Monday, September 27, 2010

Position Sizing X STOPs

I think one of the most important and still most overlooked aspects of trading is risk management.

If you don't have a system to control your risk you can be sure of one thing: you're on the right track to blow your account up (or "optionblast", like we jokingly say on Stocktwits' stream). Trust me on that one, I did blow my account many times before I understood it is a MUST to have a risk control system, at least a simple one as the one I describe here.

Below I explain how I use risk management in my trades on ES (I give ES as an example but it can be used in any market, you just have to do the math).

Before entering a new trade, once I know the area where I'll pull the trigger based on my edge, the first thing I check is where I'll have my STOP in case the trade does not work the way I expect, if the STOP is say 10 points away from my entry point, then this trade is not for me and I will pass it and wait for a better setup, the maximum loss my risk management rules will allow me to have is 3%  of my entire trading account (many people would feel more comfortable with 1 or 2% loss only).

Read this phrase carefully: you gotta love taking small losses, because if you keep the max loss to 3%, you would have to be wrong more than 30 times in a row to blow your account, by using that simple rule you will be able to live for another day, let's see an example:

Let's say your account size is US$ 20,000, the maximum you may lose is US$ 600 in a single trade, so if you have a setup that allows you to have a 3 point STOP, you may play with 4 cars for instance. You have to adapt your limits to the setups that are presented to you, not the other way round, like for example, playing with 8 cars and placing the STOP at 1.5 points, you might easily get stopped out.

And yes! Sometimes you will be stopped out and market will go in your favor, even when the stop is at the "correct" level, it kills you psychologically, but you will be happy that you used the STOP once you go through a fierce movement against you that would have wiped your account out if without a STOP...

Again, the STOP should not be based on a dollar amount but rather in a technical breach, meaning your trade might not work as expected, on the other hand, risk management will take care of the dollar amount to protect you.

This is a basic lesson on how you may determine the size you're going to trade, there's much more you can learn on this topic, but by using this simple system already keeps you protected from a catastrophy.

All you got to do now is objectively identify your edge and control your risk, good luck!

In the book below the author has great ideas about position sizing, I think it is worth reading it, enjoy:

Trade Your Way to Financial Freedom by Van Tharp

Friday, September 24, 2010

Trading from different parts of the world

One of the beauties of this business is being able to travel all around the world and still be at work...

I really like the idea of trading from different parts of the world for some time during the year, it clears my mind and helps me seeing the world from a new perspective and understand the different cultures.

I think one of the best parts of the world for the trader to spend a couple of months away from home is Europe due to the time zone there and good structure with fast Internet connections either by 3G or DSL and  they have such beautiful condos to rent in amazingly pleasant places for reasonable prices. If I had to choose one country to stay there I would choose either Spain, Italy, Greece or Portugal, and stay there from May to October, why?

Because besides having very beautiful beaches with wonderful sceneries, the temperatures are really pleasant, not to mention that the food in these countries are healthy and delicious IMO.

Once I spent 3 months in Spain, at the Canary Islands, Lanzarote, and it was just one of the best times of my life, I rented a beautiful villa with a breathtaking ocean view... The house was very comfortable with everything one needs to have a decent life, including cutlery, all the necessary appliances and nice modern furniture, all this for only 1,500 Euros per month. During those 3 months I traded so well, my account grew steadily each and every month, I felt like a million dollars!

If I wanted to trade London open I would start to work around 8 AM, but if I preferred to wait and only trade the NY open, then my day would start only after lunch, having a lazy relaxing morning and lunch... oh what a good life!

The small villages had so many different restaurants and most of them even offered a delivery service for those days when I didn't feel like stepping out, with a wide selection of good (and cheap) wine and fish, certainly a place to be...

Above, one of the many nice restaurants on the island, isn't it charming?

Already thinking about where to go next... suggestions anyone?

Monday, September 20, 2010

Emini: Why 10 ES points as a weekly target?

Many people ask me why I have decided to have a 10 point weekly target, well, the number by itself is already a very good target because if one can make 10 points a week that's 40 points a month, if played with only 2 cars for instance, that would give an annual return of almost US$ 50,000.00 and may be scaled up according to the account size, not bad at all!

I have my risk management set to a max drawdown in any trade of 6 ES points, which is equivalent to 3% on my entire account, so by knowing this I know how many cars I can play on any trade, I like to play with multiples of 5 cars so that according to the type of day, I may play from 1/4 to full position.

I have more or less around 20 good setups that I use to enter trades, but I actually use only 10 of them, I use the ones that have the highest odds of success, I mean I look for a 65-75% rate of success, I have lost quite a bit to understand this business, although I have to confess I was more like a gambler in the beginning years, so I know that if I want to be consistently successful in the markets I have to follow the rules day in and day out, otherwise it's just a waste of time and money.

Below I try to show how I use risk management and how I came to the 10 point weekly target:

These 10 setups that I take without hesitation when they show up, allow me to make around 10 trades a week, but "only" 70% of them will work, so, in a typical week, the trades go more or less like this:

70% of the trades are winners and I make an average of 3 points in each of them.

15% of the trades are half losers or b/e (break even) - I usually scale out and take 2 or 3 points profit depending on what market is willing to give me, I'm not greedy at all, I'll take whatever it gives me, so I'll lose only half, we'll put 6 points loss on half, then I have an average loss of say 3 points on entire position.

The rest 15% of the trades I make are losers, my losers range from 2.5 to a 6 points loss, so let's put an average of 4 points loss and let's see how these numbers work on those 10 trades:

7 x (+3) = 21 points
1.5x(-3)= -4.5 points
1.5x(-4)= -6 points

You don't have to be very good in math to know that the total here will give me 10.5 ES points for the week, got it? So now you know why 10 points a week.

Now it's just a matter of choosing how many cars to play according to the size of the account, I'll talk more about this in the next post.

Be well and happy trading!

Friday, September 17, 2010

Starting a new blog

Hi folks!
Anyone who knows me for a longer period of time from Twitter as @RenaTrader knows that I also have a passion for diamonds (you can read how I started in that business and also in trading by clicking “About me” on the right side of the screen) and I also write a blog about diamonds in Portuguese, so I thought: why not write another blog on my passion for trading?
So that’s what I decided to do, my aim is to try to help people by writing about the difficult task of becoming a trader and how to overcome most problems traders face when in the initial phase of the learning curve, I really think the 3 first years are the toughest, although many traders are able to make it in less time, but it was not my case. I myself thought several times it was just impossible to be consistently profitable and thought about giving up many many times… So I hope I’ll be able to help not only the beginners but also the ones who have been struggling for some time already on this tough path to to go in order to become successful in the markets.
Just a quick note: If you’re looking for charts you will not find any here, I'm writing this blog in order to share market knowledge on  risk management, trader’s psychology, strategies  and also some funny stories.
Feel free to send me emails or leave comments, I’m looking forward to hearing from you.
Good luck and happy trading!