the know-nothing investor

…money doesn't grow on trees, you know?

Tag: Money Management

4.THE STRATEGY

I had gather 10 000 USD in two year, which for Portugal standards is a considerable amount, especially if you have a young family to support and you just saw your pay-check cutted to less than 1500 USD per month.

As I said before I would trade stock’s CFD because of the leverage that I could achieve, which meant that I would have about 100 000 of total funds to invest. Pretty nice, hum?

I also establish that the most I could loose from my total capital was 1000 USD or 10% if you prefer. This rule was my first and I tried to be the strongest rule. If I would lost that amount of money I would stop for somes months for rethink my strategie. But for sure that would not happened.

The trading style that I was more comfortable to practise was trend-following, because it was simple enough for me to understand it and It was quite simple to identify trends.  I even got to do some programming based on the moving averages to give me entrance and exit points. My backtesting was quite profitable. I was getting really good…

I also defined that I would buy 10 equities shares for some diversification and mitigation of risk. I would buy 7 longs and sell 3 shorts, based on the 130-30 portfolio strategie because at the time I had read a paper that this was the way to have better returns with smaller risks.

Picking stocks

I started looking for blue chips that were near highs, because if they are near all time highs there is a great possibility that they will go higher. In opposition, to go short I chose stocks that were in a downtrend and were making new lows.

I also looked for stocks in uptrends that were near 50-day moving average for a buy and stocks that were under 200-day moving average for a sell.

I even used screeners that gave me a complete list of stocks in similar situation.

The idea was to catch major trends “à lá turtles” way. Real simple plan that I could easily understand it and mastered it.

I also tried to diversify geographically my stocks, because there are some differences between countries’ economic cycles and therefore I was reducing my risks.

Money management

Money management took me a great part of my learning. I know that in this game I will lose money. It’s part of the game and you must accept it, but It was a non-option to lose all my capital and my 2 years effort in saving that amount of money. It would be a great failure and the emotional pain would be so devastating that I probably would never look again for stocks’ investments. So I look at money management as my safety net.

My money management was really simple I would pick a stock that would meet my predefined attributes. Then I would identified a low point near 50 day moving average or some new higher low on the uptrend movement. Here I would define my stop area and I would tried to buy the nearest I could from this point. The difference between my entry and stop point would be the equivalent of 1 to 3% of my total capital. This was the amount of money that I decided that I could loose in a single trade. This implied that I would have little space for error because I would stop trading If my losts achieved 10% of my total capital.

Nevertheless I was confidence that I could have success.

Pyramiding Profits

On the other side, I established if I had correctly spotted a stock’s uptrend I would take advantage of market corrections and I would buy more of that stock, maintaining the same risk. Let always make your profits run, professionals say.

And this is very simple to do. Imagine that you bought stock and you risk 1% of your capital. After few months, you have a possible profit of 20%. Meanwhile the stock enters a corrective phase and the price falls 8%, not going lower than the previous time (where you had established your first stop), making a new lower high.  Then if it rebounds that means that the worst has passed and the uptrend is still intact, therefore you can move your stop to the new lower high area. This means that you are not risking 1% of your capital anymore and you have a  profitable trade. Now you can raise your position size on that stock, maintaining the same initial risk of 1%.  This can really boost your profits.


Example

Fig.1 – Visual image of a simple money management and how to pyramid profits

Market Timing

I didn’t take much time thinking on this. Now I know that is an important part of a strategy. By then I thought that I would go with the flow, as long as the trend lasted.


This was my approach to take my fare share of what markets have to give. A simple plan because reality is so complicated that you shouldn’t add more layers of complicatedness.

 PTEN

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3.BEFORE TRADING DAYS

As I said before I spent almost two years studying technical analysis and how to behave in a trading environment. In that period,  I came across many times with two key ideas, money management and trading psychology behaviour.

I read some articles about money management and I understood its importance quickly. Every trader use it and every good system must have it. Why? Because in trading, especially in a learning process we can do much harm to our money. Money management is like our safety belt, we don’t drive to crash but it’s a possibility when we get in the car.

While I was studying I used a paper trade account and I achieved decent returns. I was admired how good I was and how I was making quick and easy money, but I tried to stay humble and I always remembered myself that it was only a paper trading account.

Every trader I read are always reminding how difficult is to succeed in the business, how hard is to have a system that gives you an edge and how you must keep a balance between winning and losing. You should not be to confident about your winning trades or completely devastated about losing money.

I read a lot about this in forums. Although I tried to stay humble, sometimes I thought to myself how can this douchebag make any money if he has an enormous ego and he never changes his opinion.  If he can I certainly will do better than he does.  But can people with big egos and zero tolerance to change their opinions do good in the markets? Of course it is possibly, but they will be a very small minority for sure and in the internet world we can say and we can be whatever we want.

Comparatively to others I seemed more focused, more eager to learn and most importantly more humble and I thought that this was a good mental setup to start trading. The plain truth is that you need to stay focus, be eager to learn and be humble if you want to succeed in the markets.

 PTEN