“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.
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.
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.
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.
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.
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.