If you are serious about making and keeping money
by trading stocks, then there are three things you
need to do, and do well.
Money management
Orders
Trading system
Money management
Money management comes first. Without a rock-solid
method of managing your trading funds, you trading
results will be only be fair at best. Money management
is more than just knowing how much money you have
tied up in a trade. It's a method of using the right
portion of your trading account on any one trade relative
to the perceived risk and reward.
There are a few things to consider to managing
a trade successfully:
What is your account size?
How profitable is your trading system?
What is the initial amount at risk on a per
share basis?
What is the profit potential?
Account size
Your account size determines how long you stay in
the trading game. If you are skillful, then you will
not require a large account. On the other hand, even
if you are a new trader, you can use a small account
as long as you control your risk.
Controlling the risk means never using more money
then you need on any one trade. A very simple formula
for stock market success is to risk less than 3% of
your total account value on a single trade.
If you have a $10,000 account, this means you never
lose more than $300 per trade. If your account drops
to $9,000, then you risk less than $270.
As your account grows, while the total amount at
risk increases, you still only risk a maximum of 3%
of your account. Say your account is at $12,000, then
your maximum amount at risk is $360.
In theory, this ensures that you never go broke!
And that is of utmost importance.
Profitable
If your system is profitable, then you will typically
win more money then you lose. While some consider
the percentage of winners relative to the number of
losers, nothing could be further from the truth.
It doesn't do you any good to have a system that
wins on nine out of very ten trades if you give all
of your gains back on the one loser. More important
is that the winners overwhelm the losers.
A profitable trading system might have a third of
the trades result in the maximum loss planned for,
a third of the trades either make or lose a little
money, and a third of the trades bring in the profits.
Risk
It's worth repeating, risk no more than 3% of your
total account value on any one trade. If you keep
this in mind, you are ensured of minimizing losses
to your account. At what price you enter a stock and
where you place your initial stop price are used to
determine how many shares you trade.
Profit
The profit potential of a system is the "edge".
If you can estimate how much money you *might* make
over time, and if that profit comes from many trades
over time, then you probably have a winning system.
A trading system will either have a profit target
that determines when to enter AND exit (good) or it
will tell you when to enter and keep you in a profitable
trade as long as possible without giving back much,
or any, gains (better).
Orders
No matter what trading pattern you use to enter a
stock, you will make the most money by using the correct
orders.
When you wait until a stock has proven it's intensions
- typically by trading above the previous day's high
for a buy, or below the previous day's low for a sell
short - then having an order in place that captures
that exact price is crucial.
Let's say your favorite trading pattern signals a
buy for. If you are an end of day trader, then the
next morning you watch the opening price for the stock.
If the stock opens less then yesterday's high, you
place a stop order to buy above the previous day's
high. Even better is to include a limit price with
that buy stop order.
How much above the previous day's high is your call.
As long as it is greater than the previous day's high,
you are making the stock prove that it is going up.
Sure, you give up some of the profit potential. But
you are more likely to turn a profit with a stock
that is moving in your favor.
Once you are in a position, then you need to protect
yourself from loss. If your method of picking stocks
is good, then it's unlikely that the stock will revisit
the current prices. Continuing with the buy example,
to protect your account from a catostrophic loss,
place a good-till-cancel sell stop order below the
recent low. If yesterday's low is lower then the current
day's low, that's where the sell stop order goes.
And make certain that the order does not include
a limit. Stocks can and do gap down. Expecting that
you will have a sell order filled at your stop price
is a quick way to the poor house.
Trading system
Your choice of what method to enter and exit stocks
plays a critical part in your stock market sucess.
A great trading system looks for low risk opportunities
to enter a stock. Knowing at exactly what price signal
to enter and when to exit - even if it is for a small
loss - will keep your account growing. As long as
you consistently follow the rules layed out by a well
designed trading plan, you can count on steadily growing
your trading account.
My favorite trading pattern does a great job of identifying
stock likely to move rapidly in your favor.
There is no reason to be trading stocks that are
not ready to deliver the biggest gains in the least
amount of time.
If you are serious about taking your stock trading
to a higher level, then read about this trading pattern.
