Archive for June, 2010

Intra-Day Trading v/s Delivery Based Trading

14 Jun

While doing stock market investment you can trade in two different ways. You can either do intraday trading or can opt for delivery based investment. Intraday trading is typically completed within a day that means you have sell the stocks that you have purchased that day before the closing of the exchange. Even if you do not sell the stocks by yourself, they will automatically square off before the closing of the exchange. In case of delivery based investment or long term investment, you can sell the stocks as and when you wish to sell or buy them. Both these types of stock trading has its pros and cons.

Advantages Of Intra-Day Trading

In day trading you can buy stocks without paying for the full price of the stocks. The market makers allow you pay only a part of the price to hold the shares. So, you can gain more by investing less.

In day trading you can always short sell the stocks that mean you can always sell the stocks before buying them and then buy the stocks before the closing of the market. This is one benefit that can give you profit even when the price of the stock is sure to fall.

The brokerage of the intraday trading is always lower than the delivery trading.

In day trading you are getting the profit on the very day. So, you investment is for a few hours only. Therefore, even if the stock price rises, a little your profit percentage is significant.

You get back the money each day after the market closes and hence you can always start afresh the next morning.

Disadvantages Of Intra-Day Trading

The biggest disadvantage of intraday trading is the time frame. You have to sell the stocks within a day. So, if the stock loses price you are sure to loose money

Advantages Of Delivery Based Trading

With delivery based trading, you can always hold a stock till it reaches the expected price.

The long term investment can always get you dividend.

You can also benefit from split shares, bonus stocks and other benefits that the company announces.

Disadvantage Of Delivery Based Trading

In delivery trading you pay higher brokerage.

Your investment is always susceptible to market crashes, business cycles and other factors.

Whatever it is, as an investor, you should know which stock is for intra-day trading and which one is to hold as long term investment.


What is Money Management?

11 Jun

This section is one of the most important sections you will ever read about trading.

Why is it important? Well, we are in the business of making money, and in order to make money we have to learn how to manage it. Ironically, this is one of the most overlooked areas in trading. Many traders are just anxious to get right into trading with no regards to their total account size. They simply determine how much they can stomach to lose in a single trade and hit the “trade” button. There’s a term for this type of investing….it’s called GAMBLING!

When you trade without money management rules, you are in fact gambling. You are not looking at the long term return on your investment. Instead you are only looking for that “jackpot”. Money management rules will not only protect us, but they will make us very profitable in the long run. If you don’t believe me, and you think that “gambling” is the way to get rich, then consider this example:

People go to Las Vegas all the time to gamble their money in hopes to win a big jackpot, and in fact, many people do win. So how in the world, are casino’s still making money if many individuals are winning jackpots? The answer is that while even though people win jackpots, in the long run, casino’s are still profitable because they rake in more money from the people that don’t win. That is where the term “the house always wins” comes from.

The truth is that casinos are just very rich statisticians. They know that in the long run, they will be the ones making the money—not the gamblers. Even if some Mr.Patel wins $100,000 jackpot in a slot machine, the casinos know that there will be 100 more gamblers who WON’T win that jackpot and the money will go right back in their pockets.

This is a classic example of how statisticians make money over gamblers. Even though both lose money, the statistician, or casino in this case, knows how to control their losses. Essentially, this is how money management works. If you learn how to control your losses, you will have a chance at being profitable.

You want to be the rich statistician…NOT the gambler because in the long run, you want to “always be the winner.”

So how do you become this rich statistician instead of a loser?

Drawdown and Maximum Drawdown?

So we know that money management will make us money in the long run, but now we’d like to show you the other side of things. What would happen if you didn’t use money management rules?
Consider this example:

Let’s say you have a 1,00,000 Rs. and you lose 50,000 Rs. What percentage of your account have you lost? The answer is 50%. Simple enough. Now, what percentage of that 50,000 Rs do you have to make in order to get back to your original 1,00,000 Rs? It’s not 50%–you’d have to make back 100% of your 50,000 Rs. to get back to your original 1,00,000 Rs. This is called drawdown. For this example, we would’ve had a 50% drawdown.

The point of that little illustration is that it is very easy to lose money and a lot harder to make it back. We know you’re saying to yourself, “I’m not going to lose 50% of my account in one trade.” Well we would certainly hope not!

However, what if you lost 3, 4, or even 10 trades in a row? That couldn’t possibly happen to you, right? (Sarcasm used) You have a trading system that wins 70% of the time, so there is NO way you could lose 10 trades in a row. (Even more sarcasm used)
Well, while you may have a good system, consider this example:

In trading, we are always looking for an edge. That is the whole reason why traders develop systems. A trading system that is 70% profitable sounds like a very good edge to have. But just because your trading system is 70% profitable, does that mean for every 100 trades you make, you will win 7 out of every 10?

Losing Streak

Not necessarily! How do you know which 70 out of those 100 trades will be winners?

The answer is that you don’t. You could lose the first 30 trades in a row and win the remaining 70. That would still give you a 70% profitable system, but you have to ask yourself, “Would you still be in the game if you lost 30 trades in a row?”

This is why money management is so important. No matter what system you use, you will eventually have a losing streak. Even professional poker players who make their living through poker go through horrible losing streaks, and yet they still end up profitable.

The reason is that the good poker players practice money management because they know that they will not win every tournament they play. Instead, they only risk a small percentage of their total bankroll so that they can survive those losing streaks.

This is what you must do as a trader. Only risk a small percentage of your “trading bankroll” so that you can survive your losing streaks. Remember that if you practice strict money management rules, you will become the casino and in the long run, “you will always win.”

Let me illustrate what happens when you use proper money management and when you don’t…

Don’t Lose Your Shirt

Here is a little illustration that will show you the difference between risking a small percentage of your capital compared to risking a higher percentage.

Trade Total Account 2% risk on each trade
1 1,00,000 2,000
2 98,000 1,960
3 96,040 1,920
4 94,120 1,882
5 92,238 1,844
6 90,394 1,807
7 88,587 1,771
8 86,816 1,736
9 85,080 1,701
10 83,379 1,667
11 81,712 1,634
12 80,078 1,601
13 78,477 1,570
14 76,907 1,538
15 75,369 1,507
16 73,862 1,477
17 72,385 1,447
18 70,908 1,419
19 69,489 1,390
Trade Total Account 10% risk on each trade
1 1,00,000 10,000
2 90,000 9,000
3 81,000 8,100
4 72,900 7,290
5 65,610 6,561
6 59,049 5,905
7 53,144 5,314
8 47,830 4,783
9 43,047 4,305
10 38,742 3,874
11 34,868 3,487
12 31,381 3,138
13 28,243 2,824
14 25,419 2,542
15 22,877 2,288
16 20,589 2,059
17 18,530 1,853
18 16,677 1,668
19 15,009 1,501

You can see that there is a big difference between risking 2% of your account compared to risking 10% of your account on a single trade. If you happened to go through a losing streak and lost only 19 trades in a row, you would’ve went from starting with 1,00,000 Rs. to having only 15,009 Rs. left if you risked 10% on each trade. You would’ve lost over 85% of your account! If you risked only 2% you would’ve still had 69,489 Rs. which is only a 30% loss of your total account.

Of course, the last thing we want to do is lose 19 trades in a row, but even if you only lost 5 trades in a row, look at the difference between risking 2% and 10%. If you risked 2% you would still have 92,238 Rs.. If you risked 10% you would only have 65,610 Rs. That’s less than what you would’ve had even if you lost all 19 trades and risked only 2% of your account!

The point of this illustration is that you want to setup your money management rules so that when you do have a drawdown period (losing streak) you will still have enough capital to stay in the game. Can you imagine if you lost 85% of your account? You would have to make 566% on what you are left with in order to get back to break even. Trust me, you do NOT want to be in that position. In fact, here is a chart that will illustrate what percentage you would have to make to breakeven if you were to lose a certain percentage of your account.

Loss Of Capital %requires to get back to breakeven
10% 11%
20% 25%
30% 43%
40% 67%
50% 100%
60% 150%
70% 233%
80% 400%
90% 900%

You can see that the more you lose, the harder it is to make it back to your original account size. This is all the more reason that you should do everything you can to protect your account.

So by now, I hope you have gotten it drilled in your head that you should only risk a small percentage of your account in each trade so that you can survive your losing streaks and also to avoid a large drawdown in your account. Remember, you want to be the casino…NOT the gambler!

Summary of Money Management

Be the casino, not the gambler! Remember, casinos are just very rich statisticians!

Drawdown is a reality and WILL happen to you at some point. The less you risk in a trade, the less your maximum drawdown will be.
The more you lose in your account, the harder it is to make it back to breakeven.

Trade only a small percentage of your account. The smaller the better. 3% or less is recommended.


Portfolio Diversification and Risk Management

10 Jun

Portfolio diversification can be a valuable stock investing concept for every investor whose ultimate goal is to maximize profit and minimize risk. The principle of maximizing profits and minimizing risks is so simple, yet its practice is seemingly an impossible task. While the best investment advice abounds throughout investment circles, any wise and mature approach to investing is the same. Your best protection against risk is portfolio diversification; investing in multiple investment options instead of choosing to place all of your investments in only one area. You can, for example, use the stability of cash investments like CDs and money market funds to diversify your portfolio and offset the liability of stocks, futures, options and stock or bond mutual funds. Picking stocks of riskier small growth companies while also investing in the traditional blue chippers, which are the stocks of large, well-established companies allows for a structured stability that will translate to the bottoms line of an investor’s portfolio. In other words, when the return is down in one area, it’s usually balanced by a positive performance in another. In the simplest terms, portfolio diversification is an excellent hedge against stock volatility and the ups and downs of investing.

As with any stock trading plan, it is imperative to evaluate assets and realign the investment mix from time to time. For example, as the value of a stock increases, it consumes a larger percentage of the total, thus affecting the total diversification of the portfolio. In an effort to maintain a healthy balance, it may be necessary to decrease the holding in that particular stock and increase in a different area, such as bond or cash holdings. Such decisions require not only experience but the benefit of a method such as candlestick chart analysis.

In all likelihood, a well-diversified portfolio will contain most, or all, of the following: stocks, bonds, mutual funds, cash equivalents like Treasury bills or money funds, as well as other types of investments. Being able to diversify over a broad range of investment options can help minimize many of the dramatic ups and downs in investing. It has been shown through research that, over extended periods of time, investors are actually able to reduce the level of stock volatility in their portfolios (by diversifying) without sacrificing much in the way of profit at the bottom line. Establishing a well-diversified portfolio is crucial, and it is dependent on available assets, money management, risk tolerance, and long term investing goals.

Simply stated, asset allocation is diversifying an investment portfolio among various categories, also known as asset classes. A typical allocation, for example, would put 60% of the available capital in stocks, 30% in bonds, and the other 10% in cash.


What is Swing Trading and Intra-Day Trading?

10 Jun

It is absolutely essential to understand the difference between Swing and Intra-Day trading as a clear understanding of these concepts goes a long way in helping you decide your own Trading Strategy which suits your temperament and style. Here we go…..

Swing Trading

A style of trading that attempts to capture gains in a stock within one to four days. To find situations in which a stock has this extraordinary potential to move in such a short time frame, the trader must act quickly. This is mainly used by at-home and day traders. Large institutions trade in sizes too big to move in and out of stocks quickly. The individual trader is able to exploit the short-term stock movements without the competition of major traders. Swing traders use technical analysis to look for stocks with short-term price momentum. These traders aren’t interested in the fundamental or intrinsic value of stocks but rather in their price trends and patterns.

Intra-Day Trading

Intraday trading refers to opening and closing a position in a security in the same trading day. This can be buying and selling to capitalize on a potential rise in a security’s value or shorting and covering the short to capitalize on a potential drop in value. Intraday traders capitalize on small moves in the value of a security by using “leverage” or “margin”, which basically means borrowing money. Most day trading accounts are allowed to take an initial position in a security that is 4X the value of their account (per securities regulations), but some professional accounts get more leverage (i.e. 10X). For instance, a day trader with Rs. 10,000 in his/her account can take a Rs. 40,000 position in a security for day trading purposes. This amount is not allowed to be held overnight (only about 2X the value of the account can be held overnight per securities regs). The leverage inherent in day trading allows small gains in a position to yield meaningful profits (and losses). Most day traders are very strict about cutting losses with “stop loss” orders. This limits the potential downside (but not the upside) on any particular trade, hence the adage “cut your losses short and let your profits run”. With this basic strategy, a day trader can be wrong on 50% of his/her trades and still make good money. Day trading styles vary from “scalpers”, which take positions for only a few minutes, to holding a position for most of the day. Some day traders are momentum followers and jump onto any given move, while others try to identify intraday reversals. Virtually all day traders use technical analysis (stock charting) heavily in their decision making.