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EFFECTIVE
TRADE MANAGEMENT
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you know what you're doing or you don't.
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Face it... the more you know, the better your decisions.
If you want to trade,
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investor!
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Rule number one, don't lose money. Rule number two, don't
forget rule number one.
However, since losses are
inevitable...keep them small, use stop-loss
orders.
Position
sizing: this is an area that is more important than you realize.
You have to minimize losses.
As a general rule you don't want to be risking more then 2%
per
trade, 5% max, and you want to have the ability to have
multiple trades on at once. What that means is that if you have
a $50,000 account risking 2% a trade then the most you can risk
per trade is $1000 or $2500 at 5%.
You may want the ability to be in more then one or two trades
simultaneously. Generally
you will never put more than 20% of
the account value into any one trade. Let's say out of that
$50,000 we want to be able
to do six trades: $50,000 divided
by 6 equals $8,333 in any one trade of which we will not want to
lose more than 2 to 5%.
Now that we have our max risk and our total dollar amount per
trade we need to go find a trade. In this example we have a
stock trading at $20 with an objective at $26 and a stop at $18
giving us a 3 to 1 risk reward ratio. So now we take our
gross
dollar
amount per trade (8,333) divided by the price of the stock. This
equals 416 so we round down to 400 shares. Now take the distance
from entry to stop ($2.00) and multiply it by 400 now we get
$800.00. That is our risk in this trade so we are risking less
then 1.6% of the account which is even less then the 2% we are
willing to risk.
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This is a guideline to start a disciplined approach
to trading. Let’s
plug in some numbers: |
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Account Size:
$10,000
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$25,000
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$50,000
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Per trade risk
amount::
3%
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Per trade risk
amount::
3%
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Per trade risk
amount::
3%
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3% of $10,000
=
300.00
This is your per trade risk.
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3% of $25,000
=
750.00
This is your per trade risk.
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3% of $50,000
=
1500.00
This is your per trade risk.
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No more than 20% of account in any one trade = $2,000
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No more than 20% of account in any one trade = $5,000
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No more than 20% of account in any one trade = $10,000
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Divide the $2,000 by the stock price, say $23.50 per
share; this equals the # of shares you would get and
round that number up or down.
In this case, it equals 85 shares rounded up to
100 shares.
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Divide the $5,000 by the stock price, say $23.50 per
share; this equals the # of shares you would get and
round that number up or down.
In this case, it equals 212 shares rounded down
to 200 shares
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Divide the $10,000 by the stock price, say $23.50 per
share; this equals the # of shares you would get and
round that number up or down.
In this case, it equals 425 shares rounded down
to 400 shares
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Calculate the difference between your entry price,
$23.50, to your stop loss price, say $22.00, which is $1.50.
That $1.50 times the # shares you have, 100,
equals $150.
$150 is your risk in the
trade.
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Calculate the difference between your entry price,
$23.50 to your stop loss price,
say $22.00, which is $1.50.
That $1.50 times the # shares you have, 200,
equals $300.
$300 is your risk in the
trade.
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Calculate the difference between your entry price,
$23.50 to your stop loss price, say $22.00, which is $1.50.
That $1.50 times the # shares you have, 400,
equals $600.
$600
is your span
risk in the
trade.
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$150 is 1.5% of the account and less than the 3% we were
willing to risk.
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$300 is 1.2% of the account and less than the 3% we were
willing to risk.
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$600 is 1.2% of the account and less than the 3% we were
willing to risk.
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For options, you have different methods to choose from,
remember it’s a choice, your money, your choice:
I can put in the same $2,000, $5,000 or $10,000 in an
option trade and calculate my risk amount by the above
calculations where the $150, $300 or $600 will be the
amount I might pay for an option contract on that stock
until
it totals my 3%
However, here is where you have to think this through...
If I bought the stock AND I was willing to risk
$150, $300 or $600 as a loss, wouldn’t this allow me to
give my option lots of leeway?
I don’t have to be overly concerned if I follow
this one rule:
if I wouldn’t
sell the stock based on the chart action, then I’m not
going to get out of my option position even if it’s down
40% in value.
Why? Options are volatile due to leverage, but I
already was prepared to lose the amount I paid for the
option had I bought the stock. I am in control.
I can always get out.
Alternatively, I can, and probably should, consider not
20% of the account value in any one option trade, but
only the amount that I was willing to risk HAD I BOUGHT
THE STOCK.
In this example, my total option trade would be $150,
$300, or $600.
Or any number in between where you can sleep at
night if it gapped up/down against you in a big way.
The above are not rules set in stone except for the "per
trade risk amount".
The rules are a starting point for a
disciplined approach to trading.
If you start playing with options like a
gunslinger, you’ll blow up your account.
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Using position sizing enables us to manage risk. By dividing our
account up into multiple trades no one stock can kill us in the
chance that a surprise event happens such as earnings
preannouncement or geo-political event. And then by only risking
a certain percentage we cut risk even more.
Managing trades is a
difficult job for all types of traders. Headline risk can
make a profit become a loss.
You must
take
the time to appreciate the dynamics of the trading day and
week- issues and events that drive the market- .
1.
Manage open positions. There's a difference between a
scalp trade, day trade, swing trade, position trade. You
should know what you
expect in price movement over
what period of time... this will also tell you what you
have to be on top of relative to market news. You can make
things very sophisticated watching every tick or you can
take long term positions... but KNOW WHERE YOU STAND.
2. Trade
the chart you concluded was a good pattern. Use the 4 or 6
chart grid method following various time views... at a
minimum use one time period above and one below the trade
chart you started with.
3.
Previous trend in relationship to your entry will tell you
when to hold and when to exit.
4. Use a
routine for the day and week and proper money management
that will allow you to take advantage of events.
5. The
trend is your friend no matter how much you tell yourself
it's going to go the other way. Market conditions dictate
price movement, not you.
6.
Identify solid pullback in uptrends and rallies in
downtrends to capitalize on previous trend. If your pick
is going the opposite direction of the broad market but
keeping it's previous trend intact that confirms a strong
trend.
7.
Generally, take no trades during the first 15 or 30
minutes unless you're trying to scalp a trade. Preferably,
wait until the 10:30 reversal. Take no trades over the
lunch hour leading in to the afternoon session. The last
hour confirms trend, use it to enter or exit.
8.
Choose a set of indicators you're comfortable with, and
then leave them alone. There is no perfect indicator...
indicators indicate, they do not dictate.
9. Use
the Tick and Trin indicators during the day... avoid
entering at extreme levels in the Tick as measure against
recent day's extreme level.
10.
Watch your trade relative to the broad markets. When a
stock moves more sharply than an underlying index, it
should continue to do so.
11. Look
for breakouts and breakdowns of the two-day range. Look
for the 3, 4, or 5 days up or down patterns for a reversal
to trend.
12. Know
what you will do in the event of a huge quick move in your
direction... the answer is generally take something, if
not all, off the table.
13. You
are not smarter than the market and you cannot wish it to
move contrary to what you're seeing... learn to take a
small loss so as to play another day.
14. Each
trade stands on its own merits.
15.
Appreciate what indicators are telling when you see
divergence and what you'll do upon noticing divergence...
this applies to all time views.
16. Stop
concentrating on the money... focus on making a
mistake-free trade with the odds in your favor, the money
will follow. If you focus on the money, you're now trading
with emotions... a costly mistake.
17. Add to position size when winning and reduce position
size when losing... the first suggests the market itself
is helping you out, the second suggest you may be fighting
the trend of either the stock, the industry or the broad
market.
18.
There's nothing inherently wrong with being a contrarian
as long as you are comfortable with the increased risk
since your going counter trend.
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