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Anyone remember the financial crisis back in 2008? The markets were crashing, losing more than 50% at one point, and while people were cursing the ‘crooks’ on Wall Street, they were dumping their portfolios for huge losses and vowing to never again invest in the markets. The markets bottomed out in March of 2009 and have been higher for 8 consecutive years now. This is what happens when you let EMOTION rule your investments or your trades. The reason it is such a huge problem is that the average investor has no plan. Buy, hold and hope. This is a very difficult way to approach the stock market.

I think the chart above clearly reflects that having no STOP LOSS or EXIT STRATEGY is a very BAD IDEA. This is why traders are often times far more prepared for negative situations than average investors.

So, when we look at the main difference between investors and traders, the one thing that continually arises is the lack of a plan for long term investors, whereas every professional trader has a trading plan. It’s the ONLY way to make money in this business. A good trader knows his entry, protective stop loss and target BEFORE he enters any trade. Thus, why are traders referred to as gamblers, and investors considered to be smarter? It’s a simple lack of understanding about the trading business. That’s it.

Let’s take a look at the chart below to get a better idea of how a trader would prepare for a trade. Note:There isn’t the time or space in this article to get into specific patterns. We’ll save that for next time! This chart is simply to show the process a trader would go through.

Although there are actually 2 technical patterns on this chart, we’ll focus on the ‘Breakout’ play that triggers at $15.20. As you can see from the chart, everything has been predetermined BEFORE the trade was taken. The entry is clearly $15.20, the stop loss (if we’re wrong) is $15.00 and we’ve decided on a 2:1 reward to risk ratio, so the target is $15.60. Only 2 things can happen. It will either pay us $400 if we’re right or we’ll lose $200 if we’re wrong. Thus, how often do I need to be right to make money? Less than 50% of the time.

There can be some subjectivity with regard to target areas, however, for me personally I always use 2:1 as my target. Through the years I’ve found it to be a very good balance in most market environments. The topic of ‘targets’ is a whole different discussion, one we don’t have time for today, but certainly of great importance. With regard to choosing targets, the most important part is that you are CONSISTENT. I always shoot for 2:1, and never deviate from that. If you stay consistent, the odds will work in your favor. This doesn’t mean that you have to shoot for 2:1 targets, and it also doesn’t mean that you can’t have different levels of reward to risk sometimes, based on certain charts and market environments. However, for most traders, especially newer ones, shooting for 2:1 targets is generally the way to go. If we don’t hit target, then we will stop out. It’s very straight forward and simple, unlike a long-term investor trying to figure out his or her target and stop location.