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Pro Traders Share Their Lessons

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МнениеПуснато на: Съб Юли 23, 2005 12:10 pm    Заглавие: Pro Traders Share Their Lessons Отговорете с цитат

Money Management (Pt. IV): Pro Traders Share Their Lessons

Jeff Cooper, the professional short-term stock trader who writes TradingMarkets.com's "Momentum Stocks Insight" and "Weekend Stock Market Outlook" commentaries, has had more than his share of market experiences--both good and bad. Jeff’s family was devastated by his father's stock market losses in the in the early 1960s. You would have thought Jeff learned from those mistakes, but it wasn’t until he nearly went broke himself years later that he began to implement a strict money management plan.

Most traders view money management as an afterthought--something they add to their methodology as a finishing touch. Jeff on the other hand, doesn’t distinguish money management from his methodology--it’s in integral part of it. In addition, he recognizes that markets are dynamic and he constantly adjusts his money management style to current market conditions.

Dave Landry (DL): Maybe we should fill readers in about some of your history. In your first book, “Hit and run Trading,” you write that your father built and sold a very successful textile business and retired to Beverly Hills. Based on his brokers advice, he began investing in stocks. Not only did they sell him on the buy and hold mantra, but they also introduced him to buying stocks on margin to increase his fortune through leverage.
Unfortunately, the first bear swing in the market wiped out your father’s account. To add insult to injury, the brokers who originally had convinced your father to part with his money were now liquidating his portfolios on the day your mother was being operated on for cancer. Now forced into bankruptcy, your family had no choice but to move back east. If this wasn’t enough pain and suffering, the moving van caught fire in route destroying what few possessions that were left.
Your father, started yet another textile business from scratch and within five years sold it for millions and retired. Instead of enjoying the good life he decided once again to return to the markets. This time however, it was on his terms. He began investing in IPOs, but on a short-term basis. Not only did he make back all of his original stake, but he made millions on top of that.
Did you automatically become a short-term and risk-averse trader based on your family's painful experience with buy and hold?
Jeff Cooper (JC): No. I fell into the footsteps of my father’s initial tragedy. I was nearly wiped out in the late 1980s making the same mistakes that he made over 20 years earlier.

DL: Why is it that you didn’t learn from your father’s initial tragedy?
JC: I suppose it’s the Cooper family nature. We’re hardheaded. Look at my father. After being devastated in the markets, he started another textile business from scratch and made back enough money to retire. Instead of living the good live in retirement, he returned to the markets. Now, with those genetics, I couldn’t help but to go out and do it my way. I suppose as human beings it’s not enough to experience other’s pain. You have to feel it for yourself.
The lessons that stick are ones that are learned first hand. And those have to be learned and re-learned often. That’s just the way most of us are built. Bernard Baruch, one of the great investor/traders, went broke five or six times, I believe, before asking his mother for some more of the family’s funds. At this point he was told that this is the last of it. He was able to make that his grubstake, and turn it to his fortune.
Bernard Baruch was humbled by the markets before he was able to master them. And I would have to say that this is one common thread that runs through almost every great trader that I have ever met. They have all been humbled by the market early on in their careers. This creates a definite respect for Mr. Market. Until one has this respect, indelibly engraved in their makeup, the concept of money management and discipline will never be treated seriously.

DL: So you were trading longer-term and taking excessive risk?
JC: Yes.

DL: Why?
JC: The market has a way of soft-peddling risk, making the masses happy and comfortable. When that belief system is universal, that is when it (the market) is to be feared the most. Hello! (referring to the masses who are currently plunging into the market) Does this give anyone the idea I’m more of a day trader as opposed to a position trader?

DL: Why do you think people hold on to stocks and refuse to sell?
JC: It's very easy to buy a story on a company you hear about at a cocktail party. In addition, many people are paid to promote stocks. Furthermore, people are generally hopeful and optimist--dreamers by nature.

DL: Recently, I was approached by a friend at a cocktail party. The guy is a brilliant organic chemist, probably the most intelligent person I know. He took out a stack of charts and began asking me for trading advice. On many of the charts it was the same story: “I’ve doubled my money on this one but now it’s selling off. I’m still up 50% but it keeps dropping.” When asked, so why not take a 50% profit? His reply was that he can’t do that because at one point he was up 100%. He felt like a failure. Yet, here’s guy who had made some nice profits in the market--profits I envied.
JC: Many people think the object is to get out close to the top. They buy Amazon at 150 and ride it up to 280 points. It then sells off to 240 and they think they’ve made a bad decision. They forget that the real object is to make money.
The hardest thing though, whether its investing or short-term trading is to learn how to extricate oneself from a situation, whether it be positive or negative.

DL: Yes. It seems like each stock had a story behind it as to why it should go back up.
JC: It’s human nature to be optimistic. Any fool can enter, it takes talent to exit consistently and profitably.

DL: What do you think is the secret of your success?
JC: I look to take money out of the market, to create income and build wealth. I do this by consistently hitting singles not home runs. I never try to capture a huge move and I never do.

DL: How do you view money management?
JC: Regardless of what we think we know and should happen the reality is that a lot of stock action is random. Therefore, money management is crucial if you want to be successful as a trader. To me, it’s the cornerstone of both making a living at trading and building wealth.

DL: What percentage of equity do you generally risk per trade?
JC: I risk very little. I don’t really think of it in terms of percentages. I suppose if I did, I’m probably not risking more than ¼ to ½% per trade. In addition, I haven’t changed my trading size in years. Nor do I intend to. Therefore, by keeping my position sizes relatively small, my risk continues to decrease as my capital base grows.

DL: Why not keep your risk consistent to the amount of your equity to strive for even larger returns?
JC: I see things on a monetary basis. For instance, I think $1,000-$2,000 is a lot of money to lose on an individual trade. Think about it. Not many people make $1,000 an hour, yet an active day trader can loose that in a matter of minutes.
I suppose at some point in time, I might consider managed funds. At that point, I’d be forced to adjust risk to equity. However, as long as its my personal account, I’m comfortable knowing that as my equity grows, my risk continues to decrease.

DL: Would you share with us your techniques for money management and dealing with risk?
JC: Sure. Depending on the situation, I use price stops, time stops, pivot stops and size stops.

DL: Of the four, price stops seems obvious--is that points risked per trade?
JC: Yes. As a rule of thumb I never permit a stock to go more than one point against me. I’ve learned that your first loss is the best and it only gets worse from there. Almost all big losses start with small losses.

DL: Is your one-point rule rigid?
JC: No. Markets are constantly changing. Also, obviously on a carry-over trade, there’s no way to prevent a gap from making it worse. However, in those cases I reduce the risk by not taking the entire position home.

DL: What about thinner stocks, higher-priced stocks, or those that are more volatile?
JC: On those I’m willing to go to 1 ½ points or so. However, I reduce my position size accordingly.

DL: What are pivot stops?
JC: When I see a stock break out of an intraday congestion or consolidation as a momentum player, I’m looking for immediate continuation. That’s the normal expectation. My many years in the market have taught me to be cynical: Stocks don’t move, they are moved. Often stocks don’t go up, they are put up. So typically, I will place a stop immediately below a consolidation. If the stock simply is stutter-stepping after the breakout, that is, if the stock goes one to three bars (on a 5-minute chart) and then has a shallow pullback, then, OK. However, if a stock comes in below the breakout point, I’m usually gone. Most traders wait for a base to be violated. I won’t wait that long. If the stock reasserts itself, then I’ll re-enter. That’s the way I like to trade.

DL: What about time stops?
JC: As a momentum/short-term player there’s an opportunity cost to be in a stock. Especially with today’s volatility.

DL: So by being in a stock that’s not moving you miss opportunities in other stocks?
JC: Yes. Depending on the stock, I find it difficult to manage five to six positions at one time, and if we are talking about Internet stocks, managing more than two or three on an intraday basis can be a real feat. So if I enter a stock based on momentum, I expect continuation. If the stock just sits, I may simply scratch the trade and look for greener pastures.

DL: And size stops?
JC: I use size stops with my Stepping In Front of Size Methodology (SIFOS). Note: The SIFOS methodology essentially involves buying stocks at the market when a large trader persistently bids for the stock. You are “stepping in front of size.” With this, I’m buying at the market and my stop goes right below the large bid. This can often turn out to be much less than one point away.

DL: What about exiting?
JC: It all depends on the market. I recognize that markets are constantly changing and require different approaches at different times. Although this may should sound patently obvious on the surface, it’s been a real to a key to my profit-making potential.
Let’s say that the overall stock market or a sector is in a solid monolithic move. I’m pretty comfortable with a one-point stop rule. I’m also more prone to let things ride a bit. When markets are choppy, I’m going to be less forgiving, both with my stops and in taking profits. I’m much more apt to take a piece off as a soon as a stock runs up a point or so and bring my stop up to breakeven on the remaining piece. I don’t overstay my welcome in choppy markets.

DL: Are there any times when you take larger positions or pyramid?
You can take the same two people and sit them at a blackjack table in Las Vegas. The cards are coming out randomly but it’s the player who bets properly and uses a disciplined approach and knows how to recognize a streak when it occurs and go for the throat who will live to survive and play another day.
The market is very similar. There are few times where the market has a strong run and you want to do the same with your positions. This may happen as often as a few times a month or as seldom as a few times a year. The key is to recognize when this is occurring and bend the rules and press a bit.

DL: Any closing thoughts?
JC: Yes. Many people think they want to pursue one particular form of trading. For me, its day trading and short-term momentum trading. This is not to say it's for everyone. It all depends on your makeup. I admire traders like Mark Boucher who occasionally catch much larger moves. Also, you have to be willing to change. At some point in time, I might be willing to commit a small portion of my capital to trading this style. However, for now, I know my niche and stick to it.

Kevin Haggerty
Kevin Haggerty's long career in the institutional side of the trading business has given him a unique perspective from which to pursue short-term stock trading. If you've read Kevin's "View's From The Trading Desk Commentary," you know he keeps risk on a short leash.

DL: Do you always wait for your stop to be hit, or will you get out of a trade for other reasons?
KH: When you take your initial position, assume you are wrong until the market proves your position correct. You don’t have to wait until your stop is hit to get out. If the dynamics of your specific trade change, just exit the trade and immediately you will save some money that can be applied to other trades. You can always re-enter the trade again if it sets up.

DL: How tight do you keep your stops?
KH: Intraday trading requires tight stops to be profitable. You are limited by the clock and the daily range of your selected stock. Remember, a pure day trader goes home flat everyday.
With tight stops of 1/4 to 3/8 of a point and accuracy of 50%, a trader that can lose 1/4 and make 1/2 can be very successful. With tight stops accuracy is lower so you must learn to manage the trades to make multi point gains.
For example, on a 1,000-share position, a day trader is not going to risk more than 1/4 to 3/8 of a point, including commissions. If you decide to adjust for volatility and take a 500-share position in a stock with an implied volatility of 80 versus one with 40, then you could risk, say, ¾ of a point, or $375.
With tight stops of ¼ to 3/8 you are often stopped out by normal market noise, such as programs and news blurbs. You can’t let this bother your emotionally. Every trade you make is a probe and you will soon catch a multi-point move. However, you can’t make up multi-point loss in a day.
Another key point is that beginning traders are better off trading smaller size with wider stops especially, if they are not connected by direct access execution and have to rely on a standard ISP hookup and possible phone call. I highly suggest you don’t attempt to day trade with an online brokerage firm where you don’t have direct communication.
I have seen traders correct on 40% of their trades and stopped out on 60% of them who are among the most profitable in the firm because they are excellent at managing their profitable trades and adamant about taking only small losses.

DL: Can you expand on this in practical terms?
KH: Consider catching a one-point move, and losing ¼ point on three trades. Suppose your commissions are $25 per round trip and you are trading 1,000 shares. If you lose a quarter point plus commissions (-$250 - $25 = -$275) three times in a row (-$275*3 = -$825), then make 1 point ($1,000 - $25 = $975), your net result is a profit of $150 even though you were wrong 75% of the time--because you managed the winners properly.
But traders who lose ¼ and take a profit of ¼ and pay commissions go out of business. Learn to manage your winners and keep tight stops. Pyramiding positions in stocks for a day trade is difficult at best, and should not be attempted by novice traders. It is probably better for all traders to put on their maximum positions initially--that's your best entry, assuming you have enough daily range to provide you ample profit opportunity.

Summary (останалите 4 части ще постна допълнително)

In the first part of the series on money management, we looked at drawdown and why it's so important to keep it within reason. We showed that the percentage to recover from a drawdown increased at a geometric rate as the drawdown increases. For instance, a 60% loss of capital requires a 150% return on the remaining capital just to get back to breakeven; a 70% loss requires a return of 233%, and so forth.
In the second part of the series we looked at 17 general guidelines that should help to protect capital and ensure profits as a trader. These included risk control techniques such as use of stops, keeping drawdowns within reason, portfolio correlation, judging risk-to-reward, volatility of markets, understanding the instrument being traded (i.e., derivatives), percent per trade risk and overall portfolio risk.
We looked at techniques to help ensure long-term survival and capturing profits such as being adequately capitalized, 2-for-1 money management and taking windfall profits. And finally, we touched upon the psychological impact of losses.
In Parts 3 and 4 of the series we interviewed professional traders and money managers. Although their approaches to the markets varied greatly, they all had the utmost respect for risk and clear and practical methods to control it.
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МнениеПуснато на: Нед Юли 24, 2005 4:59 pm    Заглавие: Trading Is A Business: Here's How To Build A Successful One Отговорете с цитат

By Daniel Beighley

I’ve heard all kinds of market theories -- from pyramids, moon cycles and tidal currents to astrology -- and I wouldn’t criticize anything, as long as it actually worked. What I do believe is that trading is run best when it is run as a business. This lesson is about maximizing trading strategies for the purpose of meeting your goals as effectively and efficiently as possible. Once I began running my trading as a business, I experienced a profound change in my results. I found it a lot easier to manage things and gained a better grasp for obtaining my goals. Whether you are handling billions or just a part-time enthusiast, utilizing good old-fashioned business principles will keep you focused and on the road to where you want to be.
As a trader, your ambitions are similar to those of any business owner: You exist to turn a profit. Your decisions are entirely yours, and your aim is to buy low and sell high. With this is mind, it is important to look at your trading as if it were a business. The truth is most businesses fail because they don't properly prepare themselves with a good plan.
People who think they can walk into the markets and just "get lucky" would be better off gambling. In the market, forces of supply and demand are constantly affecting your outcome. You need to pit yourself against your competitors to the best of your ability. Seasoned traders will quickly take advantage of the naive, but if you center yourself with a plan, you will be able to operate more effectively. Just like a business plan, traders should have their entire strategy outlined.
While owners of Krispy Kremes have to deal with issues such as cost of labor, customer service, marketing, and location; individual traders have the freedom to buy and sell at their own discretion. For traders, there is almost always a flush supply of buyers and sellers. There are also no hassles of producing a product or service. Krispy Kreme owners must put up $750,000 capital for each store, while a trader can start with far less. Despite the differences, the main objective remains the same, you want to make the most of your capital.
Old pros will tell you that discipline and objectivity are crucial for long-term success. Aristotle came up with this notion over 22 centuries ago -- and it’s no different today:
“First, have a definite, clear practical ideal; a goal, an objective. Second, have the necessary means to achieve your ends; wisdom, money, materials, and methods. Third, adjust all your means to that end.”
Below is a five-point outline for running your trading as a business:
1. Define Your Business
This is where you give a precise description of your purpose as a trader. An example would be: “The purpose of my trading is to sustain myself." This description may change as your business grows and you possibly begin trading for others. You might want to consider giving your business a name. Charles Schwab had to start somewhere.

2. Have A Mission Statement
Here is where you give a detailed description of your trading and the direction you want to take it. An example would be “I will trade in accordance with the guidelines I know to be risk-averse and likely to succeed. I will commit $100,000 in capital. I will not use margin. I will only trade securities and hedge with options. I am an intermediate-term trader. I will remain disciplined, objective, flexible, and risk-averse.”

3. Outline Your Goals
In this section, you will outline your financial goals -- using the time frames in you would like to achieve them. For example, “My goal is to be profitable every month. I want to achieve a 30% return on my capital per year. In five years, I want to manage other people's money as well as my own.” The more specific you are here, the better.

4. Create Your Business Plan
The most important part of your business is your plan. The idea here is to write a Code of Conduct for yourself. You should define your strategy in such way that you know exactly how to react in every situation. This section may be lengthy, depending on your trading strategy. An example would be, “If a stock goes down on twice normal volume and trades at an average of over 300,000 shares a day, and is priced over $15 a share, I will short it for the purpose of gaining 1 point, but will let it ride if the momentum is there.” Of course, in the world of trading it is difficult to make an exact science of things, but your plan should be designed to capture as much success as possible. This section is also where you define your money management techniques.
5. Have Plan "B"
This is where you map an alternate to your original plan. This isn’t part of the real plan, but it’s always smart to have something to fall back on. A good thing to do is pre-define the amount of capital you are willing to risk. If you lose it, stop trading until you find out what’s going wrong and are able to correct it.
Creating a business plan and being able to verbalize and visualize your plan of attack will give you a powerful edge. You should be able to clearly define every aspect of your route to success. A business plan may also be used to show potential clients if you want you to manage their money. You will also find that having a business plan will help identify your strengths and weakness. For example, if a certain strategy appears to not be working, you will want to examine alternative methods. When the Nasdaq tide changed from a bull to a bear, I quickly realized my strategies weren’t working and realized I had to change something. Always be moving to achieve your goals. In a previous lesson on Over-trading, I discussed the importance of keeping a journal. Used in conjunction with a business plan, a journal will keep you trading as efficiently as possible.
Keeping a balance sheet is another important component for trading as a business. Having a clear picture of how you are managing your money is a necessity. Below is an example of a spreadsheet made with Microsoft Excel:

Spreadsheets make it easy for a trader to calculate the buys, sells, taxes, and broker fees. All you need to do is enter the dates, symbols, and orders. The spreadsheet will do the math and give you a bottom line. I’ve rigged mine so monthly living and business expenses are factored in as well (not shown on image above). This especially comes in handy around tax time. You will want to be sure you are making enough after taxes to meet your goals. Tax deductions are another issue to consider. Being self-employed gives you many opportunities to deduct business-related expenses. I know they change the laws every year, but at present you can deduct the percentage of your home you use as office space. It’s also possible to run statistics on your progress for a more detailed description. I will leave that for another lesson.
A business perspective should also be used to make decisions regarding your trading tools. Weighing the pros and cons, choices of computer hardware and software, quote data, news sources, and brokerage firm should be carefully considered. Depending on how active you are as a trader, you will need to make sure your purchases are in the best interests of your needs. For example, someone making hundreds of trades a day will need a higher-powered broker than someone only trading a couple of times a week. Take a good look at how you are using your tools and ask yourself how valuable they are to you. How much bang are you getting for your buck? Do you really need to pay the above-average broker fees? Is there a more cost-effective data service? Keeping track of this on a spreadsheet will also help clarify these issues.
Your working environment is another concern for your business plan. In my opinion, it is important to create as professional a workplace as possible. To rent office space or not will vary, depending on the person. Being a trader gives you the cost-efficient luxury of working from home, but it’s not always the best decision. For some people, a home office is convenient, but for others it’s a distraction that takes away from productivity. Again, take a good look at how valuable your workspace is to you and look into alternatives. If I realized I was wasting two hours a day commuting to an office, I would think about the benefits of working at home. In the same way, if I noticed I was wasting two hours at home, I would consider moving into an office. Time is money.
Having a business plan for your trading will make you a more effective and efficient trader. By defining exactly what you are doing and where you are going, you will be able to put yourself in the best position possible to achieve your goals. Discipline and objectivity are best achieved when you have something concrete like a business plan to center yourself with. I also believe motivation is directly tied into setting a good goal for yourself. So, if you haven’t already made a business plan for your trading, you should give one a try
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МнениеПуснато на: Нед Юли 24, 2005 5:01 pm    Заглавие: Money Management (Pt. I):Controlling Risk and Capturing Prof Отговорете с цитат

Money Management (Pt. I):Controlling Risk and Capturing Profits
By Dave Landry

Money management is the process of analyzing trades for risk and potential profits, determining how much risk, if any, is acceptable and managing a trade position (if taken) to control risk and maximize profitability.
Many traders pay lip service to money management while spending the bulk of their time and energy trying to find the perfect (read: imaginary) trading system or entry method. But traders ignore money management at their own peril.
The story of three not-so-wise men
I know of one gentleman who invested about $5,000 on options on a hot stock. Each time the stock rose and the options neared expiration, he would pyramid his position, plowing his profits back into more options. His stake continued to grow so large that he quit his day job.
As he approached the million-dollar mark, I asked him, "Why don't you diversify to protect some of that capital?" He answered that he was going to keep pyramiding his money into the same stock options until he reached three to four million dollars, at which point he would retire and buy a sailboat.
I recently met a second gentleman at a dinner party. He told me that six months ago he began day trading hot stocks. It was so profitable, he said, that he quit a flourishing law practice to trade full time. Amazed at his success, I asked him, "How much do you risk per trade, a half point, one point?" He replied, "Oh no, I don't like to take a loss."
A third gentleman was making his fortune buying the hottest stock(s) on the momentum list(s). He, too, was on the verge of quitting a successful business. When asked about his exit strategy, he replied "I just wait for them to go up." When asked, "What if they go down?" his reply was, "Oh, they always come back."
What ever happened to these "traders?" Gentleman number one is now homeless, and the other two are about to be. They are on the verge of financial devastation and the emotional devastation that goes along with it. This is the cold, hard reality of ignoring risk. How do we avoid following in the footsteps of these foolhardy traders? Three things will prevent this from happening: 1) money management, 2) money management, and 3) money management.
The importance of money management can best be shown through drawdown analysis.
Drawdown is simply the amount of money you lose trading, expressed as a percentage of your total trading equity. If all your trades were profitable, you would never experience a drawdown. Drawdown does not measure overall performance, only the money lost while achieving that performance. Its calculation begins only with a losing trade and continues as long as the account hits new equity lows.
Suppose you begin with an account of $10,000 and lose $2,000. Your drawdown would be 20%. On the $8,000 that remains, if you subsequently make $1,000, then lose $2,000, you now have a drawdown of 30% ($8,000 + $1,000 - $2,000 = $7,000, a 30% loss on the original equity stake of $10,000). But, if you made $4,000 after the initial $2,000 loss (increasing your account equity to $12,000), then lost another $3,000, your drawdown would be 25% ($12,000 - $3,000 = $9,000, a 25% drop from the new equity high of $12,000).
Maximum drawdown is the largest percentage drop in your account between equity peaks. In other words, it's how much money you lose until you get back to breakeven. If you began with $10,000 and lost $4,000 before getting back to breakeven, your maximum drawdown would be 40%. Keep in mind that no matter how much you are up in your account at any given time--100%, 200%, 300%--a 100% drawdown will wipe out your trading account. This leads us to our next topic: the difficulty of recovering from drawdowns.
Drawdown recovery The best illustration of the importance of money management is the percent gain necessary to recover from a drawdown. Many think that if you lose 10% of your money all you have to do is make a 10% gain to recoup your loss. Unfortunately, this is not true.
% Loss of
Capital % of Gain
Required to
Recoup Loss
10% 11.11%
20% 25.00%
30% 42.85%
40% 66.66%
50% 100%
60% 150%
70% 233%
80% 400%
90% 900%
100% broke
Table 1. Notice that as losses (drawdown) increase, the percent gain necessary to recover to breakeven increases at a much faster rate.
Suppose you start with $10,000 and lose 10% ($1,000), which leaves you with $9,000. To get back to breakeven, you would need to make a return of 11.11% on this new account balance, not 10% (10% of $9,000 is only $900--you have to make 11.11% on the $9,000 to recoup the $1,000 lost).
Even worse is that as the drawdowns deepen, the recovery percentage begins to grow geometrically. For example, a 50% loss requires a 100% return just to get back to break even (see Table 1 and Figure 1 for details).
Professional traders and money mangers are well aware of how difficult it is to recover from drawdowns. Those who succeed long term have the utmost respect for risk. They get on top and stay on top, not by being gunslingers and taking huge risks, but by controlling risk through proper money management. Sure, we all like to read about famous traders who parlay small sums into fortunes, but what these stories fail to mention is that many such traders, through lack of respect for risk, are eventually wiped out.

Figure 1. Percent loss (drawdown) vs. percent to recover. Notice that the percent to recover (top line) grows at a geometric rate as the percent loss increases. This illustrates the difficulty of recovering from a loss and why money management is so important.

Money management involves analyzing the risk/reward of trades on an individual and portfolio basis. Drawdown refers to how much money you've lost between hitting new equity peaks in your account. As drawdowns increase in size, it becomes increasingly difficult, if not impossible, to recover the equity. Traders may have phenomenal short-term success by taking undue risk, but sooner or later these risks will catch up with them and destroy their accounts. Professional traders with long-term track records fully understand this and control risk through proper money management.
In the next installment: Money management ranges from simple, commonsense approaches to complex portfolio theory formulas. The good news is that it does not have to be rocket science. A simple, straightforward approach should be sufficient for most traders. In the next installment of this series (May 15), we will look at general money management guidelines that should help keep you out of trouble and help ensure your long-term success
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МнениеПуснато на: Нед Юли 24, 2005 5:04 pm    Заглавие: Money Management (Pt. II): Rules Of The Road Отговорете с цитат

Money Management (Pt. II): Rules Of The Road

n the first installment of this series we stressed the importance of money management, illustrated through drawdown and percent to recover analysis. We mentioned that money management ranges from simple, commonsense approaches to complex portfolio theory.
The good news is that for most traders money management can be a matter of common sense rather than rocket science. Below are some general guidelines that should help your long-term trading success.
1. Risk only a small percentage of total equity on each trade, preferably no more than 2% of your portfolio value. I know of two traders who have been actively trading for over 15 years, both of whom have amassed small fortunes during this time. In fact, both have paid for their dream homes with cash out of their trading accounts. I was amazed to find out that one rarely trades over 1,000 shares of stock and the other rarely trades more than two or three futures contracts at a time. Both use extremely tight stops and risk less than 1% per trade.
Use real stop orders--"mental stops" don't work
2. Limit your total portfolio risk to 20%. In other words, if you were stopped out on every open position in your account at the same time, you would still retain 80% of your original trading capital.
3. Keep your reward-to-risk ratio at a minimum of 2:1, and preferably 3:1 or higher. In other words, if you are risking 1 point on each trade, you should be making, on average, at least 2 points. An S&P futures system I recently saw did just the opposite: It risked 3 points to make only 1. That is, for every losing trade, it took 3 winners make up for it. The first drawdown (string of losses) would wipe out all of the trader's money.
4. Be realistic about the amount of risk required to properly trade a given market. For instance, don't kid yourself by thinking you are only risking a small amount if you are position trading (holding overnight) in a high-flying technology stock or a highly leveraged and volatile market like the S&P futures.
5. Understand the volatility of the market you are trading and adjust position size accordingly. That is, take smaller positions in more volatile stocks and futures. Also, be aware that volatility is constantly changing as markets heat up and cool off.
Never add to or "average down" a losing position
6. Understand position correlation. If you are long heating oil, crude oil and unleaded gas, in reality you do not have three positions. Because these markets are so highly correlated (meaning their price moves are very similar), you really have one position in energy with three times the risk of a single position. It would essentially be the same as trading three crude, three heating oil, or three unleaded gas contracts.
7. Lock in at least a portion of windfall profits. If you are fortunate enough to catch a substantial move in a short amount of time, liquidate at least part of your position. This is especially true for short-term trading, for which large gains are few and far between.
8. The more active a trader you are, the less you should risk per trade. Obviously, if you are making dozens of trades a day you can't afford to risk even 2% per trade--one really bad day could virtually wipe you out. Longer-term traders who may make three to four trades per year could risk more, say 3-5% per trade. Regardless of how active you are, just limit total portfolio risk to 20% (rule #2).
9. Make sure you are adequately capitalized. There is no "Holy Grail" in trading. However, if there was one, I think it would be having enough money to trade and taking small risks. These principles help you survive long enough to prosper. I know of many successful traders who wiped out small accounts early in their careers. It was only until they became adequately capitalized and took reasonable risks that they survived as long term traders.
This point can best be illustrated by analyzing mechanical systems (computer-generated signals that are 100% objective). Suppose the system has a historical drawdown of $10,000. You save up the bare minimum and begin trading the system. Almost immediately you encounter a string of losses that wipes out your account. The system then starts working again as you watch in frustration on the sidelines. You then save up the bare minimum and begin trading the system again. It then goes through another drawdown and once again wipes out your account.
Your "failure" had nothing to do with you or your system. It was solely the result of not being adequately capitalized. In reality, you should prepare for a "real-life" drawdown at least twice the size indicated in historical testing (and profits to be about half the amount indicated in testing). In the example above, you would want to have at least $20,000 in your trading account, and most likely more. If you would have started with three to five times the historical drawdown, ($30,000 to $50,000) you would have been able to weather the drawdowns and actually make money.
10. Never add to or "average down" a losing position. If you are wrong, admit it and get out. Two wrongs do not make a right.
11. Avoid pyramiding altogether or only pyramid properly. By "properly," I mean only adding to profitable positions and establishing the largest position first. In other words the position should look like an actual pyramid. For example, if your typical total position size in a stock is 1000 shares then you might initially buy 600 shares, add 300 (if the initial position is profitable), then 100 more as the position moves in your direction. In addition, if you do pyramid, make sure the total position risk is within the guidelines outlined earlier (i.e., 2% on the entire position, total portfolio risk no more that 20%, etc.).
12. Always have an actual stop in the market. "Mental stops" do not work.
Strive to keep maximum drawdowns between 20-25%
13. Be willing to take money off the table as a position moves in your favor; "2-for-1 money management1" is a good start. Essentially, once your profits exceed your initial risk, exit half of your position and move your stop to breakeven on the remainder of your position. This way, barring overnight gaps, you are ensured, at worst, a breakeven trade, and you still have the potential for gains on the remainder of the position.
14. Understand the market you are trading. This is especially true in derivative trading (i.e. options, futures). I know a trader who was making quite a bit of money by selling put options until someone exercised their options and "put" the shares to him. He lost thousands of dollars a day and wasn't even aware this was happening until he received a margin call from his broker.
15. Strive to keep maximum drawdowns between 20 and 25%. Once drawdowns exceed this amount it becomes increasingly difficult, if not impossible, to completely recover. The importance of keeping drawdowns within reason was illustrated in the first installment of this series.
16. Be willing to stop trading and re-evaluate the markets and your methodology when you encounter a string of losses. The markets will always be there. Gann said it best in his book, How to Make Profits in Commodities, published over 50 years ago: "When you make one to three trades that show losses, whether they be large or small, something is wrong with you and not the market. Your trend may have changed. My rule is to get out and wait. Study the reason for your losses. Remember, you will never lose any money by being out of the market."
17. Consider the psychological impact of losing money. Unlike most of the other techniques discussed here, this one can't be quantified. Obviously, no one likes to lose money. However, each individual reacts differently. You must honestly ask yourself, What would happen if I lose X%? Would it have a material effect on my lifestyle, my family or my mental well being? You should be willing to accept the consequences of being stopped out on any or all of your trades. Emotionally, you should be completely comfortable with the risks you are taking.
The main point is that money management doesn't have to be rocket science. It all boils down to understanding the risk of the investment, risking only a small percentage on any one trade (or trading approach) and keeping total exposure within reason. While the list above is not exhaustive, I believe it will help keep you out of the majority of trouble spots. Those who survive to become successful traders not only study methodologies for trading, but they also study the risks associated with them. I strongly urge you to do the same.
In the final installment of this series, we will question successful traders about their insights on proper money management.
Additional reading on money management:
Mark Boucher: The Hedge Fund Edge: Maximum Profit/Minimum Risk Global Trend Trading Strategies (1999, John Wiley & Sons, New York).
Mark has the utmost respect for risk, one of the reasons he is consistently one of the top hedge fund managers in the world. This book does a great job of expanding on many of the concepts mentioned in this article.
The TradingMarkets.com Guide to Conquering the Markets, Mark Etzkorn, Editor (with Kevin Haggerty, Jeff Cooper, Mark Boucher, Dave Landry, Larry Connors, Manuel Ochoa, and Bob Pisani). 1999, M. Gordon Publishing, Los Angeles, Calif.
• Contains many strategies that discuss the importance of risk control. Also, contains an excellent chapter on money management written by Mark Boucher.
Larry Connors and Linda Raschke: Street Smarts (1995, M. Gordon Publishing, Los Angeles).
• In addition to low-risk strategies, there are four rules for short term traders in the money management chapter that should help keep you out of trouble.
Robert Rottela: Elements of Successful Trading (1992, New York Institute of Finance, New York.)
• This book clearly defines money management concepts and provides concise explanations of general money management formulas. It also has some excellent chapters on trader psychology that go hand-in-hand with proper money management.
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