All Entries Tagged With: "Risk"
Taking Risks
August 26, 2009 at 1:10 pm
It’s a known fact that in the market, you get paid to take risks. We all know that, right?
But are you getting the proper rewards for those risks? Are you taking the most appropriate kinds of risks? And perhaps most importantly, do you recognize the extent of the damage which can be done when you take on risks which are larger than you can handle?
I’m in the midst of re-reading a great book on risk right now (I’ll put up a post before too long about it, because it’s something you should read), and it’s got my wheels turning. I’m reconsidering exactly what is risk, how much I should be taking, and why I need to embrace it.
Before sharing too much about the book, let me share with you a couple things which are on my mind right now, and I’ll lay out the rest in a later post once I’ve finished the read.
Defined Risks are the Best Kind
Option traders often refer to their ‘max risk’ on a given trade, because on some strategies they are able to truly limit their downside risk to a set amount. If they’re long premium, the most they can lose is 100%, for example.
But an equities trader like me needs to think in terms of a different kind of risk factor. Yes, I could buy 1,000 shares of XYZ at $20 per share, and my max risk (in terms of capital outlay) would be $20,000. But that’s not realistic risk, because it’s so incredibly unlikely that stock is headed to $0 – especially over the course of a few days when I’d expect to be in the trade.
Instead, it’s important when trading stocks to think in terms of max $ risk if the trade fails (not if the underlying company fails). I touched on this concept of dollar risk per trade earlier this month, but let’s look a little closer at it. If I know my entry and I can designate a stop loss on the trade, then barring any drastic circumstances I’ll be able to exit at or very near that stop should an adverse move occur. That’s the risk I want to be familiar with. The kind of risk that says “if this trade doesn’t work out, what do I stand to lose?”
That’s very different from simply looking at every trade from a capital outlay perspective. It’s a major shift for some of you to start thinking this way, but it can also make a major impact on your trading to implement it.
Know Your Exit
Making what could turn out to be a difficult decision before getting in the heat of the moment can be the most important part of your trading plan. It’s one thing to hunt for entry after entry, locating breakout levels and spots where trend lines could get broken, but it’s an entirely different thing to know where you’ll look to exit that same trade, whether it moves in your favor or not.
I’ve said before that a good trade is usually a planned trade, and that definitely involves knowing your exit from the outset of the play. So before you place that order to enter your next trade, decide on where you’ll get out of it. Set a bracket order or jot it down, or at least verbalize it somehow! That’s still better than thinking you’ll get around to it later. Don’t procrastinate – decide on an exit.
Have a Goal
There is no reward without risk, and there should be no risk without reward. Knowing this, there’s absolutely no reason why each trade shouldn’t have some favorable objective associated with it, so set a goal for each trade. A realistic one that could quite feasibly be reached during the course of the trade.
Perhaps you’ll set a hard target and book profits once that level is reached regardless of how strong the momentum seems at the time. Or perhaps you’ll plan to book partial profits at intervals along the way.
At the very least, having some idea of a level where your stock could move to is still going to help you formulate a game plan, even if you don’t choose to leave a resting order in that zone to book profits.
If you know your stop and you have some kind of upside expectation, then you’ll have a far better grasp of just what your risk is on a given trade and whether or not it should be taken.
Thanks for stopping by and I’ll see you here soon with more. Until then…
Trade Like a Bandit!
Jeff White
Hard Stops vs. Mental Stops
August 20, 2009 at 10:15 am
When I’m swing trading, I prefer to place stop and target orders via bracket orders. That means I’ve got pending orders which will cancel out the other side based upon what gets executed first. I’ve got a hard stop in place just in case of an adverse move in price, and I’ve got a limit order in case of a favorable move.
This set-it-and-forget-it style of trading works well for me on the multi-day timeframe. First, I don’t need to watch every tick. I can trust that my orders are doing the job for me, because generally those stop and target levels are several percentage points away. Second, it helps to keep me from micro-managing trades. I don’t get so consumed with the intraday chart that I abort my original game plan. That’s good.
But when it comes to intraday plays, or day trades, I often times will take a slightly different approach by using a mental stop. There are a few reasons for this:
1. I’m watching the price action closely and developing a feel for the move that’s taking place. I will know the area where I’ll plan to exit the trade before getting in, but in the first few minutes I may not have a specific, hard number that I’m ready to commit to. That’s simply part of tape reading on a trade that may only last minutes.
2. Because I’m watching the price action, by default I’m at the PC. That means I’m able to blow out of the trade instantly when I realize the time has come that I’d rather have the cash than the shares.
3. Since my intraday timeframe is about minutes or hours, it’s often a bit tougher to continually place and cancel orders for the same trade as it progresses. Ideally, the stock is moving in the intended direction and I’m eyeballing areas on the chart where I’ll need to book some gains or begin to lighten up (or even exit entirely). Those levels change continually based upon the momentum of the stock, so I often times defer to sort of a “mental trailing stop” whenever that’s the case.
4. Fortunately, I’ve never struggled with blowing stops, so I can trust myself to bail on a trade when it’s time to. And again, I know going into the trade the general area where I’ll get out, so even if that’s crossed right away then my decision is made. My struggle generally lies with staying with big winners and allowing them to become huge winners, but that’s a topic for another discussion.
Which One is Right For You?
The answer to this depends on your personal style, and some real honesty is required on your part with this one. But it is rather simple.
If your tendency is to blow mental stops, then set hard stops in your trading platform and leave them alone. End of discussion. It’s for your own good.
If you prefer mental stops, insert support or resistance levels on your chart (literally draw them) so that you’ll at all times have a visual representation of where your trade stands and if the time to bail out is approaching. I often set red support levels and green resistance levels as sell and buy markers for trades. Whatever you do, be consistent and don’t hesitate to kick that trade out the door when it stops behaving.
Bottom line:Â if you know deep down inside that you lack the discipline to cut a losing trade when the time comes, put a hard stop in place. And if your problem is simply staying in a winning trade when you know you should, consider scaling out on the way up.
Thanks for stopping by and I’ll see you here soon with more. Until then…
Trade Like a Bandit!
Jeff White
Are you following me on Twitter yet?
Peace of Mind With Bracket Orders
August 12, 2009 at 9:54 am
Trading is stressful enough on it’s own, and all of us can at times have outside distractions which pull our attention away from the trading screens. Whether it’s a work project, a trip to the doctor, travel plans or tax season, there can be a constant flow of interruptions to your trading.
Some of them can mean actual losses while others mean missed opportunity, but the bottom line is that that’s life and we have to find ways to get around them if we want to push ahead with our trading.
Enter the Bracket Order
I’ve been using these with thinkorswim for some time now, and I’ve really been pleased. Their platform has a ton of features for options traders, but they didn’t neglect those of us who trade stocks.
I particularly like the bracket order capabilities, and I use the ‘1st Triggers OCO’ all the time in my swing trading. It’s nice to be able to set up a trade when you know your entry, stop and target, and be able to trust that it is being taken care of so that you don’t have to watch it. That allows me to spend my time seeking out new trades rather than managing existing positions.
These conditional orders are pretty amazing, and they’ve gotten sophisticated enough that they can accomplish pretty much whatever you want done at whatever time you want it. What originated as a simple alert has evolved into a multi-faceted tool which many of us will never again trade without.
Traditional order types are available everywhere, and if used properly can sure help you implement your trading plan better than you could without them.
But why ride the bus if you can be chauffeured around in a limo?
Using old-school order types like a stop buy order can certainly help you catch an entry on that trade you’ve been stalking, but won’t you need to protect your capital with a stop loss order rather quickly after your order is filled? What happens when that busy life of yours prevents you from being at the PC when it’s time to put in that safety net? You’re up a creek without a paddle.
If you could structure your entire trade in one order, wouldn’t you do it? If you know the price at which you’ll enter a trade, stop out, and take profits, then let technology help you. I can’t think of an excuse good enough to avoid using these orders, because they truly are the best thing out there.
How it Really Works
I’ve been using this functionality in the form of ThinkOrSwim’s “1st Triggers OCO” orders, so let me explain. The “1st” portion is my entry order, such as ‘buy XYZ @ $25.” The ‘Triggers OCO’ portion means that once I am filled on my XYZ purchase, a One-Cancels-Other order is immediately and automatically placed.
This latter portion is actually a pair of orders which the system will manage for me. If I set a limit sell at a higher price for taking profits, and a stop loss down below as my safety net, then I’ve structured my XYZ trade in such a way that I know my risk and my potential reward. Because I only want to sell my shares once but yet have two sell orders, the system will automatically cancel the remaining order once the first one is filled. So if XYZ climbs to my target and I sell for a gain, my stop loss order is canceled. If on the other hand XYZ were to fall to my stop level before reaching my profit target, the system will execute my stop and cancel my remaining (unfilled) limit order since I no longer own shares to sell. Pretty sweet!
Here’s a video explaining it. Select the HD option and go full-screen for best quality:
Bracket orders are excellent tools which offer the trader a ton of flexibility (there are many more of these advanced order types), but in my opinion the best thing they offer is peace of mind.
There’s just something about knowing that your plans for a trade will be carried out whether you’re at the PC or not. That gives me the freedom to put my trading ideas into motion, knowing full well that I will be able to book profits where I see fit and yet limit my losses in case I am wrong (barring an adverse price gap in the stock of course).
If you’re not using conditional orders in your trading, you should be! They can quickly become a part of your daily routine, giving you the ability to trade to your heart’s content without letting life’s distractions interfere with your plans!
Trade Like a Bandit!
Jeff White
Producer of The Bandit Broadcast
Stop Loss Placement, Part 4
August 6, 2009 at 8:50 pm
As we complete this series on stop loss placement, we’re going to discuss trailing stops. But be sure to catch Part 1, Part 2 and Part 3 first!
In this segment, I specifically want to discuss the importance of managing our risk throughout a trade, not only to reduce losses but also to preserve profits. This is achieved by adjusting our stop, or through the use of a trailing stop.
When and Why to Adjust a Stop Loss
A rock climber knows the importance of anchoring himself to the wall along the way up, just in case he happens to slip. The anchor set early in the climb at a low altitude is every bit as important as the ones set at higher levels, but the more a climber ascends, the less useful a low anchor will become. As a result, it’s wise to keep raising it along the way.
Trading is similar in that the stop loss we initially set for a position may not be appropriate once that trade has progressed, so it’s likely to need adjusting along the way.
Setting some rules for ourselves, sticking with them consistently, and maintaining an adequate reward-to-risk structure throughout the trade can keep us in good shape.
Watch this clip and let me explain more thoroughly with some specific examples. It was also posted over at the Trading Videos site, but I’ve embedded it here for your convenience.
Let me highly suggest clicking the “HD” on the video player and then going full-screen for best quality.
Update: Check out Part 1, Part 2 and Part 3 of this series!
Thanks for stopping by and I’ll see you here soon with more. Until then…
Trade Like a Bandit!
Jeff White
Are you following me on Twitter yet?
Stop Loss Placement, Part 3
August 5, 2009 at 8:44 pm
To continue the series on stop loss placement, it’s time that we build on both Part 1 and Part 2 by taking things a step further.
In this segment, I specifically want to clarify a major advantage of basing our stops on the chart. Of course we’ll know where to get out if the pattern happens to fail, but there’s one thing many traders fail to focus on in relation to that. It’s an equation, and a simple one, but it gives us our position size.
Dollar Risk Per Trade
If every stock were the same price and carried with it the same volatility, and if every pattern we traded happened to carry the same exact chart scenarios, Part 3 of this discussion wouldn’t exist.
But each stock is a little different than the next. Each setup will vary from the previous one we entered. And of course, the distance from our entry to stop isn’t going to be the exact same from one trade to the next.
So what we need to do if we want to maintain a consistent dollar risk per trade is to determine an amount we’re willing to lose on each trade in case we are wrong. Let’s face it, some trades aren’t gonna work, and we’re going to get stopped out.
Once we know how much we’ll be willing to risk (in terms of a set $ amount, or a set % of our account value), then we can combine that into a simple equation to give us our position size.
$ Risk Per Trade / Distance from Entry to Stop = Position Size
Watch this clip and let me explain more thoroughly with some specific examples. It was also posted over at the Trading Videos site, but I’ve embedded it here for your convenience.
And if you have questions pertaining to stops, add them to the comments section or contact me directly and I’ll try to work those into the next few segments.
Let me highly suggest clicking the “HD” on the video player and then going full-screen for best quality.
Update:Â Check out Part 1, Part 2 and Part 4 of this series!
Thanks for stopping by and I’ll see you here soon with more. Until then…
Trade Like a Bandit!
Jeff White
Are you following me on Twitter yet?
