Today's Quote: “To know that you do not know is the best. To pretend to know when you do not know is disease.” Lao Tzu.

There are several good books out there about trading that should be on every trader’s must read list. If you were forced to choose one and only one, the only possible pick would be “Tools and Tactics for the Master Day Trader”. We are going to run a series of excerpts from the best selling book for the next series of lessons. Now in the words of the master trader himself, Oliver L. Velez…

LESSON #1: CASH IS KING WHEN THE STREET GETS BLOODY

It is said that a timid person is frightened before the danger, a coward during the danger, and a courageous person after the danger. If this is true, I suppose we as traders fit into the latter category. We are rarely frightened before or during the danger. More often, we find ourselves feeling the pain of a sloppy market after the danger has already struck. But this is not the case for the professional community. For instance, we have found that most young mutual fund managers get frightened during the danger, which would make them cowards if we take this statement to heart. As advisors to many money managers and mutual fund companies, we speak to those in charge of vast sums of money each day. And we can tell you for sure that whenever the market goes through a rough period of uncertainty, a great deal of panic and bewilderment sets in for these young guys (the average age of a U.S. mutual fund manager is under 30). During one sharp market downdraft, a young fund manager who seeks out our daily take on the market couldn't have summed up the sheer fright of these professionals any better when he said, "Oliver, I am really, really very nervous this time. I don't know what it is, but I suddenly feel like a pizza on the way to a starving person." When we hear things like that from professionals, we can't help but get nervous for the public, because these young guys actually hold in their hands the financial futures of many Americans. But the scariest thing of all is the fact that these fund managers, who have billions of dollars in their control, only know how to do one thing. In other words, they have only one market tool. One methodology. One single approach. They only know how to buy more. Why is that? Because it has worked like a charm during most of the 1990s. For almost an entire decade, if not longer, buying more stock on the way down was the thing to do; the thing that delivered; the tactic that helped create fortunes and the method that built comfortable lifestyles. And most importantly, it was easy. But the hard part will come when the market truly starts to sour, because we're not so sure at that time that the "buy more" approach will still be a viable approach. But in all fairness to these young professionals, what else is there to do? What action do you take when you own 2 million shares of a collapsing stock? Do you sell, adding to the panic and chaos? Or do you boldly look chaos in the eye and buy more? Do you just sit idle, hoping and praying that all will soon be well, as your assets erode hour by hour, day by day? Or do you get up and go for broke? It's a dilemma, my friends. One that you and I should feel fortunate not to be involved with. All I can say is "thank heavens I'm a trader." As traders, you and I don't have to grapple with such concerns. When we see a stock which we feel has good odds of moving higher over the next 2 to 5 days, we buy it. But realizing that we don't live in a perfect world, we bring along an exit plan, a bailout point that we call a stop. This is not being a coward, this is being smart, and it's being realistic. You see, many novice traders get upset when the protective stops that they have placed on their trades get triggered. While triggered stops can be frustrating, they should be viewed as welcome friends, not as enemies. Think about it. The purpose of the stop loss is to protect. To save. To safeguard against disaster. What's even more important is what they force the trader to do. Stops, triggered ones that is, force the trader to "raise" cash that will be very necessary to have when a falling market finally does bottom out, and opportunities begin to proliferate. You see, the person who has the most cash at the bottom wins. In other words, cash is king when the streets get bloody, and being stopped out of certain plays on the way down helps to prepare us for the next round of opportunities. This is not something to be sad about. On the contrary, it is something that we should be glad about. Just guess how many fund managers wish they had the luxury of a protective stop. Guess how many wish they were not locked into the buy-more-and-pray approach. Stops are a benefit. A privilege. Perfect they are not. That is for sure. But they are the best form of protection we have. So appreciate them, and most of all, use them. They are one of the few things that are only available to individual traders.