Historically the bull-bear cycle lasts about 4 years, with the bull market lasting for about 3 years while the Bear portion lasts for nearly 1 year. Stocks have trended higher throughout the stock market’s history so the odds are with you over time if you trade long as opposed to short selling. These statistics favor being long most of the time and sitting out some market periods that are not the ideal conditions for being long. Those less than ideal conditions also provide another opportunity besides being in cash to get short the market and try to profit from falling stock prices. Selling short in a bear market can be very profitable but it is a much tougher road than being long a bull market. Tonight we’ll discuss why that is.
Many novice traders and even more experienced traders have trouble surviving bear markets. Most of the time, it is because they have a false sense of security as they simply believe that profits will continue even in a major decline as long as they just flip their long strategies into reverse. It’s not that easy folks. Bear markets are much tougher to trade through than bull markets. This is due to the emotional roller coaster of fear and greed that routinely accelerates when stocks are in downtrends. Trend-following tactics are more difficult in downtrends simply because of the sudden bear market rallies that can be quite violent at times. These spikes will often create short squeezes that will induce heavy losses for those who take new short positions at the wrong time.
Bear markets make it much harder to turn short-term profits than typical bull markets. We will actively short stocks in bear markets but understand that during these periods, it is more difficult to turn consistent profits so it is not our desired way to trade. We think it is much more important to prepare for the bear market and the ensuing bull phase that follows so we can survive and profit while waiting for better conditions. Please don’t underestimate the importance of preparing to survive the next bear market so that you are ready for the next bull market.
One reason bear markets are harder to trade is because volume drops sharply through most phases of a broad bear market recession. This induces liquidity issues and dangerous trading conditions. Spreads will widen and slippage will increase for both the entries and exits. Short sale opportunities will vanish as inventories for stocks to borrow dry up at many brokerage firms. The best stocks to short will not have any shares available to borrow. This will be particularly frustrating as the stock you wanted to short continues to fall in a downward spiral and you can’t get in position to profit from it. Volume dries up as fund managers increase cash allocations to satisfy redemption requests and will not put new money to work from any inflows of cash due to fear of stocks dropping further. And many novice traders close up shop due to a lack of interest in the markets during these bear market periods.
Another reason why trading during bear markets can be very difficult is because during these times, actual price declines often take up only a small percentage of the time that the downtrend conditions exist. Just like individual stocks, the indices fall faster than they rise and the selling panic periods tend to be sharp and end quickly. The rest of the time the market meanders back and forth on low volume while trying to heal. Also, the typical bear market doesn't end in the high volume capitulation that most people believe will happen. These capitulation selloffs do happen in bull market corrections but rarely end bear markets. Instead, bear markets end slowly as value investors start to accumulated positions while a market bottom forms. Most other participants will have little interest in stocks because the long basing period doesn’t excite them into entering the market again.
Our strategy for trading a bear market will be one of mostly cash with a combination of short selling and taking some long positions during countertrend rallies. We will act defensively through cyclical bear market conditions unless the intraday charts signal opportunities. Rallies and sell offs do offer excellent short-term setups for trading profits. One thing that we will have to do is tighten our holding time because the market environment will change drastically. We will try to anticipate where short covering rallies will take place and try to get long just before the short squeezes erupt. We will use the short seller's panic to turn a profit, and then attempt to find resistance levels where natural reversals may take place. At this time, we can flip back to the short side for resumption of the downtrend.
As a bear market evolves, follow the daily charts for key turning points and act defensively at all times. Wait for favorable risk/reward opportunities and avoid being whipsawed by the frequent swings of investor/trader’s hopes and fears. All the while we are on defense, we will be looking for accumulation and renewed interest while the market is in the long healing process of forming a base. These basing periods offer excellent long-term potential for those with precise market timing. But remember, entry at these times will require execution against market sentiment. In other words, you will be buying when nobody else wants anything to do with stocks. That is always tough to do but the potential reward if you time it right can be astronomical.
David Colletti
Founder
StockTradersHQ.com
The Headquarters for Serious Traders.
Copyright © 2008 StockTradersHQ.com
Saturday, June 28, 2008
Friday, June 20, 2008
Maximize Your Day Trading Capital for Optimal Returns
How much capital will I need to start day trading for a living?” This is a very common question that we often receive and it is somewhat difficult to answer. That is because each individual is different and has a different set of goals. Each person’s standard of living could be different and what one individual makes with day trading for a living may not be enough for another. The more money you want or need to make will depend on the amount of capital that you have at risk.
Swing Trade for Percentage, Day Trade for Dollars
The answer is that it is different for each person and it is something you must consider for yourself before you start. We can only give some practical guidelines. I personally feel that you should have enough trading capital to purchase between 500 to 1000 shares of any given stock without having to use margin. When we take a swing trade position at StockTradersHQ, we look for gains in terms of percentage points. However, when I day trade, I am looking for dollars to take out of the market that day. I need a dollar figure because this is my salary for my work. It’s how I make my living so I want to make a certain amount of dollars when I day trade.
The price of the stock I am day trading is critical because I normally buy either 500 or 1000 shares, depending on the price of the stock. Ideally, my target when I take a day trade position is a $1.00 move on the stock. I will let the stock run much more than that if I see the momentum is going to carry it up further. I have had stocks move up 2, 3, 4 dollars or more in a single day trade. If I get the move, I will run a trailing stop behind the price to lock in the profit should the stock reverse and fall back. I use the trailing stop because I want to take advantage of any more upside movement the stock might have the rest of the session. If I were to just sell at the $1.00 target, I am really robbing myself of possible further upside in the stock and limiting my potential profit. Remember, when you are trading 1000 shares at a time, you only need a small move in the stock for a worthwhile profit.
Keep Expectations Realistic
If you trade stocks in the $30 to $60 range, this could mean that you need a minimum of $30,000 to start. 1000 shares of a $30 stock or 500 shares of a $60 stock and so on. This of course would be 100% of your capital in any one position, which is very dangerous. If you want to trade 2 or 3 positions at a time, you would need $60K to $90K to start, assuming that you trade the 500 to 1000 share blocks in this $30 - $60 price range and you do not use your margin.
If you are using margin, then you could buy more shares or pick higher priced stocks. If your day trading account balance was say $120,000, you could buy 2000 shares of a $20 stock and still have $80,000 left to put to work in 2 or 3 more trades. For example, if you had bought 2000 shares of SOLF on Friday (May 16th) at the opening price of $19.00 and sold at the close, you would have had a one day profit of $7,680. It closed at $22.84 for a $3.84 gain on your trade. $3.84 X 2000 = $7,680. This is just one example and it is not that far fetched to think that you can’t catch these moves because every day there are stocks moving up and there is always a big mover in the market somewhere. We just happened to have had SOLF on our trade Bulletin and in the pre-market update as a stock to watch for a possible day trade.
In this example, we used 2000 shares but you do not need to trade that many shares. Trade what you feel is in your comfort level. Keep in mind, with lesser shares traded, you will need bigger daily moves in the stocks to make a decent living and there are times when stocks just do not move more than $1.00 in a day, especially when the market is suffering from a flat day. Just remember, if you are starting small, keep your expectations realistic. Certainly, someone trading with $30,000 to $50,000 is going to have a much more difficult time generating $1,000 per day than someone using $100,000 or more. Know your limitations with respect to your capital. Keep things in perspective and try not to expect miracles.
In the Big Leagues
When you get into the bigger leagues of day trading, you can then take on (purchase or short) a block or two of a stock, generally defined as 10,000 shares. You can trade 10K shares of a $5.00 stock for only a 10 cent move and you will have profited $1,000 in that trade. Examples of these types of stocks are CPST ($3.48) had a .15 range on Friday and FINL ($6.77) had a .30 range on Friday. You won’t capture the whole move but you can see the potential if you get a decent entry. Remember; never put all your capital in one trade. Only use 25% to 33% of your available day trading capital in each trade.
This is going to require $150,000 to $200,000 or more of trading capital plus some use of margin in limited situations and for a limited time. When you reach this level, it is easy to see how day trading can become quite profitable but also quite risky. A move of a few pennies across 10,000 shares can return quite a bit of money, quite rapidly if you scalp 3 or 4 trades a day in the stock. Just remember it goes both ways; you can quickly lose quite a bit as well. There is no right or wrong answer with regard to how much you need to start. Simply keep your objectives in perspective and be realistic based on the capital in play.
David Colletti
Founder
StockTradersHQ.com
The Headquarters for Serious Stock Traders
Swing Trade for Percentage, Day Trade for Dollars
The answer is that it is different for each person and it is something you must consider for yourself before you start. We can only give some practical guidelines. I personally feel that you should have enough trading capital to purchase between 500 to 1000 shares of any given stock without having to use margin. When we take a swing trade position at StockTradersHQ, we look for gains in terms of percentage points. However, when I day trade, I am looking for dollars to take out of the market that day. I need a dollar figure because this is my salary for my work. It’s how I make my living so I want to make a certain amount of dollars when I day trade.
The price of the stock I am day trading is critical because I normally buy either 500 or 1000 shares, depending on the price of the stock. Ideally, my target when I take a day trade position is a $1.00 move on the stock. I will let the stock run much more than that if I see the momentum is going to carry it up further. I have had stocks move up 2, 3, 4 dollars or more in a single day trade. If I get the move, I will run a trailing stop behind the price to lock in the profit should the stock reverse and fall back. I use the trailing stop because I want to take advantage of any more upside movement the stock might have the rest of the session. If I were to just sell at the $1.00 target, I am really robbing myself of possible further upside in the stock and limiting my potential profit. Remember, when you are trading 1000 shares at a time, you only need a small move in the stock for a worthwhile profit.
Keep Expectations Realistic
If you trade stocks in the $30 to $60 range, this could mean that you need a minimum of $30,000 to start. 1000 shares of a $30 stock or 500 shares of a $60 stock and so on. This of course would be 100% of your capital in any one position, which is very dangerous. If you want to trade 2 or 3 positions at a time, you would need $60K to $90K to start, assuming that you trade the 500 to 1000 share blocks in this $30 - $60 price range and you do not use your margin.
If you are using margin, then you could buy more shares or pick higher priced stocks. If your day trading account balance was say $120,000, you could buy 2000 shares of a $20 stock and still have $80,000 left to put to work in 2 or 3 more trades. For example, if you had bought 2000 shares of SOLF on Friday (May 16th) at the opening price of $19.00 and sold at the close, you would have had a one day profit of $7,680. It closed at $22.84 for a $3.84 gain on your trade. $3.84 X 2000 = $7,680. This is just one example and it is not that far fetched to think that you can’t catch these moves because every day there are stocks moving up and there is always a big mover in the market somewhere. We just happened to have had SOLF on our trade Bulletin and in the pre-market update as a stock to watch for a possible day trade.
In this example, we used 2000 shares but you do not need to trade that many shares. Trade what you feel is in your comfort level. Keep in mind, with lesser shares traded, you will need bigger daily moves in the stocks to make a decent living and there are times when stocks just do not move more than $1.00 in a day, especially when the market is suffering from a flat day. Just remember, if you are starting small, keep your expectations realistic. Certainly, someone trading with $30,000 to $50,000 is going to have a much more difficult time generating $1,000 per day than someone using $100,000 or more. Know your limitations with respect to your capital. Keep things in perspective and try not to expect miracles.
In the Big Leagues
When you get into the bigger leagues of day trading, you can then take on (purchase or short) a block or two of a stock, generally defined as 10,000 shares. You can trade 10K shares of a $5.00 stock for only a 10 cent move and you will have profited $1,000 in that trade. Examples of these types of stocks are CPST ($3.48) had a .15 range on Friday and FINL ($6.77) had a .30 range on Friday. You won’t capture the whole move but you can see the potential if you get a decent entry. Remember; never put all your capital in one trade. Only use 25% to 33% of your available day trading capital in each trade.
This is going to require $150,000 to $200,000 or more of trading capital plus some use of margin in limited situations and for a limited time. When you reach this level, it is easy to see how day trading can become quite profitable but also quite risky. A move of a few pennies across 10,000 shares can return quite a bit of money, quite rapidly if you scalp 3 or 4 trades a day in the stock. Just remember it goes both ways; you can quickly lose quite a bit as well. There is no right or wrong answer with regard to how much you need to start. Simply keep your objectives in perspective and be realistic based on the capital in play.
David Colletti
Founder
StockTradersHQ.com
The Headquarters for Serious Stock Traders
Sunday, June 8, 2008
The Zero Sum Game
If you have read the book “Trading for a Living”, one of the books we recommend (see recommended books in resource section), then you already know about the Zero Sum Game. But for those of you who have not read that book yet, we are going to talk about it tonight. Dr. Elder discusses this in the first chapter of his book. Why? Because it is so important for you to understand this concept. The Zero Sum Game? What is it? Most people on Wall Street would like you to believe trading stocks is a Zero Sum Game, meaning that the winners will win as much as the losers will lose. For every trade made, there is a winner and a loser and the money simply flows between the two traders to equal a Zero sum. This is false. What people fail to realize is that the winners receive LESS than the losers lose because the industry drains the money in the form of commissions and spreads. Trading stocks is a LESS than a Zero Sum Game, meaning money flows out of the market daily and has to be replaced in order for the financial world to survive.
Every day millions of dollars are sucked out of the market and into your broker’s pockets by commissions. Millions of trades are made each day in the stock market. For every stock you buy, someone is selling it to you. The broker not only makes a commission off of you, but he also makes a commission from the seller. So in the same trade, he gets two commissions for one transaction. If you pay an average commission of $10.00 to buy a stock, then that is $20.00 to the broker because the seller just paid the same commission. This is 20 million dollars for every 1 million transactions. Folks, there are more than a million transactions a day in the financial markets.
These are conservative numbers we are talking about. An example of this less than Zero Sum Game is as follows: if you and I were to make a trade, and I buy $1,000 worth of stock from you, I would pay $1010 for the stock and you would only receive $990 in return. $20.00 in commission goes to the brokers. This happens on every trade everywhere. The point here is, without us little people trading stocks, there would be no Wall Street. They are always looking at inflows of cash into the market. This number is important to them because this inflow of money provides their next meal; it puts food on their tables and feeds their families. They need us to survive, and they love it when new online trading accounts are opened. This is fresh money coming into the market, replacing the millions of dollars that they just sucked out of the market the day before in commissions.
The markets live off of losing traders. Markets will always need a fresh supply of losing traders; these losing traders bring fresh money into the markets, which is needed so the trading industry can survive. The commercials you see on TV every day that want you to open an online brokerage account are not because they want you to get wealthy. Believe me they could care less about you; what they need is the commission they’ll get when you trade, whether you win or lose, all they really want is your money. These new trading accounts are most likely a fresh batch of inexperienced novices being fed to the wolves, many of these new accounts will be sucked dry with commissions and losing trades. They will fail and move on without ever learning the game and be replaced by a new batch of novice trader’s right behind them. This is how the financial markets have survived since their inception.
Markets are set up for you to lose. Being an average trader is not good enough to overcome the commissions that you lose on every trade. You must be better than average; you must be very good to beat the market. There are a very limited number of good traders compared to the masses. Our goal here at STHQ is to help you become one of those limited very good traders.
David Colletti
Founder
StockTradersHQ.com
The Headquarters for serious traders.
Copyright © 2008 StockTradersHQ.com
Every day millions of dollars are sucked out of the market and into your broker’s pockets by commissions. Millions of trades are made each day in the stock market. For every stock you buy, someone is selling it to you. The broker not only makes a commission off of you, but he also makes a commission from the seller. So in the same trade, he gets two commissions for one transaction. If you pay an average commission of $10.00 to buy a stock, then that is $20.00 to the broker because the seller just paid the same commission. This is 20 million dollars for every 1 million transactions. Folks, there are more than a million transactions a day in the financial markets.
These are conservative numbers we are talking about. An example of this less than Zero Sum Game is as follows: if you and I were to make a trade, and I buy $1,000 worth of stock from you, I would pay $1010 for the stock and you would only receive $990 in return. $20.00 in commission goes to the brokers. This happens on every trade everywhere. The point here is, without us little people trading stocks, there would be no Wall Street. They are always looking at inflows of cash into the market. This number is important to them because this inflow of money provides their next meal; it puts food on their tables and feeds their families. They need us to survive, and they love it when new online trading accounts are opened. This is fresh money coming into the market, replacing the millions of dollars that they just sucked out of the market the day before in commissions.
The markets live off of losing traders. Markets will always need a fresh supply of losing traders; these losing traders bring fresh money into the markets, which is needed so the trading industry can survive. The commercials you see on TV every day that want you to open an online brokerage account are not because they want you to get wealthy. Believe me they could care less about you; what they need is the commission they’ll get when you trade, whether you win or lose, all they really want is your money. These new trading accounts are most likely a fresh batch of inexperienced novices being fed to the wolves, many of these new accounts will be sucked dry with commissions and losing trades. They will fail and move on without ever learning the game and be replaced by a new batch of novice trader’s right behind them. This is how the financial markets have survived since their inception.
Markets are set up for you to lose. Being an average trader is not good enough to overcome the commissions that you lose on every trade. You must be better than average; you must be very good to beat the market. There are a very limited number of good traders compared to the masses. Our goal here at STHQ is to help you become one of those limited very good traders.
David Colletti
Founder
StockTradersHQ.com
The Headquarters for serious traders.
Copyright © 2008 StockTradersHQ.com
Monday, May 26, 2008
The Gold Mine
There is a gold mine in this country and it is available to anyone who wants to go in and help themselves to it. This gold mine is located in Manhattan NY. The gold mine I speak of is on Wall Street and it is called the U.S. Stock Market. It opens its doors every day and invites us all in and we can leave each day with as much cash as we want to take from it, if we can. That is it; we can literally go inside the stock market everyday and walk away with a fortune, if we want to. So why don't we? It sounds so easy to do and “they”, the stock market, are so willing to let us do it, and yet so few market participants can do it consistently each day. It is much easier said than done. Trading stocks is probably the hardest way to make a living and probably one of the most stressful. It takes time, patience and persistence. With hard work, anyone can do it.
The “Big” Money
A doctor goes to school for 8 years before he can treat patients and make the “big” money. A lawyer goes to school for 8 years before he can defend O. J. Simpson, an alleged murderer, and make the “big” money. A professional baseball player has played baseball all his life and practiced many years before he gets to the big show and makes the “big” money. Why do so many people think that they can just walk into the stock market and make the “big” money without first paying their dues and learning the profession?
Just like the casino’s in Vegas, sometimes the odds are stacked against those naive investor’s that choose to be in the stock market without learning first. Somebody who has never been to a casino before will probably lose their money, as does the new investor or trader. A professional gambler makes money because he has taken to time to learn the business. He can beat the casino at will and the professionals on Wall Street can do the same, they beat the market at will. It took many years for the professional gambler and the professional stock trader to get to the point where they can beat their opponents at will.
A doctor, lawyer or baseball player may be good at what they do and have money to invest but it does not mean that they will be successful in the stock market. The best thing about the stock market is, when you do finally get good enough to make a living, you know you will be a trader for the rest of your life. The other professions that I mentioned do not carry with them this security. A doctor can be sued for malpractice even if they did nothing wrong. A professional athlete gets too old to perform; the professional gambler gets kicked out of the casino and banned for life, if he gets too good. You are never too old to trade stocks, you will never be sued for winning a trade, and no trader has ever gotten kicked out of the stock market for being too good.
Learn to trade stocks like a pro
http://www.stocktradershq.com/
The Headquarters for serious traders.
Copyright © 2008 StockTradersHQ.com
The “Big” Money
A doctor goes to school for 8 years before he can treat patients and make the “big” money. A lawyer goes to school for 8 years before he can defend O. J. Simpson, an alleged murderer, and make the “big” money. A professional baseball player has played baseball all his life and practiced many years before he gets to the big show and makes the “big” money. Why do so many people think that they can just walk into the stock market and make the “big” money without first paying their dues and learning the profession?
Just like the casino’s in Vegas, sometimes the odds are stacked against those naive investor’s that choose to be in the stock market without learning first. Somebody who has never been to a casino before will probably lose their money, as does the new investor or trader. A professional gambler makes money because he has taken to time to learn the business. He can beat the casino at will and the professionals on Wall Street can do the same, they beat the market at will. It took many years for the professional gambler and the professional stock trader to get to the point where they can beat their opponents at will.
A doctor, lawyer or baseball player may be good at what they do and have money to invest but it does not mean that they will be successful in the stock market. The best thing about the stock market is, when you do finally get good enough to make a living, you know you will be a trader for the rest of your life. The other professions that I mentioned do not carry with them this security. A doctor can be sued for malpractice even if they did nothing wrong. A professional athlete gets too old to perform; the professional gambler gets kicked out of the casino and banned for life, if he gets too good. You are never too old to trade stocks, you will never be sued for winning a trade, and no trader has ever gotten kicked out of the stock market for being too good.
Learn to trade stocks like a pro
http://www.stocktradershq.com/
The Headquarters for serious traders.
Copyright © 2008 StockTradersHQ.com
Sunday, May 11, 2008
The 3% Risk Trading System
Last week I mentioned the 3% Risk Trading System which is much more aggressive than the 10% Rule used with the StockTradersHQ (STHQ) portfolio. Just a reminder before we proceed, the 10% Rule = 10% of the portfolio value is placed in each trade. As the portfolio value increases, the dollar value placed in each trade also increases, compounding gains while minimizing risk.
I have used the 3% Risk Trading System in the past with great returns; I have not used it recently though. Fair warning: it is for aggressive traders only. You will need tough skin and nerves of steal to use it. If you have a heart condition, you may want to consult your physician before entering any trades using this system.
The 3% Risk Trading System requires more capital to be allocated in each trading position compared to the 10% Rule. Please do not get this system mixed up with the 10% Rule. The STHQ trade record is based on 10% allocation in each trade, and it will stay that way. I am disclosing the 3% Risk Trading System as an alternative approach some members may find attractive. If you decide to use this system, please set up a separate account and do not blend this system in with your STHQ trading account.
In the 3% Risk Trading System, the money allocated to each trade will vary based on your buy point and your stop price (more on that later). What is important is to limit losses to a maximum of 3% of your portfolio. This means that in a $100,000 portfolio our maximum loss of 3% will be $3,000 in our first trade. If we are starting with a $25,000 portfolio then our maximum loss of 3% will be $750 in our first trade.
Here is how it works:
Let's say you want to enter stock XYZ as it breaks above a resistance of $25.00. You set a buy stop order at $25.10. Once you are filled you MUST IMMEDIATELY set a stop loss order. This stop loss is not an automatic 3%. Instead, the stop loss is based on previous support. Let's say the support for XYZ is at $20.00. Our stop would then be just under support at $19.90.
To calculate the number of shares to purchase:
1. Take the difference between the buy price and the stop price you have determined: $25.10 - $19.90 = $5.20.
2. Divide the difference into your risk level of $3,000 (3% of $100,000) $3000 / $5.20 = 576 shares
To calculate the value of your trade:
Multiply the 576 shares by the buy price of $25.10 to get a total of $14,458 (14.5% of your 100K).
Let's look at this example more clearly below along with two others.
Example 1
Buy Price = $25.10
Stop price = $19.10
Risk per share = $25.10 - $19.10 = $5.20
Max loss of 3% = $3,000
$3,000 / $5.20 = 576 shares
576 X $25.10 = $14,458
$14,458 = 14.5% of $100,000 portfolio balance
In Example 1, you have to use 14.5% of your trading capital and you risk 3%.
Example 2
In this example we will use the same buy price but a different stop price for XYZ. The different stop price will depend on the chart and where you see the support levels. Again, you will risk 3% or $3,000 of your $100,000 portfolio.
Buy Price = $25.10
Stop price = $22.10
Risk per share = $25.10 - $22.10 = $2.20
Max loss of 3% = $3,000
$3,000 / 2.20 = 1,363 shares
1,363 X $25.10 = $34,211
$34.211 = 34.2% of $100,000 portfolio balance
As you can see in Example 2, you will use 34% of you portfolio balance because of the tighter stop you have placed on the trade. You risk the same amount ($3,000) but you must use more cash in the trade.
Example 3
In this example we will use the same buy and sell points as Example 2, but the risk will be narrowed to 2% instead of 3%. This system can be adjusted to risk any percent of your portfolio you wish. You can bump it up to 5% risk if you wish. It is the same formula; you will just be adjusting the dollars you want to have at risk.
Buy Price = $25.10
Stop price = $22.10
Risk per share = $25.10 - $22.10 = $2.20
Max loss of 2% = $2,000
$2,000 / $2.20 = 909 shares
909 X $25.10 = $22,815
$22,815 = 22.8% of $100,000 portfolio balance
As you can see, it does not matter what you pay for the stock or how much of your portfolio goes into each trade as long as you risk only 3% (or whatever % you are comfortable with) of your total portfolio. Some trades will cost more or less based on where you determine the stop price to be on the chart to insure a maximum loss of 3%.
This is obviously a much more aggressive approach then our 10% position size rule. Let's take Example 1 again using our normal 10% position size rule. We will assume we will be stopped out of the trade with a 10% loss according to the STHQ trading rules.
Buy $25.10
10% of $100,000 = $10,000
$10,000 / $25.10 = 400 shares
Stop $2.50 (10% below buy price) = $22.60
Sell at $22.60 = $9,050
$10,000 - $9,050 = $950
$100,000 - $950 = $99,050
The loss of $950 = 10% of your 10% position but only 1% of your total $100,000
As you can see, the 10% Rule is more conservative compared to the 3% Risk Trading System. The 3% Risk Trading System is ideal in Bull markets, but performs poorly in flat markets. It is too easy to get whipsawed out of you position in a flat market, and those losses will add up quickly. However, in a Bull market, the 3% Risk Trading System should out perform the 10% rule. Using the 3% Risk Trading System, only four or five positions are open at any one time.
Example 4
If you bought JRCC when we first recommended it on March 26th (see chart) http://stockcharts.com/h-sc/ui?s=JRCC&p=D&yr=0&mn=4&dy=0&id=p29039817531&a=132229947&listNum=19
at $17.50, you would have done very well when it closed Friday 31.10. Let's use the 3% Risk Trading System with this real example. Keep in mind, JRCC is still running and should move higher next week.
Buy Price = $17.50
Stop price = $13.90 (based on $14.00 support on chart)
Risk per share = $17.50 - $13.90 = $3.60
Max loss of 3% = $3,000
$3,000 / $3.60 = 833 shares
833 x $17.50 = $14,578
$14,578 = 14.58% of 100K portfolio balance
Sell at $31.10 x 833 = $25,906
$25,906 - $14,578= $11,328
$100,000 + $11,328 = $111,328
The gain is $11,328 and your risk was only $3,000. This one trade could balance out almost four losing trades with a 3% risk level. This shows that you can lose 3 out of 4 trades and still break even if you keep your losses to a minimum. Remember to risk 3% of the new balance. This means, if the GENC trade was your first trade you now would risk 3% of $111,328 instead of $100,000. This is how you compound your gains very quickly.
To Reiterate
I can not stress this enough, it is imperative with this system to PLACE YOUR STOPS IMEDIATELY AFTER YOUR BUY ORDER IS FILLED. You are risking substantial loss if you fail to place stops with 34% of your capital at risk as with Example 2.
I hope you have enjoyed tonight's Commentary and the introduction of the 3% Risk Trading System. If at some point in the future we decide to open an aggressive portfolio, this is the system we will be using. We currently have two portfolios we trade, a long term portfolio (Dynamic Dozen) in which we buy and try to hold for a year or two and our short term swing trading portfolio which we trade in and out of positions frequently. I have described the 3% Risk Trading System in advance so you will be familiar with the system if we do decide to open an aggressive portfolio at some point in the future.
David Colletti
Founder
StockTradersHQ.com
I have used the 3% Risk Trading System in the past with great returns; I have not used it recently though. Fair warning: it is for aggressive traders only. You will need tough skin and nerves of steal to use it. If you have a heart condition, you may want to consult your physician before entering any trades using this system.
The 3% Risk Trading System requires more capital to be allocated in each trading position compared to the 10% Rule. Please do not get this system mixed up with the 10% Rule. The STHQ trade record is based on 10% allocation in each trade, and it will stay that way. I am disclosing the 3% Risk Trading System as an alternative approach some members may find attractive. If you decide to use this system, please set up a separate account and do not blend this system in with your STHQ trading account.
In the 3% Risk Trading System, the money allocated to each trade will vary based on your buy point and your stop price (more on that later). What is important is to limit losses to a maximum of 3% of your portfolio. This means that in a $100,000 portfolio our maximum loss of 3% will be $3,000 in our first trade. If we are starting with a $25,000 portfolio then our maximum loss of 3% will be $750 in our first trade.
Here is how it works:
Let's say you want to enter stock XYZ as it breaks above a resistance of $25.00. You set a buy stop order at $25.10. Once you are filled you MUST IMMEDIATELY set a stop loss order. This stop loss is not an automatic 3%. Instead, the stop loss is based on previous support. Let's say the support for XYZ is at $20.00. Our stop would then be just under support at $19.90.
To calculate the number of shares to purchase:
1. Take the difference between the buy price and the stop price you have determined: $25.10 - $19.90 = $5.20.
2. Divide the difference into your risk level of $3,000 (3% of $100,000) $3000 / $5.20 = 576 shares
To calculate the value of your trade:
Multiply the 576 shares by the buy price of $25.10 to get a total of $14,458 (14.5% of your 100K).
Let's look at this example more clearly below along with two others.
Example 1
Buy Price = $25.10
Stop price = $19.10
Risk per share = $25.10 - $19.10 = $5.20
Max loss of 3% = $3,000
$3,000 / $5.20 = 576 shares
576 X $25.10 = $14,458
$14,458 = 14.5% of $100,000 portfolio balance
In Example 1, you have to use 14.5% of your trading capital and you risk 3%.
Example 2
In this example we will use the same buy price but a different stop price for XYZ. The different stop price will depend on the chart and where you see the support levels. Again, you will risk 3% or $3,000 of your $100,000 portfolio.
Buy Price = $25.10
Stop price = $22.10
Risk per share = $25.10 - $22.10 = $2.20
Max loss of 3% = $3,000
$3,000 / 2.20 = 1,363 shares
1,363 X $25.10 = $34,211
$34.211 = 34.2% of $100,000 portfolio balance
As you can see in Example 2, you will use 34% of you portfolio balance because of the tighter stop you have placed on the trade. You risk the same amount ($3,000) but you must use more cash in the trade.
Example 3
In this example we will use the same buy and sell points as Example 2, but the risk will be narrowed to 2% instead of 3%. This system can be adjusted to risk any percent of your portfolio you wish. You can bump it up to 5% risk if you wish. It is the same formula; you will just be adjusting the dollars you want to have at risk.
Buy Price = $25.10
Stop price = $22.10
Risk per share = $25.10 - $22.10 = $2.20
Max loss of 2% = $2,000
$2,000 / $2.20 = 909 shares
909 X $25.10 = $22,815
$22,815 = 22.8% of $100,000 portfolio balance
As you can see, it does not matter what you pay for the stock or how much of your portfolio goes into each trade as long as you risk only 3% (or whatever % you are comfortable with) of your total portfolio. Some trades will cost more or less based on where you determine the stop price to be on the chart to insure a maximum loss of 3%.
This is obviously a much more aggressive approach then our 10% position size rule. Let's take Example 1 again using our normal 10% position size rule. We will assume we will be stopped out of the trade with a 10% loss according to the STHQ trading rules.
Buy $25.10
10% of $100,000 = $10,000
$10,000 / $25.10 = 400 shares
Stop $2.50 (10% below buy price) = $22.60
Sell at $22.60 = $9,050
$10,000 - $9,050 = $950
$100,000 - $950 = $99,050
The loss of $950 = 10% of your 10% position but only 1% of your total $100,000
As you can see, the 10% Rule is more conservative compared to the 3% Risk Trading System. The 3% Risk Trading System is ideal in Bull markets, but performs poorly in flat markets. It is too easy to get whipsawed out of you position in a flat market, and those losses will add up quickly. However, in a Bull market, the 3% Risk Trading System should out perform the 10% rule. Using the 3% Risk Trading System, only four or five positions are open at any one time.
Example 4
If you bought JRCC when we first recommended it on March 26th (see chart) http://stockcharts.com/h-sc/ui?s=JRCC&p=D&yr=0&mn=4&dy=0&id=p29039817531&a=132229947&listNum=19
at $17.50, you would have done very well when it closed Friday 31.10. Let's use the 3% Risk Trading System with this real example. Keep in mind, JRCC is still running and should move higher next week.
Buy Price = $17.50
Stop price = $13.90 (based on $14.00 support on chart)
Risk per share = $17.50 - $13.90 = $3.60
Max loss of 3% = $3,000
$3,000 / $3.60 = 833 shares
833 x $17.50 = $14,578
$14,578 = 14.58% of 100K portfolio balance
Sell at $31.10 x 833 = $25,906
$25,906 - $14,578= $11,328
$100,000 + $11,328 = $111,328
The gain is $11,328 and your risk was only $3,000. This one trade could balance out almost four losing trades with a 3% risk level. This shows that you can lose 3 out of 4 trades and still break even if you keep your losses to a minimum. Remember to risk 3% of the new balance. This means, if the GENC trade was your first trade you now would risk 3% of $111,328 instead of $100,000. This is how you compound your gains very quickly.
To Reiterate
I can not stress this enough, it is imperative with this system to PLACE YOUR STOPS IMEDIATELY AFTER YOUR BUY ORDER IS FILLED. You are risking substantial loss if you fail to place stops with 34% of your capital at risk as with Example 2.
I hope you have enjoyed tonight's Commentary and the introduction of the 3% Risk Trading System. If at some point in the future we decide to open an aggressive portfolio, this is the system we will be using. We currently have two portfolios we trade, a long term portfolio (Dynamic Dozen) in which we buy and try to hold for a year or two and our short term swing trading portfolio which we trade in and out of positions frequently. I have described the 3% Risk Trading System in advance so you will be familiar with the system if we do decide to open an aggressive portfolio at some point in the future.
David Colletti
Founder
StockTradersHQ.com
Thursday, May 8, 2008
Building a Winning Trading Plan
There is an old saying in business: "If you fail to plan, you plan to fail. Ask any trader who makes money on a consistent basis and they will tell you, "You have two choices: you can either follow a plan, or you can fail." That's it in a nutshell. Have a plan or fail. If you have a written trading plan already, congratulations! While it's still no guarantee for success, a plan is better than none at all. If your plan is flawed, at least you have something that can be adjusted. Your success won't come immediately, but at least you are in a position to chart and modify your trading activity. By documenting the process, you learn what works and how to avoid repeating costly mistakes. If you have a plan, super, keep modifying it. If you do not, I have listed some idea's that can help you get started.
Assess Your Skills
Ask yourself, "Am I ready to trade?" "Have I tested my system on paper, before using my real money?" "Do I have confidence that my system is going to work?" Can I follow my signals without hesitation?" If you can answer these questions with an honest "yes", then you are ready to take that first step and begin trading for a living. The stock market is set up to separate you from your money and transfer wealth to the professional trader. Trading is a battle of give and take. The real pros are prepared and they take their profits from the rest of the crowd who seem content to hand their cash over. These novice traders, lacking a plan, give their money away through costly mistakes. This may sound brutal but I got to tell it like it is. It's your job to take the crowds money from them and make them pay dearly for their mistakes. The market does not tolerate people who lack respect for it. The crowd lacks respect for the market and for this, they will pay. Always respect the market and never become complacent. Always look for the edge, look for the advantage. Your cash is on the line, you can't let them take it from you.
Mental Preparation
How do you feel? Do you feel up to the challenge ahead? If you are not emotionally and psychologically ready to do battle in the market, it is better to take the day off; otherwise, you risk unnecessary losses. Trading is financial war. It's you against everyone else. When you enter your trading room, there are millions of people trying to take your cash by getting the better of you in a trade. For every trade you make, there is somebody on the other side of the trade who thinks you're wrong and they're right. Only one of you can be right and they have no mercy. I remember what my martial arts instructor told me years ago while I was training for a big tournament. He said " For every hour you are not training, your opponent is in the gym training with one purpose in mind and that is to beat you" Trading is the same way, it's a constant learning process and when you are not doing all you can do to better your trading, your opponent is. Without mental preparation, you will lose. If you are angry, hung-over, preoccupied or otherwise distracted from the task at hand, you can't consistently make money. Many traders have a routine before each market day that prepares them for the day ahead. You must do this also. Create one that puts you in the trading zone.
Set Some Goals
Before you enter a trade, make sure the risk/reward ratio makes sense. Many traders will not take a trade unless the potential profit is at least three times greater than the risk. For example, if your stop loss is $1.00 below your entry point, then your goal should be at least $3.00 to the upside. If resistance is $3.00 above your entry, then the trade makes good sense. If resistance is just $1.00 above your entry, then this trade has a very high risk verses reward and should not be taken in my opinion.
Preparing for the Trade
Whatever trading system or program you use, identify major and minor support and resistance levels, set alerts for entry and exit signals and make sure you can easily see and detect all signals your system generates. Your trading area should be free from distractions. No small children running around and needing attention. No trying to listen or watch that movie you rented last night and didn't finish. No trying to catch an afternoon baseball game on TV while trying to trade. I love baseball, but I do not watch any games during market hours if one should be on. I reserve that for the evenings only. Remember, you are trading for a living and distractions can be costly.
Exit Rules
Most traders make the mistake of concentrating only on their buy signals and entry points and pay little attention to when and where to exit the trade. Many beginners won't sell if they are down because they don't want to take a loss. They say "It's not a loss until I sell" . I got news for these people. At the end of the day, if their account value has dropped significantly, they have lost money, whether or not they sold the stock. If your stop gets filled, get over it or you will not make it as a trader. If your stop gets hit, it means you were wrong, don't take it personally, its part of the business. I lose more trades then I win when I day trade because of my tight stop loss rules but I'm still able to trade for a living and make plenty of profit by managing money properly and limiting losses. I don't care if I'm wrong 4 out of 5 times. I never risk more than a set percentage of my portfolio on any trade and all trades are equally distributed. If I lose 1% on the 4 trades and make 10 or 15% on the one winner, I'm going to have a substantial overall gain at the end of the year.
Record Keeping
After each trading day, adding up the profit or loss is secondary to knowing the why and how you did it. Write down your conclusions in your trading journal so that you can reference them again later. All good traders keep good records. If they win a trade, they want to know exactly why and how. More importantly, they want to know the same when they lose, so they don't repeat the same mistakes again. Record comments about why you made the trade and lessons learned. Also, you should save your trading records so that you can go back and analyze the profit/loss for a particular system. Record the average time per trade, this is necessary to calculate the efficiency of your system. The longer the stock takes to move after you are in the trade diminishes the efficiency of the trade. It may be a winner, but if it takes too long to get there, funds are tied up and opportunities are missed elsewhere.
Final Thoughts
There is no way to guarantee that a trade will make money. Your chances are based on mathematical probabilities and your skill and system used. There is no such thing as winning without losing. Professional traders lose many trades, it is the excellent management of there capital that keeps them in the game. By letting your profits ride and cutting losses short, you may lose some battles, but you will win the overall war. Most traders and investors do the opposite; they cut their winners short by taking the small gains while refusing to part with the losers which is why they never make money. The goal of any trader should be to gain enough skill to use their system so that they are able to make trades without second guessing or doubting their decisions.
Assess Your Skills
Ask yourself, "Am I ready to trade?" "Have I tested my system on paper, before using my real money?" "Do I have confidence that my system is going to work?" Can I follow my signals without hesitation?" If you can answer these questions with an honest "yes", then you are ready to take that first step and begin trading for a living. The stock market is set up to separate you from your money and transfer wealth to the professional trader. Trading is a battle of give and take. The real pros are prepared and they take their profits from the rest of the crowd who seem content to hand their cash over. These novice traders, lacking a plan, give their money away through costly mistakes. This may sound brutal but I got to tell it like it is. It's your job to take the crowds money from them and make them pay dearly for their mistakes. The market does not tolerate people who lack respect for it. The crowd lacks respect for the market and for this, they will pay. Always respect the market and never become complacent. Always look for the edge, look for the advantage. Your cash is on the line, you can't let them take it from you.
Mental Preparation
How do you feel? Do you feel up to the challenge ahead? If you are not emotionally and psychologically ready to do battle in the market, it is better to take the day off; otherwise, you risk unnecessary losses. Trading is financial war. It's you against everyone else. When you enter your trading room, there are millions of people trying to take your cash by getting the better of you in a trade. For every trade you make, there is somebody on the other side of the trade who thinks you're wrong and they're right. Only one of you can be right and they have no mercy. I remember what my martial arts instructor told me years ago while I was training for a big tournament. He said " For every hour you are not training, your opponent is in the gym training with one purpose in mind and that is to beat you" Trading is the same way, it's a constant learning process and when you are not doing all you can do to better your trading, your opponent is. Without mental preparation, you will lose. If you are angry, hung-over, preoccupied or otherwise distracted from the task at hand, you can't consistently make money. Many traders have a routine before each market day that prepares them for the day ahead. You must do this also. Create one that puts you in the trading zone.
Set Some Goals
Before you enter a trade, make sure the risk/reward ratio makes sense. Many traders will not take a trade unless the potential profit is at least three times greater than the risk. For example, if your stop loss is $1.00 below your entry point, then your goal should be at least $3.00 to the upside. If resistance is $3.00 above your entry, then the trade makes good sense. If resistance is just $1.00 above your entry, then this trade has a very high risk verses reward and should not be taken in my opinion.
Preparing for the Trade
Whatever trading system or program you use, identify major and minor support and resistance levels, set alerts for entry and exit signals and make sure you can easily see and detect all signals your system generates. Your trading area should be free from distractions. No small children running around and needing attention. No trying to listen or watch that movie you rented last night and didn't finish. No trying to catch an afternoon baseball game on TV while trying to trade. I love baseball, but I do not watch any games during market hours if one should be on. I reserve that for the evenings only. Remember, you are trading for a living and distractions can be costly.
Exit Rules
Most traders make the mistake of concentrating only on their buy signals and entry points and pay little attention to when and where to exit the trade. Many beginners won't sell if they are down because they don't want to take a loss. They say "It's not a loss until I sell" . I got news for these people. At the end of the day, if their account value has dropped significantly, they have lost money, whether or not they sold the stock. If your stop gets filled, get over it or you will not make it as a trader. If your stop gets hit, it means you were wrong, don't take it personally, its part of the business. I lose more trades then I win when I day trade because of my tight stop loss rules but I'm still able to trade for a living and make plenty of profit by managing money properly and limiting losses. I don't care if I'm wrong 4 out of 5 times. I never risk more than a set percentage of my portfolio on any trade and all trades are equally distributed. If I lose 1% on the 4 trades and make 10 or 15% on the one winner, I'm going to have a substantial overall gain at the end of the year.
Record Keeping
After each trading day, adding up the profit or loss is secondary to knowing the why and how you did it. Write down your conclusions in your trading journal so that you can reference them again later. All good traders keep good records. If they win a trade, they want to know exactly why and how. More importantly, they want to know the same when they lose, so they don't repeat the same mistakes again. Record comments about why you made the trade and lessons learned. Also, you should save your trading records so that you can go back and analyze the profit/loss for a particular system. Record the average time per trade, this is necessary to calculate the efficiency of your system. The longer the stock takes to move after you are in the trade diminishes the efficiency of the trade. It may be a winner, but if it takes too long to get there, funds are tied up and opportunities are missed elsewhere.
Final Thoughts
There is no way to guarantee that a trade will make money. Your chances are based on mathematical probabilities and your skill and system used. There is no such thing as winning without losing. Professional traders lose many trades, it is the excellent management of there capital that keeps them in the game. By letting your profits ride and cutting losses short, you may lose some battles, but you will win the overall war. Most traders and investors do the opposite; they cut their winners short by taking the small gains while refusing to part with the losers which is why they never make money. The goal of any trader should be to gain enough skill to use their system so that they are able to make trades without second guessing or doubting their decisions.
Wednesday, May 7, 2008
Self Discipline
Trading success is all about discipline. The discipline to take the trade in the first place and even more importantly to take the loss when necessary. If you possess the necessary discipline to follow a profitable methodology it can lead you to financial freedom. The freedom to make as much money as you need trading for a living and work at a profession you love. You can do it all with the right amount of discipline.
Let’s break discipline down into a two part process:
1. Preparation
2. Execution
Preparation covers several aspects, such as mental preparation; thinking through the risks of each trade and most importantly, knowing when and how to get out of the trade. These aspects are crucial. Getting in most of the time is much easier than getting out. I’ve always said that I would rather be out of a trade wishing I was in it, than in a trade and wishing I was out of it.
When the market is closed, we should be preparing ourselves mentally for the next trading day. One of the most important things NOT to do is making compulsive trading decisions while the market is moving. Your preparation prior to the market open should consist of your trading plan for that trading day and you should not deviate from the plan. If you do, you are not maintaining your discipline. If you did not plan to trade a particular stock that suddenly spikes up on news, then our advice is, do not trade it, despite the overwhelming urge to get in on the action. You make get lucky and make a fast buck, but at the same time, you are proving to be a very undisciplined trader.
The execution part of discipline involves preparation for the actual trade entries. Doing the technical analysis and fundamental work needed to enter a trade with a reasonable chance at profitability. We at STHQ are technical traders, trading on pattern recognition and technical indicators. Each pattern or indicator we trade has its own probability of success and each pattern has its own measurement of risk control. We have a plan for executing every trade we make and we must follow that plan. If we deviate from the plan, then we are not disciplined.
Combining the execution process is risk control and profit protection. Finely tuned execution skills are going to account for a great percentage of your success in trading.
For the most part, risk is the only thing we can control in the trading process. Sometimes, we can’t even control risk when there is news released on a stock we own and it gaps down, but that is rare, so other than that type of thing, we can certainly control the risk of our trade most of the time.
Profit protection requires monitoring the price action in order to reduce risk as soon as possible. Once a trade begins to work, it is good money management to take steps to reduce risk in the trade. If we control our risk the probability of getting a winning streak is increased. If we don’t control our risk, the probability of financial ruin is certain.
Let’s break discipline down into a two part process:
1. Preparation
2. Execution
Preparation covers several aspects, such as mental preparation; thinking through the risks of each trade and most importantly, knowing when and how to get out of the trade. These aspects are crucial. Getting in most of the time is much easier than getting out. I’ve always said that I would rather be out of a trade wishing I was in it, than in a trade and wishing I was out of it.
When the market is closed, we should be preparing ourselves mentally for the next trading day. One of the most important things NOT to do is making compulsive trading decisions while the market is moving. Your preparation prior to the market open should consist of your trading plan for that trading day and you should not deviate from the plan. If you do, you are not maintaining your discipline. If you did not plan to trade a particular stock that suddenly spikes up on news, then our advice is, do not trade it, despite the overwhelming urge to get in on the action. You make get lucky and make a fast buck, but at the same time, you are proving to be a very undisciplined trader.
The execution part of discipline involves preparation for the actual trade entries. Doing the technical analysis and fundamental work needed to enter a trade with a reasonable chance at profitability. We at STHQ are technical traders, trading on pattern recognition and technical indicators. Each pattern or indicator we trade has its own probability of success and each pattern has its own measurement of risk control. We have a plan for executing every trade we make and we must follow that plan. If we deviate from the plan, then we are not disciplined.
Combining the execution process is risk control and profit protection. Finely tuned execution skills are going to account for a great percentage of your success in trading.
For the most part, risk is the only thing we can control in the trading process. Sometimes, we can’t even control risk when there is news released on a stock we own and it gaps down, but that is rare, so other than that type of thing, we can certainly control the risk of our trade most of the time.
Profit protection requires monitoring the price action in order to reduce risk as soon as possible. Once a trade begins to work, it is good money management to take steps to reduce risk in the trade. If we control our risk the probability of getting a winning streak is increased. If we don’t control our risk, the probability of financial ruin is certain.
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