If you are serious about making and keeping money by trading stocks, then there are three things you need to do, and do well.
- Money management
- Trading system
Money management comes first. Without a rock-solid method of managing your trading funds, you trading results will be only be fair at best. Money management is more than just knowing how much money you have tied up in a trade. It’s a method of using the right portion of your trading account on any one trade relative to the perceived risk and reward.
There are a few things to consider to managing a trade successfully:
- What is your account size?
- How profitable is your trading system?
- What is the initial amount at risk on a per share basis?
- What is the profit potential?
Your account size determines how long you stay in the trading game. If you are skillful, then you will not require a large account. On the other hand, even if you are a new trader, you can use a small account as long as you control your risk.
Controlling the risk means never using more money then you need on any one trade. A very simple formula for stock market success is to risk less than 3% of your total account value on a single trade.
If you have a $10,000 account, this means you never lose more than $300 per trade. If your account drops to $9,000, then you risk less than $270.
As your account grows, while the total amount at risk increases, you still only risk a maximum of 3% of your account. Say your account is at $12,000, then your maximum amount at risk is $360.
In theory, this ensures that you never go broke! And that is of utmost importance.
If your system is profitable, then you will typically win more money then you lose. While some consider the percentage of winners relative to the number of losers, nothing could be further from the truth.
It doesn’t do you any good to have a system that wins on nine out of very ten trades if you give all of your gains back on the one loser. More important is that the winners overwhelm the losers.
A profitable trading system might have a third of the trades result in the maximum loss planned for, a third of the trades either make or lose a little money, and a third of the trades bring in the profits.
It’s worth repeating, risk no more than 3% of your total account value on any one trade. If you keep this in mind, you are ensured of minimizing losses to your account. At what price you enter a stock and where you place your initial stop price are used to determine how many shares you trade.
The profit potential of a system is the “edge”. If you can estimate how much money you *might* make over time, and if that profit comes from many trades over time, then you probably have a winning system.
A trading system will either have a profit target that determines when to enter AND exit (good) or it will tell you when to enter and keep you in a profitable trade as long as possible without giving back much, or any, gains (better).
No matter what trading pattern you use to enter a stock, you will make the most money by using the correct orders.
When you wait until a stock has proven it’s intensions – typically by trading above the previous day’s high for a buy, or below the previous day’s low for a sell short – then having an order in place that captures that exact price is crucial.
Let’s say your favorite trading pattern signals a buy for. If you are an end of day trader, then the next morning you watch the opening price for the stock. If the stock opens less then yesterday’s high, you place a stop order to buy above the previous day’s high. Even better is to include a limit price with that buy stop order.
How much above the previous day’s high is your call. As long as it is greater than the previous day’s high, you are making the stock prove that it is going up.
Sure, you give up some of the profit potential. But you are more likely to turn a profit with a stock that is moving in your favor.
Once you are in a position, then you need to protect yourself from loss. If your method of picking stocks is good, then it’s unlikely that the stock will revisit the current prices. Continuing with the buy example, to protect your account from a catostrophic loss, place a good-till-cancel sell stop order below the recent low. If yesterday’s low is lower then the current day’s low, that’s where the sell stop order goes.
And make certain that the order does not include a limit. Stocks can and do gap down. Expecting that you will have a sell order filled at your stop price is a quick way to the poor house.
Your choice of what method to enter and exit stocks plays a critical part in your stock market success.
A great trading system looks for low risk opportunities to enter a stock. Knowing at exactly what price signal to enter and when to exit – even if it is for a small loss – will keep your account growing. As long as you consistently follow the rules laid out by a well designed trading plan, you can count on steadily growing your trading account.
My favorite trading pattern does a great job of identifying stock likely to move rapidly in your favor.
There is no reason to be trading stocks that are not ready to deliver the biggest gains in the least amount of time.
If you are serious about taking your stock trading to a higher level, then read about this trading pattern.