se BETTER eee DARYL GUPPYTing Aion Shares Tring Toes Marke Tag Tats ane the, “The Bass of Spedatng” by Geld Kroes “The Da Tales Adve by Howard Al pions ~ Tag Sos Thar Work by Wiliam BEng ng Rue” by Wali EE [SEN I 876627 964 { tnventmenc— Australia, 2 Stocks ~ As Vide 332.65220094 Cover design by Rb Compe 10987654321 Preface PARTI CONTENTS Gs ks PERFORMANCE PROFILING or Bust? ch Srl Mate of Time Equity Curves PROTECT CAPITAL Risk and Uncertainty Detours With Danger PROTECT PROFIIS Exploiting Trends Ordering Profits PROTECT PORTFOLIOS Made to Measure Risk and Diversicy Slicing Risk Swiss Curves Active Investing No Sweat B 6 31 #8 6 % 34 103 Ho 122 BI 18 153, 17 189 196 23 2m 24332.6322 6977 Better trading : money and risk management Business LCN: 10815074 Po#: 200207824/0001 B/C: 31259007196426 Preface - CASH STACKS sisted this ade round to go around. No vas gone, spent on recreation and daily Mesos intr a Teyerage they need to magnify ‘rade, This book examines asm waders. Sot ‘Active Trader and Your Trading Edge. They are exa hook is not writen for those wi ‘with $21,000, $60,000, $150,000 or so in the stock marker.BETTER TRADING. Most of my income eon perfect although they are bat mn journey from Tra sghou the ook wo denne . ststat, There is a hey ind risk, Tt does not only come from the amo els ot from the number and s performance, but at hear, the di way they manage of returns from succesful trades is same foreach of these traders, 2s shown in Figure L Figure 1_ Four Traders ~ Distribution of Returns ‘Trading performance 4 dstihuton cave si 20% Trade returns 20% ‘0 26 » ost Few ‘Anal portoio Number of trades performance ~four traders PREFACE ‘and the exit Spreadsheets ‘Thre exploration of money management protected. They are ‘Then select UNPROTECT WORKS! ‘The price chars in this book ae taken fom data Freeway service. Charts PROTECTION. downloaded ae created with-ounts Ishous you! Please read on and prosper. Daryl Guppy Darwin November 2001 Part | PERFORMANCE PROFILINGChapter ie BOOM OR BUST? ss ison beter ways 3 lies if we think the difference between wealth ‘money. This does not explain how money is usedby trading successes. Apply just one money management technique and id and appreciate the impact oft for you Ifyou want to find out more about ued to achieve these results, then the rest ofthis book is written for you WORK SMARTER NOT HARDER how they work and when they ae best applied is an of trading—in theory. action in the market we discover many ‘We do not have much money when we Figure 1.1_ Trader Average Improving returns without ‘The market provides deep in boo ing trades, we are easly distracted by the promise of rading developed by other people. These approaches may work very well for oth 13.8% profit 28.8% profi % Return 19.2% loss 10% risk 5% risk 2 risk % risk1. BOOM oR BUST? Ler’s say we succeed Figure 1.2 Increasing the Win Ratio in reaching the 80% bow igh z ree of difficu know enough to succeed consistent Degree of dificulty i success possible i ‘Working harder also Trader Superstar ‘Trader ‘Success litle knowledge, Trader Novice cal 1. With more knowledge and skill Trader Average find ‘easy to boost the success rate to 60%. This means for every ten trades he enters, only four 62.50% win 68.75% win 81.20 % win Income are generally working his grouping, ‘one ofthe losing trades into @ ‘Geetng from 60% to 70% is much more difficult. For every en trades only three are i trades return a profit equal to mero get to this level. The very top of them are interviewed in Jack Schwa ost. This sno overnight place to research trading styles and to learn about the level of succesful trading enjoyed by these trading superstars. ‘greater than 80%—an Performance Summary spreadsheet is available as an ‘emplate as part ofthe Better Trading pak from ww. guppytraders.com1. Booman aust? 7 profit. sme foreach trader: ber of winning and trader ordinary shares and warrants—and ‘This benchmark of sample trades is used recess ate. Each ofthese traders uses exactly 4 ‘of trades as shown in the rading report. of sample trades has six common features “Total trading capital is always $100,000 to allow for a cons 41. and allows profits to work more effectively. If Trader sing trades then performance ey management approach, using simple ‘not Trader Superstar returns, ten trades wrong. Profits for winning trades remain as shown in the base trades. Wedo: profits to trading capital. Profits are swept into 2 holding account and not used for trading.BETTER TRADING 1. Boom or BusT? level rom 62.50% winners to 68.75% isnot Figure 1.4 Average Trader Trader Average lifts returns to become Trader Is important to note the increase 128% prot — 28.8% pratt 18.2% loss 10% sk 5k ek risk rate up t0 69.75%, Even with this win Trader Success have enough I contemplate a 10% lossrate, enough ex, discipline to keep the losses 41.6% pot capital reduced ier tt fas wet on wT Sacer eso ing needs money management skills to survive, but he is the very person who is least, likely to develop them. 1096 isk 5 isk isk 33.0% pot 18.6% rot 0% ak “Sib ik Derik ‘risk ty and generate these types of returns.losses imp: for Trader Novice and Trader Average to develop. Trader Succes. It isnot a lack of charting and anal segue to fecivelyinlement money mand on ei trading style Chapter ae RISK WITH STYLE not easy. Should ‘eramble wildly choose hasan important bearing on your succes you do not know how to operate it. Your skill with capital, we need to make sure our performance pro benchmarked from arting point, Without this agreement confusion follows because we talk ofthe same concepts but understand them in diferent ways RISK ‘We stare with a working def ‘When we turn ingle factor. If price moves xen our risk has increased. Risk, in this case, sequal ned to tll us when choose is not asShare Trading. You might apply do range of recent price movements as explained by Christopher Tate in The Ar of Trad, Osher metho we she a trade that capital to understand the How Much? The keytorisk management is how mi re prepared to lose before you admit you are fig m ly we are prepared t0 Figure 2.1_What is at Risk? to the problem understanding of what i arr If ‘This is summarised in Figute 2.1. 2. RK WITH STE $2,000 from an adverse price this i 10% loss of capital ply states that no single risk more than 2% of our total ding capital. Ifwe have2. RSK WMH SLE | portfolio exposure. We trade v mort as much safety as we trade blue chip Entry and Exit ‘This takes us back to our entry and exit figures. The method we select should se loss exit price to protect our trading capital. The 28 rue tells us how much thi terms. For any entry and exitprice combinat take, The method you choose depends entry price, stop loss ext price andthe dollar size equal to 2% of trading ca the maximum position size. We examine these calculations in more detail in Chapter 6. RISK WITH STYLE of trading, or investing, have a ma} ‘upon your starting point—your style. ‘We often call about thre trading stles—pesition, agressive and conservative—without really explaining how these are different. Other styles tend to be variations on these main 6 ing terms for new traders are se are shorthand terms to describeBETER TRADING 2, RK WITH STVLE ‘This method is used by large institutional traders, For privat iets such as futures and iments magnify dhe be ity. These traders look for a com ‘money, these finar the parent stock ‘Shorter traders aim for trades lasting one to five days. They usually look for two, to "These traders want to capture short sharp price moves and rallies. "They look for volume, momentum, and short-term bullish charepatters. Theit focus tends to ‘be ot low-priced stocks asthe price leverage magnifies returns. Price leverage sbased on asingle ‘observation. Irs easier fr prices to move from $0.03 to $0.06 than i is to mave from $3.00 t0 rader focus on momentum, and include: get caught holding ont + "The position trader makes better use of mi cost averaging and Grow_Up strategi Figure 2.4 Position Trading as those used by Robere Deel in Trading the Plan Shorterm trader rend context information. cure of intra-day and end-of-day data ing takes a longer perspective. The position trader isnot looking fr short rah he takes them if exceptional returns ae offered. The car in Figure 2.4 thshort-term trading. The to join long-term trends inthe marker that may go on for weeks, or even months "The tools ofthe position trader are trend management tools and include: Moving averages. (Guppy Multiple Moving Averages. signal for action in the market on the next Long-term vending ve seen day trading. "The investor buys a ‘poston’ forthe longterm, CCountback line for managing the trade. Point and figure chartingBETER TRADING even years AGGRESSIVE TRADING Te isa mistake to think aggressive trading means buying depressed ddowntrend, in the hope the trend will reverse. When investors do ‘aggression and bravado. the downtrend does not change the ile entries and rapid to stay with this long-term reverses. Then the obj cor trade against the trend approach. Other traders use it to cor more commonly, to get out ofan uptrend before it changes way without p ressive traders have also been described a traders who fel comfortable losing more thu $40.00 of $10,009 porn. This snot aeons fancy of te ted by the resules in Chapter 1 when risk was permitted to grow to anticipation ofa patter development, or Please do not confuse aggressive trading with foolhardy, high-risk trading that is really gambling on the market > the work by Benjamin 2. RSK Wm SIME ‘CONSERVATIVE INVESTING. Figure 2.5_Aggressive Trading t0¢ey 8: moving ave are encouraged ay depressed Graham and his most able student, Warren goressive erty wee Westpac Bank Dally barehart holds onto the stoc 1d then. and rapid exits until the downtrend act arts going up. go up. He may use multiple fers into 2 uptrend, aFigure 2.6_Fading the Trend 2. RISK WITH STE Figure 2.7_Position Trader's Entry and Exit an ry? A oe tatniqroman easel approach hunts in the same performance by understanding Iie not very ervativetradeeBETTER TRADING Figure 2.8 Conservative Trader's Entry and Exit Cconeratve traders ext 2. RISK WH SME swe by sock we open the dot ask How ve open the door— aggresive etal apt [captal soca to lnace Fast E wera | Yond Psion + Daly bar chart wih 10-and 0-y Postion? Postion Positon4 Positen exponential mova averages inthe pointofenty, but Hd oui sree "Foy lata” "J entry decision turn out +—aggressve, postion and3. MN’ MATCH Trend Trading Tools “Trend erading sat the hear of many trading techniquesso there are many indicators designed todefine the trend, including: > Stnght edge trendlines Moving average combinations ofa short-term and long-term average ort General Property Trust Dally bar chart ‘The Guppy Multiple Moving Average indicator rams ‘The ADX group of directional indicators On balance volume. (Of these we find the straight edge trendline, a combination of long averages-—10- and 30-day—and the Gupy le Moving Average generally the most wefal: The other indicators ae used for confirmation ofthe signals generated by these. f Wl BREAKOUT TRADING fired up by anews event or often seen after a Some traders bought at this level just had been a few weeks before, Encouraged rise, These are more ‘straight edge rrendl downtrend. Figure 32 “Trend trading suits trader send change from down to u Higher than average volume that drops off ax price hit the resistance level. 2BETTER TRADING. rally chat does not break above the existing downtrend as defined bya straight iy, IHG Led Daily bar chart 7 H ,_, Resistance aH i" ile Moving Average in Figure 3.3 shows there 3. MCN MATCH Figure 3.3_ Guppy MMA ‘Guppy muttipte Moving Averages Rally Indicators, ding ptf breakout indicators are ‘Esme dfnethetmuect the rally Some ofthese include: > Price and volume searches Guppy Mi > Rally search formulas, such as those described in MetaStock in a ‘Nutshell by Simon, Sherwood,Figure 3.4 Double Bottom MXN MATCH Breakout Trading Tools Simon Sherwood. > Confirmed breaks of the downtrend line, > Confirmed volume behavious on failure and retest. > Rally search formulas. » » » ‘A 10-day and 30-day moving average com! Verification ofa trend break using the Guppy Ue posiilies and rade accordingly. Al ally ings shorter tdi wth defined p effective way to trade neroperand hen o ene the An indicator such as the Guppy probability ofa trend change. ‘The rally is par ofa sequence of ‘The retreat creates a reversal pattem, such asa double bottom, iple Moving Average shows there i high and trade planning, sponse toa balance of supply and demand of shares at particular when buyers co have many teaso me together ata single price. As buyers bid up prices, the tellers ge nervous. 38ies of price extremes ata then react away Support and resistance are powerful forces in the market hecause they represent points many shareholders make signifi sions about profit and loss. When jing the postion of support in the jon we should always loo 18 docs a poine and figure char. ‘Support And Resistance Trading Tools In placing a support or res > 1 level, raders note the following: single close below the support level that is part of daily volatility and not part of a Aeveloping trend wams the support level is weakening. tance levels are persistent overtime and the data is adjusted ford helps to define safe entry points trends. In channel ‘of price activity are defined by raders buy on support and sll on resistance. 5 captures a 5% spread between support and the concepts blind them to the proftsavailable 4 3 MON MATCH Figure 3.5 Support Levels Resistance becomes support Fai Support THe Thakral Holdings Daily bar chart ould be. There may be advantages for you in reducing some ofthe time spent ‘on trading methods which are incompatible with youchapter - RISK OF TIME ited if your trading isa confused mixture of incomps objectives. sas true asin the y management. In wo related common belies about the way traders and re their capital They are the dolla-cost-averaging approach and -market is more importa to capture long-term hich rely heavily on capturing trend reve 3 to worry about the collapse in Telstra prices for the longterm. the investor cannot time the market so she should ‘the market. Timing the market means judging the4, RSKOFIME I seems contradictory wh asmincoasa long-term i Encouraging investors to hur the-market means the investor buys stock ina qual i to hold onto it for three to five ye reading, An index value of 3110 is shown as $31. the period we close all open investmer 1001 market value of $32.71. The market performance for Figure 4.1_ Market Performance joined by ahidden riskiseffectively stor who bought company, HIH Insurance. No amount of ime is going to ‘company failed rapid 3s who believed in the ideas the-market and dollar-cost-averaging bought more stock in HIH Insurance as the price plummeted TIME COUNTS4. RSKOF MME i sample was taken from a falling market. There are togrow your capital. We explore them in the rest of ‘of retumn, The bess investor Jan, Het 2.70% retura. This very 1 result for each ofthese investors is plotted in Figure 4.2. To construct these results wwe take the total numberof All Ordinaries shares owned by each iwvestor and value them 4 at the last price 2001 of $32.71. Each investor has exactly the same number of investments. They all spent $80,000 since January 1999. Buying che same dollar value of stock every three months or six manths doesnot protect Inca he satey exposes youto the vagaries They do note dhe se ‘year, ot perhaps two. Ps Figure 4.2 Time in the Market keep deferring the inflicted by stock dohave ro recognise long enough to see a ‘when you most need a return from your invest irement years, the negleted portfolio underperformers ae u TIMING THE MARKET best return of just Sori or Seem have achieved comparabl ‘These results illustrat the-markee using doll averaging techniques is not very good, even in a gent Py4 RSKOF TIME ‘The second trate is from $28.81 to $31.50. Again Investor Time but there is an important difference. Investor Ti uses the original $10,000 recovered from thefts trade. This ders who were asked to come up with an + banks $10,933.34. ‘open atthe end ofthe test period, so he open profit. This story of investment succes, Retum on Capital the market? The novice believes it tes. The more experienced ‘The novice is blinded xAo AM Ordinaries Monthly bar chart 2600 oor lars and look atthe percentage return and they ha tobuild their dollar- 1001 at $32.71, and the at 2813, or $28.13 for this exer sn. Ths ist trade is closed at $3 same period based on an entry at $28.13 and an mun of §34.22 is 21.65%. The time-in-the-marker strategies are wel below collects hiDemTER TRADING. Figure 4.4 Time vs Timing portfolio performance profile. performance. In chapters we examine the issues surrounding these benchmarks and l The timing-the- market strategy gives the 1e concepts of risk and risk management leads to 4 sults. How you understand and apply chese concepts has a making, We know the theory decidedly more dificult. Chapter a EQUITY CURVES en Tuy a share it always seems to drop in price. In around 70% of trades the ive recovers and the trade turns into a profit. Some trades drop ime 1 keep dropping. ed erders develop gut the stock. The price never threatened. tchesto protecting 0 clear profi les, They are a rare experience, we had anticipated. ‘our buy order “There is no doubt withthe agony of ut the practice’ islinking our personal trades toget iy or to enter too early on @ By developing a personal eq ive stop loss strategy to confirm wi trades we also winning trade and to 2s we manage a trade using stop loss techni protect open profits, We can also manage a curves are a useful way of comparing trades and identifying ws performance. - pinorless. Mealy the trade improve trading 5, EQumY cumves The equity curve offers two important pieces summary of your performance in each trade, Th fen novice traders ese to even take a peck. ‘The second important scrap of information isthe average sie of your loss after you buy a stock and before it goes on to make money. This dravdown, or temporary los, provides th don. The first isa graphic lwaysa pretty picture and too show common characteristics ing behaviour and we use th about a trade. The experienced trader draws on his experience n. The les-experienced trader draws on his performance profile asillstrated by an average equity curve USING THE EQUITY CURVE ‘The equity curve in Figure 5.1 records a single trade completed by Trader Average. He has ‘the same profile used in Chapter I. He gets six out of ten trades correct, but sometimes he hha to waita long time before a trade starts to make a profit. The equity curve plo Figure 5.1_ Equity Return Curve Cup stats stanro tare making mone ‘breakout, he selected ahi igher point.BETTER TRADING 5. EQUITY CURVES The equity curve moves into negative veritory and takes several weeks before moving | into profit ‘The shape of the curve shows the maximum loss was and moved back into profitanaking territory. By le from this process. A igure 5.1 Trader Average suffered a 13% nade a profit is information is not particularly useful, Combine equity curves fr trades by Trader Av the average maximum drawdown o ‘This figure provides a useful guide t performance profile for Trader Average. ‘The aggregate equity ‘This record ofa single trade tells usa lot about our skills, and our analysis techniques. ‘curve suggests the trade entry vas too eat of day when entry is made to bing the urge to chase prices back to planned buy levels. tic i identified, the most difficult pro! Figure 6.2 Equity Return Curve - Average of all Trades is constructed from the erage performance of al can dramatically eheeat curves, we develop Thinking trad ‘off with comments losing days.” The experienced trader uses instincts, honed over many trades to tell when a ing days is OK and when it isnot OK. We use the equity curve co rake ashort-cut to an dere ee parameters sf goodandtadtaen We accept chats decisior fe rrovid thei “Two sep back OK. any move beyond 13% os. n consistent pattems of behaviour turn up on your equity curves, i provides a clea provernent. When we know the average shape of our personal equity curve wehave 4 ‘an imporrant way to judge the early succes, or likelihood of falure, in any individual trade independent eat conatons Kly ecognise the Four progres. back is deadly. The f HOW MANY STEPS BACK? The curve provides ‘The classic stereotype of a drunk’s progress down a footpath is described as three steps forward and two steps back. As long as tis ratio is maintained, the drunk moves forward. cep for Trader Average is 4“ «6BETER TRADING. By examining our trading history with an equity curve, we establish when a trade is just stcuggling, and when itis dro know what the equity curve fora good trade looks i like, and we know what the curve looks like fora bad trade i “The aggregate equity curve prov : in too early and, on ave sround and stats to work in| itis also a repeated consequence of abot ‘only lose 6% before they start making money. The really bad trades lose 15% and just keep on going down. ‘The performance of every individual trade is compared with the aggrege ‘The curve provides an independent way to recognise and manage the 1 LOSING TRADE PROFILES ‘What does an unsuccessfil trade look like? Consider the equity curve shown in Figure 5.3 ‘of an unsuocessfl ade made by Trader Average. I plots the percentage value: Trader Average out of this eycle of hope and ‘5. EQUITY CURVES disappointment. As soon as the marke ‘This ihis personal foursteps back. He cormarket loss exceeds 13%, he exits the trade. the aggregate equity curve performance profile ‘money. Even Trader Success has.an aggregate performance profile that shows he loses money efor starting omake money. The equity cuveer thie show in Piguet sand reps toward the " nite poten ier Average does no have thisexperence, ‘but by using an aggregate equity curve as a guide he id Trader Sues iy cates de he sens ron rdf maximum debwn—Jhn ‘Sweeney's maximum adverse srt nd an ‘with confidence : But when the equity curve for an individual trade dps below this average—when we lose more than normal—we know the trade has higher probabiliey of disaster. Tismany trades we have @ tool to confirm trading succes is to make each trade conform to, or outperfo past trades, ity curve in our collection of, Figure 5.4 Equity Curve ~ Successful Trade 4,600.00 4,000.00 3,800.00, 3,900.00 2,500.00 2,900.00 500,00 1,000.00 00.00 1.00 ‘500.00 -1,900.00 Performance protect capital, protect successful or appropriate they are depen tools, techniques and methods 5. EQUITY CURVES ‘ANNEX TO CHAPTER 5 Coristructing an Equity Curve Using a Spreadsheet ‘This is best constructed on a spreadsheet as soon spreadsheet template for this is avalabl pak from www.guppytraders.com Reader themselves, The layout is shown Figure 5.5. mn D is the return end of the day. Fe by Create an embeded chro gop thefgmesin column D. w percentage change in value each day. The value is it clearly on the chart display. increased bya factor (On day 2 ofthe Figure 5.5 Equity Curve Spreadsheet rage ae Og am ai ans} sa0000 o0a00 ssno0.00 00Part Il PROTECT CAPITALChapter a RISK AND UNCERTAINTY Iain found wealth hidden in a cave, ‘on out computer screens, The potent available turnsBETTER TRADING. PROBABILITY OR PREDICTION? 1 chart analysis to understand crowd behaviout. Why do you use analysis? ‘Usually the answer fall into two dis provide a way to predict market moves and pri ishes a probability framework. TI ey divide eraders and te charting and techni fem Trading. back three years and found tha ing fo analysts who use these ong to. Ifthe analysis is based. 5 who, as wveaveraged a jtion then you may end up with rou have averaged lo yea. This from e know, that you ely ean buy bottoms and can buy bottoms and exact ah me peopl dow the aprenches ery aces Clover hey ao se oe wading ecg eum god ding The Risk of Prediction Weallbring with usto solution tothe pro indicators and separate packages. ‘kage is neat and procedures provide a good s stocks. Many people stop there, bel eel Sree that good sto hey recover quickly. The quality stocks to lower ts we second package contains ana prediction, “The objective is the same for both the investors using nical indicators. They aim to red arable outcomes— using charts and opportunity? How do we turn risk into reward? Successful 1 mes from just three numbers that accurately define and %Jc. The solution starts as soon as we buy because the nature of risk changes. We introduced these the very foundation of tading success, so we consider ying these calculations to determine how many shares the risk comes down to a ing money, then our risk has increased. rated and measured because risk i the product ofthe re between entry, exit and capital ‘We sare defining risk by noting exit price. This price is designed to co happen, but we ‘equity curve from he price we pay to buy the stock. Next we decide the , Remember, we cannot ‘when the trade is going bad—we stat losing last chapter tells when 2 trade slips cowards 1 stop loss price. The difference between he market. Not everybody ‘understands this an« third number in the caleulation—the tal amo Jy the entire amount che company goes out of positon, is $20,000, then it ishighly lose the entire $20,000 but not very often. Tin arca of confusion. Many people measure the loss in te This ss isa 10% loss when allocated to the trade. In this example, a $2, the $20,000 used in the trade. If we me risk. We mus ‘or ade, should putat risk more than 2% we does not mean each trade is limited t0 actual zsk of the trade—the amount we are prepared to lose ing ¢ ‘total of $2,000. Ie before we admit we are wong—Is not larger d all ‘We use the 2% rule cons! the impact of changing the amo prove drama 4. RSK AND UNCERTAINTY Figure 6.1_What is at Risk? Pie fl tm centy poe to Sop ome ont ———__Figure 6.2_ Percentage Risk ___= nakes 194 I the; 1 s¢op loss. ward spreadsheet ‘example we propose entry at $5.00 and we spend more than ‘around $20,000 on the trade. ‘This is @ reasonable trade size. ould take 390 successive losing trades. BETTER TRADING. ‘no single trade has the power to destroy us sk by understanding the ami ose to lose. When we control cin the Better Trading pak provides an opportunity ing risk grow beyond 2%. With $100,000 Trader row hefore his account is reduced Let risk grow to 5% and Trader Novice is ; aoe Planned enity $5.00 capital grows, and the dollar c decreases, Every time we enter a new fount we truly I thisdecision usinga stop loss order we financial aspect. The second is a tomatch the financial requirements makes fora safe trade because the price falls after he buys the stock, he gets our f the 6. PSK AND UNCERTAINTY Figure 6.4 Financial Stop Loss ‘baced on fill cost ‘This combination sets the stop‘When we come t0 complete the trade we If we spend $40,000 on the wae loss happens when we decide 0. The igure 6.6 Position Size Too Large ____ Figure 6.6_Position Size Too Large _____ the stop los level rarely coincides with a logical point on the chart. f we ee ee capital than we have, or more than oe ade before the chart-based logt this trade no mat swe decide to trade on the trade, We donot want to pend the trade. Ths spreadsheet shown in Figure wwe can spend on the trade $4.15—and the amount we famount we are prepared £ lose if we are wrong-$2,000. This combi .0w how our preferred sop loss money management solutionsBETTER TRADING. Chis Kiev and The Trading Game by Ryan Jones. CALCULATING RISK AND REWARD ips. One ofthe risk and reward from each plann ‘There area minimum of two features we need to consider: 1. Decide where the signifi pice rise andl defines the Is based on a preferred mi ‘This isthe trade reward. Ic isthe diferes planned profitable exit price. By fon the trade: 2. Decide where the significant support one ‘acts asa safety net, and defines the stop los figure also used in the based on a logical chart point. These point trades it may be the value of a moving average ‘of a count with trades like the exam ‘ows a planned entry at $33 with an dof § how strong the chart patter, how the indicator, how enticing the trade oF explore other solutions will find interesting diseussior "Tharp, Trading o Win by Ar ipher Tate, Trade Your Way to Financial Freedom by Van potential downside of any planné sop loss point, My preference isto sel ed tre oF ‘between the planned ent le, We need to combine or level the level of risk in the trade calculations discussed above. der lade 3O g PROFIT] Protecied] AL Redee ALR SELL ourims TRENO| Prtectes achieved by Ter Luck. This ale has not radi capital. Alchough trader Sel AYSING MARKET ceeded in protecting profs At ey trader FALLING MARKET $1.30 recovers capital a ak ‘apie when asesiedagunst his total market exposure. U Figure 83 Zero Cost Averaging Calculations to prowct his rai ipa tradi ‘0 2m | decision as MIM prices rose to a peak of $1.75. An effective money deliver some of these additional profits aa 8,00 esBETTER TRADING 8. SECURING CAPIAL Figure 85 Trade Exit at $1.75~Rising Market @je FALLING MARKETS If and Zero both muster che courage to sell the truth, many rade stil ind agement technique helps reduce 000, He callected $14,500 fom the ecovery is $19,500. He loses 2.5%, or $500, a round oral of $30, 4 trader tothe risk of capi dolar ference between Trader ZeroCest and Trader Se! : protected ina cee His profits on the total posi to disappear quicl Figure 8.6 Trade Exit at 50¢ — Falling Market Zoro Buyatold4. SECURING CAPIAL Figure 8.8 Zero Cost Averaging Calculations fading spreadsheet pak and shown ‘STARTING TRADE BUYVALTE, advantage is enough. For oth approach 1500.00 ssioo00.00 Zero cost strategy stats to outer this point | Zoro cost average prof Proft can © ssooco the MIM downtzend reverses and tends upwards traders 1.30 on the right: 9 $0.50 in enely 2000 he turned the ‘computer off and stopped looking at the screen. We force him back to reality in the final pare of trade 2 rend, the ero cost averaging technique protects and allows profit to run. This technique removes the stress associated with do both protect crading capital and profits, At some stage in oe evelopment as traders, we all have the experience of a uprendsoften eated with in __ MULTIPLE TRADES TRIGGER INVESTMENTS ‘Good traders captue rallies, retire during price retreats, and then enter again on new trend teversals. Successful implementation depend ing ca aalvantage ofthe oppor this example we ee a new trading opportunity in Figure 8.9as MIM prices rise fom the low of $0.50 to $1.30. Ideally, we want to be buyers and take seni @BETTER TRADING depressed prices shown ‘Trader BuyAndHold has fared 206% recurn on ca inthe face ofthese 1 chart this represents drop drama 11 Two Trades — Figure: ‘% Return on Capital trader Zero a8 $20,000—his original capital—aval tad ginal capital—avalable complete and exp: ‘extended time risk, to the heights of del depths of despa fe beca Figure 8.12_PBL Monthly Chart 1700 1600 600 400 1300 s100 | 1000 nconeas WHAT ABOUT INVESTMENTS? trades were completely closed at the isstock, recovering both the technique when this tader again he opportunity to turn those profits into trading cob tilly risk veraging ‘the media company Publishing and Broadcast {$20,000 capital is recovered after each trade the series ace is entered in 1997 at $5.80. The zero cost strategy 9.00. This leaves 1,244 Publishing and Broadeastin The second trade starts at $6.00 and ends at $10.20. 8.80, closes at $15.20 and adds another ZERO COST GROWTH ‘The zero cost averaging approach has three main advantages: ‘over from this transaction, ly-protected trades for a tot ‘commitment of $20,000 this trader now has 3,923 ing and Broadcasting. They are pure profit. Even on the most recent profits growBETTER TRADING. “The impact on capital and profits for each strategy is summarised again in Figure 8.13. Figure 6.13 Risk for Each Strategy [vcr Hat r00% gain ‘PROFIT | Prt a Arak SELL DURING TREND| Jcaprra| Pieced Ask PROFIT | Protected Ask RISING MARKET Avie Ate caPrTAL, PROFIT FALLING MARKET caprraL| Aus ity in picking anywhere near the top price in fast-moving stocks, § roach gives a more effective outcome in a volatile market. 100%, then sand participate in the remainder of the trend. chere traders worry the the tra rovery, Later, he as the capital on hand t0 building multiple postions in a single stock which ‘a general mar pethaps 8, SECURING CAPTAL Tax Consequences oe thee npc bree endian creaoantes an ancum ener ee Seah eaiho ain afccalsen Dotan ke ae ten ule youwantonyea talegend hee ee ev ou tang lino bee recurs by ws eve they achieve fe ame real by alg th is dangerous detour in the next chapter.9, DETOURS Wm DANGER ‘The second facet of dangers the unintendes reduction of trading profits. Margin lending provides a link between this section of the book, which deals with protecting ea th hich deals with protect fan from a bank or a broker and the mechanics are much the same. re ofthe shares in a company, the value of your portfolio or the value of your house urty against a loan. Chapter ae DETOURS WITH DANGER ad process. Trader Average wants to buy blue chip grouping. ‘The ratio of lending to che capital value of the value of $10,000, the ‘margin example is $7,000. Thisi the fist part of the your trading performance? Can you aod to tke 8% to 12% out of J ant pelt away to sometotyee? Can you fod wo od 86 ert your broker Foro For Trader Average, this is yet the appeal of a margin loan sil beckons, Margin ang as benefits bec al traders to use the value ofa stock asco t horrowing money to buy more tod simplify, once Trader Average has borrowed funds, she i requ the agreed ratio between the market va and the money she borrowed. This ‘constant and leads to an. is. There is a lue to move down to a minimum level before a MARGIN TRADING Margin trading! means borrowing funds to trade, hrs vena loan facility offered by brokers Now i the tum-the-upstairs bedroom into-2 in loan can now come from property, nan stock—falls 109% or more below sd ratio berween what she owns and value falls to $7,000. Seventy per cent ofthis for the stock is $5,600. This is now the new maximum amount the ‘margin lender will lend against chese shares. Tider Average has an obligation to reduce > her up the value of what she owns to maintain the 1 the mari a sed iverchargaiy in his igs treed moe.BETTER TRADING Margin erading isan ‘been rempted by offers ‘a personal view rather than a guide to the jour understanding of the serv ble. The objective in this chapter is to increase tisk involved in teadingon the margin soyou can make abetter decison when these facilities | are offered to you Types of Leverage “The appeal of margin trading is the leverage. Just a small amount of cash, or an aset su as the new bedroom extension, could be tur ading at $0.03 vo $0.06 than, same, but the amount of work refinements and some qui provides useful background. Guy Bower provides more for Australian Investors and Trade joer Tate in Thisis mangin lendi = pay the piper—the lender—before we pay ‘The shadow ofthe 9. DETOURS WITH DANGER ‘The third eype ofleverage is promoted by the money lenders including banks and brokerages. jon using the value ofthe shares purchased as cllateral for loan forshares, Margin lon, A margin loan uses shares or other assets as security, This can include your home. Hore loan. A lender typically gives you 20 of 25 years to pay offa home loan with, regular payments based on interest rate movements ‘Home loan. The home loan repayment schedule is not related tothe market value of the house. I ket, the level of repayment dacs not increase. . isthe margin yr many traders because once interest is aied fe sometimes grows to more than 100%. ‘They set stop loss conditions based on a range Chapter 6. They feel uncomfortable surrende ry to make a decision even in arising market.BETTER TRADING bi and hanl-eamed experience is a profit of 10%, 0 their bank account. Some ofthis profit ed away by brokerage fee. ‘The reward for 20%, 50% or mor ambushed by the tax man, % xy ia trade beyond his ext signals in an at pay the piper cessful trading approach is under pressure and attacked by 4 ‘demands that have nothing to do ain the requ ig market, people are reluct have spare cash to meet raders believe they can live with the demands of borrowed traders experience losing periods. Sometimes it is just an extended run of cent with the overall behaviout oftheir trading approach. Trader Ave demands from their margin lenders fora between the value of the shares and the amount with cash. Most met the calls bys pare, because margin ket other than as 2 measure 9. DETOURS WH DANGER accelerated. brokers loan facility account so the value of your shares and your cash sven your borrowed funds and the asset—the shares. In a to add more money, and in some cases, chey do not incall. Figure 9.1 shows how funds are distributed. Figure 9.1_Margin Trading ~ Who Takes the Risk? “These are important decisions. They are made more ‘constrains our action, cr demands repayment at inconvenient times. sbi ding for somebody else and the ye is one of the prime bene ‘Bear markot— falling prices| Your cash recuired to estore the 2oteed margin Value of your personal shares now 50% of fan amount a Extra persona cash Bank's funds oe ing the same way,Tending document you signe so the cont they want money quickly to protect the the funds. Dumping, we, Forced magi slling often means mveard spi ‘The precise mechanics of margin lending and margin and bank to bank. The general mechanics remain the: sand keep the mon ge and other asset iuces a risk over and above that created by the marker you are Marginal Risk advised by his father, Polo ‘no pressure to come Up gf borrawed money. They 3g capital and to pr leced in the next Part Ill PROTECT PROFITSChapter ie EXIT GREED en there isa chance we may do some Before we examine specific protect-p ed post-mortem of the way wing defined the probler, ving chap ices. Perhaps we ara 53.60, fd then ade higher at $3.6, Thisingle ups pon a des and our good ws the power ons. Should we stay with the trade and aim for 1e money and run? in the trade. We consider some in the following by examining the problem we wish to solve. Come with me and eet greed in areal i vos,| : i manage tas he hopes for higher es and takes his position ‘Sioces Resources Dallybar cart fon the bottom and the top ofthe price gap. 1. exrereeD ‘A parabolic tend develops in fx Figure 10.2 Parabolic Trend moving price rallies. Ie provides a way of |< —=—— ‘managing momenaum-deven trades. The tend is best described on acharcby wing aac or parabolic curve: The curve sas edslouly then sceeres very api ut Parabolic rend Mutple short- term straight edge tendlines 0.28 provides a 75% rerum. The important point is not the se of the return. Focus on this and gree creeps in undetected, The important point i the way ths exit at $0.28 is consistent with the original trading plan established when the trade was fast entered :DETER TRADING. Figure 10.5 Sirocco Resources ‘Once Were Profits Taming a profit into a Get out here and the pr © from the o move back up to $0.24. recover In jus a few days he shi from well. When Trader Ccountbacklin stop os Average trades Sirocco The price dips below the straight edge for another sell signal at a lower price. This defers any action, and “ade shows acaptal_| loss below 80.16 RO Sirocco Resources Daily bar chart wun’ Paagust” [eestember der Average is disappointed and decides to get ou vasual dave es. Profi grow o our bai of hn put eso apa age a + techniquesto prevent prof erson and mets inguptend. These involve combination ofchar high of “Trader Average is not trading wel. His decision noc to place a back tothe level where oe 109,DETIER TRADING FAST MOVERS Fast-moving stocks whip away profits ina lash. abl diffculttocaprure oo far away from the current amount of rk calculated on ime entry point, position cost foreach trading example: ‘both om a spreadsheet and a chart. The Juded in the Better Trading spreadsheet ry. The impae ick up and down it trade opportunity is shown in Figu Why do we apparently waste urs take an entry into A\ fist risk managen ‘using the same dollar risk ong ‘he tae entry. When $2,000 of pocential profit from the most recent hig made she curs to the 5 “Austpac Gold hit a high of 0.058 and the calculations are shown in Figure 11.2 12 Ns PRORT ATK Figure 11.1_Austpac Gold “Trader Novies. Half entry tak 80.066 out rink 80.059 A = Ty it ua he ——_Figue 1.2 Trader Success [Liarr DOLLAR RISK [To ENTRY RISK T.aSE, ono __"‘s0.026 | Total east 70,400.00 200 he ota onET TOIT f+ Hianest High onthe ‘sevond day afthe aly ue 19,600.00 Profit at risk 1,000.00, Prost atrisk = Ext pce ‘Your Profit return% ‘Max proft § $12,800.00 Maw proft % 123.00) Working the Profit Squeeze 1e maximum out of every trade. Getting ‘was $0.058, Some dtdayconfaton The venta ce 0 de Novice cof Austpac Goltetethe wend hava charg ech heal gh approach: ead of using te full amount of 0.058, of ‘as many dollars at risk on the profit ex 14 us{eTTER TRADING Risk approach is much more successful than volatility-and range fast-moving surrenders 19% of red with 80% surrender forthe countback line approsch, asshown 4 Figure 11.5 Relative Performance ENTRY RISK = EXIT RISK cet Exit EXIT RISK HALE ENTRY RISK ink approach gives the trader an effective way t0 ‘pood way to protect open pF sn with other andard trend ders might choose «by the countback dk of sudden trend collapse. Trend identifi e op loss cal Hardie Industries in Figure 11.6 as an exam! “Trader Success applies the Proft Dollars at Risk 1 countback line approach. Both caders star with an egy, and Trader Average entry at $3.55. de. The best exit method should delive solute high of $4.60 puts $14,175 profi in price is at $4.40 but Trader Average cannot act oi I the next day. This delivers an exit at $4.30 for a profit on the trade of 11, PRORTATRISK Figure 11.6 James Hardie Industries 470 460 460 440 430 420 400 390 380 a70 360 360 340 330 320 310 300 290 aH James Hardie Daitybar chart Day [auoust” Taelaat Figure 11.7_ Exit at $4.30 maximum profit Surrendered profit11. PROFT AT Sk BETTER TRADING altel Figure 11.9 Exit at $3.90 sen the maximum profi ‘Thediference beeen he maximum he dale the mt 1 ‘ade opened. 52660 Profit 4705 7 ‘maximum sale at this time 64,675 Based onextat $4.05. In late May, Trader 3 wm profit 6,750 4 Surrendered profit 20025 vit isk $2025 egy, used by Trader Novice in the h James Hardie, Trades based on this method the very beginning ofthe trend development. The exit signal he current highs ‘SELECTING THE BEST EXIT e purchased 1050 shares fora total ? common erty point pol nl i: sk was $2,000. The current high p ofthe trend. Thes aH ‘ames Hardie Daitybar chart 52,000, the exie trigger price is $25.30. The 9 as $25.295. We need provide a comparison point foraltemative ty risk on trade entey—are of the spreadsheet chang price determined by anal cere level Howcves, hiss trend strength. Relying only on fnanc Satioctory.SETTERRADNG Figure 11.10 Comparative Spreadsheet 1 ROBT AT ISK “The brtom ine ofthe spreahee compares the exif at compare the ext efficiency ofthe selected state Inthisexample Sore effective. Euiped wth this infernation Max profit value a 3a 362 [number 316 5 apm2s2|cost § 300200 § 343000|Curont value $2,844.00 158.00 Jopen profit, § 4652067 $ 79,146.00 Total trade capital Current value Total open profits | choose to se the Guppy Multiple Moving Average to identify che tes ‘rend. Luse the countback line as stop et for new entry poin ‘Jevelops You may choose other techniques fr tools. What is importants to understand the w influenced by the 1d new postions ses rey for adding to trend growth, and trend collapse isthe Grow. Up approach. ‘understanding ofthe development she ery right. By matching each new postion siz wit S| vereraal we havea better technique to grow profits and to keep them. 160 | [oro up sategy = §9,000. The trader needs a to maximise our profits when we ae right and reduce the impact when the tend fi ‘COMPETING PYRAMIDS egies. We use exactly the same »yramid approach id the Better Tiading Excel template pak from www.guppytrade Figure 14.8_Return on Capital - Three Strategies Constant size pyramiing_Dolarcestaverasng Totaltade capital 102543. Totaltade capital $ 7207739 | ete, SEARED Carte HB sen 487032 Toalopen | ‘ae cca 10 etna ts eet 2 Asia Ace ‘The dollarcost-averaging approach returns 56.44% on capital. Each new trade costs raegy. Not only is this moreBETTER TRADING Figure 14.9. % Return on Capital - Four Strategies Chapter re ORDERING PROFITS Zerocost Constant Grow Up averaging postion size Despite using the she entry point and che same exit point, the choice of money ‘management makes fant difference. Trader Lucky between the three pyramid serategies remains constant. Th onship add to winning erate istently the most successful ofthe ‘ses the least amount of eapital and generates the hi fom each ofthe pyramid strategies may be particular car sarket, Defensive trading would be unneces precisely because che future remains unproven a “approaches play in grow “Trading is more than ‘management agement has a major impact on range of eadig icc ln these examples Wb just afew cents, and ce has a significant co get the price You unch intoa more detailed discussion of specif onder stat x deed dco of pci re aati oak a moment“The quote-drven market from the market. In listof buyer descending bid order. ftder ine shows a buyer who wants to pay $3.32 ace prepared (0 ich they wil buy oF middlemen, They quote Figure 15.2__MarketCast Live Screen — Level 2 fon and restrict access markets ate buile on trading transparency 50 i reer driven masket matches buyers with sellers without ed the ine. This shows the total nur “co py this much, Because the market ‘ee how much other buyers are prepared ‘There lace with a broke this stock. The hen srades are complet trders extend all the way downBETTER TRADING Look at the detail ofthe order line-up for ‘This shows every order at every price le 30 shown in Figure 1 system. Orde placed Theme of oder ‘OPENING MATCH ct screens by internet brokers When irdinary tra by ere given access to depth of mark MarkerCast, they small numberof ‘came from a poor understanding of the open of trade. the open shows 740 shares wanted then the ASK matching eae le, 71400 x SLI6 = $8,584 3,500>x $0.95 = $3,325 > Add these together, $8,584 + $3,525 = $11,909 ‘cneategy diminished However it ioe torrets than the one sed the effecrivene the entry into a trade to get a price cl trading plan. 186 15, ORDERING PROFITS ‘Tosee how this works we look atthe activity in Cluff Resources In late October many traders wanted to buy Cluff Resourcesas it showed signs ofa strong rally: The stock came up as a trading candidate on searches based on end-of day data. When traders tumed to the he market open, they saw a wide spread in the onder line as shown in Figure Figure 15.4 Cluff Resources BUY SIDE SELL SIDE cusrety_ Pree Tota ‘uantiy Pics Tat Sa]? OOS Sao OS aos? st ao] 0] § cosa] s . Enao| 0] $ 083} $ 354000) "Tie wi be the and 0.05, ana some’ complies. The Byer wl 280 on Ofer at 058 shares on gale a 0047, 52,000 shares sled ing price then we use the ASX ed opening price. A rough and te the difference between the highest bid and the lowes is. high-risk strategy. You should never bid mote than You ay pull out the cheaper sell td . This is good ifthe briceBETER RADING Figur 16.5 Order Line for ‘Using this information either fom our own cal display, we know in advance what the match pri afes Price falling towards ‘Support at $3.00 Buyers at $3.00 ~ Day 1 Day only Day only Our Good till Cancelled Good til Cancelled Good till Cancelled Day only you see is wh a age in order execution. With acces Senden jump the gn, othe li epee Patience is rewarded by the: unexecuted orders ‘When we place a good 1 very useful technique for en ing ly breakouts on pullback. This method does Wing momentum stocks where the t “These uades eure handeon guidance. Te go. bled ends and those showing moderate eakots fom downtrends anda propensi They all identify a support level at § level several trades take place 3 15 ORDERING PROFS ading activi Jind ewo day-only orders. removed from the order line. ‘There are many reasons for sing a /pportunity and know the price they are ‘opportunities tomorrow. Using a day-only order means they do not have to worry about contacting their broker to remove all he end ofeach day because iis dane automatically by SEATS.BETTER TRADING Figure 15.6 OrderLine for Buyers at $3.00 ~ Day 2 “Price reaches support at $3.00 day-only orders fom day L. These un Then me patience, and an understanding of how th der line quite a distance down and sill end up the pack. Figure 15.7_Order Line for Buyers at $3.00 ~ Days 1, 2and 3 Cancelled DAY fy miro Pb om suppor at $3.00 suppor at $3.00 Good till Cancelles Day ory ‘Our Good Good ti Cancelled Day only Day only Good til Cancelled fas ithe i fist to place he i disappointed because no ma ‘down from the head of G today’ and looking for common order other buyers "At the end of day 2 the order from Trader Success Day 3 in Figure 15.7 shows sed ot ‘ORDER STRUCTURE AND E-TRADING who aks a butcher fora seo meat he get een Both ef ent, te der wth a baker we ex so men theft broker we use Uneasy snot dee come Th ae ee completed when we deal with tert tokrage Some of hem have suc nema ode proce quedifeely Some have ipod thet owns orpua the ASX order proces You do not alway fee what You includes the good-tll-canceled order that was eit fer. This po very good strategy inaBETTER TRADING 15. ORDERING PROFS weekly grocery he problem is t0 five choices: With some electronic tr ang services iis impossible ro lodge anat-market order bec to chase price upwards treated in the same way asa you want your on n option aval ly limi. 10 achieve these five outcomes. The impact is Buy the stock forthe cur _ Buy the stock atthe best Bay the open, or sel same and the order is. traditional brokerage. By setting a lit ind no further. Be aware the order is, ss your intentions a $10.51 then your order up to $10.50". Any sll orders including those at $10. no more purchases are made until prices fall back to ‘The buy-at-market order. The order execution usualy start with the current ask, say $10.50, a the order the order completely with whatever stock is available In this way, you ngthe fl si of your onder. This dpi service brokerage. The main difference is you pay a brokerage fee » ede instead ofa single brokerage fee forthe group of se-est races, 1‘getting the timing rel E When placing an order, ‘opening price. The key placed. Other traders have and they ificule and work out what you want to do, then structure your order 3 ‘consistent with the way your brokerage executes those orders to achieve your objectives. Figure 15.8 Orders Taking Out the Market ‘completely filed. ‘order untlled F closed. An order entered during the faker. 4,000 shares for sale § price-—before the open ofthe next days trading, Th 15. ORDERING PROFS AFTER THE BELL wen the marker closes at 4 pm. Right? w. tading for the day stops. The matket then moves to a pre-open «before the open of trade in the morning. The afternoon pre-open xended or cancelled in thistime. In the randomly generated by SEATS, Orders beginning of the chapter. Al resus the lst traded price £06 pm. ing feature that may allow traders to sing price—after the market has closed, 5.00 p.m, are processed in pr ime priosty as di ‘orders in the same security are executed at the 00; fiom the} they wi ide must phone the broker on the other side of a late trader. The price of ded atthe quantity of ‘matching buyer ate remember, the next day's looks dumb the next day, «The ASX closing phase ttades. Not al Eases some que Biking the electronic broker’ language isa step towands od few step created by some brokerages who have decided eo apive days. This a disturbing he onder. | believe ng at $0.30 may fers at $0.10. These orders are accepted because: tnd their price leverage make ifex Gold in Figute 15.9. of the trading methods I use, also unconscionable 15. ORDERING PROFS Figure 15.9 Spinifex Gold Orders Faure 18.9 Spinifex Gold Orders Real depth of market and imits on out Sand Tes [ex igh Jlow [open Tava, SPX 0003-60 0ST [0047 — 050 Last sell orderis 483% higher than the last trade at $0.048 [O.051Part IV PROTECT PORTFOLIOSChapter hs a MADE TO MEASURE B measure our perfor The henchinat captured by the Al changes were made to dard requirements of US fand managers Should we use it as earger or asa stating point? select a benchmark for comparison and apply it consistently. We ted by the mechanies of index construct trade management, fer marker becauseHEDGING RETURNS SETTER TRADING Enter the hedge funds. These specialist funds were originally developed inthe United States ‘Classic hedge funds have @ commor their commission fees, stare where the marker fini 12 months then the hedge funds do standard for professional mone} made on the back of a general 15.5% is considered good. et relationship between hedge funds and other funds is shown in Figure 16.4 they are pid only for porting te ‘The hedge funds they outperform the market. : hedge fund survives by earning. mance over and above the market ey from management fees levied irrespective of the underperformance, of the fund. first match and then outperform the g a wide range of sec ‘the marker they should be able to, Fund Performance Hedge fund | Market performance shown as a zero reference line / Diversified fund performance 5 we | do beter than an individual. Thei assertions would be nds management and for the ing be hedge nc evaluate fund performance. Funds he donot deserve our capital. When we asses portfolio peformance we aim for returns to outperform the market by 10%, 15% or me ety of money management strategies to protect our personal ly if we apply an appropriate standard to judge the level of and the damage to ‘expected. Apply the cash intrest rate asa benchmatk and ii deposits is not an adequate comy ability to manage our mat a mere effcive way of making oun beyond oe benchmark and aim to’ = vd in tomatch the peformance ple of any than cash nd abo a god sper mart earn, Be igh as they * fund ma bigadvanage of aged fn cflacktmninid: Thee dash based on performance rath woney managem Isand techniques are not beyond ge success and reduce the impact off ity provides very important advantages. The later cha land Investing approaches to portflio protection show how these advantages ave wd 7BETTER TRADING Many eaders and investors are satisfied when they generate returns matching market pevfotmance. To get there they need to apply some ofthe techniques and methods discussed fn previous chapters. They may well use other approaches hance made ro mene Bue wih beter mesg tls we ‘now investigate these strategies. bs a si ‘eet performance are a more accurate measure of our sucess. Figure 18.5 Absolute Performance ‘Above 15.5% ASX 200 Return BRSREA 817 RSKAND DIvERSTY This recovery calls fora return of more than 11% just to claw back to the original level of In Chapter 1 we examined the impact of even a few loses on annual portfolio Chapter yg RISK AND DIVERSITY of modem portfolio manage In summary, the theory ae general market we cocks held in the portfolio. The sw cents. The market offers a variety of different levels seine or pont ‘managed by selecting divesiy based on. and we hope the we howeves a faw i th bell teense 41 180 181‘When we accept the volat ly concentrate on managing the risk and achieving a be BETER TRADING ks, then we m ‘balance in our porcol profile is the WHEN THE CHIPS ARE DOWN, trading strategies suggest blue chips are safe. The strategy im chip stock has a low probability of retuming 100% cases we look for a 10% to 20 if 20% th H ih ir Start figure $19. wl |! F teduced execut vray to der Povo cleus te pie equl 2286 re he chart, Then count : ile ade de a iveen rade ‘broad mar i A mid-cap stock is expected to deliv bet 30% and 50%, er retums between 30% and 50%. TI ty alo suggests these ld be available more frequently, the higher 50% return, ling opportu veloping a trading strategy ws the capacity to increase capBETTER TRADING. 17, SK AND DIVERSITY Figure 17.4 Redlex Holdings Figure 17.4 Redlex Holdings _____§_ Figure 17.5 Zylotech tty 50%. il Start figure $1.98, ROF Redlex Holdings Weekly bar chart a Zylotech Weekly bar char this understanding of me scale yet you shoE p SETTER TRADING. Figure 17.6_Which Class of Stock? igure 17.6 Which Class of Stock? Figure 17.7 Expected | Annual retum frequency pertrade | of trading 10% to 20% 1-2 Lage Deep) 20% 050% 2-5 Midrange | Average | Speculative | 50% io 100%+ | 2-4 Small Low 16 capa nother look ud ot al absolute ratios, they ate alloc: cks and four of these are specu isk based; the opporeunity to pr there is no guarantee we 2% loss of goes to ks with theBETTER TRADING Figure 17.8 Volatility and Capital Allocation (CUMULATIVE RISK We need to distinguish Blue chip | Mid-cap |specuiative} Varatiity Capital allocation anticipated. While a general market collapte is 190 - Speculative group Retum Riek Volatity Midcap group Blue chip groupBETTER TRADING mney they are prepared 0 lose money because they can af isk is to allocate our capital and one trade wrong. Ove three or five or more lo asthe skills to roves his chances of success by taking ju This gives him time to manage the trade 28 before spreading the trades out, Trader Novice gi “Trader Success has 2 70:30 sucess Le open postions in the one * trading positions in each sector where vol Intrading les volatile ectorsof the ma ing risk withthe total amount of capital we! we are prepared to lose. these approaches Trader Novice may end up with @ riskacrossa variety of market segments. By spreading les, based on volatility he effectively reduces the probability ‘This means his effective diversified tsk is ich greater than 2%,BETIER TRADING 17. RSK AND DIveRsTY Figure 17.10 Total Risk reap the benefits of diversity by selecting stocks with a diverse ‘nota function of the numberof stocks in our portfolio. leis management when it covers a range of returns coming a range of volatility. We protect and enhance our portolis vere balance between blue chip, mid-cap and speculative stocks an their eputation. Traders look for High Risk] Speculatwe | # postion [2% Zpositons | 4% high volaity cumulative cumulative tsk tisk Midcap- | 2posiions 4% 4posiions | 6% rid ange cumdave cumulative voiaity sk tsk Blue Chips - | 3 postions |6% A postions — | ai Low Risk | low vlatity cumulative comulative tik figk Total risk for Total isk for ‘rater | Trader Trader Novice Novice Success portoiot 2% analysis. wwe have no control over the market or the probability ofa systemic or sector collapse, we do have control over our analysis ing trading exposure to ou of hhow much capi 19578, SUCING Rsk ‘on through a series of rises and dips does not cap armen reel nought compensa forthe in prof ture any retum or any los. The dividend deawdowns—the periods of los of capital, Chapter he SLICING RISK ‘0 liquidate your port Thesol ext it is not the fast tradi forthe stocks in the portfolio and take ly relatively infrequent process. Us I we see cher are ut ive ety or ene short-term trading scenario. ia Bank example in Figure requiring action over 36 months, Hardly @ {is the enemy of good portfolio management. volatility stocks are shunned be Figure 18.1_National Australia Bank Entry point for investment portfolio wt I “he, , a "J ryt Sentry Position in loss Drawdown area not supposed to be a hedge yma of running an investment portolio and eapturi ‘objective isto deliver sound returns over an extended horizon is longer he can afford to ride out the lows in favour ofthe highs to come. This eatoning is satisfactory only ifthe investor captures the profits on the highs. Mesely hlding We[ETIER TRADING. A SWISS ROLL STRATEGY Figure 18.2 Vertical Cut t poine ‘two showing alos. The jn ie spread t Figure i 1nd exytal 8.2 asec at the same time, Common enty point A Esther captures Trade {= profit Trade 2= prott Trade 3= loss) Trade 4= oss] Trade Trade 2 Trage 3 Trade § 78. SUCING RK of the vertical cut to point B we do slightly better with three the portfolio depends on the timing ofthe cut, {Common entry paint Trade1 Trade _Trade1 Trade Trade Tradet Traded ‘Trade Trade? Trade? enty —enty ety entry enty ing as in trading, 3s however, require a willingness to act when necessary to 19BETER TRADING 76, SUCIG RK Figure 18.4 Horizontal Slice some investinent approaches, this strategy act westment srategy. We s top 100 stacks. These could include a ly looks for volatility because and reputation, hose in the top 100 Ahorzontat slice overtime MA Next we select those stocks with the highest dividend yield. These figures are avail {fom Shares mageine. We want a portfolio poa of around ten stocks The wat ofthe top 100 and are selected in order of dividend! basis of dividend yi This poo isthe we achieve a diversification in te high yields supplement any poor price performance. ‘These two factors—soundness and yield —form the base pool for portfolio candidates five open 9 TUTTE TT Position in loss, umber of companies included Ichough the membership of the pool may change. The isto trade quality companies while having a reserve of quality companiera dive ‘upon as replacements through time Drawdown area NaB _ Re ESE TOTO TTT TTT National Australia Bank Weekly / [ae Ta TE «strategy we examine in thischapter. We start by looking at ways to build an of investment stocks. We consider a poor solution and a better one. We. ive solution and we need proof before we accept it as investment candidates. ment of superannuation style portfolio the search for suitable stocks includes They are: mafirmed by membership of the top 100 stocks Top Stocks With Top Yields rice trending upwards port 0 performance. We look at both Reasonable volat ach group we consider the impact ofa buy and hold stadegy and to deliver capital gains the Swiss Roll 200 m0BETTER TRADING those pai term success depends on prices tending upwards and not in January 2000 near the top ofthe bul 2x months, capturing the tech wreck ‘This was not a geod time for investor show litle sign of recovery. We allocate around $5,000 ‘Yield this market volatility and to produce acceptable rewns. We have a choice of rw 18, SUCING PSK ~TEniry [Value [Ext__Vaue (profioss | WET §289/§ 6000 /§ 326 § 54 1ough to selec the four ceven though these ar fail to meet the market benchmark. rr ry _|Value (Exit (Value _|profitfos 434 |$ 5000 '§ 140'§ 5203 /§ 224 289 | 000 § 3.28. § S674 § 675 72 oT 224GETTER TRADING summarised in Figure 188, Figure 18.8 Strategy Returns 2500 2000 1500 ‘1000 500 8% market return Profit 2,024 or 10.3% Proftt.499 || or 7.5% “Yield 34.48 6.8 16.45 15.48 16 14a 14.08 13.91 13.13 12.95 ang 78, sucnne Rsk Vertical cut returns Swiss roll Returns Bolter Yields Wehve evo choice inslecting the tang pol The end choice moe socks by yield. W re this selection option because many inves ks contribute to outstanding portfolio performanee. The rs fr this poo ae: —__[Enity Value JExit Value NLY |§ Figure 18.1 $$ 085/§ soos 08215 § 213/$ 49997 $ 1.69 | 29554957 | § 280 0.80 | § 5000 | § 0.73 3 the buy and hold ‘lose the portfolio on 30 June, shown in Figure 18.10, 10_Buy and Hold - Vertical Cut 19,996 |‘Taking this vertical slice on 30 June th loss! Remember we ha When profits are realised che re forthe same period. The return is 6 ‘of 8.0% and not as good asthe 10.34 ACTIVE INVESTING Contributing author: Alan Hull A rate of return equal to or greater than 25% > We have witnessed buyer support ase price i in the bay zone ofthe shares which we've selected for our portfolio ly because the buy zone. It is quite normal to spend several iying into the mar shares as they dip down into the buy isknowing which shares to buy and when to buy them. i being th dlccates, 2s possible, the boundaries for holding and profit-taking 228 20. ACIVE INVESTINGinside our envelope, th the balance of proba ing f a re-entry signal and re > fp ces that drive share pi reducing com) Furthermore we can empl ealeulations. trend following strategy and, is no need to close a pos ‘overheats and moves into che profi-take zone then reason for selling when the price activity exceeds the upp of more on my original nonth then I am looking at 1e end of the week in the > Ifthe rate of return falls below 25% per ant ways hand at work. The range i SETTER TRADING chase snualised profit of 120%. As an return of between 20% and 50% per annum. At 120% per curve and I consid ge our open pi range indicator values to perform our risk manage 36 Price has closed at the end of the week in the stop loss zone. ng ‘ice for performing out pos do the calculations using actual figures fom the range indica the chart we can see thae the price activity h for one week, indicating the presence of buyer and it port todo our risk management. However closing price as our entey pice in the bigher a out sk management we have not: ral trading day. The second problem i a quick and easy so than the elosing yield a more conservative inthe buy zone,Figure 20.11_ Institute of Drug Technology Ran: 98 co get the numberof shares we can buy—I,020 shares ,020 by the closing price of $2.70 to gee the postion sie—$2,754 ring my stockbroker and issue my instruct I pay up 0 $3.08 per share.” 20, ACIVE WWEsTING: DIVERSIFICATION io risk is the sum total of our position risk and i ‘of positions we own by the pos and we have seven different shares in our port a catastrophic event such asa stock re example, is 14% of total capital. To total number of shares that we own. Wha ing the 2% lirik 29 x7 = 14%, ‘offer high rates e doing ourselves more re only a limited number of ify our portfolio unnecessarily then we harm than good. own five ie performance of my portfolio by having most, not 1 top of the pyramid. Figure 20.12 _Rate of Return 20 20 20 20 20 10 10 10 10 10 10 um nunnber of positions that age rate of ret ning just five 10% chan 15 ths ategy and management techniques, not on the unc ading is about focusing on the market strategy and management techniques we einChapter D1 NO SWEAT ime lag between the development of new anayeeal ‘as part ofan affordable sanding a permanent and the ules ofthe trading ge are played ona selatively level play So whe and bon ma : pones ‘a modern team game, one player has and the in wild on his sills and take a team to slogans to remind people of deeper and more complex prob C& develop because they encapsulate a relevant and pe the cliche provides a shortcut ‘common usage, and are quickly devalued. At the private trader does not work ina team. We ply is enough to gain /h to ensue suri competitors are 1s firmly focused on the object of the game. ele renultimate decision real and necescary sweat work, but not as much as we hope. he raw understanding and mastery ofthe technical n of how they reveal ing “Thediferencentesuls comes most conten fom our undestandingand application of money management techniques They boost our run 1g the marker field very much towards them. The clu secret nrwork of gentlemen's clubs with rules and insider convent the last century certainly ensured the playing field was tipped towards the 234BETTER TRADING smain level then we supposed ro work. | westing 222-2 Active Ineesting - A Complete Deel, Robert 18 orp 8,192 Average True Range (ATR) 18,66, 27fading the tend 20, 21 Long Term Secrets to Short wading approach 45.53, Sherwood, Simon 31, 33,225 Sitoceo Resources 104 ‘Top Stocks 224, 225 ‘Trade Your Way wo Financial Freedom 66 20