We do not know why the market sold off, we cannot tell you what to do with your investments, we don’t measure companies by how much money they make (or lose), we do not listen to Yellen or Goldman, we do not do anything of this. We listen to everyone that has a voice in the markets, every market participant. How? Through the study of price.
This is our process:
Calculating Position Size
The calculation of the position size is a crucial step in taking a trade. When our trading career first began we did not concern ourselves with relative position sizing, rather we used the same dollar size for each and every trade. Of course, this was a foolish idea as we know now stocks move in different ways, different amounts, and different ranges. Therefore we must adjust our sizing to compensate for the fact that each trade is not the same and does not reflect the same risks.
To determine the correct size relative to the desired risk we incorporate this simple formula:
Shares Purchased= (Desired Capital At Risk)⁄(Current Price-Stop Price Location)
After plugging in the required information for the use of this formula we receive the number of shares of the security we should use to fulfill our desired amount of capital at risk per trade.
Using this position sizing strategy limits the emotions involved as it requires us to choose an amount of money we are comfortable losing before we even take the trade.
Stop Placement & Exit Rules
The selection of the place in which we are wrong is vital to ensuring a successful trade. We do not want to give the trade too little room to work and vice versa we do not want to give it too much.
Often time the patterns we trade are consolidation patterns basing above a moving average, this makes the stop placement job a little easier for us. In this case, the stop should go directly below the most recent consolidation/base. Below is a chart and a great example of the correct stop placement:
As seen above, at the time of entry, within the consolidation the 21 ema was in control of the trend. Therefore, we placed a stop directly below the most recent pivot low within this trend.
The required criteria to exit a stock is simple, it reaches our stop location. If however the stock has moved higher since the purchase, the stop will as well. After each and every stall in price the new stop will be moved to below the most recent consolidation. See below chart for a visual.
There is no adding to a losing trade as we believe that if we are wrong, we want to get out. There is no reason to stick around in a losing trade, find the next one.
Stock Selection & Entry Rules
Selecting a stock for purchase is arguably the most important step of all. We must know what type of stock to purchase and when.
To purchase/short a security:
– Average Volume over 200K
– Price over $4
– In a favorable consolidation and tight pattern
Each and every one of the above criteria must be true before any action is taken. We do not hold through earnings as we view these events to be potentially trend altering and added risk that was not accounted for in the selection of the security.
Our timeframe for our trade is dependent upon the type of trade we are taking. However, the one truth that is constant is we hold until either the trend changes, price becomes to extended away from key moving averages or a news related event is scheduled to occur (earnings).
As a result, the timeframe for each trade can differ from a couple days, to a couple months depending on the subsequent price action.
We scale out of positions, we do not scale in. We do not believe in dollar-cost averaging positions, nor do we believe in adding more risk to a trade than the original amount set forth at the trade selection date (see above position sizing section).
We do not incorporate dollar cost averaging because if we are wrong in a trade, we want to get out. There is no reason to stick with a losing trade. It damages emotion capital and ties up capital in a trade that is not working. We wholefully believe in the ‘cut your losers, run your winners’ mantra.
However, when a security begins to move in a favorable direction for us we do scale out of it. The first scale, half, occurs at the first tag of the upper Bollinger Band (20, 2). The second half of the trade is then held until the trend breaks or a news related event is scheduled to occur (earnings).
We use this strategy to quickly lock in gains and preserve emotional capital within winning trades.
Determining the Health of the Market
Determining the health of the overall market is a process we use to judge the conviction we have in taking trades. To determine the health we examine how many favorable set ups are appearing on our scans for the required criteria to take a trade (see above Entry Rules). If there is a plethora of high-quality set ups appearing, we will be more likely to have added conviction to the long side. Likewise, if there are a very few amount of favorable long set ups appearing and more favorable short set ups, we will have more conviction with taking our short set ups relative to the long counterparts.
Percentage of Portfolio Risked Per Trade
Determining the percentage of the overall account at risk within a particular trade is a simple process. As a general rule, we want to keep each trade risk on a percentage basis no more than 2% of the overall account balance. However, usually the trade risk is below 1% of the balance. See the above section of position sizing for how we determine how much of a security to purchase.
% of account at risk (x100)= (Capital at Risk for Trade)⁄(Account Balance)
We use the above formula to determine how much of the account we are risking on a particular trade.
Preparing to take a trade is a combination of all the previously listed steps. However, as a general guideline this is how it should look:
- Scan for set ups
- See a favorable price pattern
- Look up earnings date
- Determine stop location
- Determine position size
- Take action on the security
Entry and Exit Time for Market Hours
We will only enter new swing trades within the last hour of the trading day. We will only exit swing trades (if stopped out), during the last hour of the trading day. We do this to ensure we are not whipsawed out (or in) of trade on an intraday basis.
If on the rare occasion I am day trading, the above rule does not apply and I will enter strictly on the intraday charts.
We always have goals in mind, we have desired milestones we are working to achieve, we are never stagnate. We are constantly evolving and improving our mental, emotion and technical strategies. Once we reach a goal, another is set. As we grow in account size and reach new levels, we add more risk per trade as long as stay above certain account balance limits and below the 2% max risk per trade.
Goals are important for us to be constantly growing and improving.