Trading Tips

Trend-following trading exits trades when:

(1) an initial stop-loss is hit, or

(2) when a trailing-stop is hit.

Selling with a trailing-stop is the only time a profit is booked in trend-following.

If you don’t know how a trailing-stop works, you can never experiment with it in your portfolio.

*trailing stop

Dr. Michael Burry from “the Big Short” commencement speech:

Poker and Trading

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A poker player shouldn't play in games where his entire bankroll is at risk--sooner or later, he will go broke, no matter how skilled he is.

It's better for a player to grind away at lower stakes and slowly move up in higher games as his bankroll permits.

If a player goes on a losing streak and no longer has the bankroll to comfortably play at his current stakes, it’s probably best he move down in stakes until his assets appreciate enough to play higher again.

If one cannot afford to lose in the game, one should not be playing in that game.

This is the same exact risk management structure that goes into every valid trading system; as total assets shrink or grow, so does the dollar amount of risk per trade, but the risk as a percentage of total assets is more-or-less fixed.

For example, I’ll risk at most 2% per trade, but I’ll often trade less than 2% to adjust for portfolio correlation. If I have $100K in my account, I’ll max out at $2K risk per trade, if I have $10K worth of assets, I’ll max out at $200 risk per trade.

The more money your system creates, the bigger your initial bets should be. As your system loses, the bet sizes should also get smaller. It's not wise to chase losses with bigger bets at the hope of getting back to even. Using fixed risk % is how you capture compounding gains when assets grow and avoid going broke when asset shrink.

If risk management isn’t perfected, at best you’ll be building a house of cards.

In poker or trading markets, it's better to grind at lower stakes and slowly build (or rebuild) your foundation than to be in a revolving door of “boom and bust.”

The Art of ATR

ATR stands for “average true range.”

The ATR measures the dollar volatility of a stock/instrument.

Using ATR in a trading system quantifies the trading process and eliminates emotional decision making.

ATR provides an unbiased answer to the following questions:

• How many shares should I buy?
• When should I sell and take a loss/How far do I let a losing trade go?
• How/when do I win and book profits?

Before these questions can be answered, you must first determine your dollar risk per trade.  

When I trade stocks, I’m willing to risk 1-2% per trade(probably closer to 1% because stocks are highly correlated to each other--if the broad market falls, most stocks fall with it). This means in any given trade, my projected worst-case-scenario is that I will lose 1-2% of my account.

This doesn't mean that I buy as much stock as I can get with 1-2% and allow the stock to fall to zero.

Instead, this means I determine how volatile a stock is and allow X units of volatility to go against me. 

I divide my risk per trade by the number of units of volatility I’m comfortable with (in my case, I like using 10ATR) and this let me know how many shares I should buy(always round down to the nearest number).

I’ll sell when a trade moves 10 units of ATR against me from any given peak price.

This means at worst, I will enter a trade, and it falls 10ATR and stops me out.

But this also means that a trade could appreciate 100% and fall 10ATR from its peak price and I’ll still book a solid win. The whole key for me is 10 units of ATR.     

I could write all day about ATR, but I want to make my material somewhat palatable, so instead of overwhelming you with all this info, I’m going to cut this article short.

If you are willing to learn about how to calculate ATR and apply it to your trading, I’m willing to help you conceptualize it. Its really simple once you jump in and commit to learning(I use barchart.com to do all the ATR calculations for me, so the real key is not in its calculation, but its application.)

**Remember, its all about the system, not any particular trade.

***Books I’m digging into in order. Already half way through the first book and it is a snooze-fest, but necessary as I want to create my own trading algorithms. If you want summaries of any of these books or if you’ve read any and want to discuss, hmu.

The Monday Market Newsletter: The Urgency of Managing Risk in a Trading System

One of the most important traits of a good trader is to have the ability to take small losses and move on. It's never about one trade. It's about the system. 

The right system will always capture the inevitable massive opportunity. The hardest part is that nobody knows when the big wins will come.

Markets are largely unpredictable, volatile, and trading results are heavily skewed(~90% of profits come from ~5% of trades).

How can you win long-term in the markets with a poor risk management system? You can't.

Concentrate on the process, the results will take care of themselves.

Don’t have a quantifiable process in place? Email me and I can help.