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Stock Trading: Lessons Learned From Martha Stewart
Respect for the rules, planning, risk management lead to better decision making.

(RightLine) -- Certainly everyone knows Martha Stewart. For over two decades the charming television and magazine personality has made her presence felt as an ultra-successful business woman and investor. America's best known homemaking advocate, the near-billionare proved throughout her career that she was capable of careful financial planning and brilliant execution. No one ever imagined that that the former stock broker would risk it all for one relatively unimportant trade.

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Martha Stewart's "Rules" book grew out of her prison experience, when inmates asked her about starting their own businesses.

In 2002 Americans were shocked when Ms. Stewart was charged with insider trading and other related felonies stemming from statements she made to investigators. After two years of extensive legal wrangling, public humiliation and tabloid fanfare, she was found guilty of the major charges and sentenced to prison.

After five months in jail and another five under house arrest, she was released in March 2005. That's the penalty she paid for illegally trading stocks on insider information and then trying to block a government investigation of the matter. She made $50,000 on 3,928 shares of ImClone Systems - a small amount compared to the massive damage the affair had on her numerous businesses and her reputation.

Ms. Stewart has a net worth of almost a billion dollars. So why risk so much for so little? Without speculating on the answer, it's certainly clear she didn't plan THAT trade very well . . .

Most traders underestimate the importance of carefully planning their next move. Though it ranks at the very top of our list, planning doesn't seem all that important to the "average" trader. So why is planning so important?

Winston Churchill once said "Plans are worthless, planning is priceless." The underlying message in this somewhat paradoxical statement is that the process of planning is much more important than the final plan itself. Whether you agree with the former English Prime Minsister or not, the idea that the planning process is valuable makes excellent sense.

On the other hand, so does the concept of the final plan. Of course plans are always evolving, which explains the "worthless" point of view. To think there will ever be a final "perfect trading" plan may be expecting a bit too much. But from a realistic trading perspective, the process of writing down the specifics of your methods reveals their strengths and flaws. Obviously Ms. Stewart's planning was flawed, because it landed her in prison. Had she taken the time to write it down and get input from professional stock traders, they would have strongly advised her against the trade.

At one time or another we've all been tempted to take short cuts. Unlike Martha, most traders don't go as far as trying to cheat the system. However, there are commonly used trading approaches that send folks down the wrong path. For example, most stock advisors seem to be mesmerized with trying to predict what the market will do. In other words, they live by the crystal ball. Fortunately there is a simple solution to this impossible preoccupation ... planning ahead.

Instead of worrying about what the market will do, it's best to spend your time planning what YOU will do - specifically planning your response to the "one thing" that the market always does - MOVE.

When it comes to the stock market the most important quality is an action - price movement. Your primary objective as a trader is to capture this movement. Though trying to predict what the stock market will do may seem like a logical way to capture price movement, it actually overcomplicates the process. It is extremely difficult to consistently predict market direction. It's best not to waste your time.

This is a case where planning is much better than fortune telling. That's because there are only three specific ways that the market can move - up, down, or sideways. Instead of trying to predetermine which of these three will occur next, it's much easier to use a strategy that captures movement regardless of direction.

There are a number of methods that work well with this approach, but we won't go into the details of specific setup and entry requirements in this article. However, we can start to lay the foundation for understanding this strategy by asking ourselves two simple questions within the context of the three possible ways the market can move - "What" and "When."

What and When should always be considered in advance of entering any position to arrive at specific entry and exit instructions for these possible scenarios:

Entries:

1. price goes up

2. price goes down

3. price moves sideways

Exits:

a) the trade moves in your favor,

b) the trade moves against you,

c) the trade doesn't move at all.

"What & When." As far as these two are concerned, details do matter. It isn't a good idea to approximate, or wait until you "get there" to decide what to do. Plan ahead, put it in writing, and always include the specific conditions and/or price levels for entries and exits. When using a trailing stop method to lock in gains, make certain that you plan in advance exactly when the trailing stop will be adjusted.

Bottom line: Always ask, "What & When" before you put money in the market. And if some corporate insider calls you with a hot tip, make sure it is legal to act on it. If in doubt, ask before you leap.