Capital Management

It is always tempted to allocate all your capital on a trade or trades that you “believe” is/are technically and fundamentally sound.  However, next time when you have this temptation crossing your mind, make sure you don’t fall for it.  Remember the old saying, “Don’t put all the eggs in one basket”.  It is always easier to say than done.  That is why we need to use a system to help controlled/ managed our emotions, so that if the basket drops, you don’t lose all your eggs.

This saying has a slight different meaning when applied to our trading system for capital management. At any given time, I never allocate more than 70% of my capital (eggs) on a stock position or positions.  The remaining 30% capital is set aside as a reserve for a critical moment.  As you venture longer into the stock trading profession, you will eventually realize the importance of this 30% of your “eggs”. This could also be applied to your personal financial planning.  We should always put aside some capital for emergency needs.

Recently, the critical moment came when the market dropped violently on Monday, August 24th.  I was stopped out of all my longs, but I did have the shorts to help offset this nasty gap down (the beauty of pair trading).  My system gave out fresh buy signals on several strong stocks (NFLX and UA for illustration) that I followed on the day prior (the 21st).  The trade is to buy the next trading day, which is Monday, the 24th.

Donchian-Buy-NFLX-08242015 Donchian-Buy-UA-08242015

If you did not sell when your stop hit and you were fully invested, meaning that you were out of capitals when the opportunity showed itself, you would be beating and screaming at yourself why you did not have more “eggs” to work with.  It is by then, you would be able to comprehend how important the other 30% of your capital is.

Respect your stop loss!  Sometimes, you have to give up a loss in order to gain a profit.  To rephrase, only if you take your stop loss that you will be able to release your capital, in addition to the 30% reserve, to work with on new trades that will come along.

This capital management technique can also be helpful when facing hard choices.  Remember, you let go of one thing so that you can have room for other things in life.

Learn to Ignore Noises in the Market

One of the hardest thing to master in early life of my trading is learning how to filter/ignore the noises in the market.  Whenever the markets or individual stocks advance or decline, you would always hear people trying to explain what had cause the volatile price movements.

The market has been trading in a tight range since the beginning of the year.  Ups and Downs.  We blamed it on the Greece when the market pulled in, then we cheered when good economic data came out and the market advanced; then the Chinese market crashes, and then because the Chinese Yuan is devalued, everybody is freaked out and the market tanked, on and on and on…

We have been driven by all this media outlets that overload us with so much information now a day.  You will easily lose your focus as you scan through internet with all these market headlines.  We always try to explain why a stock rises or falls.  And you will see the analysts also shoot out articles after articles to explain, or trying to explain why a particular stock moves-remember, they are paid to get you excited.

I have found that the best way to ignore all these “noises” is to find your system and stick to it.  Your system itself will be able to help you to focus on why you take a position in a stock, be it long or put; and why you exit your position.  There is no other explanations.

You may read the news to read the news, but don’t let the news dictate whether you should enter or exit a position.  Let your system do the job.  As time goes on, you will find that it helps take away lots of your stress, and free you to do other things of interest in life.

People ask me why I give out all these information on my trading system that I been working hard to refine.  I am not being paid to write all these (or maybe I am paid through my trading :-) ).  The answer is actually very simple: life is not just about taking, it is also about giving.  Cheers!

Trade Review

With the market pulling in hard today, I think it is a good time to give the previous trade a review to show how important it is to have a good risk management plan in hand.

1st, let’s show the charts:

Donchian-Buy-ALXN-07302015 Donchian-Sell-QCOM-07302015

 

 

 

 

 

And today on 08/06/2015.

Donchian-Buy-ALXN-08062015     Donchian-Sell-QCOM-08062015

The long trade on ALXN results in a stop-loss with slippage of about 30%, while QCOM has managed to give halt (1/2) position at 30% profit on 08/04/2015, and then the other half position at roughly 50% profit.  Overall, we still managed to make a profit on this pair trade, even though is small.  However, if I just did one or two trades on the long side, I could have been crushed along with the market today.

My goal is to use the system to draw in consistent profit, small or large, safely over time.

 

Risk Management

I know that the topic has been mentioned in other places, but here I would like to elaborate it more pertaining to my “Price Channel” trading system.

You may have noticed that the trades that I posted here are in pair, which means that one long/call option on one stock and another short/call option on a different stock.  The reason is that at any give time when the trades are triggered, we cannot foreseeing how the market is going to react in the near future.  If we have all the trades on one side, i.e. long side, and the market tanked and we will be cut like butter.  Not very pleasant!

Some people would short the market (put option on an index ETF, such as the SPY, IWM, QQQ, etc) as a hedge on their stock holdings to manage their risk.  As to my system, I would try to find the trades in pair.  If we have two (2) long trades, we would try to find other two (2) short trades.  The long trades will be on relative strong stocks and short trades will be on relative weak stocks.  With so many stocks trading, it is not hard to find them in pairs.

The logic is that, if the market pulls back, the strong stock should be able to hold up better, while the weak stocks will fall harder.  Or if the market advances, your strong stock should propel higher than the weak ones.  Therefore, no matter what way the market moves, in the end, you are still ahead!  Even if the market is stagnant, both side of the trades can proved to be profitable.

Risk management is very prudent to your long term success in this business.

Other Parameters in the Equation

I’ve mentioned the other parameters that were used to confirm the “buy/sell” signals of my channel trading system.  Here, I am going to elaborate on the details of what they are and how I use them to scan through my list of stocks, ETFs to find the ones that trigger the trade signals.

Here is a chart of the previous trade I did with the parameters noted, and I will go through them one by one.

Chart-TSLA-ParametersSo, first of all, we need to identify whether the stocks is in an Uptrend or Downtrend.  I use the 200MA to help justify: when the stocks/EFTs price are above the 200MA, it is still in an uptrend; while the price is below the 200MA, it is in a downtrend.  The reason is that, we only look for “BUY” signal when it is in uptrend and “SELL” signal when it is in a downtrend.

The 2nd one is the “DMI”, Directional Movement Index with 14 periods.  When the green (+DI) is above the red (-DI), that means the stock is in an uptrend.  However, when they finally come down/up and touches or crosses each other, that means that the stock is coming down to test your psychological level (gut-check): are you going to be confident enough to hold on to your shares or got shaken out?  Most people would have been shaken out. To help you enter the trade, that is where the other two (2) parameters come into play.

The 3rd one is the “RSI” indicator with 14 periods.  When the RSI is still above the center line, that means, buyers are still there, it is safe to enter the trade.  But, to give it a little more confidence, we also have one more parameter to look at before we hit the button.

That is when the 4th indicator comes into play, the Commodity Channel Index (CCI) with 16 periods.  The red horizontal line in the CCI is at -100 level when it signals an oversold condition (the green line is at +100 level corresponding to an overbought condition). If it is still above the red, that means the stock is technically not in an oversold territory, the chance of a bounce is high.  We now have a “BUY” signal — “Buy Signal 1″.

And now we look at “Buy Signal 2″,  you may have noticed that the RSI is below the center line, which means that the buying interest is waning, but it is still above the red line – we are still okay.  And the CCI also tips below the RED, which technically speaking, is in the oversold zone.  So “signal 2″ is not as strong as “signal 1″.  I traded “signal 1″, but didn’t do “signal 2″, even though in hindsight, “signal 2″ also would have worked.

The “Sell Signal” will be the opposite of the above “Buy Signal” as illustrated.

Trade with a system, leave your emotion out of it.  Trust me, if you can do that, you will be way ahead!

New Trades on ALXN, QCOM

Market continues its bounce from recent sell off, with the Russell trailing behind and while the QQQ is leading the way.

IWM-07302015

QQQ-07302015

SPY-07302015

We are still hanging in there.  The market will either being dragged down by the Russell or led out of the recent pull back by the Q’s.

There are couple trades triggered, one is the long/call trade on ALXN.Donchian-Buy-ALXN-07302015ALXN reports earning today, dropped and bounced back. Relative strong price action, with DMI crosses to confirm the test. One (1) 190 August 21 Call option was bought to start the long position.

And the 2nd trade is on QCOM short/put.Donchian-Sell-QCOM-07302015QCOM had its recent earning miss, dropped, and now rebounding to the channel with other parameters confirming. Buy three (3) 67.5 August 21 Put options.

During the earning season, it is always good idea to check the date of the earning on a particular stock of interest before entering a trade on it.  Or if you’ve entered a trade, I would exit the position before the earning announcement regardless profit or loss.

Channel Trading Explained

The technique that I am using, Channel Trading, is different than the more conventional method that most traders use by drawing trend lines with the support and resistance highlighted but not really defined, such as the chart below:

BIIB-TLThe question is how are we going to be able to enter and exit the trade with the above so called “channel”?  This is very hard to define.  Instead, I use “Price Channel” or so called “Donchian Channel” at some sites.  Through painstaking back testing and real money tradings, I have found that the “Price Channel” with 7 bars parameter achieves with the most accurate “buy” or “sell” signals, when incorporated with my other technical parameters.  The most recent, or I should say, on 7/27/2015, couple stocks I selected give the trade signals as shown below:

        Donchian--BUY1-7272015

Donchian--Sell1-7272015

And you see today (07/29/2015):

  Donchian--BUY1-7292015

Donchian--Sell1-7292015

As you have observed, the “channel” is clearly defined as the support and resistance (top yellow as resistance -high and low yellow line as the support-low).  It is actually the high and low of the past 7 bars.

Of course, there are stop and target levels that you need to defined before entering a trade.  As for this system, I normally initiate the trade use the options for the underlying stock with no more than $1500 or 15% of your capital (call or put options with one month out in expiration, with a delta of around 70) and give it no more than 25% of stop loss and partial profit of 30% and final target when it reaches the other end of the channel.  I will move the stop up/down on the other half to break even. Very simple and straight forward to follow system.