An Introduction to Technical analysis/Money Management/Position $izing and Ri$k

Some here will be my personal veiws from my own experiences,others will be the explainations of methods and ideas presented by others.

All are presented to help those who have little idea on applications of the topics,to be in a position to understand and apply the topics---one of the most important and least talked about in trading forums.

When Taking a trade your main aim at this time should be protection of your trading capital.
During a trade your main aim at this time should be following your methodolgy or plan.
When exiting a trade (After a period of time) your main aim should be Maximising Profit or Minimising loss.

Preservation of capital IS the most important of all rules as without capital your out of the game.

The 2% rule
The stalwart of Risk Stratagies.
The premise is that only 2% of your capital be risked on anyone trade.
The idea is that youll need to have an amazing string of losses to lose all your trading capital.
While a good idea most would know that a 50% loss in capital will take a 100% gain to replenish it.
Personally I prefer to have less risk at most times and more risk when I feel appropriate.

There are many many ways of taking,maintaining and exiting a position.
Soon I'll present on chart some of the less explored favorites of mine.

If they dont generate discussion at the very least they will have you thinking and possibly expanding your view beyond the 2% rule.

Books of interest on these topics.

MASTERING RISK Mike Lally ISBN 070163667X If you buy ONE book this is it!!

Trade Your Way to Financial Freedom Van Tharp ISBN 0070647623

The Trading Game Ryan Jones ISBN 0471316989.

Its when you sell that counts (A fundamental rather than technical approach)
Donald Cassidy ISBN 0786311290
Ill stick with the easy basic principals initially and happy to explore the more "Exotic" like optimal "F",Fixed Ratio and the like if there is an interest.

First lets get past GO.
Moer when I have time to make up some charts.
Starting with the most common.

"Fixed Fractional Trading."

Re: An Introduction to Technical analysis/Money Management/Position $izing and Ri$k.

===

So as you can see the more your RISK----(The wider your stop)
the less shares you can buy to maintain your 2% risk.

Now your Risk to Return if you make 17c is 1:1
34c 2:1,51c 3:1 etc.(Just thought Id explain R/R ratios while we are here
you often see the term R/R 3.5:1 etc---this is how its determined).

Re: An Introduction to Technical analysis/Money Management/Position $izing and Ri$k.

Good Topic Tech

If there is one message which is most important to get out, then this is it.

I have some material on my site on the subject, which echos the above.

But the more ways the same thing is said, the better.

Cheers

Re: An Introduction to Technical analysis/Money Management/Position $izing and Ri$k.

OK thought Id throw this parcel sizing and money management plan on the table.

I intend to introduce practical methods all can use.Excellent M/M requires knowledge of all aspects of your trading from R/R to Maximum Drawdowns to consecutive losses.Most dont have this information or the capability of systems testing to find out--- so simplicity here is the key-----you must keep good records of your trades (Ill cover what they should be later) so that you can maximise your methodology---but for now simplicity---so there can be some understanding.

Firstly there are literally 100s of Money management and and sizing/trading plans that can be written.
Many Ive noticed here particularly FUNDAMENTAL Traders dont have a plan other than X,Y,Z is good value so I'll buy.They have little or no interest in the VOODOO of Technical analysis.

For all of you I offer this the 20/10/10 Plan.

But before I do here are a few pointers for share traders which will help in that decision making process that youll all begin to use as time goes by.

The following is relevant to the 20/10/10 Plan or its derivatives.


Major Rule Our main aim is to preserve capital and Maximise Profit


(1) Always trade in the direction of the PREDOMINATE TREND Yes you can counter trend trade but until your very proficient---forget it! To determine this I suggest the following.Regardless of TIMEFRAME 2min,10,min,1hr,EOD or Weekly. EVEN IF YOUR A FUNDAMENTAL TRADER by or sell with the Predominate Trend.

To determine this use a 40 period SMA (Smooth Moving Average) most free charting services have a moving average facility.This is your SHORT TERM market indicator of sentiment.If trading short term this is all you need ------
now Ive used the term PERIODS This I've done for a reason.If your intraday 40/1 min ticks will make up your 40 PERIOD SMA. OR and EOD trader 40/Days---weekly---40 Weeks.

So here I define SHORT TERM in ANY timeframe as less than 20 periods so to an EOD trader thats <1 mth an intraday 5 min tick trader thats 100 mins.

If trading beyond 20 periods then select a 120 PERIOD SMA.


GIVEN THAT YOUR TRADING WITH THE TREND.

(2) Testing (mine) has shown that using a stop of 3-5% of purchase price will see you stopped out 50-60% of trades---regardless of how you select them.
IE buy for $1.00 stop is $.097-$.095.

At 8-12% you will be stopped out 20-30% of your trades.
At 15-20% youll be stopped out of < 12% of your trades.

Over 60 periods average--most stops are over less time if lower % obviously than the longer ones.

SO WHAT'S THIS MEAN.

GENERALLY

Trading Short term it is wise to have closer stops but not to close.You need to return atleast 3:1 risk to reward ( AFTER BROKERAGE ) .----For longer term 7:1 or higher----one model I trade is 12:1

The closer the stop the MORE we can buy--check back to Fixed Fractional model.

The wider the stop the longer youll need to be in the trade to pick up the SAME R/R ratio.

The trade off is that longer term trading means less trades---less brokerage and less time in front of the screen---I like the less STRESS.

I would also suggest that the shorter the timeframe with the high frequency of trades that you use LESS of your TOTAL trading funds each trade.

Your expecting more wins to bring up profit NOT larger wins as LONGTERM traders aim for.

Lets look at 20/10/10 Plan and some examples.

Whats it mean.
20% is the risk
We buy 50% of the position
We add to then add 50% to the position once its increased 10% in price.We exit the position AT ANYTIME after the second buy if it comes off 10% from its last most recient high that we are trading.

Once you take the 2nd buy the 10% exit applies and the stop is then not required.

You can use 20/10/10 etc etc.---but its designed to MINIMISE loss of capital and MAXIMISE profit.

Re: An Introduction to Technical analysis/Money Management/Position $izing and Ri$k.

Tech, you are so right about the importance of trading to a plan. I teach my students that when starting a business you must have a business plan, the same thing for traders. It's good to get the fundamentals right but there is no doubt that reduce the risk in trading if you also focus on the technical analysis and listen to what the charts are saying to you. Thanks for sharing your wisdom and experience with us. I certainly find it reassurring!

Re: An Introduction to Technical analysis/Money Management/Position $izing and Ri$k.

Thanks OBI I,m sure eventually we will put a few together.But I will mention one thing re plans.

They are of little value unless you know they have a Positive Expectancy (Will Return More than you Risk----Longterm---)think youd agree with that in business as well!! Anyway will enjoy this topic further down the track.

There are some things about the very simple stratagy presented above Id like you to note.To do this we need to look at some results.

Lets say for all trading exercises here we have a Starting capital of $25000

So all examples will assume this base.

Taking ZFX trade.

2% risk is $500 so INITIALLY we take 50% of the trade
Trade Risk is 48c so thats $500/48c/2 = 520 shares---we buy

520 @ $2.44
Then
520 @ $2.67

Average at $2.55
We sell all at $3.13
and collect a 57c per share profit or 57 x 1040 = $592.00

How could we have still MINIMISED RISK and done even better.

Some will have noticed that at the second buy the stop was no longer required as the exit of 10% loss took over---infact had it fallen 10% from the second buy level we would have lost BROKERAGE ONLY.

So the second buy can be DOUBLED and we would still only lose 10% or LESS than 2% of our starting capital.

So Buy 1 520 @ $2.44
Buy 2 1040 @ $2.67

Average $2.44 + 2.67 + 2.67 / 3 = $2.59.

Profit = 54c/share = 1560 x $0.54c = $842.

Now lets have a look at R/R Risk to return.

Plan 1

Initially we had a 20% risk or 48c
Our return was 57c so our R/R multiple was
57 / 48 = 1.18.

1.18 times our risk.

Plan 2

Risk if doubled is 10% of Buy price $2.55 or 25.5c

Profit is 54c so R/R is.
54 / 25.2 = 2.11

2.11 times our risk
100% better with one small change.


I know many will see this as BORING but this is where the WAY you trade can have a massive impact on your PROFIT.

Re: An Introduction to Technical analysis/Money Management/Position $izing and Ri$k.

Tech/a thanks for the input of these threads - a great reference for beginners to go to when they first start with these forums.

Just a point with the risk to return ratio. I've noticed that you like most of the other times I've seen it say that it is a

Risk to Return ratio but when you work it out with numbers it is really shown as a Return to Risk value - any reason why ? To me its back to front.

Re: An Introduction to Technical analysis/Money Management/Position $izing and Ri$k.

Dutch.

Yes I know your correct,I find that I naturally say Risk to Return or Reward.
The Ratio of Return gained to Risk taken is more correct I feel.

Re: An Introduction to Technical analysis/Money Management/Position $izing and Ri$k.

tech/a said:

Thanks OBI I,m sure eventually we will put a few together.But I will mention one thing re plans.

They are of little value unless you know they have a Positive Expectancy (Will Return More than you Risk----Longterm---)think youd agree with that in business as well!! Anyway will enjoy this topic further down the track.

Click to expand...

Tech, You're right I would agree. The whole purpose of planning is to assess risks, minimize them as far as possible and try to ensure that your return on investment will be worth the risk you took. Otherwise put it in the bank! I do teach the students the old addage "failing to plan means your planning to fail!" Having said that, plans are not a sure fire guarantee of success. I also teach my students ratio analysis. I'm always amazed at how this concept mystifies people. Keep up the good work tech!

Re: An Introduction to Technical analysis/Money Management/Position $izing and Ri$k.

We could investigate many types of moneymanagement but I feel this will be enough for traders to cope with and implement.As more examples unfold particularly in realtime--- I will post them up.



Before I move on to the next topic just some more thoughts on Money Management to ponder.



Its been my experience that most new traders do one or both of the following.

(1) Overtrade---to many positions open at once and/or always in a position.

Standing aside from the market is a position.

(2) Buy to larger parcels

------Here is a test if losing (on stop ALL) of your current positions would cause you financial grief----then chances are your positions are too large for your personal comfort.

This can cause you NOT to take a stop when you have planned to------

"I'm not going to lose $xxxx,It will come back/worse "Ill average down".

Trading becomes enjoyable when your trading within your comfort zone

Below is a table showing the exponential rise of one of the portfolios trading Tech Trader.I enclose it to illustrate a number of things.

(1) The natuaral compounding of position sizing when your trading plan becomes profitable

As you take profits and your working capital grows so too does your position size-----even maintaining the SAME rate of return ensures ever increasing working capital---with no input from your own wealth.

(2) The natural increase in the leverage of your shares as they become more expensive and your still in them.

This only occures when you hold for a very long time--6-24 mths.

As an example-----I traded UTB at $3.67 and bought 5000.Initially a 10% move on my investment could take a few weeks---as the stock rose to $8 and more this could occur in a week or less as it did with TOL QBE and ALL.

(3) The natural increase in the return on initial investment as your portfolio becomes more profitable.

Although I trade Margin which gives me around 2x leverage my initial capital began to double quicker as profit kept on compounding.As you can see the initial capital was $90K on Margin $30K down.Doubling my initial $30K came at $120K---9/10 mths another $30K in 12 mths now its around 5mths.for 30K lifts.(Well it was until just reciently)

As you can see the rise becomes wonderfully steeper.

Another idea I've seen is "Free Trades"

This is a more conservative very low risk (eventually) method.
Simply when an exit is triggered the Initial capital for the trade plus brokerage is sold.
The profit is left to run.As you can see the stock would have to be delisted to reach zero.
Often over a period of time other buy triggers appear and the stock can be traded as a normal trade adding to the profit with the held profit also increasing.
Eventually over years there are stocks running on profit often returning dividends as a passive income.They are just left to run unless the owner needs to generate venture capital ------ if so he sells the weakest---least performing.
Of course it is wise to have a final loss level youll tolerate on all trades so as not to lose profit when stocks fall totally out of favour.

I know of one investor who has around 50 stocks----10 actively traded at one time and 30-40 which are just operating on profit---Fine if you dont need it to live on.

Here is the equity curve to demonstrate the power of compounding consistent profits.

I can continue with other aspects of M/M and position sizing and risk if you like but thought this enough for practical application.
What do you think?

Re: An Introduction to Technical analysis/Money Management/Position $izing and Ri$k.

We could investigate many types of moneymanagement but I feel this will be enough for traders to cope with and implement.As more examples unfold particularly in realtime--- I will post them up.



Before I move on to the next topic just some more thoughts on Money Management to ponder.



Its been my experience that most new traders do one or both of the following.

(1) Overtrade---to many positions open at once and/or always in a position.

Standing aside from the market is a position.

(2) Buy to larger parcels

------Here is a test if losing (on stop ALL) of your current positions would cause you financial grief----then chances are your positions are too large for your personal comfort.

This can cause you NOT to take a stop when you have planned to------

"I'm not going to lose $xxxx,It will come back/worse "Ill average down".

Trading becomes enjoyable when your trading within your comfort zone

Below is a table showing the exponential rise of one of the portfolios trading Tech Trader.I enclose it to illustrate a number of things.

(1) The natuaral compounding of position sizing when your trading plan becomes profitable

As you take profits and your working capital grows so too does your position size-----even maintaining the SAME rate of return ensures ever increasing working capital---with no input from your own wealth.

(2) The natural increase in the leverage of your shares as they become more expensive and your still in them.

This only occures when you hold for a very long time--6-24 mths.

As an example-----I traded UTB at $3.67 and bought 5000.Initially a 10% move on my investment could take a few weeks---as the stock rose to $8 and more this could occur in a week or less as it did with TOL QBE and ALL.

(3) The natural increase in the return on initial investment as your portfolio becomes more profitable.

Although I trade Margin which gives me around 2x leverage my initial capital began to double quicker as profit kept on compounding.As you can see the initial capital was $90K on Margin $30K down.Doubling my initial $30K came at $120K---9/10 mths another $30K in 12 mths now its around 5mths.for 30K lifts.(Well it was until just reciently)

As you can see the rise becomes wonderfully steeper.

Click to expand...

Again thanks Tech/A. I agree. Business and trading is about patience and right judgement based on informed decision making. Working within the limits with which you are comfortable (and trading to the plan) is more likely to lead to success. Likewise, buying small parcels and growing your business from the ground up can bring its own rewards and be very satisfying. Likewise buying small parcels may allow you to have more than one parcel of a stock at varying prices. This may allow you to profit from the same stock at different times. I guess its common sense! As a general rule, investments often start to double around the 7 year mark (may vary), hence the compounding nature of reinvesting profit upon profit should lead to a steeper gradient on the graph. It may be wise to retain some profits though for that opportunity that comes your way when the market takes an unexpected dip and that stock you've had your eye on suddenly becomes realistic and worth buying.

This may be the point in money management where it is pointed out that there are three variables that can go wrong in investing: Time, Money and the Investment itself.

Again thanks!


__________________
This is merely my opinion and does not constitute financial advice. When considering your financial objectives, please consult a suitably qualified and licenced professional.

Re: An Introduction to Technical analysis/Money Management/Position $izing and Ri$k.

Thanks Tech/A this was an extremely interesting thread and I got a lot out of it! I hope to hear more on this topic from you in the future! Your wisdom is really appriecated by this forum newbie .

Re: An Introduction to Technical analysis/Money Management/Position $izing and Ri$k.

ob1kenobi said:

As a general rule, investments often start to double around the 7 year mark .

Click to expand...

geez I hope not! that's 10% compounded
might as well milk cows!

Re: An Introduction to Technical analysis/Money Management/Position $izing and Ri$k.

This is a topic we all need to be EXPERTS.

Found this link I've hard copied it for reference.

Enjoy and prosper.

http://members.aon.at/tips/moneyMan1.htm

Im sure the course on Money Management will generate more discussion.

Re: An Introduction to Technical analysis/Money Management/Position $izing and Ri$k.

Re: How to figure risk to reward (a formula)

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TECH A NOTHING IS 100 % PERCENT
SO DON'T BE SO HARSH ON RISK TO REWARD TRADES , AND TRADING WITH AN OBJECTIVE IN MIND .......


So why , do write about this method of understanding as being a gaurantee ?

What makes a market place is all of our diffrences of oppinions .
------- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

It is far more difficult to exit a trade than to enter a trade .... I am sure that you have heard that said before ,,,

THIS IS WHY ,

When making a trade, it is just as important to have an idea where you want to exit as it is to place a stop to protect yourself from a move against you . ( THIS IS A PEARL OF WISDOM )


THERE IS NO HOLY GRAIL ///// I KNOW THAT YOU KNOW THIS ...

THATS WHY I TRADE ELLIOTT WAVES becase its giving you a
probaility of where to look for a turn in a given market .....

The smaller the risk in relation to the price objective , the better chance of success in long haul .... It's just the way that is ...Think of a Head and Shoulder pattern ... you learned of them long ago .... they always have a target based on the head and the neckline area ... This is not my design ... It was around long before all of us an will be around for some time after we are gone //

Please try to understand the price target in a head and shoulder set -up ... as an example , Because there are other patterns like symetrrical triangles and falling wedges and ascending triangles that also have price targets tied to them .... Traders have beeen measuring these price patterns for a long time ....

Surely ... they don't all make it to thier targets or so called objectives , and I totaly agree with you , that they don't ..

But , it is the best premise there is to work on... if you are doing any type of teaching or explaining of price patterns ... this is always explained and drawn out on charts ////

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Re: An Introduction to Technical analysis/Money Management/Position $izing and Ri$k.

A nice discussion with examples of the 2% rule from Colin Twiggs at Incredible Charts: http://www.incrediblecharts.com/technical/2_percent_rule.htm#Real_World