How I Manage Short-Term Trading Ideas

"Markets are never wrong -- opinions often are."
-- Jesse Livermore

Short-term trades are demanding, far more than longer-term investments.

The chance of near-term trading success is materially less than the chance of longer-term investing success.

In the near term ... noise, sentiment, luck and random price action plays a much great role in the outcome you receive than in the long run. But over the long run, as The Oracle of Omaha emphasizes, fundamentals generally win out. That is because over the short term the stock market is, in actuality, a voting machine but in the long run it more resembles a weighing machine.

The frequency of short-term trades also reduces your chance of success. As Bruce Kovner once said, "Novice traders trade five to 10 times too big. They are taking 5% to 10% risks on a trade they should be taking 1% to 2% percent risks."

I probably look at 15-20 potential Trades of the Week for every Trade that I select.

I give this a lot of thought. So, I am obviously very selective in filtering out ideas.

I spend Sunday night sorting out the various alternatives trades for the Trade of the Weekto be published on Monday or Tuesday.

Here are some of the questions I ask myself before I write up and make the determination of my " Trade of the Week " (and now this process applies to my " For Traders Only "column):

* Is the short-term price momentum bullish, bearish or neutral? If it is bullish, I will generally lean to longs. If it is bearish, I will generally lead to shorts. However, a strong enough idea could still be a contrarian play (and running against the primary trend) -- but I must be relatively confident and convicted in my out-of-consensus view or thesis.

* Why select the idea now? What are my near-term catalysts?

* If the idea is sector specific (and not company specific), are there any other stocks in the sector that might offer a better reward vs. risk?

* Why put on the trade at the current share price? With longer-term investments, as you all know, I tend to average into positions on the belief that no one has a concession in determining the perfect entry point. But trades of shorter duration are tougher!

* Is there a margin of safety if I am wrong? (What can I lose?) What is my reward vs. risk (upside compared to downside)?

* What are the factors that contribute to my decision -- and even more importantly, what are the probabilities associated with each bullish scenario? And what are the factors (and assigned probabilities) that could ruin the trade?

* What is my stop loss -- in the event Mr. Market disagrees with me?

* If the stock is volatile (and this applies to either longs or shorts) -- am I better off using options (buying/selling calls or puts) rather than using the common shares?

* My conviction level must be high for me to sell short (naked) calls/puts. I vastly prefer buying calls/puts as my risk is defined in a market that the only certainty is the lack of certainty. This helps me deal with the market's uncertainty and volatility.

* If quickly successful in a trade (e.g., today's iShares Barclays 20+ Yr Treas.Bond ETF (TLT) long "Trade of the Week") I usually scale out slowly on strength -- not waiting for the "perfect price."

* Finally, I size my short-term trades appropriately. Depending on my degree of conviction usually they are small-sized. My greatest convicted trades are no more than between small- and medium-sized. Traders with little or limited experience should almost always make very small moves.

I hope this is helpful in explaining my process for selecting and managing short-term trading ideas.