Iron Condor Trading Course

After a few months of writing my new Iron Condor Course is now available for download. Download the free Iron Condor Course here. Later on I will upload a new video that shows how to enter a Iron Condor into OTrader. OTrader can manage any combination of option strategies including the Iron Condor. If you have questions let me know.

Bill Buchanan – Trader Interview

Q. What’s your name? Bill Buchanan Q. What is you website address? http://www.rightedgesystems.com Q. Can you give us a little bit of background about how you got involved in Trading and what led you to become such an expert? I began trading stocks in 1998.  Things were simpler back then, you placed an order, the stock went to the moon, you sold for a profit.  Obviously, this “strategy” didn’t hold up very well during the subsequent bust.  Having an analytical and programming background, I took to system trading very quickly. I’m not sure I could call myself, or anyone, an expert.  It is a constant evolution of both technology and psychology.  The game constantly changes.  Ones risk tolerance and objectives evolve too.  I find myself paying a lot more attention to risk than when I initially started down this path. Q. How long did it take to you to become really become proficient at Trading? If by proficient, you mean profitable, years.  The main problem was that of self discovery and understand what the pitfalls of trading systems were.  It was very easy for me to fool myself by means of ignoring issues like data problems, system shortcomings, execution feasibility and the host of other things that a backtest just can’t describe.  Unfortunately, I had to learn this the hard way.  That means, I had to lose money. Q. What markets do you trade? Is there any reason for choosing them? U.S. equities.  Mostly ease of access and liquidity. Q. Would you view yourself as a fundamental or a technical trader? If both what percent to give to each? I’m evolving a little here.  I was purely technical.  Over the last 2 years, I’ve been introducing light fundamentals into the equation.  This is mainly used as a screening parameter or as a means of culling a watchlist. Q. Are you more a systematic trader or discretionary trader? Mostly systematic.  RightEdge must generate a signal for me to even entertain the idea of trading.  However, based on risk parameters that I define, I may pass up the trade if I feel I’m too heavy.  A good example of this is financials.  My systems are still generating trades, but I’m well exposed at this point and will decline a trade in that sector for the time being. Q. Is there a certain instrument that you like trading? I.e. options, shares, warrants, CFD’s, futures, forex? I am mostly an options trader.  Although I will dabble in stocks from time to time.  The reason why I like options is that I can craft a position that’s in tune with my outlook.  For example, given the recent volatility, I’m much more likely to open a spread position to cap my risk (and decrease my reward).  In less volatile markets, I may be more inclined to accept more risk. Q. Are there any specific strategies that you trade? Can you provide any details of them? I’m a band violation / mean reversion trader.  I also use other technical indicators to confirm the strength or weakness of the violation. Q. Do you or your systems trade every single day? No.  I may get several signals in a day and run dry for a several days. Q. How do you react to the winning and losing streaks? I usually have my risk and reward well defined from the beginning.  The risk I take is acceptable to me upon initiation, so I just let things run their course.  I have good days, weeks, months and bad ones.  Staying detached is always a challenge, but one I’ve spent a lot of time working over the years.  I feel that I’m better than most at this point. Q. What is the most important part of that discipline? What is your golden rule? SWAN.  This is an acronym I stole from a local financial planner.  It stands for “Sleep Well At Night”.  If a position has me nervous, I’m out.  No matter how good or bad the P/L is, sleeping well at night is my golden rule for anything. Q. What charting systems do you use? RightEdge.  Naturally, I’m biased, but being a system trader for so many years, charts were something we spent a lot of time on.  If I couldn’t use them for real trading, they weren’t going to work for our customers. Q. What news/broker services do you use? I don’t trade the news at all. Q. What portfolio management / trade tracking software do you use? Interactive Brokers provides me with sufficient portfolio management.  Risk analysis for live trades is done with Excel on an as needed basis.  Risk analysis for backtesting strategies is done with RightEdge. Q. What kind of risk do you take on a position? When if ever would you increase this risk? Each position is less than 2% of my overall account value.  In a band violation situation, I may increase the position size up to 2 times.  This is rare and is usually only done on indexes or something that has a very low probability of failure.  Couple this with the fact that it’s always a small percentage of my account value, it allows me not to violate the SWAN rule. Q. Do you use stop losses and things like that? No, options really serve as a stop loss.  If I trade a spread, max risk/reward is defined.  I find stop losses severely degrade system performance. Q. How do you handle your position sizing for each trade? Percentage of overall account value. Q. What do you find so good about Trading and the markets? It’s a thinking man’s game.  It forces a lot of discipline, thinking, analyzing and self discovery. Q. Do you remember your very first major trade/win? Yes.  UBID – 1998.  Bought at 40 3/4 (remember when they didn’t quote pennies?), sold at 180 in just a few days. Q. Can you recall your worst trading day? How did you deal with it? It was sometime in 2002.  I had put my first heavily curve fitted trading system into production after a single night of backtesting.  How foolish.  I dealt with it by learning my lesson and never making that mistake again.  The hardest part in this isn’t losing the money, it’s usually letting your spouse know that you were an idiot. Q. What do you consider are the characteristics of a successful trader? Persistence and perseverance. Q. If you had one secret to give about Trading, what would it be? 3 things.  Paper trade, paper trade and paper trade again.  There are so many strategies that backtest well and I would say 1% of them actually trade well.  Also, it’s easy to get confused by the instruments that you’re trading.  I run into so many folks who get into a position, the position goes against them and now they want to understand why and how to get out.  This is precisely the wrong time to understand what you’re trading. I would personally like to thank Bill Buchanan for taking the time to reply and provide some insight into his style of trading. James Ramsay Visit www.otrader.com.au for more interviews and a Free 20 trial of our Stock and Option Portfolio management Software

Dr. Barry Burns – Top Dog Trading Interview

What’s your name? Dr. Barry Burns What is you website address? http://www.TopDogTrading.com Can you give us a little bit of background about how you got involved in Trading and what led you to become such an expert? I was a businessman and owned several small companies over the years. When I decided to make a career change I did a lot of research to find the perfect career for me. It had to be something with enormous income potential. But I also wanted time and travel freedom – to be able to work when I wanted, where I wanted and only when I wanted. Finally, I was pretty burned out on always catering to customers needs. I wanted true independence. When my due diligence was complete, there was only one choice left standing: Trading! My dad was a stock trader for 70 years before he passed away. So I had grown up with it in the household and my dad had taught me some things when I was a kid, but at the time I was more interested in karate and girls. When I realized that trading was the perfect career for me, I started looking into it again and things had changes dramatically since I was a kid living at home. Electronic Trading was just coming on the scene and it was a very exciting time. The average person was more empowered to compete with the big boys. I joined a local trading club and read every book I could get my hands on (over 100 eventually). And when I was ready to make the commitment to become a full-time trader, I called my dad and asked him to mentor me again. He agreed and I moved back in with him for a short time to become his student. After that I put a lot of screen time in, and later found 3 more mentors who were willing to work with me. One of them was a floor trader in Chicago. How long did it take to you to become really become proficient at Trading? I went through years of being successful for a while and then losing again. In fact I found that just as there are cycles in the markets, there were cycles in my own behaviour and my trading method. Learning that cycle helped me be aware of when I was in a down cycle and to stop trading. People focus on trying to control the markets, but that’s impossible. What they really need to do is learn to control themselves. The owner of our trading club said in his experience it takes people at least 4 years to become a professional trader. I’d say that’s about right, although it varies dramatically from person to person. What markets do you trade? Is there any reason for choosing them? I swing trade and day trade. I had started trading stocks simply because that’s what my father did. Now I also trade futures, currencies and options. For years I was afraid of the leverage of these other instruments, but now that I’m better at managing my risk, the leverage allows me to make so much more money. Primarily I swing trade stocks and ETFs and day trade futures and forex. Would you view yourself as a fundamental or a technical trader? If both what percent to give to each? I’m close to 100% technical trader. That’s all I look at. If I hear some good news regarding the fundamentals of a company, I may look at the company, but when I do, I’m looking at the company’s chart. Are you more a systematic trader or discretionary trader? My trading rules are extremely objective. Anyone trading my rules precisely would be trading the same way. However it’s just a fact that people who master any skill or profession incorporate a lot of their experience into their subconscious. It’s natural and unavoidable. It’s like the master saying to the kid “I’ve forgotten more than you’ll ever know.” What the master has “forgotten” is not in his/her conscious mind, but that information is still at work in the subconscious influencing what they do. Are there any specific strategies that you trade? Can you provide any details of them? My strategy is very objective and scientific. I look for 5 market “energies” to align in the same direction and at the same time. The alignment of these energies creates a probability scenario that favors my position. It’s my edge. It’s what puts the odds on my side. Those 5 energies are: 1. Trend (direction) 2. Momentum (trend strength) 3. Cycle (timing highs and lows for entries/exits) 4. Support Resistance (blockage to energy) 5. Fractals (looking at the bigger picture or scale) If you are in a take-profit situation and your system is telling you to exit rather than hold on, how do you bring yourself to exit even if it’s still running in your favour? Most of the time I exit with hard limit orders. They are placed before those levels are reached. I let the market take me out rather than depending on myself to make a split second decision and risk hesitating. How do you react to the winning and losing streaks? Winning and losing streaks are a natural part of trading. They are part of the “cycles” inherent in the market. The key is to have stop losses in place to minimize your draw down. Just as I place a hard stop loss in every trade I execute, I also have stop losses based on a percentage of my account for every day, every week, every month and every quarter. If my daily stop loss is hit, then I stop trading for the rest of that day. If my weekly stop loss is hit, then I stop trading for the rest of that week. If my monthly stop loss is hit, then I stop trading for the rest of that month. Likewise, I have trailing stops that work the same way. If I’m in a trade and I’ve made a lot of money, I’m not going to allow that trade to turn into a loser. I’m going to put in a trailing stop on that trade to make sure I lock in some profits if the market turns against me. So too, I have trailing stops for every day, week, month and quarter. If I’m up a certain amount in a day, and then I start losing money. I have a daily trailing stop that won’t allow me to give back all my profits for the day. If that daily trailing stop gets hit, then I stop trading for the day. The same principle applies for the week, month and quarter. This is one aspect of money management that is critical and I don’t see many traders utilizing it. What is the most important part of that discipline? What is your golden rule? The most important thing is to keep my losses small. Not all my trades are winners. But if I can keep my losses small, then I can keep trading until the big move comes along and I catch it. To do this, you must be very picky on your trades. The #1 sin for most retail traders is over trading. My opinion is that the market is mostly a random walk. But periodically things line up to give you a high probability trade. It’s not a predictable trade as the market is never predictable. But it is a probable trade. For me, this is when the 5 energies align at the same time as mentioned earlier. The key is to be patient and wait only for those times. Let the retailers (amateurs) over trade. We stand on the sidelines and watch them chop up their trading accounts and wait patiently for the real opportunities. There are plenty of good opportunities. My slogan is to take “fewer, better trades.” What kind of risk do you take on a position? When if ever would you increase this risk? On a chart I only risk a bar to a bar and a half on my trades. So my risk is small. And even when my trades don’t succeed, I’m usually not even losing that much because of the way I manage the trade. My rule is to keep my risk on each trade to no more than 2% of my account. How do you handle your position sizing for each trade? My rule is to risk the same dollar amount on each trade, so I adjust the number of shares/contracts to match that dollar amount. What do you consider are the characteristics of a successful trader? Psychology is the most important thing. I think the Mark Douglas books are excellent and should be required reading by everyone. I would highly recommend his books “Trading in the Zone” and “The Disciplined Trader.” If you had one secret to give about Trading, what would it be? There is no one secret, but I have several slogans I live by. I’ve been around trading for so many years now and heard so many things that I forget where they all come from, but they may be from Mark Douglas. My favorite trading sayings are: 1. Successful trading is simply a business of not making mistakes. 2. The consistency you need is in your mind, not in the market. 3. Be like the Jaguar – crouching perfectly still, waiting for the setup to come to you, then pouncing without hesitation or thought. You only need 1 to feed the family. The first two are about learning to discipline yourself, which is the key. Becoming a master trader is not about mastering the markets, it’s about mastering yourself. The last one is about over trading. Any further comments you would like to add? If any of your readers would like to learn more about my trading methodology, I’ve put together a free 5-day video course which they can have by going to: http://www.TopDogTrading.com/free_course.html I would personally like to thank Dr. Barry Burns for taking the time to reply and provide some insight into his style of trading. James Ramsay Visit www.otrader.com.au for more interviews and a Free 20 trial of our Stock and Option Portfolio management Software

Gary Tanashian – Trader Interview

Q. What’s your name? Gary Tanashian Q. What is you website address? http://www.biiwii.com Q. Can you give us a little bit of background about how you got involved in Trading and what led you to become such an expert? Well, I think expert is a strong word because I don’t believe anyone ever masters trading.  I have some things that work for me much more often than not however. As for my background, it is actually in business as the owner of an American manufacturing company where I developed an interest in macroeconomics while niching the company’s successful place in the world.  From macroeconomics, I began looking at market sectors and the stocks therein. I do not trade stocks exclusively on technicals, even though TA is probably my strongest area.  A given sector must be in alignment with my view of the macro landscape.  This helps me be a strong holder when necessary.  I find I would be a weak hand when holding something for purely technical reasons and frankly do not have the time to baby sit positions.  So also you can gather that I am more of a swing trader than flipper. Q. How long did it take to you to become really become proficient at Trading? About four years.  The bear market of 2000-2003 taught me that I was good at market timing; trading those huge bear rallies and declines.  It was like a meat grinder, but it got me attuned to the market’s rhythm. Q. What markets do you trade? Is there any reason for choosing them? At this moment, the gold market.  Specifically the gold miners.  The reason is simple, the gold stocks as represented by the HUI and the EFT GDX, are making what I believe is a historic bottom.  I am not necessarily bearish the US Dollar as measured in competing currencies, so I am not like the gold bugs who can tend to have an us against them mentality. What I see when I look at gold’s ratio to oil, to industrial metals and to human hopes for prosperity is hockey sticks!  Just like what the USD did in October.  The same forces that drove up the Dollar drove up gold’s ratio to gold miners’ cost inputs!  It is the play of year and likely the start of a new bull markets. I am also bullish broad markets for an extended trade, not due to fundamentals but rather due to technicals and historically bad sentiment. Q. Would you view yourself as a fundamental or a technical trader? If both what percent to give to each? Fundamental 40%, technical 60%. Q. Are you more a systematic trader or discretionary trader? Definitely a discretionary trader, using a good dose of instinct. Q. Is there a certain instrument that you like trading? I.e. options, shares, warrants, CFD’s, futures, forex? I mostly trade shares and once in a while a few puts and calls. Q. Are there any specific strategies that you trade? Can you provide any details of them? I am a bottom feeder, pure and simple.  I see an inverted head and shoulders or massive falling wedge with bullish divergence by indicators like MACD and RSI I get very interested.  I will also look for trend by AROON and confirm with Wm%R and when I see several indicators hinting at reversal, see a bullish pattern and some clear support and resistance points all showing a confluence toward a given outcome, I then pay close attention.  But I must be on board with the fundamentals as well. If you are in a take-profit situation and your system is telling you to exit rather than hold on, how do you bring yourself to exit even if it’s still running in your favour? I do not have seller’s regret.  Well, maybe just a little.  But it comes with the territory and emotion should not be part of the equation. Q. Do you or your systems trade every single day? No. Q. How do you react to the winning and losing streaks? Even keel.  Act like I have been here before.  The market can be very humbling so I may as well make an attempt at humility on my own before it is forced down my throat. Q. What is the most important part of that discipline? What is your golden rule? Keep that emotion contained.  I am not the genius I think I am and I am also not as dumb as some trades have made me look.  If you show up with a brittle ego, you are done. Q. What charting systems do you use? I use stockcharts.com.  I really do not watch live charts that come with my trading platform.  Again, I try not to micro-manage positions. Q. What news/broker services do you use? None, except as contrary indicators. Q. What portfolio management / trade tracking software do you use? Fidelity Active Trader Pro Q. What kind of risk do you take on a position? When if ever would you increase this risk? It varies.  Throughout the bull market from 2003 to 2007 I was pretty pleased with the fact that I managed risk at ALL times by generally keeping a 50% plus cash position and still doubled the bull market’s performance consistently over that period. As a bottom feeder, I will increase risk at a time like now for instance, when the crowd is frightened.  Of course the opposite holds true as well and when the herd gets over confident, I decrease risk. Q. Do you use stop losses and things like that? Very rarely. Q. How do you handle your position sizing for each trade? It varies.  I generally have many positions and each position is weighed against the overall portfolio. What was your best trading day/week/month? What was going through your head? I am sorry, I cannot recall to that level of specificity.  But I will tell you what was going through my head; I just KNEW I was a genius, so I sold a bunch of stuff before the market taught me it wasn’t true. Q. What do you find so good about Trading and the markets? It allows me to match up against a massive, emotional and sometimes very predictable collection of other human beings.  It allows me to practice something that comes pretty natural for me, a contrarian outlook. Q. Do you remember your very first major trade/win? No. Q. Can you recall your worst trading day? How did you deal with it? Yes, I was on my way to get a root canal.  I checked the market in the waiting room on my Treo phone.  They called me in and I told them the procedure would be a welcome change from the day I was having. Q. What do you consider are the characteristics of a successful trader? 1) Keep emotion out of it. 2) Keep emotion out of it. 3) Keep emotion out of it. Q. If you had one secret to give about Trading, what would it be? Keep emotion out of it. Q. Any further comments you would like to add? Thank you for the opportunity to give one trader’s view.  I realize there is a lot of sharp people out there with good systems that work more often than not.  My thing is basically just a good b/s detector, a firm view on sector fundamentals and charts.  I am actually quite simple as a trader compared to some folks who have really gotten this down to a science. I would personally like to thank Gary for taking the time to reply and provide some insight into his style of trading. James Ramsay Visit www.otrader.com.au for more interviews and a Free 20 trial of our Stock and Option Portfolio management Software

Written Option Strategies for a Volatile Market

With increased market volatility over the last 12 months it seams appropriate to have a look at some written option strategies to benefit from. Over the coming days I will cover:
  • Writing options – Call and Puts
  • Spreads including Bull Call Spreads, Bull Put Spreads, Bear Call Spreads and Bear Put Spreads
  • Combinations including Long Strangles, Short Strangles, Long Straddles and Short Straddles.
In each strategy I will cover how time decay and volatility affects the strategy. To start I will go over the basics of how volatility works, how time decay affects you, what effect dividends will have and how an interest rate change can affect your position. Once the strategies and basics are covered I will go over some advanced options parameters such as Deltas, Option pricing and Options Probability Calculators. Finally I will finish of with my entire Iron Condor Strategy document. As always if you have any questions along the way let me know.

The benefits and features of writing Covered Calls

#1 Additional Income Writing covered calls can provide you with an ongoing stream of income from the option premium. This is particularly important when stocks do not pay dividends or pay very small dividends. The call option premium can also substantially increase total returns in flat or slower growth stock markets. #2 Income paid up-front The income from writing covered calls in credited to your account the next day, creating immediate cash flow that can be reinvested, withdrawn from cash management accounts or used to pay interest on margin loans. Since the call option premium is paid up front it can be reinvested to enhance the total return of your portfolio. #3 Predetermined Return In a rising market, the immediate return from call writing can be evaluated prior to initiating the investment position. You will know what the call writing income will be and the maximum additional capital appreciation you may expect from your shares. Covered Call Portfolio Management Software The Trader’s alternative to MYOB, Quickbooks and Excel. Get your FREE 20 day trial of OTrader Investment Portfolio management software for stocks, options and warrants. #4 Risk Reduction If a stock declines in price,(Not that they ever do that…) the call writing income will help to offset some or all of the capital loss. Writing covered calls will provide some downside protection when stock decline in value. #5 Cash Dividends As a writer of covered calls you will continue to be entitled to cash dividends so long as you own the shares. Beware dividends can lead to early exercise though. #6 Novation Exchange-listed option contracts like shares, are interchangeable with another contract with exactly the same expire month and strike price. This is known as ‘novation’. This enables the covered call option to be initiated through a ‘sell to open’ order, but also to close out the position if desired through a ‘buy to close’ order. Got a question about covered calls? Let me know.

Options Probability Calculator

With the current market volatility now is a good time to brush off those options strategies. My personal favorite is the Iron Condor which is made by using a bear call spread and bull put spread. With the Iron condor we are looking to sell time and volatility. We look to sell options with a > 75% chance of expiring worthless. The Options Probability Calculator will help you determine which options have a > 75% chance of expiring worthless. In the coming weeks I will be releasing my report of how I trade Iron Condors. It is an eight step check list for opening and closing the spreads each month. Let me know if you would like a copy.

How to Calculate Risk/Reward Ratios

Risk to reward ratios. If there is a cornerstone to any trading philosophy, it starts at the risk to reward table. Although identifying good risk/reward trades does not guarantee success, not identifying good risk/reward trades almost always guarantees failure. Let’s explore yet another important subject in the life of a trader and look at a trade setup we took late Friday in the context of this subject matter.

Determining a Good Risk/Reward Trade

Contrary to popular thought, successful traders can take on any type of trade in terms of size and risk as long as they first understand the implications of the trade and are willing to stomach the losses should they occur. If a trader feels that they have the hot hand, they may choose to press a bet (to make a larger than normal purchase or sell on the belief that the odds are in their favor). They do this knowing that they may suffer greater than normal losses if the trade doesn’t pan out. Traders do this all the time. It is critical, if you are to be successful, to understand that trading is a game of probabilities. Technical traders are simply looking for patterns with a greater than 50/50 chance of repeating themselves over and over again. Once such patterns are identified, traders attempt to recognize such patterns in current charts and then identifying entry and exit points based on those charts. Entry and exit points are typically associated with support and resistance areas of the charts. Ah, support and resistance areas. These were the tools of the early traders, traders that read the tape … traders that were successful at technical analysis long before the advent of all these derivative indicators, these answers to the problem of technical trading, this onslaught of technical wizardry. The oldest and purest form of technical analysis is support and resistance. Understanding it provides a large portion of the technical analysis that one needs to be successful at identifying entry and exit points.

Calculating the Risk/Reward Trade

In previous chapters we have talked about the need to identify potential trades based on chart patterns. The idea is that you collect a set of candidate charts, charts that have positive prospects for immediate or reasonably near term trading time frames. It is with these candidate charts that one can dig deeper into the possibility of trading that particular issue. The identification of a probable trade centers around the proper identification of realistic entry and exit positions based primarily on support and resistance. Once you have properly identified the support and resistance points you can take those numbers, plug them into a simple spreadsheet and calculate the risk reward. The simplest form of calculation involves nothing more than the following
  • Entry Price
  • Stop Loss Target
  • Stop Profit Target
  • The resulting Risk/Reward Ratio
Now, let’s apply this to a particular trade. The following graph shows NEM as it looked on May 17th, 2002. Gold is enjoying a significant run up and this trade actually goes against the prevailing trend, attempting to time a quick short trade based on chart patterns. On the fundamental side, there is concern that gold could continue to rise as the dollar continues to weaken and as world events dictate increased fear on the terrorism front. On the other side of the coin, the technical picture shows a potential short candidate given the annotations provided below. View image here Given the chart above, here’s an example of the most simplistic risk/reward ratio calculation. In the end, it turns out that world events and the spot price of gold ended up making this trade a losing trade, but risk to reward calculation remains the same … regardless if the trade wins or loses.

Ranking Trades and the Spreadsheet

To see if a potential play is worth wagering money on, one must determine what the potential losses are if your analysis is wrong, and what the potential gains are if the analysis is correct. You should always shoot for a minimum of 2:1 ratio, that means that your potential profit should be roughly 2 times your potential loss. This is a rule of thumb that many traders use … especially the good ones. In the example above, if one enters a trade at the price of $29.12 with a define stop loss exit of $30.68 and a potential target exit for profits at $26, then the ratio is roughly 2:1 (a bit less in this case). That’s it. It’s really that simple. Recognize that once one has entered such a formula into a spreadsheet and begins using it, one can easily play with the numbers to make them work. For example, let’s say that NEM looks like a great short right now, but that the exit is really $31, not $30.68. Now, one could stretch the target to $25 even though the support lies at $26 in order to justify the trade, but the trader inside you knows this is not the case. When setting support and resistance points, one has to realize that if the numbers are fudged, the person fudging the numbers is the one hurt. It’s their money that’s on the line. An easy way around the temptation of making the numbers work, is to always look at the support and resistance points first and allow as much slack in the numbers as makes sense. Now, plug in the entry price. Does the risk/reward make sense? If it doesn’t change the entry price, not the stop or target prices. Jiggle the entry price to the point where it makes sense and then simply wait until you get that entry point or pass the trade up. There are always more fish in the pond. Once a number of potential trades are identified, the next step is to take a position in the trade. It is important to realize that no trade is a certainty as they are all probability based. The likelihood of success and failure can be quantified to some degree based on certain risk factors. By quantifying the risk factors and ranking the potential trades based on these risk factors, one can take a systematic approach to trading … an approach that can pay huge dividends. This is a laborious process that takes time and organization. The simplest way to organize this is via a spreadsheet. Since spreadsheets can contain simple arithmetic equations, you can easily build equations to compute the risk factors described below. When first experimenting with trade rankings, one should error on the side of simplicity as having too many factors is no better than having any at all. So how can you begin to construct a ranking system that allows you to increase your reward and reduce your risk? It’s not so much difficult as it is tiring. Looking back, you must first screen a large number of stocks and then flip through a large number of charts looking for technical patterns that have potential. The primary technical indicators you are interested in are those that have the highest percentage of success. Edwards and Magee go to great lengths to point out all types of technical trading patterns in their bible of technical trading, Technical Analysis of Stock Trends . The obvious factor when ranking trades is to balance the risk versus the reward with the idea that the higher the reward relative risk to the risk, the higher the probability over time that you will make money. The simplest way to calculate the risk to reward ratio, is to pick an entry price for a given stock and then ask yourself, where would you have to consider exiting the stock if it turns out that you are wrong on the trade. For the reward, you ask yourself the same question but the exit is associated with your having a winning trade. Based on how many shares you intend to trade, you can calculate the amount you will loose and the amount you will win. Don’t forget to add in your transaction costs as part of this. This is the fundamental basis of all ranking systems. From there, you can begin to add other variables such as, how long do you expect to be in the trade. The shorter the period of time relative to the risk/reward, the more money you can make over time (assuming you win more than you lose). As your refine your ranking system you will find that stocks with higher betas are naturally more susceptible to short trading periods given their volatility. Another key variable is a confidence factor. The confidence factor itself if typically based on several factors such as the probability that the technical picture is favourable, the probability of the market contributing to your individual stocks success. Regardless of the factors you experiment with, it is important that you keep your data available for study over time so that you can continue to refine your system. Without constant scrutiny, your ranking system can loose it’s value overtime as the markets are dynamic and always changing.

Embellishing the Formula

Once one has mastered the use of the simplest formula for risk/reward, one can consider embellishing the formula to include other criteria. For example, if one could reasonably judge the amount of time it takes a trade to play out, then that knowledge could be incorporated into the spreadsheet in order to rank the trades on a more favourable basis. Think about it. There is only so much capital to use when trading. Using that capital on the highest potential return over some period of time is the desire. Another key element of gaining the highest potential return on ones money is to associate a confidence factor into the equation based on the stock, the technical pattern being traded, whether the trade is in the direction of short, intermediate and long term trends, etc. Again, there are a number of factors that can be added to the formula to rank the trades and use that ranking as a basis for decision making. The desire is to remove some of the gut feeling that goes into trading with a more logical and less emotional process.

Analyzing the Results

Another advantage of plugging numbers into a spreadsheet s that one than then have a historical accounting of trades taken be they successful or not. Keeping ones historical data allows later analysis of that data in order to improve ones performance in the future. For example, examining historical data to determine where the largest losses were and then deciding if they were because of failed stop exits could provide fruitful insight to changing trading behaviours. The same is true for wins. Another exercise would be to look over the charts a month after the trade and examine other data points for exits (both success and fail exits). In doing this, one could speculate on what if scenarios such as, “What if I had maintained the position longer. Would it had continued to perform or would it have turned into a bust?”. The imagination can run wild with such scenarios and if you are like most, the amount of time available to ones research is limited to the minimum analysis of old trade data, but there is value in it. It has been said that if mankind doesn’t understand the mistakes of the past then we are doomed to repeat those mistakes in the future. Dwelling on the past is not the issue, but learning from it does have benefit. The game of trading is a lonely game. In today’s world it is, for the most part, a game of solitaire where individuals from all walks of life stare endlessly at flickering screens while moving piles of money around. One has to show the motivation to sharpen their game as no one else will. As we all know, if one is not on top of your game, at least in this game, one doesn’t last long.

Summary

Always calculate your risk to reward ratio prior to making a trade. Refuse potential trades unless the risk to reward ratio is 1:2, that is for every dollar risk, there is a potential for two dollars in return. By calculating your risk to reward for every trade you will ignore marginal trades and you will identify your exit points before taking a trade. Recognize that you want to understand your exit criteria … at the beginning of the trade, not sometime later. Once you are comfortable with simple risk to reward measurements and are identifying support and resistance zones reasonably accurately, you can consider increasing the complexity of your formula to consider other variables such as time and confidence. Lastly, keep your data points and analyze your successes and failures over time in order to hone your trading strategy. Article written by Technical Analysis Today – www.tatoday.com

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