A Rally Can Make You Feel So Smart, But Practice Safe Trading…

So my portfolio made a good double digit advance over the course of the past week and a half. The speed of the recovery is simply mesmerising.

But rose-coloured glasses and all, I’m really getting a bit apprehensive. If the market bottom has happened, I’m not complaining. What if it’s a fakeout?

I’ve got four to five major equity positions on the verge of breakeven and two bond issues that have made medium to high double digit gains. I missed out on the whole GBP/JPY rally, but the recovery of AIG was nothing short of miraculous.

I do understand the positions that are recovering in my portfolio may not have been the best picks as there are countless stocks that have at least tripled in price since March 2009. The point is that I’m actually still in the game. If I had just been sitting on my hands and not adding to my positions, I wouldn’t be near recovery yet.

So, I did something right for once, but the implementation could have been much better.

I prepared myself while it seemed like there was nothing else to do. I’ve learned so much during this downtime and I’ve got a lot more to learn.

Most importantly, however, I do have to keep telling myself over and over one of Warren Buffett’s best trading maxims: “Be fearful when others are greedy. Be greedy when others are fearful.”

In practice, this means that if we’re averaging into positions, we need to ensure that we build up positions at the lowest price possible to minimise risk. We need to ensure that the largest part of our position is acquired at the lowest price and that the average price on our total position still enables us to profit (i.e. lower than 52 week high by a good margin so that when the 52 week high is tested, we’ll be able to sell if we so choose). We then need to sell at optimal levels – when others are so drawn into buying that logic clearly has taken a back seat.

If 2008 should teach us anything at all, it’s that it’s far better to err on the side of being too conservative rather than being too tolerant of risk.

So whilst I like the rally, I’m still going to continue moving my stops once a position moves in my favour. This is a strategy I’m going to continue to implement over the long term. And I’m hopefully going to find better and better ways of moving my stops.

If there’s anything we really need to master, I think it’s moving our stops. After all, we are only as smart as our stops.