(I posted this link to the money management thread-but that one is too long and might get overlooked. I think the idea in this post is crucial to understand. I quit stock trading because I didn't understand this and went on futures trading because I understood the fixed ratio method. Any other stock money management ideas would be helpful...... moderator-you can erase the post on the previous thread.) BEGINNING I just realize one of the major reasons why I lost so much dough trading stocks last year..... position sizing. I have a buddy who subscribes to a chat room where they pound this idea more than they pound the stocks calls themselves. He showed me that you can be -$2.00/share for the day and still make money. It's basic-but enlightening. Here's how: Assume your method you trade is accurate only 35% of the time and the win to loss ratio is 2 to 1. If you risk 1% of you $100,000 account on each trade ($1,000) and you know where your stop is before you enter a trade-you can be profitable. Think about it- if you have these numbers-and make 100 trades-35 winners and 65 losers- You win $5 (35 winners times $2=$70 minus 65 losers times $1). Here is an example below. EXAMPLE: Trade #1 has a stop $3.50 away Trade #2 has a stop $1.50 away Trade #3 has a stop $2.00 away Trade #4 has a stop $.50 away On trade #1-you would buy 285 shares of that stock. ($1000 divided by the $3.50/share stop). If you get stopped out..... you lose $1,000. Trade #2 you would buy 667 shares...if you get stopped out- you lose $1,000 Trade #3 you would buy 500 shares and if you get stopped out you lose $1,000 On Trade #4-you buy 2000 shares and the stock goes up $2/share. You make $4,000 on this trade but lost $3,000 on the other three- so you still come out with $1,000. HERE IS THE KEY: What I was doing before was tradin 500 shares on every trade no matter what. This is how I was losing money On trade #1 my total is -$1750 On trade #2 my total is -$750 On trade #3 my total is -$1000 On trade #4 my total is +$1,000 for a total net of -$2,500...... I thought I had to find a way to be right more often than not and ended up losing my butt...... The first example I showed proves you can be right only 1 out of 4 trades and still make money. (the example is obviously hypothetical and designed to fit this example)...... This is something I just learned and thought a lot of other newbies could relate to and help them with their trading before they lose more dough..... Good Luck
This is like any other average down method or progression type betting system. The theory is that 1-of-4 trades will win, but when you go 0-for-4 you will feel the pain. If you have a sound method, you should never average down. If this money-management technique works in the long run, then why not risk nothing until you've lost 3 trades in a row, then wager on the 4th bet only.
In your illustration above, you would have a better chance of making $ on the first 2 trades and losing $ on the last 2 assuming the stocks have similar volatilities. So the expectation would probably be still negative since you'd be making little $ on the first trades (wider stops) and get whacked on your big share trade since their stops are so close to entry point. I think it is better to keep shares constant and work at trend identification in order to achieve higher win/loss and couple it with sound risk reward discipline.
It was just a gross hypothetical example....... you could actually have all 4 trades opened at the same time. It has nothing to do with a "system" it has everything to do with position sizing. You never know which trade will work. In the above example given-even if you lost on all 4 trades- you are down $4,000. Where as- if I risked only 500 shares per trade and lost on all 4 in the example-I'd be down only $3,500....... The idea is to look at the method or style you trade over a large number of trades and know the mathematical expectation involved. If it's not a positive mathematical expectation-why are you trading the method anyways? The example is to show that if on average if you made 100 trades and only had 35 winners and 65 losers-yet your winners averaged 2 to 1 risk to reward..... you would still be profitable. The example was to show that if your methos has a 2 to 1 risk to reward ratio- you only need to win 35% of the time to be profitable...... I didn't understand this concept and lost a lot of money. I was always trying to make a minimum of $1/share per day of $500/day....... Now I know I can be negative $2/share on the day and still make money based on position sizing.
By trading the same shares on every trade- you commit the error that I did...... unless you use the same exact size stop on each trade..... you are asking you wider stop trades to do more work for you. By risking the same on each trade-no one single trade has more importance and impact on you account than a smaller range stop. I like volatilty stops-not set stops------ so my stops will be different every time. If that is the case- you need to adjust your shares so the wider stops do not have more meaning in affecting your portfolio. Just an opinion
Each stock has to be traded on its own merit. You cannot have a .50c stop on a stock like GS and you don't need to have $1.50 stop on GE. Your ideas of position trading cannot be use like a blanket strategy. I think if you lose the minimum amount possible ( but trade the stock the right way ) and get the most from your winners, you will still end up ahead. Most traders are right 40% the time anyways.
This must be a new concept then I guess...... I agree you must trade every stock on it's own merit...... let's say then that QCOM is trade #1 with the $3.50 stop and T is trade #4 with the .50 stop....... WHO CARES!! The principle still applies that if you have a method that produces 2-1 risk to reward, and you make these 4 trades every day- you can still make $$ Add up the net on those four trades..... if you traded a set amount of shares...as most traders do- you would be down -$4.50 for the 4 trades...... a bad day in most traders minds...... you can still be profitable though if you position sized correctly. IT'S JUST AN EXAMPLE FOLKS!! THEY'RE NOT REAL TRADES!!
If you vary your position size based on your stop (i.e. the same dollar risk per trade if you get stopped out), I can see what you're getting at, but you are assuming that your model accurately predicts % profit based on your variable stop. E.g. if you are using the lowest-low of the past 10 days as your stop, and for a particular stock you notice that the lowest-low of past 10 days was only 0.50 away, so you load up on your position because the overal numbers of your system say that you win 35% of the time, this does not mean that for this particular trade your % will be 35%. (same goes if you use a % volatility stop) In fact, if you use variable stops and are going to use this position sizing strategy, what you need to do is run a set of simulations and analyze each stop level separately. You'll notice that performance of different stop levels, either fixed or %, perform differently. You'll notice that whent he system calls for a tight stop your risk/reward changes, you only win, say 20% instead of 35% but your profits tend to be a higher multiple of losses. Now having said this, you're much better off position sizing based on % of equity rather than % of perceived risk. Use an optimal f strategy and bet a certain % of equity on each trade and if your system works you'll be rich soon enough.
dottom, my optimal f computes to 0.4. Assume I trade ABCD (price = 20) only and that I have $100,000 in my account. This means my optimal position size is 2,000 shares. (i) What is R, my risk per trade? Till now, it was r% of my equity and through backtesting I was able to determine my optimal stops and hence position size. Assuming R is still predefined, won't my 2,000 share position size force me to use non-optimal stops? (ii) Is there any provision for margin (4:1, 10:1 etc.) in optimal f strategy?
The concept is old but it still works. My trading is based around it and I am happy with it. What is most important - it makes money for me