Hi, I’m Tim Sykes. Maybe you’ve heard of me.
I built my fortune through trading, taking my Bar Mitzvah money and turning it into millions of dollars.
Now, I work with Nilus at Agora, as well as teach people how to trade penny stocks… and make tons of money doing it.
I asked if I could fill in for him over the weekend and today so that I could share something really important with you all…
Risk tolerance is a big buzzword for most financial companies.
I opened a small E*TRADE account a few years ago in order to show my students how to grow a small account fast.
On the landing page for their Online Portfolio Advisor system, right in Step #2 they tell you this program is going to take your risk tolerance into account.
It’s one of the first things E*TRADE tells you that you need to think about when you’re opening an account.
But I’d never recommend that you use a tool like this. Portfolio tools aren’t meant for active day traders. I only created a portfolio through them as a teaching mechanism.
I just want you to see how wide spread and almost reverential of an attitude people take towards risk management…
It’s not just that I wouldn’t recommend using a tool like this.
I’m going to recommend something way more radical.
I’m going to ask you to rethink what risk management means entirely.
The Traditional Risk Management Perspective
Go to any “respected” financial blog, and you’ll quickly see that it makes a couple assumptions…
- It assumes that you can minimize your risk by “diversifying” your portfolio. That is, you can protect yourself by making investments in some mythical combination of stocks, funds, bonds and other securities.
- It assumes that your goal as an investor is to achieve an 8-10% rate of return each year.
Now, this is going to sound crazy to those of you who haven’t known me very long…
But those two assumptions are some of the riskiest things I’ve ever heard of!
Let’s back up a minute, though, and look at what a portfolio that follows these assumptions looks like in real life…
Let’s say you’re 25 years old today. You have $10,000 saved in your 401k account, and you commit to saving 5% of your $55,000 a year income until you’re 65, at which point, you hope you can retire.
Now, let’s assume your salary grows a few percent a year and that inflation holds between 2-3%. Since most retirement calculators assume you’re going to need 85% of your pre-retirement salary each year you’re in retirement, we can safely say that you’re going to need between $2-$3 million dollars in your accounts to cover your post-working expenses.
If you follow the investing model described above, do you know how much you’re going to wind up with?
Not even $850,000.
You aren’t just a little short – you’re millions of dollars off!
And that’s something that no amount of diversification is going to fix.
Real Financial Risk
If you ask me, following traditional financial advice is among the riskiest of things you can do with your money.
I mean, look at the numbers up there!
If you follow the conventional wisdom, you’re basically going to be spending your golden years living off cat food and hoping you never need to go to the doctor (let alone undergo something big like a hip replacement or cancer treatment).
And that’s discounting that the calculator I used to run those numbers included Social Security benefits.
(I hope I’m not surprising you when I say the Social Security system is pretty much worthless. If you’re counting on it to provide for you when you retire, that’s truly as risky as you can get.)
What else could go wrong with the plan above?
Well, what if there’s another major recession right before you’re supposed to retire?
What if future taxes go higher to cover the country’s deficit, cutting into the amount you’re able to draw from your retirement accounts?
Most of your contributions are tax-deferred, so you’ll be stuck paying whatever rate is in effect when you retire…
I can’t think of anything riskier you could do than to hinge your comfort, your happiness and your enjoyment of your golden years on traditional financial “wisdom!”
So what’s the solution?
Let me know if the following picture makes you feel any better…
Instead of contributing small amounts over dozens of years, you make your money while you’re young.
Having built a substantial nest egg means you can invest in conservative vehicles that’ll keep your money safe while you live off the interest.
It means having paid off your dream home, your credit cards, your car loans and your medical bills so that, when you get to retirement, it costs you very little to enjoy a great life – even though you have more money than ever before.
That’s the power of generational wealth, and that’s why I’m so passionate about teaching people to trade penny stocks.
See, penny stocks don’t grow at 8-10% a year…
They can double in a day.
That’s the kind of return you need to take a small account and turn it into something that’ll provide for you for the rest of your life.
And best of all, it’s something that anyone – anywhere – can do.
You don’t need to be a math whiz (I’m certainly not) and you don’t need to be rich to get started.
If you can follow my instructions and learn the patterns and setups I like to trade, I can teach you to be a millionaire.
Managing Day Trading Risk
Obviously, you can get rich off trading penny stocks.
I’m living proof of that, and I’m using my money to do fun things like fly private jets, celebrate my birthday in Japan and give back to causes I care about, even starting my own foundation.
But with everything the media has done to put down penny stocks and the people who trade them, I get a lot of people asking me, “Tim, isn’t it risky to trade penny stocks?”
Clearly, I’d argue that following traditional financial advice is even riskier, but if that’s not enough to convince you that day trading isn’t nearly as risky as people say it is, you need to know that there are several things you can do to cut your risks…
1. Learn to cut your losses.
Here’s the #1 reason new day traders lose money:
They’re unable to let go.
They get emotionally invested in a company’s “story,” or they fear taking a loss and hope the stock will bounce back…
And for whatever reason they use to justify it…
They don’t get out of trades when they should.
You think the company you bought into is going to be the next Microsoft?
99% of penny stock companies are bad companies that are going to crash and burn at some point – probably soon.
Penny stock trading isn’t about finding future winners and getting in at the ground floor.
It’s about spotting companies that are going through predictable price action patterns and using them to your advantage.
I rarely even know what the business is of a company’s stock I’m trading. It’s all about the patterns it’s following.
Once you start to think of your trades in these terms, you cut your losses automatically because, now, it’s all about the numbers.
Which is what trading should be.
You know how much money you’re willing to put in, what risk you’re willing to take in exchange for what potential reward, and you know when you need to get out of a stock – whether it goes your way or not.
If you learn this, you can pretty much eliminate your risk of taking major losses.
2. Use stop loss orders.
Thinking about cutting your losses is one thing – stop loss orders are the tools you use to put this thinking into practice.
Say you’re in a stock that you think is going to be the next big supernova.
You don’t ride the thing to the top.
You ride it to a certain point where you’ve made the profit you wanted, and then you get out.
This is difficult for some people – when they let their emotions or beliefs get the better of their logic.
It’s actually the least risky way to trade.
You can do this by executing a stop loss order for that exit point that tells your broker to execute your sell (or buy to cover) order when the stock hits a certain price.
Sure, you might miss out on some upside or downside potential, but getting out when you know your profits are secure is what will keep you in the game for the long-run.
3. Never risk more than 10-20% of your account.
Another major mistake I see amateur traders making is risking too much of their portfolio on a single play.
Going all-in is great for dramatic poker movie scenes – it’s just juvenile for penny stock traders.
I never EVER risk more than 10-20% of my account on a play, and even that’s the high-end.
I’ve made big mistakes and taken big losses in the past, and that’s shown me how important it is to limit your exposure.
All this is is asking yourself, “If I have a bad trade, would I rather wipe out 5% of my account or 50%?”
It’s that simple.
These aren’t the only things you can do to cut your risk – you can also do things like measure daily trading volume to be sure you’re never taking too large of a position in any one company.
In future articles, I will be discussing methods you can use to reduce risk while continually gaining upside advantages.
You can’t forget the tried and true fable…
Slow and steady wins the race.
But be deliberate in your portfolio choices…
Don’t just listen to the crowd when it comes to taking financial advice.
Like you’ve learned today, they’re not always right.