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In this part I am not talking about technical analysis, but about money management. The best technical analysis will not be successful without a good money management system.
Maintaining good money management habits is perhaps more important than correctly applying technical analysis! Good money-management habits ensure that you’ll survive much longer in the stock market, even with a number of trading failures in a row. Practicing good money management habits helps limit losses in losing trades and helps create more profit in winning trades.
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Hallo, Sylvain Vervoort with technical analysis part 27. In this part I am not talking about technical analysis, but about money management. The best technical analysis will not be successful without a good money management system. Pay a visit to my website at stocata dot org and buy my new book “Capturing Profit with Technical Analysis”, a complete technical analysis reference and a winning trading system.
Maintaining good money management habits is perhaps more important than correctly applying technical analysis! Good money-management habits ensure that you’ll survive much longer in the stock market, even with a number of trading failures in a row. Do not forget that behind every stock is a company that can go broke! You may lose all of your money by investing it in one stock only.
Let's first mention some good basic money management practices:
A first money-management method would be to trade in a limited number of stocks out of an unlimited list of stocks spreading the available capital evenly between the stocks, sharing profits and losses. A second method, which we will discuss later on, would be to trade a fixed, limited number of stocks with no profit or loss sharing. A $25,000 starting capital could be divided to invest in 10 stocks at any moment in time, limiting the capital per stock at the start to $2,500 or 10% of the available capital. An average loss per stock of 10%, or $250, would only constitute a 1% loss in relation to the total capital. Of course, you would have to calculate your buying power with each purchase in relation to your cash value and the value of the stocks in the portfolio. One-hundred percent of the cash value above the $25,000 starting capital will be available for new investments.
The actual value of the 10 contracts in the portfolio will be reduced by 10%, the average stop loss value, as an extra precaution when calculating the new maximum allowed contract value. The maximum buying value for one new contract will then be the available cash and the value of the open contracts divided by 10, for 10% of the total capital. In the table you can see the result for consecutively buying 10 stocks with the $25,000 starting capital. The first buy is with $2500, but the tenth buy is limited to $2284.
As an example, let’s close trades 1 and 4 with a 30% profit, while all of the other contracts remain open. Adding this profit to the capital gives a new allowed buying value of $2,458. In the table you can always see the total invested value and the remaining value when all trades would suffer a 10% loss.
The important question is, is this Setup Sufficiently Crash Resistant? Let’s apply this system and calculate the maximum allowed buying value for each contract. Next, let’s assume the most negative scenario: Each of the 10 contracts ends up as a losing trade with a 10% loss. This happens 10 times in a row for a total of 100 consecutive losing trades. There still is a remaining capital of $9,151. It looks like good money management; you can survive for quite a while, and it’s possible that just a few trades will make up for all of the losses very quick! In the table, you can see the remaining capital after each 10-stock losing trades.
Another possibility is to select just a limited number of stocks and not sharing profits or losses. I prefer this method because it is much easier to follow-up a very limited number of stocks with technical analysis techniques. With a fixed, limited number of stocks, it is possible to keep individual charts with specific notes over longer periods of time. We can start with a fixed capital per stock. Assuming a starting capital of $25,000, we could divide this money over 20 stocks, each of which gets a starting capital of $1,250. Each of the 20 stocks is traded individually, with no profit or loss sharing. All profits or losses are attributed to the individual stock. This means, of course, that each stock must be followed individually because it can only use its own private capital.
Applying this kind of money management is effective and has a number of advantages:
To find the results using a portfolio with or without profit and loss sharing, we can run a test with the same stocks over the same period and with the same buying, selling, and cost of trade conditions. I used one of my automatic expert buy-and-sell test systems. Although the system used is not necessarily important, it is important to use the same system test under the same circumstances and during the same time period. In this example, we only took long positions. For the first test, we have a starting capital of $25,000 to be divided between the 20 stocks. But there is profit and loss sharing, so each stock will get 5% of the portfolio value at any moment in time. There was an average of 25 trades per stock in the total time period. The total profit was $128,872.
The result without Profit and Loss sharing; there were, on average, 25 trades per stock during the entire period. The total profit was $265,356. Meaning, the final profit has more than doubled. Trading a selected, limited number of stocks and not sharing profits or losses is clearly the better choice! So, this is the system I would recommend as a very good money management system.
This is the end of the part about money management. Next time we will have a look at risk management. Tell your friends about these videos and while visiting my website order my new book “Capturing Profit with Technical Analysis”, a complete technical analysis reference and a winning trading system. See you in the next video!
Risk Disclosure: Futures and forex trading contains substantial risk and is not for every investor. An investor could potentially lose all or more than the initial investment. Risk capital is money that can be lost without jeopardizing ones’ financial security or life style. Only risk capital should be used for trading and only those with sufficient risk capital should consider trading. Past performance is not necessarily indicative of future results.
Hypothetical Performance Disclosure: Hypothetical performance results have many inherent limitations, some of which are described below. no representation is being made that any account will or is likely to achieve profits or losses similar to those shown; in fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk of actual trading. for example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all which can adversely affect trading results.
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