Every trader/investor must guard himself against draw downs, which refer to the percentage drop in his account size after one losing trade or consecutive losing trades.
For example, imagine that after losing a few trades in a row, your $20,000 account is reduced to $12,000; that would be a drawdown of 8,000/20,000 = 40%.
If I were to ask some new traders, “In order to be back up to $20,000, what percentage return do you need to generate?”
Many would answer, “Since I lost 40%, I have to make back 40%!”
This couldn’t be more wrong! Note that after losing 40%, the trader now starts with a lower base, i.e. to undo the $8,000 loss, the return he needs to generate is 8,000/12,000 = 66.6%!
The more severe the drawdown, the harder it becomes to undo the damage, as shown in the numbers below.
Drawdown%……%Required to get back to break even
10%……………….11.1%
20%……………….25%
30%……………….42.8%
40%……………….66.6%
50%……………….100%
60%……………….150%
70%……………….233.3%
80%……………….400%
90%……………….900%
That is why all professional money managers only risk 1-2% per trade. It’s because no matter how good your trading system is at some point it is a statistical fact you will have 10 losers in a row.
Based on risking only 1-2% per trade this is only a 10-20% drawdown and easily recovered. 99% of the hype trading and investing courses in existence don’t say or do this. They say risk 5-10% per trade. It is wrong and will cause you serious financial pain if you follow their advice.
Many of them also use arbitrary stop loss advice. For example they say, “Place your stop at $100.10 because that is on the other side of a major support or resistance, trend line, MA, etc.”
This makes your risk based on the size of the stop. That is also wrong because the risk can be too large and it’s not the same risk on each trade.
Others reverse this and say risk only 2% total period and let that determine your stop. This is also wrong and will hurt you because it is important to have the correct technical stop.
The answer is to do both. Use a % and technical stop together. It works like this. Let’s say the technical stop is $100.10, but based on your entry price that is a 3% risk. Since your plan calls for a 2% risk you simply lower the number of shares you are trading.
This lets you stay within your 2% risk and have the correct technical stop. This is exactly what most professional money managers do. I know because I used to trade 50 million at a time and risk controls with correct technical stops is the number one priority.
Some say that this will lower their profits because of trading fewer shares. So what? Study the numbers above again. You know the old quote, “More risk equals more reward.” Well it’s not always true. Sometimes more risk equals more risk! If you lose your money you have no chance to make a profit. Even losing 50% is disastrous because you would then need to make 100% to get back to even.
Like Warren Buffet says, there are only two rules in investing.
Rule #1: Don’t lose money.
Rule #2: Don’t forget rule #1.
I’d like to add a third rule. Correct money management and position sizing must be mastered to insure your long term success.
The good news is that it is easy to have correct money management and position sizing. I just explained how to use a combo of a % stop and a technical stop.
Your system of entries, stops and profit taking is only half of your key to success. The other half is money management. If you get this part wrong you will lose your account every time regardless of how good your system is.
Learn more about ETF Trend Trading or ETF Trend Trading Course
Jason Goode
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If you are looking for investment tools that will help you become a better investor then this article will point you to some of the more popular ones available online and the best part is that they are all free. You can google them or you can get all the links at darvas.
So here goes the list…
Magic Formula Investing : This strategy by Joel Greenblat shows how successful investing can be made easy for investors of any age with a “magic formula”, that makes buying good companies at bargain prices automatic. He has a free web site where you can search for these companies. Start with a few companies at the beginning. You take a look at your portfolio once every year and sell companies not in the list and replace them by the new ones. You can also read his book “The Little Book That Beats the Market” as your guide. You’ll know exactly where to go and what to do—and it won’t even take much time
Darvas Box: Use the strategy used by Nicolas Darvas who Turned $25,000 Into $2.25 Million Using A Simple Trend Following Technique. I have also put a link for a tool on my site which allows you to use the “Darvas Box” technique. Using this technique use you decide your “sell price” along with your “buy price”. No more guess work. A Darvas box is an area of price consolidation wherein the stock treads over a long period of time. The premise behind the Darvas box system is that when the stock breaks out above the top of the box, it triggered a buying opportunity.
A.I.M. – Automatic Investment Management : Robert Lichello provides a revolutionary investment method that overcomes the vagaries and risks of both the market and individual judgement. Automatic Investment Management (AIM) is designed to work in any kind of market with any size investment. You can use it in your 401K/IRA. You can use it with stocks or mutal funds. It is a plan that gives the investor a systematic and logical model for managing the ownership of long term investments. It is tax efficient in that most capital gains generated are long term in nature (over 12 months of ownership). It is generous in its realized profits (approx. 30% LIFO gains generated between a buy and a sell). It is a contrary model buying into market weakness and selling into its strength.
Rule#1 Investing : Phil Town’s strategy relies on Rule#1, which the famous investor Warren Buffett will tell you is, dont loose money. It essentially comes down to buying shares of companies only when the numbers—and the intangibles—are on your side. I will also give you a tool on my site to search for value stocks at bargain, based on Phil Towns Rule#1 Investing.
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An investment firm is an organization (limited financial obligation firm, business concern, partnership or corporation) that issues investment securities and is primarily engaged in the dealing of investment securities. The performance of an investment firm depends on the performance of the assets and another protections that it owns.
In common, investment firms is termed as a financial installation, which sells stocks and shares to individuals and invests currency in protections of other companies. By putting money in assist of their stockholders, an investment firm is liable to their gains and losses. investment firms are also termed as Investment Companies and are very much affiliated to the Investment Bank concepts.
Investment Banks assist government and private bureaus in respect of increasing money over issue of protections and selling them into the capital market. They also assist the private and common financial corporations in setting funds from the primary market with the assistance of both debts and equities. In addition, they provide valuable guidance and hints in acquisitions and fusion of firms and other financial dealing.
U.S. securities of SEC (Security and Exchange Commission) law separate three different kinds of investment firms namely Mutual funds, UIT (Unit Investment Trusts) and Closed-End Investment Company.
Kinds of Investment Firms – In Brief:
Mutual fund companies focus on mutual stocks that are joint pool of assets. They get big money from investors and put in share-market, bonds, equities, money market securities and instruments. There are different classes of mutual funds available for investors such as equity funds, money-market funds, hedge stocks and open-end stocks. Mutual fund companies are the kind of investment firms where financial manager trades in the firm’s primary protections, actual investment benefits, incentive and corresponding losses.
Dissimilar a mutual fund company, the Unit Investment Trusts is a United States investment firm, which has fixed security portfolios. These portfolios are brought some specific period. A Unit Investment Trust (UIT) does not have an investment consultant, corporate officer or directorate, to offer advice or guidelines during the lifespan of the trust.
A closed-end stock implies collective pool of assets but by specified number of stocks or shares that cannot be established until the funds liquidate.
Overview:
Each variety of investment firms has its own distinctive features. For instance, UIT and mutual fund shares are convertible. Meaning, while investors want to sell their shares, they can easily sell them back to the Trust or Fund Company or to brokers acting on behalf of Trust or Fund Company at the approximate Net Asset Value. On the opposite, close-end fund shares are not exchangeable. Therefore, those investors who desire to sell shares can sell them to the secondary market investors at a planned price by the market. Furthermore, there are differences inside each kind of investment firms in terms of exchange-traded stocks, bond funds, stock stocks, money market funds, interval stocks and index funds. Investment firms such as Merrill Lynch, ING Investments and JP Morgan are some of the famous investments firms all round the world.
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Trading stocks involves two basic decision areas: stock option and timing. In other words, what stocks to trade and when to pull the trigger. For those of you who are not veteran traders, here’s a basic investment guide to simplify stock selection for you.
Trading stocks is unreliable enough without adding an extra element of risk to the mix. I’ll refer to this extra component as proper risk. Let me give you an example of proper risk, and why I attempt to avoid it.
The stock market has been volatile and financial stocks are the focus of attention. After being pounded for a few days, you expect them to rebound. JKL Financial has been particularly unreliable for no obvious cause. It’s early in the trading day when a news alert reaches the market…great economic data. You start on JKL. Sure enough the stock market soars on the great news, lead by financial stocks. JKL gets a dive. After getting your loss like a man, it comes to your attention that JKL’s accounting exercises were in doubtfulness, and the news went public.
Few things ruin the trader’s day more than lost chance. In this case it was a matter of good timing…bad stock option. In trading stocks I’ve gave on getting the best stock to trade, and have in effect annihilated proper risk. Now trade stocks named ETF’s. Here’s a primary investment guide for those of you new to trading stocks who desire to simplify your trading life.
ETF’s (exchange traded funds) trade as stocks on the major exchanges. The popular stock ETF’s are index funds that track a stock index. Trading these vs. individual stocks like JKL Financial has its rewards. This brief investment guide highlights the ETF advantage.
You can avoid proper risk by trading the major-index stock ETF’s. For example, (SPY) tracks the S&P 500 Index. If the stock market is up as measured by the S&P 500, (SPY) should follow suit.
Traders can focus on a sphere or industry group of stocks by buy and selling a single stock. For illustration, instead of picking JKL Financial, you could have sold (XLF) which tracks an index of major financial stocks. In which case you’d have established money and not lost it.
You can sell and earnings from price increases in hard pluses or commodities like real estate, primary materials, oil, and gold by simply trading the befitting stock ETF.
Stock traders can go long or short (bet up or down) with one easy buy dealing in their brokerage account. If you want to bet that stocks will fall, you simply buy a short ETF.
Stock ETF’s can be bought on margin, like another stocks can if you want some leverage.
If you want to huge or multiple your profit posible and risk, you can do this simply by trading leveraged ETF’s. For illustration, (UYG) gives you double the action in financial stocks, and (FAS) gives you three times the process
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Learn Commodity Trading. Commodity trading can be fun and profitable if done well. However, commodity trading is never easy. It’s not meant to be. It does not matter whether you are trading gold, soybeans or bonds; a successful speculator has to keep an eye on what is happening in many markets around the world.
We must learn to trade like mercenaries, trading not on the bull side or the bear side but on the right side. Commodity trading is certainly not for everyone. So what is the right vehicle for commodity trading? It depends on what commodity you want to invest in.
Commodity futures: Although many new futures products have been introduced but the physical commodities still are the major components of the futures market. Until 1970s, the futures markets and commodities were synonymous because the futures markets were all about those physical products that you could touch, taste, grow, mine, consume or deliver.Trade Dow Futures.
Like other segments of the futures markets, commodities can be broken down into several categories like metals, energy, grains, livestock, food and fiber. Metals include copper, gold, palladium, platinum, silver. Learn Candlestick Charting.
Futures on Energy did not begin trading until 1978 when the New York Mercantile Exchange (NYMEX) launched trading in heating oil. Crude oil futures began trading in 1983. Natural gas futures contracts also get traded on NYMEX. The energy futures market has become one of the most important gauges of the world economic and political developments.
Similarly you can trade copper, silver, platinum futures contracts on different exchanges. Now gold is a very important precious metal. Gold futures contracts trade on NYMEX! Chicago Board of Trade (CBOT) offers mini gold futures contract with lower margin requirements for retail investors.
Like all commodities markets, meat markets also have a number of futures contracts like the feeder cattle contract, lean hog futures contracts, pork bellies contracts. CME offers milk futures contracts as well as the live cattle contract.
Similarly you can find many futures contract that cater to the agricultural markets like soybeans futures contracts, corn futures contracts. You will also find coffee sugar, orange juice and coca futures contracts traded on various exchanges.
Although the futures markets offer the most direct way to invest in commodity trading, equity markets also offer access to commodity trading in an indirect manner. You can invest in companies that specialize in the production, transformation and distribution of these commodities.
For example by investing in the diversified mining companies like BHP BILLITON or electric utilities or the integrated energy companies like EXXON MOBIL will still allow you to profit from the commodities boom.
You can also invest in the Master Limited Partnerships (MLPs) that invest in energy infrastructure like the oil pipelines and natural gas storage facilities. You can also invest in commodities mutual funds and exchange traded funds that deal with the commodities sector.
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