Last week we covered the topic that investors throughout the world are currently experiencing a down market that is correcting the excesses of the runaway markets of the late 1990's. Despite the fact that the major market indexes have been down three years in a row, a condition that hasn't been equaled since the start of World War II, we may still have a long way to go. Last week I suggested that if you want to protect your investment fund, 1) Invest with the current trend of the market and 2) Never Enter A Position in the Market Without Knowing Where You Will Get Out. (If you missed last week's article click here to review.)

Below I will continue with points 3-5 on this subject:

3. Never Expose More Than 1% of Your Portfolio In Any Given Position.

Let's look at our example with JDSU. Suppose you started out with $25,000. Our rule says don't expose more than 1% of your position to any given stock. That means we cannot risk more than 1% or $250 on JDSU. However, our initial risk is only $2 per share. If we divide the total exposure we want (i.e., $250) by the risk per share of $2, then we discover we can purchase 125 shares.

Let's do a second example. Suppose you want to buy Microsoft stock today at $50 per share. Our second rule says "know when to get out" and we recommend risking 25% of the entry price. 25% of $50 is $12.50. Thus, we would enter a stop at $37.50 when we purchased and our risk per share would be $12.50. If our portfolio is worth $25,000 and we only risk 1%, then we can only expose $250 to the Microsoft position. And when we divide $250 by 12.50 per share, we discover that we can only purchase 20 shares.

Thus, in our first example, our risk per share was only $2 and we could purchase 125 shares. In our second example, our risk per share was $12.50, so we could only purchase 20 shares. However, in each case our exposure to the market if we are wrong about the stock is only 1% of our portfolio or $250.

And if you look at our example of JDSU, we sold at a profit that was 53 times our initial risk. That means that even though we only risked 1% of our portfolio, we made 53% on that one stock alone.

4. Continually observe yourself and notice your patterns. Self-awareness of your patterns, habits, and emotions is the key to improvement.

I once asked one of the world's greatest traders, "What's your secret to handling your emotions and psychological problems?" His response was surprising at the time. He said, "I just notice that I'm emotional and then I continue to trade the system."

Most people allow their emotions to control them. They get caught up in those emotions and don't even realize what is happening. The great trader, in contrast, is simply aware of those emotions when they occur. Awareness is the key to change and it is essential if you want to improve. People who are not aware of what they are doing psychologically are victims of their own patterns and emotions. They are psychological robots.

Thus, a key step toward improving your trading is to become aware of what goes on inside of your head. Keep a diary of your trades and record what you are feeling and thinking on a regular basis. Look for patterns in your diary that might be self-destructive.

5. Take responsibility for everything that happens to you.

One of the problems in today's down market is that everyone is trying to find someone else to blame. We can blame the market. We can blame corrupt CEO's and poor accounting practices for our losses. We can blame our broker or mutual fund manager for our losses. We can blame the analysts at the major brokerage houses.

People who blame someone else are always repeating their mistakes. For example, someone recently sued a large mutual fund because his account went down 90%. However, this person got an account statement every month and watched his account drop. Only when his account was down 90% did he finally decide something should be done... Who was really to blame? The investor! He risked too much of his portfolio on one investment and he didn't have a predetermined exit point. Seeing that he is now suing the mutual fund, he still has no idea that he made those mistakes, so he'll probably make them again.

No matter what happens to you in the market, you must be accountable for the results. That way you can learn from the markets.

Part 1 of this article: Five Ways To Improve Your Market Performance (part 1) >>