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Quantifying Low/Risk High/Reward Trades

lowriskQ:  How can do you quantify odds of 10-1 in your favor before you make a trade? Is it your profit goal is 10x more than your stop loss? 10 indicators that look good and one that does not look good? Can you share with the group how you get to 10-1 odds? It may not be an easy answer, but I wonder if you could expand.

Think of it this way. After I’ve performed my analysis of all of the things I look at (fundamentals, technicals, sentiment) and list them out at the price I’m considering making a specific trade, they must without any measure of doubt be highly tilted in my favor. In other words, it must fit my definition of what I consider to be a low/risk high/reward setup. For every negative I can find that argues against a specific trade, I need more than just a few positives to offset it.

What results from this analysis is that the total number of trades I make is lower than most, but the percentage of average winning trade is higher as well as my win/loss average. (more…)

Trading Rules

*The big money is made from position sizing. You really must stop chasing a holy Grail and spend time on different position sizing rules. This is the one “secret” that separates a professional from the man in the street.

*Question everything and everyone. Even me. Never blindly believe anything you read or hear about. Be careful about what you read and even more careful about what you believe in. after all an opinion is only some-ones belief.

*If you have to ask you shouldn’t be in. I can’t believe people actually ask other people whether they should hold or sell a stock position they are in. Surely before you enter you have your exits all in place. I’ll guarantee if you are asking this question you are not making money.

Book Review-Trading Beyond the Matrix-Great Book for Traders

Now ,This Book in our Library

1. Trading with the use of R Multiples. Risk a set amount per trade with the goal to make a minimum of three Rs for every one risked. If the trade is does not work out cut the loss at 1R.

2. Only trade if you have an edge, which is defined by only taking the very best trading opportunities, position sizing correctly, being in control of your feelings, and having a great risk to reward ratio, etc.

3. To be a successful trader you must know what your trading objectives are, how much do you want to make in a year? What percent of return are you looking for?

4. You need defined goals of whether you want to trade for a living, make a million dollars, or just trade for capital appreciation.

5. A primary goal of this book is to make the leap from trading our opinions about the markets to trading what is actually happening in the markets.

The power of this book is in the psychology and spiritual insights shared by both the author and many successful traders that share their journey with the reader with the chapters they wrote for this book. (more…)

10 Trading Psychology Points

1) We are most likely to behave in inhibited or impulsive ways, violating trading rules and plans, when we perceive events to be threatening;

2) What we perceive to be threatening is a joint function of events themselves and how we think about those events;

3) A key to gaining control over trading and maintaining consistency is to be able to reduce the threat associated with market events and process adverse outcomes in normal, routine ways;

4) We can reduce the threat associated with adverse market events through proper money management (position sizing) and through proper risk management (limits on losses per position);

5) We can reduce the threat associated with adverse market events by training ourselves to respond calmly to adverse outcomes (exposure methods) and by restructuring how we think about those outcomes (cognitive methods);

6) Optimal skill development in trading will occur in non-threatening environments in which learners can sustain concentration, optimism, and motivation;

7) A proper mindset is therefore necessary to the development of trading skills, but does not substitute for such development;

8) The cultivation of trading expertise is a function of the amount of time and effort devoted to learning and the proper structuring of that time and effort;

9) Proper structuring of learning involves the setting of specific, doable, cumulative goals and the provision of rapid feedback and correction regarding the achievement of those goals;

10) Practice does not make perfect in trading or anything else; perfect practice makes perfect. Training must gradually build competencies and correct deficiencies in a manner that sustains a positive mindset and optimal concentration and motivation.

To become a profitable trader, you must

  • 1. Manage Risk: Learn to trade a manageable portion of you portfolio .Always establish a risk/reward ratio before making a trade. Without the ratio, how do you know your risk?
  • 2. Understand Position Sizing: All traders must learn to know “how much” to trade on each position. Do not overtrade or you will runt he risk of ruin. Position sizing is rule number one of managing risk.
  • 3. Cut Losses: Do not allow losses to run wild. You must learn to cut losses and understand that losses are a part of the game, a large part of the game. Check you ego of winning at the door. We are here to make money, not go undefeated. Play sports if you want to keep score with a record rather than your bankroll.
  • 4. Learn when to Sell: You must learn when to sell. Selling is more important than buying as it ties directly to risk management. Use stops if you haven’t yet developed the discipline to get out at your predetermined stop or profit goal.
  • 5. Average up in Price: I will never hesitate to add shares in a stock that is moving higher  but I always avoid averaging down. Remember, cut losses and never throw good money after bad because we know that’s a quick way to the poorhouse.
  • 6. Have Patience: It takes years to master trading as an advanced skill; even then, you are never done learning or adapting.

Expectancy

Expectancy
Expectancy along with position sizing are probably the two most important factors in trading/investing success. Sadly most people have never even heard of the concept.
Expectancy is the average amount you can expect to win (or lose) per rupee at risk.
Here’s the formula for expectancy:
Expectancy = (Probability of Win * Average Win) – (Probability of Loss * Average Loss)
As an example let’s say that a trader has a system that produces winning trades 30% of the time. That trader’s average winning trade nets 10% while losing trades lose 3%.

Expectancy, position-sizing and other aspects of money management are far more important than discovering the holy grail entry system or indicator(s). Unfortunately entry techniques are where the vast majority of books and talking heads focus their attention. You could have the greatest stock picking system in the world but unless you take these money management issue into consideration you may not have any money left to trade the system. Having a system that gives you a positive expectancy should be in the forefront of your mind when putting together a trading plan.

Basic principles for Traders

Many of you spend too much time worrying about things like other peoples trading signals, what price pattern it is you are looking at, which strike price to select, how to read implied volatility, etc when you haven’t constructed the basic tenets of portfolio management or asset allocation.

Shame on you.

To your defense, I can’t make any assumptions when I have no idea what your time frame is, what your financial standing is, your risk tolerance, your investing objectives, or anything else looks like about you. What I do know is this… I don’t care who you are or what you are trying to accomplish, you will not last long in the pursuit of becoming a decent trader without creating a firm foundation of these basic principles, which are…

Risk management- Plan your loss before planning your profit.

Diversification- Be bullish, be bearish, be involved in various groups/markets.

Proper Position Sizing- Trade small, trade safe.

Effective Trading Plan- Make sure your plan works, and/or makes money.

Cutting Losses Short- Enter a trade that offers a small loss.

Letting Winners Run- Don’t kill your winners.

Curbing Your Emotion- This is a bi product of trading small.

Six Positive Trading Behaviors

6-1) Fresh Ideas – I’ve yet to see a very successful trader utilize the common  chart patterns and indicator functions on software (oscillators, trendline tools, etc.) as primary sources for trade ideas. Rather, they look at markets in fresh  ways, interpreting shifts in supply and demand from the order book or from  transacted volume; finding unique relationships among sectors and markets; uncovering historical trading patterns; etc. Looking at markets in creative ways  helps provide them with a competitive edge.

 2) Solid Execution – If they’re buying, they’re generally waiting for a  pullback and taking advantage of weakness; if they’re selling, they patiently  wait for a bounce to get a good price. On average, they don’t chase markets  up or down, and they pick their price levels for entries and exits. They won’t lift  a market offer if they feel there’s a reasonable opportunity to get filled on a bid. (more…)

10 Rules for Traders

  1. Never add too a losing trade. In adding to a losing trade you are already wrong but now become more wrong with a bigger trading size. Adding to losers makes you a counter trend trader that usually ends badly.10-Rules

  2. Never lose more than 1% to 2% of your trading capital on any one trade. This means use position sizing and stop losses so when you are wrong the loss is not a big deal.
  3. Never trade anything you do not understand 100%. Stay away from trading futures, forex, or options until you understand the risk and how exactly they work.
  4. Always trade with the trend in your own time frame.
  5. Only look for low risk, high reward, high probability setups , when there is nothing to trade, trade nothing.
  6. Trade the chart and price action, not your own opinions or predictions.
  7. You have to trade your own way, the trading style that you are comfortable with that fits you.
  8. If you do not have a full trading plan with rules on entries, exits and risk management stop trading until you create one.
  9. The size of your wins and losses ultimately determine your trading success regardless of your winning percentage. 
  10. Your risk management rules will ultimately determine the success of your technical trading system.

7 Weakest Points of Trading

The weakest part of any trading method is the trader themselves. There are many, many, robust trading systems and methods that do make money in the long term. The problem is the trader having the discipline and mental toughness to trade one of them consistently. The vast majority of time it is not a system failure but traders that fail in this game through one of seven common errors. If you can understand these error and overcome them you could make a lot of money in the right market conditions.

  1. The trader must have the discipline to take the system’s entries and exits.
  2. The trader must have the discipline to take the stop loss on a losing trade when it is hit and not keep holding and start hoping.
  3. No matter the method the trader has to manage risk through proper position sizing, getting greedy and trading too big will blow up even the best systems.
  4. It is the trader that must have the perseverance to stick to the method even during losing periods, and also stick with trading until success is reached.
  5. If a trader can not manage their mind then the stress will break them, I have seen this happen many times. If you can’t handle losing you can’t trade.
  6. The trader must find a robust method, must understand why it has an edge, and must believe in their methodology.
  7. The trader has to know themselves and trade the method that fits their risk tolerance levels and own psychology. (more…)