Managing Your Risk

Well Traders, probably the most valuable lesson I learned last year and at my recent INVESTools classes is the absolute importance of Managing your Risk. Because trading can be very emotional (and the death knell of ANY trader), it is paramount that you reduce trading down to your fundamental/technical analysis/strategy, and then simple mathematical equations. By doing this, and sticking to your goals, both profitable and not, you are managing your emotions, which help to manage your risk.

Dr. Alexander Elder, who wrote "Come into My Trading Room," a book I highly recommend, establishes his own risk. He will not risk more than two percent (2%) on any one trade, and no more than six percent (6%) at any one time. While I subscribe to his 6% overall risk, I only risk 1% in any one trade. This gives me a minimum of 6 trades I can be in at any one time.

I created a Risk Management Tool on Microsoft EXCEL which enables me to monitor all my postions in different accounts to see where I am with my "at-risk" trades (those exposed to the 1% loss). This helps me manage my risk and exposure. The sheet, shown below, begins with total cash available at the beginning of the month, then that establishes my 1% risk exposure, which is $500 based on this example. I also have four different risk calculators based on what type of trade I am playing. Longer term TREND plays have a greater risk because I allow 3% below support of the stock. Shorter term SWING trades I play tighter with only a 1% risk below support. This enables me to correctly size my position for each trade. Since I only trade in round lots of 100 shares, I always round DOWN. This is more conservative, but managing risk should be conservative in order to be successful. Here is a glimpse of my worksheet:

(Click to enlarge, use your browser's "Back" key to return to the Blog)

You can see that I have six (6) fictional trades (I used real stocks, but made up the prices, they are NOT suggestions to buy or sell). However, due to position sizing, I only have 3.4% at risk at this time, or $2,197.00. You'll notice that just under the dollar amount I have the words "Keep Trading" highlighted in yellow. That is because I have not yet reached my 6% "at-risk" limit. Therefore, I am allowed to continue to trade in this account. It also shows I have only $2,390 left in Cash available to trade.

On the right sie of the sheet are the risk calculators. I have them set up for each account because different accounts may have different cash balances. Each risk management is unique to each account. This is how you try to stay ahead of the game.

Here is another worksheet example:

You'll notice I put a few more trades in there. Now, since my "at-risk" exposure has exceeded 6%, the yellow box below the dollar amount at-risk now reads "Stop Trading." This helps alert you to when your exposure exceeds 6% at any one time. Now here is here is where the fun part begins.

Since I now have a little over 6% at risk, I am NOT allowed to trade any more until one of two things happens. The first, if all these positions get stopped out (which would really suck, but could happen), then I must close them ALL, and wait on the sidelines until that month is over. That prevents "Get Even-itis" which is a gambler/trader sickness. You HATE losing (I do too), so you want to "get even" with the market. That leads to irrational trading behavior and could be devastating to one's portfolio. If you get stopped out of all your positions, then you need a break, like stepping away from the Blackjack table when the dealer is kicking your ass. It is a time to regroup and re-evaluate what you are doing right and wrong. It is an important cool-down period.

The other thing that could happen is better. If any of your positions move to such a point that you can move your Stop-Loss position to a point the trade is profitable, then that trade will move off the "at-risk" position (but not off your worksheet, just change the "Stop-Loss" price to your profitable point), freeing up any more available capital to trade.

This chart needs to be re-started at the beginning of each month. Why? Well, your capital position will more than likely have changed from the preivious month, for better or worse. If you started at $50,000 in January and now begin with $53,000, your "at-risk" capital will rise from $500 to $530. Conversely, if the account dropped from $50,000 to $47,500, your 1% "at-risk" amount would only be $475. This helps you with all your position sizing for the month. Remember, we are not trying to get rich quick here, we are trying to beat the Market, and to do so, you need to be steadfast and prudent when trading. It is okay to be wrong. You'll be wrong more often than you are right. However, by trimming your losses to bare minimums, your winners should overcome your small losers making you profitable in the long run, and that's what we are in for, the long run.

The Risk Management Tool is available to purchase for only five dollars ($5). Believe me, this is money well spent if you are trying to manage your trading accounts. Email me at GSOTrojan@aol.com and I'll give you details on how to purchase the tool.

Happy Trading!

CROX, CLF and CCJ

Well Traders, I am back after a few days with some updates on my portfolio positions. But, before I delve into those, I have a great reading recommendation. I have just finished the book, "Come into my Trading Room" by Dr. Alexander Elder. Let me tell you, if you are new to trading, this is a MUST READ! Great advice on Options, Money Management (an absolute MUST to know!), Stop-Loss placement, etc.
Now, onto my trades.

CROX (3 Month Chart)
Here is a look at the 3-Month chart. The past two days, the stock has broken out from a consolidation, or Bollinger Band squeeze, to have a solid gain in the price. Today's action was fueled by the announcement of licensing agreements with the NFL and NHL which will boost the company's sales substantially. Crocs really has touched the surface in my opinion. They still have the NCAA, NBA, MLB, etc. Who knows what other creative ideas they can come up with for these shoes? Anyway, as I have marked on the graph I have two profit targets. Once I reach the first one, I will tighten up my Stop-Loss to capture some profits. If it breaks the first price target, then I'll shoot for the second one. Should it reach that point, that is where things may get VERY INTERESTING! Here's why:

CROX (9-Month Chart)This is showing what may be a "Cup and Handle" formation. You'll notice the channel in which I define this pattern. The "Cup" is the first peak that curves down to the bottom of the channel, then rises to the second peak. the "Handle" is still forming, but it is the smaller "Cup" to the right of the second peak. In order to complete this pattern, CROX must hit the second price target. If it passes the second price target, the theory of this pattern is that it will rise the same depth of the "Cup," or in this case $19! That would make for a VERY nice trade! The time frame for that would be about 6-7 months, but hey, for $19, I'll wait 6-7 months for that gain. Of course, it is just a theory, but it will be interesting to watch as it develops. Stay tuned for that!

CCJ This is somewhat an aggressive trade with limited downside. I expect the stock to bounce here and continue up the channel to its resistance level, at which point I will either sell the stock, or write a Covered Call and take in some income. The MACD and STO indicate that the upswing may be imminent, so I thought I would take the risk by entering here. Because a bottom/support was created yesterday, I have put my Stop-Loss 2% below the low of the day. I am only risking 1% of my portfolio value, so it isn't a big risk especially since the reward is about $7.

CLFAgain, another "bounce" play (my favorite). I am looking for the stock to continue up in its channel to resistance where I will either sell the stock, or a Covered Call and take the income. CLF has been a really good play for me in the past, I hope it continues. Again, I am only risking 1% of my portfolio value with this trade and I have about a $6 upside, so we'll see what happens.

Happy Trading!