5% decrease in the purchase price. The point where you place your stop depends on the level of risk you are prepared to take and the amount of investment capital you are prepared to lose. In this situation, you are setting a stop loss, because it is placed on the downside of the share price and is designed to stop you from losing too much money.

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Placing Stops
Learning to place stops is like learning to drive defensively. Just like putting on a seatbelt as soon as youre behind the wheel, you should always set stops the moment you enter a trade. As time passes, stops need to be adjusted to reduce the amount of money at risk and to protect a bigger chunk of profit. But you should only ever move your stops upwards. In some markets you can tell your broker in advance where your stop is and if the market trades at that level, he will automatically execute the stop for you. In other markets, you will need to record the stop yourself and contact your broker to let him know to close your position.

Definition: Investment Capital

Investment capital is simply the money you are using to fund your investments. This can include your initial funds as well as any profits that you choose to reinvest.

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A Tale of Two Traders

Trade #2
For their second trade both of our traders have chosen to invest in XYZ again. Given that it has begun to move back up they believe that it has reached its lowest level and should continue on its way up. Michael has been studying his course further and now understands that not only should he limit the amount of his investment, he should also be very careful to keep his losses small. Correspondingly he has committed himself to losing a maximum of 5% in any trade. Looking at the chart again we can see that XYZ has now moved to $5.80.

Michael calculates that if he buys the stock at $5.80, the maximum loss of 5% that he could accept occurs if the price goes below $5.51.

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He buys 150 shares at $5.80 costing him $870. Nev on the other hand was a little shell-shocked that he lost so much money in his last trade. He has realized that he shouldnt put so much of his money in one trade but he still has no strategy to limit his losses. Nev buys 200 shares at $5.80 costing him $1160. Once again the market makes its own decisions and not long after our traders buy the stock it promptly turns around and heads down. As soon as the market goes down past $5.51, Michael sells all of his 150 shares at $5.50. He has made another loss but it is only small because he got out where he set his limit. Nev on the other hand is not sure what to do. He believes that the share price must surely go back up. He doesnt want to admit that he was wrong and holds onto his shares hoping they will go up. Our chart below shows what happens.

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A couple of weeks later the price of XYZ has slipped all the way to $3.06 and Nev cant stand the pain any longer. He sells his shares and works out that he has recorded a loss of $548. Lets look at the accounts.

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Step 3

Always Know Your Destination

It is just as important to have a profit target as it is to have a limit for you losses. Why? Taking a loss can be emotionally hard, but taking a profit can be even harder. Imagine that you had bought a stock and that it has gone up. You are sitting on an unrealised profit of $2,500. The market is expected to go up in the future. You have been listening to financial commentators and, based on the strength of the economy, they are predicting that the market is nowhere near its top and could move up strongly over the next few months. If you hold the stock you could make several thousand dollars more. Should you sell or should you continue to hold the stock? The answer is that this is the wrong time to be asking yourself this question! Let me show you what we mean. The next day your stock might go up or it might go down. You are risking the unrealised profit in your trade because you have no plan. In investing, people often talk about fear and greed and it is a situation just like this that they are referring to. Basically your fear is telling you that the stock could go down and that you should sell your stock while your greed is telling you to hold it because the stock might go up. This is the roller coaster of emotions that can make trading a very uncomfortable proposition. Fear and greed destroy traders by clouding their minds. The only way to succeed in trading is to use your trading plan. The whole point of having an investment plan is that you should know your destination. In other words when you buy a share you should already know how much profit you expect to make out of the share. In the same way that you set a stop loss you should also set a take profit. Once the share price reaches the profit level, sell the shares and convert the unrealised profit into a realised profit.

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Setting a Profit Target

So where should you set your profit target? You could expect to make 4% interest per year without any risk if you left your money in the bank. So we obviously want to make a better return than that. But how much is enough? Generally you would want to make at least 10% out of a trade and it is possible to make 50% or even 100%. These amounts can be made in weeks or months, not years. Lets say that your investment plan says that you should look to make a 20% profit out of your trade. You can get the share price data for this stock for the last few years and check what would be the effect of holding onto a stock until you made 20% profit. Remember, increased profit is always associated with increased risk, so you need to determine a profit level that is right for you. Once you have this problem sorted you have the third question answered.

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A Tale of Two Traders

Trade #3
Both of our traders are very stubborn and have decided to stick with XYZ for their third trade. The share price is currently around $3.55.

Michael has been very encouraged by his first two trades even though he lost money, because he has seen the effect of his new knowledge in protecting his capital. He has gone further with his studies and has decided to add a 50% profit target. This will mean he has to sell his shares when it goes past $5.32. While this is quite ambitious, Michael has looked back at the way that the chart of XYZ moves and is confident that this is a reasonable objective. He buys 240 shares at $3.55 for a total cost of $852. For Neville it is a different story altogether. After his first two trades he has lost over a quarter of his money and he is not really any wiser. Because he has no plan, he has no yardstick against which to judge and adjust his investment method.

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He decides that he will buy 200 shares at $3.55 for a total cost of $710 because he is sure that XYZ will not go down any further. After entering the trade, both Michael and Nev are very pleased to see the price of XYZ shares move sharply upward. The company XYZ has made an unexpected announcement that will see the companys profits increase sharply. The share price moves strongly up to $4.50 and then, after another positive announcement spikes up to $6.65. This is way past Michaels profit target of $5.32 and so he must sell his shares. This seems very difficult to do because it looks like the XYZ price is going from strength to strength. Michael can feel his greed pushing him to hold his shares and disregard his plan but he forces himself to stick to it and sells the shares at $6.65 for a profit of $744. Neville is sure that he is on a winner this time. He is very excited and tells all of his friends how successful his trade has been (he forgets to mention his two earlier trades of course).

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However Neville has spoken a little too soon. The market starts to move back down again. After going up to $6.80, it then starts going down and continues going down for the next month. Neville has had his emotions in turmoil and finds that he is very indecisive. He does not want to admit that XYZ is going down and hopes it will go back up. Finally he cannot take it any longer and sells his shares at $4.10 for a profit of only $110. If he had sold his shares earlier he could have made a profit of up to $650 but he had no plan as to when to get out. When we look at their accounts, we can see that even though they have both had two losing trades and one winning trade, Michaels trading plan is starting to pay dividends. He has now made a profit of $439 on his $9000. Neville on the other hand is not looking so good, with a loss of $2438 on his $10,000.

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Step 4

Never Let a Profit Turn into a Loss

Remember Step #2 Cut the Losers with Stops? Of course youll remember how we talked about using Stops to make sure that any of our losses remained small losses. Well now well let you in on another secret. You can use stops to protect profits just the same way we talk about using them to protect our capital. Let me explain what we are talking about. Imagine that you had bought 1,000 shares in a company for $3.00. Now imagine that you had set your stop loss at $2.85, which is equal to a 5% loss. Therefore if the shares you bought at $3.00 go down below $2.85 you will get out immediately. Being smart you have also set your profit target at 50%, which means you are going to sell the shares when it gets to $4.50 and get out with a handsome profit. Since you bought the shares, the price of the stock has gone up to $4.00. This means that you now have an unrealised profit of $1000. Not bad! But it also means that you now have a problem. Should you wait for the shares to go to your profit target before you sell them? What if they never get to $4.50 and instead go down to $2.85 where your stop is? That would mean that you would lose the unrealised profit of $1,000 that you currently have and make a small loss on the trade. The answer is to use a different type of stop, a Profit Protection Stop to make sure that we never let a profitable trade turn into a loss.

Definition: Unrealised Profit

Unrealised profit is the profit that you would make if you sold the shares you currently hold. Unrealised profit is still at risk from market movement and therefore needs to be differentiated from realised profits, which are the profits you have received from selling shares that you previously bought.

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The Profit Protection Stop

So how does it work? Although it might seem complicated, its actually quite simple. If you take a trade and you find that prices move in your favour you will start to have an unrealised profit. What you should do now is to set a limit on the amount of the unrealised profit that you are prepared to lose. This will depend on your plan and the stocks that you are trading but well use 20% for our example. In other words we never want our unrealised profit to decrease by more than 20%. If it does we will sell the stock and take the 80% of our unrealised profit. Lets go back to our earlier example. If our unrealised profit is $1,000 then what we are saying is that if prices go down such that our unrealised profit is less than $800 we should sell our shares and keep the $800. We dont want to hang around to find out if the market will turn around and go back up to our profit target or if it will keep going down. What this means is that every time the stock that you are holding goes up and gives you a greater unrealised profit, then you have to work out what 80% of your unrealised profit is and set a new level as to where you will get out. As prices continue to move in your favour, the unrealised profit will grow and you have to protect it. Take this as seriously as if it were real money and continue to apply the profit protection rule. When you hold a share, you can keep your stops in one place or raise them but never lower them. Giving extra slack to a losing trade is a losers game. If a trade is not working, regardless of the reason, it means its time to get out. Using this strategy requires a little more work because you may have to adjust the stops each day but the results can be well worth the effort.

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A Tale of Two Traders

Trade #4
Its been only a few days since Nev closed his last trade and given it was a winner, hes looking forward to placing another trade. Despite the fact he has lost nearly a quarter of his capital, Neville is feeling very confident because his last trade was a winner. Its human nature to see things the way we want to see them. Michael has not been in a trade for several weeks now because the XYZ stock has been moving consistently down, but having watched the last few days he believes it is ready for a move up and so he is looking for a trade as well.

Both our traders decide to enter their fourth trade in XYZ at $3.99. Michael buys 230 shares, being careful to stay within the 10% limit of his portfolio. He sets a 5% stop loss and a 50% profit target. In addition, he has been studying his course and decided to add a profit protection stop to his trading plan. He has decided to use a profit protection stop of 10%.

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On the other hand, Neville is still flying by the seat of his pants. There is nothing really intelligent about the way he is approaching his investments. He is essentially gambling and the only thing he has learnt is that he needs to keep his bets small so he doesnt get wiped out. He decides on 200 stocks for a total investment of $798 (which is still more than 10% of the money he has left). After a couple of weeks the price of XYZ has moved up to $5.98, which is nearly at Michaels 50% profit target of $6.00. He is getting ready to exit his position but he also knows that he has to adjust his profit protection stop of 10%. Michael calculates that he has an unrealised profit of $1.97. Therefore, he calculates that his profit protection stop is at $5.78, which means that if the price of XYZ goes below this level he must sell his shares and keep the remaining 90% profit. The next couple of days sees the market move down to $5.77 and Michael sell his shares because his profit protection stop has been triggered.

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Neville on the other hand, is in the same position he was with his last trade. He is watching his share value plummet but, because he has no plan, he is unsure of what to do. Finally, he sells out a few days later when the price has dipped back to $4.00 for a loss of $2.00. Neville has committed a cardinal sin. He has let a profitable trade turn into a loss. Lets have a look at their accounts after 4 trades.

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Step 5

Turn the Odds in Your Favour

Up until now we have been focusing on money management techniques. We have been assuming that there is only a 50% chance of picking a share that will go up. We have seen that even if we could only pick 50% winners, we can still make a profit. Now imagine that we had some way to improve our chances of picking a winning stock to 60% or even 70%... Welcome to technical analysis!

What is Technical Analysis?

Technical analysis (or charting as it is called) is the use of the share price information to evaluate a company. Most often technical analysts use charts to find patterns that might give them a clue as to which direction the market will move in the future.

All the Information is in the Price

Technical analysts believe that all the available information has been included and factored into the current share price. What we mean by this is to say that anybody who knows anything about a particular company (even if it is insider information known to them only) will act on this information to either buy or sell the shares. The buying and selling of these shares forces the prices up and down and forms certain patterns. To put it simply, some of these patterns give us clues that people are buying the shares and will likely force the price to go up while other patterns tell us that people are selling the shares and that the price will likely go down in the future. These patterns are not always 100% correct but looking at them can certainly give you a much better chance than a 50 / 50 bet. The idea of technical analysis works for private investors as they can monitor and predict the movement of shares by simply following a price chart. Professional analysts will assess a company and decide to either act to buy or sell the shares of a company. Using technical analysis we can watch for signs of these professional players buying or selling to give us clues as to what a companys shares might do next.

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Recognition of Recurring Price Patterns

Regardless of why investors and professionals are buying and selling (this will be different reasons each time), it can still make the same patterns on a chart. If we can learn to identify these patterns we can make assumptions as to which way we think the market is likely to go. A really good way to get confidence in this type of approach is to get a chart of a stock and go back and search for the patterns you think may be significant. You can then see how well you would have faired in trading had you followed this approach. This type of testing is normally called papertrading or back-testing. This type of research is very important if you are going to succeed as a trader.

Charting Basics
Charting is the primary tool of technical analysis. Share price charts are a visual representation of the price that investors paid for stock at a particular time. This provides a graphical representation of price movements and allows us to take in a lot of information from one single picture. There are many different types of charts including line charts, candlestick charts, swing charts and others. Most investors do this using software that takes the hard work out of drawing them by hand but it is advisable to draw some charts by hand when you begin because it will give you a really good feel for what it really means.

Summing Up Technical Analysis

Technical Analysis gives you a real advantage when trading because it lets you swing the odds in your favour. Rather than guessing or listening to other peoples analysis, you have some hard numbers with which you can independently test your trading plan. By studying the behaviour of historical stock prices with a view to identifying common patterns or changes in trend, technical analysts believe the chart information can provide them with some guidance as to what investors are going to pay for stocks in the future. For the technical analyst, price reflects crowd behaviour.

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In this way, technical analysts dont feel it is necessary to know the reasons why prices are moving up or down because they believe that any factors that affect the market price will ultimately be reflected in the market price. The aim of technical analysis is simply to determine the current state of the market and the likely outcome. So, although the newspapers will often tell you what people say they are doing, a chart will reveal what they are actually doing and what this is likely to mean for the future share price movement.

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A Tale of Two Traders

Trade #5
After his last effort Neville has become very unsure of himself. Its not really the fact that he has lost a bit of money, its more that he feels lost at sea. Because he never really had a plan, he has no way to measure what he has done so far and compare it against what he should be doing. He is starting to lose his interest in trading altogether because it is certainly not fun to lose money or to feel out of control. Michael, on the other hand, is beginning to feel like he might yet become a successful trader. He knows that he will have losses but he feels that he can deal with them. The latest stage of his investment course has been focusing on technical analysis and with some of this new information, Michael has gone back over the price chart of XYZ. He sees one of the pattern signals that he has learned about and that he believes increases his chances of picking the winning trades.

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Based on this information, he decides to enter the trade, buying 190 XYZ shares at $4.98 for a total cost of $946, which is still less than 10% of his account. He also sets a stop loss, a profit target and implements a profit protection strategy. Neville who has no way of identifying trades other than gut feel misses this one and stays on the sidelines feeling rather disillusioned about the whole trading thing. As it turns out, Michaels work has paid off and he has entered the market at the right time. Over the next couple of weeks, the share price of XYZ moves up strongly on good news for the company. Michaels profit target of 50% is $7.47 and by mid April the stock has jumped to $8.15. He feels that the stock has a lot of upward moment and is likely to go higher. It is very hard for Michael to stick to his plan...but he does selling out at $8.15.

Michael feels even more disappointed as he watches the price of XYZ continue on up to nearly $9.50. He vows to review his trading plan to see if he can adjust it so that he does not have to limit himself to a 50% profit target.

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Michael shouldnt feel too disappointed. He has just made a profit of $602 on one trade after investing only $946. Thats equivalent to making 63% in only a few weeks. There is no way he could have made that sort of interest leaving his money in a bank. Nonetheless, from what weve seen of Michael, he seems like a pretty persistent guy and it wont take him too long to adjust his trading plan. Actually, hell learn that you probably never stop adjusting and refining your trading plan. However, the most important thing is to have one to begin with. So, based upon his technical analysis, Michael is working to pick more winning trades than losing trades. It obviously worked for him in this trade and is certainly better than guessing. Importantly though he realises that technical analysis wont get it right every time either and so its critical to have his stops and money management rules in place as well. So after the 5th trade, lets consider the accounts of our two traders.

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Step 6

Make Your Own Decisions

If you dont have a complete plan then you are not really in charge. Similarly, if you dont make your own decisions you are also not really in control. You should now be getting the picture that, contrary to popular belief, there is a lot more to trading than just picking winning stocks. Trading involves money management, stock selection, hours of analysis, buying, selling, and personal development. However, if you dont have the personal discipline to follow the plan and make your own decisions you will blow all of the good work you have done in developing your plan. It can be very seductive to get involved in an investment because you fear that you will miss out. If this investment was not part of your plan then you should not get involved. This means that you cannot trade on advice from someone else. It also means that you must not take tips! Trades based upon emotion rather than your plan will quickly eat into your investment capital. If you develop a mechanical approach rather than a system based upon your feelings at the time, then you will have overcome some very important stumbling blocks that have de-railed many traders. Set up a checklist of criteria to physically tick off for each and every trade. This will ensure you stick to your plan and make it easier for you to develop the discipline you need to be successful. If nothing else, make sure you follow these two basic rules:

Only Buy When Stocks Meet Your Entry Criteria.

No exceptions! Earlier we mentioned that it doesnt matter how you select securities to purchase, as long as you are consistent. Regardless of the method you use, you do need to make sure you have a method and that you use this method consistently. If you plan and then time your buying carefully you have half of the battle won! Be very selective and again set up a list of criteria to meet before a BUY is initiated. There is no such thing as you thought it was a BUY. Do all of the research first and make sure all or most of your BUY criteria are met. Then you will know it is a BUY. It is up to you to work out which criteria best fits your trading style.
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Sell Immediately when your Exit Criteria is Met

You can see from the examples throughout this book what can happen when you dont have an exit plan. Before you place your trade, make sure you know exactly when you are going to exit the trade. Dont be fooled into thinking that you wont become emotional once you have entered the trade. By systematically limiting your losses to small ones you will always be around to trade another day. Similarly, make sure you have a system for protecting your profits if the share price goes up. Once profits have been made, protecting them is all important otherwise it can all be in vain. Unless you are looking for long term investments, you should also have a take profit point established at the time of entering the trade. These stops are the best way of controlling the fear and greed that grips most traders and clouds their judgement.

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A Tale of Two Traders

Trade #6
Before we leave the tale of our two traders, there is one more interesting twist! Good old Nev, whos just about given up on the whole thing and hasnt even looked at the market for weeks, gets a tip from one of his mates. He has a friend that works at XYZ and he reckons that they are about to announce a big deal that will send the share price well past $10. Neville, who hasnt really had a reason to trade, suddenly has his interest in XYZ rekindled. This is a sure way to recoup some of his earlier losses. He hurries to call his broker and finds out that XYZ is trading at $8.65. Although he is a bit nervous, he doesnt want to miss out (Nev has the whole fear and greed thing going again) and he buys 300 shares at $8.65 which costs him $2595, more than 30% of his remaining capital. Over the next couple of days the price does rise a bit, however the company makes its announcement and the share price does nothing but trade sideways for a couple of more days. Neville is at a bit if a loss. He had no real plan for getting in...it was a tip after all, and he has no plan for getting out. Consequently Neville just holds onto the stock hoping it will go up. After a few more weeks the share price has slipped down to $7.59 and Neville sells out blaming his mates bad tip for his misfortune.

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Michael never got involved in this trade. His technical analysis had not given any signals on XYZ so hes been off looking for signals in other stocks. As a result we can see what each of their accounts now looks like.

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Step 7

Play it by the Numbers

Finally, one of the most important things that we can tell you about trading is the importance of keeping good records. Financial records of your investment activity need to be kept, as well as qualitative records that show whether or not you stuck to the plan you had set yourself and how you felt during the trade. By keeping tabs on all these things, you are more easily able to identify the things that add to or take away from your success and you can adjust your trading plan accordingly.

Document Your Plan

First of all you need to document your plan. It is absolutely no use having a plan if you have not committed it to writing. You can easily change or bend your plan if its not in black and white.

Monitor Your Position

Secondly, you need to keep good trading records. This means you need to be able to clearly track which trades you have taken, how many contracts you bought, how much you paid in fees brokerage and importantly how much profit or loss you made. It is important that you continue to monitor your position in the market by reviewing share price data on a daily basis to monitor the stops youve put in place. Once the hard work of finding and getting into a trade is done, it is not just sufficient to sit back and completely relax. The ongoing management of your investment requires you to continue watching the trade in relation to your plan.

Learn from the Numbers

A trade should not end when you exit out of your position. You must analyse it and learn from it. This review and self-analysis is an essential part of growing to become a more successful trader. Have you identified a good trade? Which selection criteria were useful and which did not work? How good was your entry? Was the initial stop too far or too close? Why and by how much? Did you move your stop too early or too late? Were your profit protection stops too loose or too tight? Did you recognise the signals to exit a trade? What should you have done differently?
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A thorough analysis such as this is the best weapon against emotional trading.

Keep a Trading Diary

Its a good idea to keep a journal that outlines your position and reasoning before and after the trade. Jot down your main reasons for buying or selling. Write down your plan for entering the trade. Complete this exercise again once you have exited the trade. Write down your reasons for exiting, and list what you did wrong or right and how you felt. Learn from history and profit from experience. Your trading diary should record all of the details of a trade, including how you made the trading decision, whether you were feeling uncertain, confident, or dispassionate, and indicate the background information of the trade. By reviewing detailed records of a past trade with the benefit of hindsight you can identify particular aspects that you are doing well or doing badly. These numbers, the profit or loss, the % of winners, the average size of a trade are the real results. If you see problems with the numbers, work hard to adjust your trading plan to improve future results. You have to deal with stress and a huge potential for self doubt. Because trading so often takes profits from being out of step with the crowd, you need a level of self discipline that is not dependant upon the approval of your peers. Private trading is a lonely business that requires strength of conviction and of character. Anybody can open a trading account, but only those who have the right temperament, or who can develop it, will feel comfortable and succeed. Learn to play it by the numbers they dont lie. If you can build up a strength of conviction in your system because you have good information then you are all the closer to becoming a successful trader.

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A Tale of Two Traders

De-Brief
An important tip that Michael picked up in his investment course was to document as much as possible about each trade he made so that, regardless of whether the trade made a profit or not, he could go back and review the circumstances under which he made decisions. He knows that it is important to keep tabs on himself. Once he had finished a trade and was away from the emotion of making decisions about his money he was able to take an unbiased eye to actions and motivations. Lets take a look at the results of our traders and apply some really simple analysis.

What we can see is that in a period of only 5 months Michael has been able to generate a return of 16% on his capital. Neville on the other hand has managed to lose 28% of his.

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Michael managed to win on 60% of his trades. This tells us that even if he was winning or losing the same amount of money on every trade, he would be ahead. Even better than that, we can see that Michael has managed to keep his losses small in comparison to his wins. The average winning trade was $580 while the average losing trade was - $150. If Michael could stick to his system and maintain these types of results he could earn a substantial income from trading. As his account grew bigger he could be able to afford to trade larger parcels of shares and his profits would also increase. Neville on the other hand is a different story and unfortunately is representative of a lot of people that try to get involved in trading their own investments. Neville made a few major errors: He failed to properly educate himself He failed to keep any records He failed to do any analysis and learn from his mistakes Consequently he had more losers than winners and his losers were way bigger than his winners. Neville will probably not try trading again. He is very unlikely to take responsibility for the fact that he lost his money and will probably find other people to blame or other reasons why he lost money all because he didnt take the time to get some basic Investment Know-How.

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Conclusion

What Does it All Mean?

What does it all mean? Thats a very good question to which the answer is:

You really can earn a living from trading

However you must realize that it will require hard work and will take time. In addition you will need some available money to trade with. Assuming that you can put all of this together, trading can offer a great lifestyle. No boss, no employees, no customers, no suppliers. Basically no one to answer to except yourself. You can spend as much time or as little time as youd like trading each day. It all depends on the trading plan you put together for yourself. However, regardless of the plan that you put together, remember to make sure that it addresses all of the steps that weve talked about. Step 1 - Never Put All of Your Eggs in One Basket Step 2 - Cut the Losers with Stops Step 3 - Always Know your Destination Step 4 - Never Let a Profit Turn Into A Loss Step 5 - Turn the Odds in your Favour Step 6 - Make Your Own Decisions Step 7 - Play it By The Numbers These steps plus a disciplined approach will help you work your way to success! With a little practice you can develop Investment Know-How.

So What Next?
If you want to find out more about how to develop your own systematic trading plan and the discipline to trade successfully, register for our FREE 2-Hour Trading with Safety Seminar at www.tradingwithsafety.com. au or by calling 1300 387 102. This dynamic and informative event will introduce you to techniques for maximising profit and minimising risk in all market conditions. Register today for a Trading with Safety session!

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What our students are saying...

I selected Safety in the Market after attending an intro seminar on their system which caught my imagination. I was impressed by the integrity of the presenters and have since re-attended Trading Tactics seminars some five or six times. I continue to add to my knowledge each time I attend and am much more confident in being able to select better trades. I recommend this system to anyone who is serious about trading. Margaret B., Victoria

With very little experience in the stock market I began trading with the Safety in the Market system 10 months ago.The Safety in the Market team was a huge support. With the Safety in the Market trading plan and support team, we have turned my initial investment of $25,000 into $53,000. Archie M., Queensland

Almost like clockwork the principles that the Safety in the Market team had taught me over the last 18 months started to fall into place. I was thrilled to see that my order had been executed to the tee and my broker sold three March SPI at 75% for a return of $3795. Not a bad start to my trading. Ben P., New South Wales

Each Safety in the Market seminar I have attended has encouraged me to go further with my trading - to open my own trading account, to place my first trade, to start getting experience and to ask as many questions as I want. Ive received heaps of support and encouragement for all the small steps I have taken so far. Deanna R., Victoria

We would like to say how great Safety in the Markets trading system is and how well you guys present all the seminars. Recently we placed some contracts with Newcrest Mining and within three weeks we have more than doubled our trading account from these contracts alone by trading into and out of the significant low. I think it shows how Safety in the Markets system really works! Jamie T., New South Wales

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