Sept 26, 2011- Humbled by the Markets: Reviewing Money Management Strategies

“They (great traders) have all been humbled by the market early on in their careers.  This creates a definite respect for Mr. Market.  Until one has this respect indelibly engraved in their makeup, the concept of money management and discipline will never be treated seriously.” – Jeff Cooper, trader and author of Hit and Run Trading series.

How To Prevent Financial Ruin, Money Management Strategies:

Construct portfolio looking at multiple set of possibilities, and prepare a strategy for it.  Below are the most commonly used by traders turned “Ipit”/ Involuntary Investors:

a.) Martingale Betting Systems- These rely on luck, and need substantial drawdowns in capital.  Tough Way to make money. – Quit While You Can – If you’ve ever played baccarat, you would know what I mean.  For example, you make a $100 standard bet that takes the $100 bet , either resulting in +$100 or nothing.  After a run of five successive losses occurs, using a martingale system, the next bet will require $3,200 above the $3,100 already lost (100+200+400+800+1600=3100).  Thus, to bet the sixth time after five successive losses would require 6,300 hoping for a win that would just net $100 above the previous commitment.  This is a tough way to make $100, and chances are, the substantial drawdown capital will not be able to be withstood by the portfolio.  Even if you have belief that the company you’re investing in is not a penny stock, the Martingale system , as traders have found out for over many centuries GENERALLY NEEDS a LOT OF LUCK to work out for you.

Each trade brings financial havoc, which further perpetuates duress.

Note that traders don’t deliberately trade a Martingale system, but this is what their emotions led them to do, whether they knew it or not. That’s how vicious a cycle it is if you don’t learn to take small losses and flush your ego. Traders don’t think it can happen to them, and then all of a sudden they’re emotionally invested in the outcome of a trade. A trader must detach emotionally from the outcome of any particular trade.  If the scenario I typed above is you.  Quit while you can.

(Personally, I have to type and tell this myself, because I’m getting too emotionally attached to buying this market’s blue chips, when I should probably detach from buying prematurely.)

2.) An-Apple(AAPL)-a Day System

3.) Position Size – Predetermined Risk Level by the System Owner

For 2 & 3, this is my preferred strategy in buying this market.  Assuming you don’t know the bottom (I don’t know either), but believe values are around, consider buying 5000 pesos every single day of the week, with a possible allocated size of 50K pesos on the stock. Allow 10 tranches of pilot buys.  Allow drawdowns of 20-50%, as this is deliberately trying to bottom fish yourself.   Maximum drawdown on your 50K investment needs to be determined, whether it’s 10K -25K for that bottomfish.  Also, make sure the 50K investment represents around 20-25% only of the portfolio.

Above are simply examples.  The reason for example about the Apple a day system, is the risk of complete loss of capital.  Knowing how much you can lose on every bet (example, lose 500 pesos every day on that 5000 investment) will help the trader from not getting wiped out of his initial capital, until the final position size comes into fruition.

(The Apple A Day System is a real system that was employed by equity investors using $1000 as initial capital in buying the AAPL stock, this system resulted in 88% chance of profit over the 5+ Year Period).  Do not leverage.  This increases the volatility of the portfolio, magnifying the dangerous possibilities from increased probability.

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Important Reminders:

1.) Once lack of success begins, lack of confidence also begins causing even more errors of judgment.  The purpose of designing systems is to reduce the outside emotional effects and let the system operate by itself.  (2008 traders/investors can testify to the success of Apple a Day system–or in this case, type your favorite stock to bottom fish (example MBT).

2.) Trade One At A Time- 10 losing trades in 10 stocks is the same as 10 consecutive losses in 1 stock.  The drawdown is the same.

3.) Security Quality – There is almost 100% correlation when the market tanks that all companies go on sale (from bluechips, to midcaps to pennystocks).  Make sure you’re buying the quality securities (if you ever are).  Quality concept —I can’t address, as you have to read some fundamentalist blog for that.

Exit Strategies:

1.) Prevent Loss of Capital, or Close at a target profit or price – 

Placing your trading stops too tightly will prevent a single large loss, but many small losses are equally devastating as well. (Buy cut, buy cut 10X is very expensive).  Place a buy, have the right size. Have a number where you’ll cut. Example if a stock is bought at 60, and you will cut at 50- if one buys 1000 shares- he is willing to lose $10 drop *1000 or 10K loss in his portfolio (that possibility is just that, a possibility).  One needs to be open to the idea of many possibilities.

2.) Hard Money Stops or Dollar Stops

Assuming one has preserved trading gains, and wishes to buy (maybe premature, but one doesn’t know what will happen in the future), one can always use a dollar stop to bail him out if one is wrong.  Assuming you will risk $500 in the trade, know how much you will buy and look at the dollar amount, instead of the % drawdown.  The market doesn’t care about the stock’s prospects.  Only quality fundamentalists do, so a trader needs to have a dollar stop.

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Summaries:

Perhaps the Apple A Day method works better in very volatile periods.  Know how much you will pay the market tollgate,and just do that if one’s tempted to bargain hunt.  Murphy’s law takes hold whenever markets experience panic collapses.  Everything that can go wrong, just does.  A standard for closing the entire system is usually around 20%.  No system cannot sustain a loss larger than that.

Everyone needs to understand that trading and investing aren’t just a matter of entry into positions.

 Technical signals may be useful for entries, but a technical understanding of risk is even more important. – Edwards and Magee

Remember the law of percentages and how difficult it is to recover from losses.

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I am going to tell you the truth and not sugarcoat it.  I believe we are in a bear market, though not a lot of people want to talk about it.  Stocks are the place to be nonetheless, with many great companies selling at huge bargains while paying good dividends. 

Regardless, the detritus of the housing bubble will clear, banks will begin lending again and the stock market will eventually go into a bull market. – Mary Ann Bartels, Bank of America Chief Technical Analyst.

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What’s going to happen? Who knows? If it were that easy, kindergarten kids could do this. But chance favors the prepared mind.

I’m not all that comfortable with the market because there are so many issues that are beyond my ability to grasp, so my feeling is there are a lot of stocks that are interesting and worth buying.  Money management is key.  Mary Ann Bartels is a technical analyst I respect so much, and for all its worth, there’s technical damage everywhere.

I won’t give levels.  It’s futile.  Adopt an Apple a Day strategy if you’re brave, stop Martingales’ betting system.  It doesn’t work.

Of course, staying out is also an option, but there’ll be a time when you’ll be tempted to buy (so when that happens, I just figured I’d already write the systems you will employ.)

– Faceless Trader- restarts anew.

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25 Responses to Sept 26, 2011- Humbled by the Markets: Reviewing Money Management Strategies

  1. Ben says:

    Nice article FT. Thank you.

    Like

  2. Jaydee says:

    I think Cliff should read your article to enlighten his coolconut head.

    Like

    • Investment/Trading Methodologies are personal systems and strategies. I used to be a very hard-core fundamentalist, but I think in the markets, what’s important is not to be right, but to make money. To allow the possibility that we may retest 2008 lows (even if my mind cannot imagine it), and perhaps to have a method to be prepared how to buy those 2008 retests if it comes. It’s very hard to really do trading and investing. Drawdowns are easy in this type of market, but I think being cool-headed with the fundamentals and doing Apple-a day- method generally works for 1-3 year formats.
      -FT

      Like

  3. Ipit Investor says:

    Thank you for this nice article. You answered the questions I needed to be answered. Continue posting to enlighten us some more during these trying times. I wish I had read your posts earlier.

    Like

    • Thank you for the kind words, ipit investor. Do share to your friends etc. If you think the articles have helped you a lot, just share. It’s free and just one click of a button anyway. Plus, I’m not really doing this to gain anything, except perhaps simply help a fellow Filipino who toils in his work, and tries to make a little more money in his investments. I find it the most purposeful part of my work (helping clients manage their risk first, instead of focusing so much on the jackpot trades or the rewards). Writing actually makes me aware of my own pitfalls myself (from doing the Martingale’s double down betting system etc). The truth is I originally wrote the blog for myself. It is to compile my thoughts, to help me in my personal trades (as well as to help some of my friends who ask me about the markets every now and then). From just helping a few friends, I suddenly found myself talking and writing to a wider group of people. If it helps, just share. I will never ask for anything anyway. If you guys become richer financially through discipline and hardwork, it will never be me, but yourself who did it. I’ve always wanted the Filipinos in general to realize that the stockmarket is not some scam, but a legal way to make money, if one has system and discipline (no need for cumlaudes or some financial gimmickry). Ordinary investors and traders can do what I do. – FT

      Like

      • orisgen says:

        thanks for being so selfless. we really appreciated it. in my observance, those who charges people to read their blogs loses their credibility. how? they are obliged to write to please their readers, which i think is not good.

        Like

      • hmm, thank you for your kind words. I cannot exactly be “selfless” as I have my personal selfish reasons — i.e. to be seen as at least less biased, or at least give a big picture analysis. It’s impossible to be entirely objective in the markets. I have my own biases, which can be clearly seen in my writeups. I can be bullish, bearish etc. Rarely am I neutral. I just do my best to present a picture so that most Filipino traders and investors who want to make money in the markets, see one traders’ viewpoint. 😀

        Some of my friends do not even take the time to read my posts. They just want blind tips on buying and selling. I cannot help these people. For people like you who will read, learn and do your own independent, diligent work, it is for you that I write.
        – FT

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  4. Pingback: Sept 27, 2011 – Mr Fibonacci Reminders | Faceless Trader

  5. Hi FT!

    Do have more readings/links on the an apple a day system. I don’t quite get it yet.
    THanks.

    Like

    • well- essentially Apple a Day system essentially means—- I do not know the bottom. I’m simply testing the waters by buying 5K pesos per day, or 10K pesos per day, or 100K pesos per day (depending on the size of the portfolio) which can be 10 days worth of buying. (I think US markets bounced, so maybe next few days I can already sell the shares I bottomfished). Nevertheless, I cannot use technical levels because they are all squished and squashed, so I can only rely on position size to make sure that when I see values, I can take advantage of them without leaving my portfolio “wasak”. Whether I’ll be accumulating until 6 months, we shall see. Things are fast in the markets, as you well know 😀

      Just ask away, about the apple a day system anytime you feel like doing so. I will regularly update my blog as much as possible. I think we’re still looking for a bottom, so maybe the Apple A Day System will work when the PSEI hits 3500 to 3000. We shall see by then. 😀

      – FT

      Like

      • I better prepare for that possibility. 3000 is scary.
        Thanks. Understood the concept more now.

        I’m so impressed with your discipline and eagerness to read all these books and articles about trading. *bow

        Like

      • Erm… mejo nabobored ako magwatch lang ng screens whole day. Nabobobo ako..kaya I read trading books, or articles re trading. As for 3000. Scary nga! Sana di mangyari…pero just in case mangyari, we need to be prepared!

        – FT

        Like

      • sana mo na rin being able to write more than a couple of articles every week!
        Thanks again for all the info that you share.

        Like

      • hmm.. if the markets are too volatile, napipilitan akong maganalyze—hence the many articles. If hindi naman super gulo ung markets…I probably won’t be writing as much. – FT

        Like

  6. Ronald R. De Jesus says:

    An apple a day.. I think I will try that.. thanks.

    I find your writings and advise very useful.

    Like

    • thank you sir. Well, An Apple a Day is just my personalized “nickname” to remember a very old technique more popularly known as dollar or peso cost averaging. – FT

      Like

      • marvin says:

        Hi FT! I like the An Apple a Day method, Same lang pala siya sa dollar cost averaging, idea ko kasi sa dollar cost averaging is not on a daily basis. Hehehe! Cheers! 😀

        Like

      • well, kung kulang ng funds— monthly na lang instead of daily hahaha 😛

        An Apple a Day system is just my invented nickname. Para lang mabilis matandaan, kasi diba an apple a day keeps the doctor away? so un. naisip ko mejo nice analogy. 😛 – FT

        Like

  7. Ipit Investor says:

    Just an idea… how about letting us know your trades when you feel like sharing? Still our risk if we follow… what do you think? Your posts are a big help. Thank you again.

    Like

  8. pautrades says:

    TY for the article 🙂 Yesterday’s fire sale was very tempting but i decided to opt out because this is simply a time when I don’t have any technical set ups to trade and I’m very poor with bottom fishing.

    But yes probe positions muna ako when I think the valuations are outrageously low (and to just get the emotion of “missing out” out of the way, it usually goes away even with a 1 board lot position) haha

    Keep up the good work. I”ve been out of this market for a long time now with my last trade in the first week of September. Using the time to sharpen up on my tech analysis and review this year’s trades 😛

    Like

    • great to hear that you’ve preserved your gains. Quite a lot of bargains, but I fear it will be cheaper in the next coming months. We shall see. Everything’s just resting too much on Europe nowadays. Being out of the market is perhaps one of the most prudent positions. 🙂 – FT

      Like

  9. Pingback: May 13,2012 – The Quicksand Graves and the Indescribable Opportunities « Faceless Trader

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