It is essential that any Trading/Investing endeavor has an easy to follow Money Management Program. In addition to using a Stop-Loss for each and every trade that is made there must be a method to limit risk. Too many novice traders that start with a limited amount of capital try to get rich quick and will invest most of their capital on a stock touted by some so called guru they saw on television. Thus they end up broke before they have an opportunity to learn the art of successful trading.
The three most important things anyone must learn to survive in this business are:
A simple rule developed by Daryl Guppy and explained in his book “Share Trading”, is his 2% Rule. The rule states we must limit risk on any one trade to a maximum of 2% of total trading capital. If we have $25,000 total equity to trade, we cannot risk more than $500 on any one trade. This must include brokerage fees, exchange fees and the loss in our position. In other words our total loss from our total equity can only be $500. Now how do we figure the number of shares for a particular stock we can buy at any given point? Use the following formula:
((Total Equity * 2%) – (Brokerage fees + Exchange fees)) /
(Entry Price – Stop Loss Price) = Number of Shares to Purchase.
Don’t worry if you are not a math wizard, enclosed in the CupTrade Strategies© Package is an Excel spreadsheet that you can fill out to make these calculations for you. Before we can start considering a trade we must determine our entry and stop loss prices. The entry price is easy, that’s the pivot point on the Cup With Handle formation plus 8 cents. We should use either 7% or 8% below the Pivot Point for our Stop-Loss. That is the amount we have at risk. If our Entry Price is $18 then $18 minus 8% would equal $18 – 1.44 or $16.56 our Stop-Loss price.
In the case of our example we are risking $1.44 per share. To find the total number of shares we can purchase we would divide our maximum amount of risk which was $500 by $1.44 and find that we can purchase 347 shares. If you use this guide for all your trades you will be around to trade for a long time. If you don’t you will find yourself overtrading.
When trading Options never risk more than 20% of your total Capital on any one trade. If you have $15,000 in your account you can risk only $3000 on any one trade. If the ASK for the Option you are purchasing is $3.25 then you would multiply 100 times $3.25 to find out the cost of each Contract = $325.00. Divide $3,000 by $325 to find the maximum number of Contracts you could purchase. In this case it would be 9. Remember you can only do this after you have made your 30 Option Trades and have proven you are capable of being successful. Make it a habit to determine the number of shares or Option Contracts you can safely trade before making any trade. THIS IS A MUST TO KEEP YOU FROM OVER TRADING.
Limit the number of stocks you are trading. Once you have learned to trade the Cup with Handle Family you will develop the ability to pick SURE WINNERS. That is key. In any given year there will only be four or five sure winners. You will not be making just one trade on each stock but in a good market you will be making several trades on each as it makes its run. It is smart to say you should never be in more than two to four trades at any given time. That is not what so called Day Traders want to hear. They can’t wait to blow through their entire capital. Less than 4% ever become successful. Their only success is bragging about it to their friends. A knowledgeable trader does not have to have a so called guru verify his decisions. Stay off message boards and away from people that know less than you.
This is also a good time to remind you to NEVER trade on MARGIN. Most brokerage houses will allow you to borrow up to two to four times your Account Balance for trading. This allows you considerable leveraging thus giving you the power to make tremendous gains in a short period of time. This only works well in a powerful stock in strong Bull Market. Every strong Bull Market comes to an end. Most of the time it is an abrupt end catching those on Margin wondering what happened. It leads to Margin Calls by your broker as he asks you to cover the loans he has made. This in turn leaves traders/investors jumping out of windows several floors up.
Never confuse Brains with a strong Bull Market. You and you alone are responsible for the winnings and losses you rack up in your account. A well prepared patient trader that sticks with a sound course of action stands the best chance of being a winner.