Risk Management by determining Stop-Loss and Target Levels

"Of all speculative blunders there are few worse than trying to average a losing game. My cotton deal proved it to the hilt a little later. Always sell what shows you a loss and keep what shows you a profit. That was so obviously the wise thing to do and was so well known to me that even now I marvel at myself for doing the reverse."

-Jesse Livermore

Believe it or not, this quote is one of the most helpful and famous of all trading quotes in the last 100 years that you'll read. That's saying something. As you can imagine, every time the market rises fast, there is also a bull market (rising market) in books written on how to 'retire tomorrow' by picking 'this' investment. Rest assured, this series about developing a trading strategy will help put you on a steady path to trading GCM.

In fact, if you could take a look at the first 10 years of a trader's career, you'd likely see three distinct stages.  The first stage would be littered with excitement about the money that can be made trading (of course, there's risk in every single trade though). A close second and often a large chunk of the traders first decade is looking for the Holy Grail so that maybe they wouldn't place a losing trade again (not going to happen). Lastly, and the area that will turn a good trader into a great trader, is seeking how to really take advantage of the opportunities of the market without letting the market take too much of your finite money supply which is also known as Risk Management.

Your Risk Management Strategy

I've had the privilege  of looking over the live results of millions of trades over the course of one year working for GCM. Sadly, a prevalent  behavior underlined most losing traders.  That behavior is that by many trader's emotional default, they will hold onto losing trades far longer than they will hold their winning trades. This isn't limited to GCM as the faulty behavior is rooted in a behavior bias known as loss aversion.

The loss aversion bias can be explained by this short quiz presented by famed psychologist, Daniel Kahneman.  The following questions has brought about Prospect Theory:

Scenario 1:

A:  Would you rather take a guaranteed win of $75,000 or

B:  Would you risk a 75% chance of winning $100,000 but a 25% chance of winning nothing?

Scenario 2:

C: Would you rather take a guaranteed loss of $75,000 or

D: Would you risk a 75% chance of losing $100,000 but a 25% chance of losing nothing?

Experimenter after experimenter overwhelmingly chose choices A & D.  Peeling the layers of the proverbial onion, you can see that the subjects were risk adverse when facing greater gain and risk seeking when seeking greater loss. Effectively, this means that traders are looking to take less from the market than their allowing the market to take from them by opening up the possibility of taking the chance of a larger loss while going for the guaranteed winnings at a smaller amount.

Applied Theory to GCM

"In theory, there is no difference between practice & theory. In practice, there is."

-Yogi Berra

When it comes down to the art of trading and trying to take money out of the market, a few things must be in line.  First, you must fear the market and what the market can do to you if you don't take care of the losses before they take care of you by removing you from your ability to trade another day. Second, you must know up front that because you do not know the future, you must manage risk first and foremost. In other words, your ability to manage your risk is your only true edge in the market where anything can happen.

How I Mange Risk & Other Professional Traders Do The Same

Improved management of your risk can turn a decent strategy into a very good strategy but not even the greatest trading strategy can perform if risk is not managed. Therefore, the common ways to manage risk so that a losing trade doesn't get out of hand are as follows:

Chart Pattern Invalidation 

-Once the reason for getting in a trade, like a bull flag or moving average crossover, is no longer valid, it's time for you to find the nearest exit door on your trade.

Risk: Reward Ratio

-Many traders have a default emotional aversion to loss that causes them to allow the market to take more from them than their willing to take from the market. Therefore, to flip that, it is recommended that you look to profit 2 or 3 times the amount you're willing to risk on any given trade.

Breaking of Progressive Support or Resistance

-Whether a market is pushing higher, lower, or moving in a tight range, there are always key levels to focus on that, should they break, would signal a significant move that should confirm or invalidate your trade. This is how I manage risk and it can incorporate the first two methodologies. The easiest method that most can adapt is either to use support and resistance levels of Pivot Points or a Moving Average so that when either breaks, you exit the trade.

Closing Thoughts

This is the longest piece of the series and most would argue it's most important to your long-term success. To instill another excellent quote into your trading psych, I leave you with another gem from Jesse Livermore:

"Losing money is the least of my troubles. A loss never bothers me after I take it. I forget it overnight. But being wrong–not taking the loss–that is what does damage to the pocketbook and to the soul."

Happy Trading & Risk Managing!

For Individual Investors, These May Be The Best Of Times

The raging debate on high frequency trading generated by Michael Lewis’ controversial bestseller “Flash Boys: A Wall Street Revolt” may lead the average retail investor to think that he/she continues to get a raw deal in a stock market increasingly dominated by institutions and hedge funds. Coming as it does on the heels of scandals like the ones surrounding the fixing of benchmark rates for LIBOR and foreign exchange, the controversy may reinforce the impression that financial markets are rigged and unfair. Though there will doubtless always be areas of the market that are relatively inefficient or not the fairest of forums for individual investors, the reality is that these are probably the best of times for them. Here are five reasons why:

1. Transaction costs are the lowest ever: Transaction costs have two major components – commission costs and trading spreads. The surging popularity of online brokerages from the late-1990s onwards has driven commission costs relentlessly lower, to the point where it has become routine to trade hundreds of shares for a dollar commission in the single digits. As for trading spreads, the advent of “decimalization” since April 2001 for U.S. equities has resulted in one-cent spreads for the most liquid stocks, rather than 1/16th of a dollar ($.0.625) which was the minimum spread prior to 2001. The dramatic decline in transaction costs since the 1990s generates significant savings for investors and enables them to retain a bigger proportion of their trading gains. It also allows them to manage their portfolios more actively, since high trading costs are no longer a deterrent.
2. Plethora of investment choices:  Investors currently have no shortage of investment choices, thanks to the pace of innovation in financial products in recent years. Investors can now invest in most categories of financial assets, even obscure ones and investments that were formerly not available to them – currencies, commodities, foreign markets, real estate, options, hedge funds and so on. Most of these investment choices are available through exchange-traded funds (ETFs), the market for which has grown tremendously in this millennium. Global ETF assets as of October 2013 amounted to $2.3 trillion, of which over 70% comprised U.S. ETF assets. On the derivatives side, the introduction of special options such as mini-options and weekly options gives investors more tools for hedging and speculation. Overall, investors now have a much wider range of investment choices than they did even a few years ago, and the sheer number of these choices continues to expand.
3. The Information Age: With investors now having access to a vast repository of market information, the days when the only sources of information were brokers and other market professionals are long gone. Most companies now promptly upload on their websites a wealth of valuable information such as their quarterly results, financial statements, corporate presentations,   and even transcripts or recordings of conference calls with analysts. Online portals like EDGAR in the U.S. and SEDAR in Canada give investors access to other information such as prospectuses and corporate filings. Then there are blogs and micro-blog services like Twitter that often beat newswires to the punch in terms of breaking news. Plus the thousands of websites on stocks and markets that can be accessed by investors at no charge with a mere mouse-click. Lack of timely information is no longer a handicap for the individual investor.
4. Better regulation: One consequence of the two savage bear markets in this millennium has been better regulation to protect the small investor. Widespread accounting irregularities and “tainted research” – whereby analysts published glowing reports on dot-com companies that they privately disparaged – were two features of the 2000-02 “tech wreck.” In its aftermath, Sarbanes-Oxley legislation was enacted to improve corporate governance, while new regulations were also introduced to preserve the independence of investment research. Similarly, the LIBOR and forex rate-fixing scandals erupted as a result of financial institutions' excessive risk-taking coming under the spotlight after the 2008-09 bear market.

Concerns about regulation are now centered on two aspects – (a) regulators typically clamp down on abusive market practices only after they have already occurred, and (b) some regulations have unintended consequences, such as Regulation NMS (National Market System); “Reg NMS” was introduced in 2007 to ensure that certain orders are executed at the best available price, but many believe it has contributed to the surge in high-frequency trading.

The fact remains, however, that investors’ rights are presently well protected. As well, efforts continue to level the playing field between individual and institutional investors, thanks to regulations like Reg FD (“Fair Disclosure”) which requires all public companies to disclose material information to all investors at the same time. That said, savvy operators will always be around to exploit loopholes, just as fraudsters and charlatans will always exist to dupe the unwary; but although regulators may occasionally be a step behind, they eventually catch up.

       5. More tools for the DIY investor: Plenty of tools exist for the do-it-yourself investor, ranging from
           trading simulators and technical analysis charting services to free educational sites (like this one) and
           portfolio management software. These tools can range from free basic ones to sophisticated suites
           that can cost a packet, depending on one’s requirements. The availability of these tools can greatly
           enhance learning of investment concepts and help one become a better investor.

The Bottom Line 

Record low transaction costs, a wide range of investment choices, access to timely information, better regulation, and more DIY tools – for individual investors, these are the best of times, despite the debate on high frequency trading and recent price-fixing scandals.

Introduction To Momentum Trading

In momentum trading, traders focus on stocks that are moving significantly in one direction on high volume. Momentum traders may hold their positions for a few minutes, a couple of hours or even the entire length of the trading day, depending on how quickly the stock moves and when it changes direction. Here we'll look at momentum trading and examine a typical day in the life of this type of active trader.

Reviewing Different Types of Traders 

Before we focus on momentum trading, let's review all the major styles of equity trading:

• Scalping

The scalper is an individual who makes dozens or hundreds of trades per day, trying to "scalp" a small profit from each trade by exploiting the bid-ask spread.

• Momentum Trading 

Momentum traders look for stocks moving significantly in one direction on high volume and try to jump on board to ride the momentum train to a desired profit. For example, Netflix (Nasdaq:NFLX) surged over 260% to 0 from January to October in 2013, which was way above its valuation. Its P/E ratio was above 400, while its competitors' were below 20. The price went up so high primarily because many momentum traders were trying to profit from the uptrend, which drove the price even higher. Even Reed Hasting, CEO of Netflix, admitted that Netflix is a momentum stock during a conference call in October 2013.

• Technical Trading - Technical traders are obsessed with charts and graphs, watching lines on stock or index graphs for signs of convergence or divergence that might indicate buy or sell signals.

• Fundamental Trading 

Fundamentalists trade companies based on fundamental analysis, which examines corporate events such as actual or anticipated earnings reports, stock splits, reorganizations or acquisitions.

• Swing Trading 

Swing traders are really fundamental traders who hold their positions longer than a single day. Most fundamentalists are actually swing traders, since changes in corporate fundamentals generally require several days or even weeks to produce a price movement sufficient enough for the trader to claim a reasonable profit.
Novice traders might experiment with each of these techniques, but they should ultimately settle on a single niche, matching their investing knowledge and experience with a style to which they feel they can devote further research, education and practice.

Let's begin our exploration of momentum trading.

A Day in the Life of the Momentum Trader

A good way to illustrate momentum trading is to look at a typical day of a momentum trader:

He gets up an hour before the market opens, switches on his computer, goes online and immediately logs into one of the popular trading chat rooms or message boards.

When looking at these boards, our hero focuses on stocks that are generating a significant amount of buzz. He looks at stocks that are the focus of trading alerts based on earnings or analyst recommendations. These are stocks rumored to be in play, and they are anticipated to provide the most significant price movements on high volume for that trading day.

While surfing the web, he will also turn on CNBC and listen for mentions of companies releasing news or positioned to undergo significant movement.

He eyes the morning equity options pages to find stocks with significant volume increases in calls. Any increase in calls written indicates that a price increase or decrease above or below the option premium is expected.

Once the market opens, he watches his initial list of stocks in relation to the rest of the market: Are his stocks going up when the market goes down? Are they significantly increasing in price in relation to the rest of the market? Are they behaving consistently with his expectations based on his pre-market assessment?

He will then narrow his watch list to include only the strongest stocks: those increasing more rapidly on higher volume than the rest of the market, stocks trading contrary to the market and stocks with movements clearly propelled by external factors.

Analyzing the Charts

Next, a momentum trader will analyze the list of stocks he has chosen to focus on by examining their charts. The primary technical indicator of interest is the momentum indicator - the accumulated net change of a stock's closing/ending price over a series of defined time periods. The momentum line is plotted as a tandem line to the price chart, and it displays a zero axis, with positive values indicating a sustained upward movement and negative values indicating a potentially sustained downward movement.

That upward or downward momentum indicator often immediately portrays a breakout for the stock, which means that even a period or two of sustained momentum will propel that stock in the direction of the breakout. While watching the momentum chart, he has hisLevel 2 screen up, looking for evidence of a push, where bids start to line up (indicated by the presence of market-maker limit orders) and offers start to disappear.

When the trader believes he has identified a breakout, he does not necessarily need to jump immediately into the stock. He is not generally worried about missing the first one or two breakout ticks, but he has his hand on the buy trigger (or sell trigger in the case of a short sale, but a short sale must be done on an uptick) for one of the next momentum periods. And he is generally not too concerned about hitting the bid either, as he will have an easier time getting in at the market price. Then he places a market order.

Momentum Trader: In Position 

Once he has entered into his position, the white-knuckle ride and nail-biting begins. Will the stock continue to move strongly in the direction of his momentum line? Or will it immediately change course, proving the momentum chart wrong and perhaps pointing to a trap set by the market maker? Or will the breakout fizzle quickly, providing some limited upside but not enough profit to make the trade worthwhile?

Whether the momentum fizzles almost immediately or continues to build, the trader remains glued to his screen. He is looking for a saturation point, where orders start piling up on the offer and bidding slows or thins at the market price a few levels back on the Level 2 screen. The saturation point does not mean an immediate end to the momentum, but it may signal that the top is near. So the trader sells his position (or covers his position in the case of a short sale) and takes his profits to pack it in for the day or to move on to the next stock on his list.

Note that in the event of a breakout gone wrong, where a stock immediately turns direction and moves against the trader's wishes, a special strategy applies. Far from hoping for yet another reversal to make the stock go his way, this astute trader immediately cuts his losses and sells (or covers) his position. It is often a far better strategy to take a small loss early after a bad trade than to hope for a reversal later in the day. The odds generally ensure that a small loss will turn much larger the longer the trader waits with crossed fingers.

And here's where psychology rules the roost: The astute trader realizes that there will be bad trades that result in losses. Accepting that fundamental fact of trading life helps us manage our money so that trades that go swimmingly will outweigh these losses.

Pitfalls of Momentum Trading 

Like all investing - and particularly active trading - momentum trading is not without risk. The pitfalls of momentum trading include:

• Jumping into a position too soon, before a momentum move is confirmed.
• Closing the position too late, after saturation has been reached.
• Failing to keep eyes on the screen, missing changing trends, reversals or signs of news that take the market by surprise.
• Keeping a position open overnight. Stocks are particularly susceptible to external factors occurring after the close of that day's trading - these factors could cause radically different prices and patterns the next day.
• Failing to act quickly to close a bad position, thereby riding the momentum train the wrong way down the tracks.

The Bottom Line

Because of these pitfalls, momentum trading is fraught with peril that can easily destroy even the most disciplined and knowledgeable trader. However, this style also offers the most potential for significant profit, since rarely any factor inside or outside the market drives a stock as powerfully as momentum. With a proper understanding of the technique, sufficient knowledge of the risks and a willingness to take an occasional loss, momentum trading offers an appealing choice for the aspiring trader who enjoys living on the edge.

Manually backtesting the trading strategy

Now you have learned how to effectively use a trading journal, we will now show you how to backtest the data to safely take a strategy from a demo to a live account and then continually monitor a strategy after you have started trading with it on a live account.

Testing the strategy initially with 30 trades

First of all, you need to record 30 trades using a demo account.

If a trading strategy is not profitable over 30 trades, it is likely that modifications to the strategy are required or that the strategy is not worth using on a real live account. At this stage you may need to find an alternative strategy and test in the same manner.

Every time you change or modify your strategy, you must backtest it again with 30 trades.

The reason why you need to test a strategy with at least 30 trades is because many strategies regularly have losing streaks of several trades in a row. You need a sample size just large enough to incorporate several cycles of winning and losing streaks and to see if the sample is initially profitable.

If, after the initial 30 trades, you find that the sample is not profitable, then you may want to modify the strategy or change it altogether. If the sample is profitable, then you can go onto the next stage of backtesting.

Carry on testing until you have 100 trades

Once you have found your initial sample size to be profitable over 30 trades, the next stage is to continue collecting trades until there are a minimum of 100. A larger sample size of 100 trades provides a clearer picture of the potential performance of the strategy. With a sample size of 100 trades you can find the following information:

• What kind of drawdown does the strategy seem to produce?
• How often are losing streaks likely to occur?
• What is the ratio of winners to losers

Having the answers to these questions will help you later when you are experiencing a performance downturn. If, for example, your initial sample showed that you had a drawdown of a certain percent, then if you experience a similar drawdown when trading live, you will understand that this is a normal part of the strategy.

Benchmarks help you determine how much of a down turn in performance you can accept

Once you have at least 100 trades, you can now see the extent of a drawdown period with your strategy and you can create benchmarks.

A benchmark is the maximum negative impact that you allow on your trading strategy. The following is a list of example benchmarks you can create with your backtesting:

• The maximum amount of losing trades in a row.
• The maximum percentage drawdown of your account.
• The maximum risk to reward you can use in the strategy.

Once you have your benchmarks, you can start to trade your strategy on a live account. You can use these benchmarks to monitor if your strategy continues to work in different market environments. For example, if the maximum drawdown in your initial 100 trades was 15% of your account, then you can use this as a benchmark while trading with live money.

As long as the drawdown does not exceed more than 15% of your account, then the strategy is within the normal limits – you can confidently continue trading until the strategy becomes profitable again. If a losing streak results in a drawdown of over 15%, then the benchmark from your testing has been broken – this highlights that there could be something wrong and the strategy may no longer be functioning as normal.

This is the point when you would stop trading on a real account and assess the strategy in the same manner as before – going back to a demo account and testing another 30 trades.

If the results are positive on these 30 trades, then the benchmark can be adjusted and live trading can continue. If the testing does not produce a profitable result, then it can be that for whatever reason, your strategy no longer works. At this point, you can go back to adjusting the strategy or testing a new one until you find a sample size of 30 trades that are profitable.

You must continually monitor the performance of the strategy to see if a benchmark is broken, even if the strategy performs well, because the market environment can change at any time causing your strategy to become ineffective.
Once you have at least 100 trades, you can now see the extent of a drawdown period with your strategy and you can create benchmarks.

How To Invest in Global Markets

Global Investing Trading

Today I’m writing about long term investing trading the global growth trend. Two very significant country economies going forward are China and India. Chindia as some call it, comprises about two billion people, and the surrounding areas of Asia and the Middle East are very significant also. The growth moving forward long term in these areas is exponential that was has happened in the past, and a great opportunity for anyone around the world to benefit from.

ADR – Advance Depository Receipt

One great way to invest in global growth is through Foreign stocks listed on the NYSE and Nasdaq stock exchanges as ADR’s or what’s called Advance Depository Receipts. Today with online trading access anyone from any country can open an investing trading account with a number of different brokers from around the world and invest and trade in global growth companies. Of course locals in their respective countries may choose to invest trade direct with their local brokers and exchanges, but also have the choice of an account with an international broker too. Direct investment in foreign companies on foreign exchanges through foreign brokers may or may not be available to foreign investor’s traders. Check with a broker from the country you’re interested in investing trading whether you qualify to open a investment trading account that specific country.

The Most Liquid Financial Market in the World

Another very good market to be invested trading in is the forex or currency market. With its 24 hours a day 5 day a week market, buy or sell in the most liquid financial market in the world. Forex involves high leverage and risk. The first major factor to understand and implement is the amount of leverage you’re using and understand its profit loss consequences, or what is called risk management. Simple to learn and once implemented now you can fine tune the amount of leverage you’re using creating low-risk high-reward returns of 3:1 plus profilt/loss ratios. Managing your leverage and only entering investments or trades with 3:1 plus profit/loss ratios or another term reward/risk ratio. With a disciplined risk management system such as this, you will have smaller losses and much bigger winners providing sustainable strong long term returns. The more active you are in managing and always fine tuning your portfolio income, the more potential you have in earning above average returns.

New Economy Low-Risk High-Reward Profitability

The greatest thing of the new millennium is the availability of online practice demo investing trading systems for stocks, options, forex, and futures. Trading the live markets with fake money to practice and hone your investing trading skills. I called it interactive new school financial intelligence old school never taught. I learned this way as many others have also. Now there’s no more need to aimlessly throw real money at the market and lose because you don’t know what’s going on. You do the practice losing first with fake money, then you go with your real money after, when you feel confident enough to do so.

Institution Program Trading – Small Investor Trader Automated Trading

Also another new investing trading innovation today is automated trading computer programs. Wallstreet has been using computer program trading for decades. Automated program trading is now available and very affordable for small investors and traders too. I highly recommend to investigate and use these very disciplined low-risk high-reward stock and forex auto trade programs. They produce phenomenal low-risk high-reward returns once implemented, fine tuned, monitored and managed.New Economy Low-Risk High-Reward Profitability

The opportunity for anyone in any country with even small amounts of investing money has the ability to invest and trade in the global financial markets now. Globalization is here providing a multitude of low-risk high-reward investment and trade opportunities. Start with knowledge, set dated investment trading goals, have an investing trading plan, execute that plan or plans with discipline, and benefit with better than average returns in the long term.

Good day, good investing and trading for your financial freedom future!

Stop Loss Basics

One of the trickiest concepts in forex trading is management of stop orders. A stop loss order is an order that closes out your trading position with the intent of cutting your losses when the market moves against you.

There is no clear rule of thumb when it comes to placing stops, it all depends on your trading strategy.

If your trading strategy is more of a forex day trading style, you might place a stop just outside of the daily range of the currency pair that you are trading. This way, if the market suddenly breaks the trend that you are trading and moves far enough in the opposite direction, your account is protected because your position is closed.

If your trading style is more of a swing trading style, you might set your stop loss outside of twice to three times the daily range.

Remember, the point of the stop loss is to end the trade when the market goes far enough in the opposite direction, that your trade no longer makes sense. It can be difficult facing the fact that you made the wrong decision, but the markets are as unpredictable as the weather. Sometimes you look at things expecting what seems obvious, only to have the market behave unexpectedly. Setting the stop loss at the time that you enter the trade can help you to draw a “line in the sand” for protection.

No matter what stop loss strategy you choose, remember not to move your stop loss further out to prevent the trade from being stopped out. There are exceptions to every rule, but generally if your stops are getting hit on good trades, you aren’t placing them correctly to begin with. It is better to modify your stop loss strategy. By moving your stop loss to avoid having it hit, you are defeating the protective purpose of it.

When coming up with your stop loss strategy, just remember to set stops that make sense for your account and trading style. The whole point is to limit your losses when you are wrong. If your losses continue to be excessive or your stops are constantly hit, you may need to rethink your system.