Monday, January 29, 2007

It Takes a Dollar -

To make a dime. We've all heard this old saw and it is as true now as it ever was. And when you trade you need to understand something about the relationship between your trading account and the value of the stocks you trade.

I normally stay in the 15 to 35 dollar range. I don't like the less than 15 dollar stocks because of my opinion (tested thoroughly) that cheap stocks are cheap for a reason (notwithstanding that I just wrote a post about buying same). And I generally stay below 35 for the simple reason that I'm using only a portion of my brokerage account for day/swing trading purposes and a small portion at that.

So what is the difference? When you find a potentially good trade the best way to take advantage of it is to buy as much as you can afford - either at one time or layered in. And what you can afford is dictated by your total trading account. If that is a small amount you should probably be concentrating on lower priced stocks - if a large value then the range can expand. Here is a single filter with two different entry ranges -

Tweezer Bottom - $15-35 - 71 entered - 75% win rate - Equity appreciation - 23630
Tweezer Bottom - $35-55 - 54 entered - 67% win rate - Equity appreciation - 9084

This is an extremely good filter. It has a high win rate across the board (many do not but that will be a subject of another post). What didn't change? The amount of money the back testing software put into each trade - it was always 25% of the same basic trading account value - starting at 100K and going up or down in system time. What happened is that by buying higher priced shares the system gave up opportunity to make more money because of fewer shares being bought. So to trade at the higher levels you would have to increase your trading account. In other words, you start small and move up as you earn it.

The second part of the equation, naturally, is the number of stocks you are involved in at any one time. I always believe that if you want to be involved in many stocks for "diversification" then you can use any one of the several index ETFs and be done with it. You will have an absolute Beta of 1 and life will be grand. On the other hand if you are trying to follow 8 or 10 or more stocks at one time then you have probably sliced and diced your trading account to an unacceptable degree of tiny. Remember your main trading constraint is available cash.

Here's proof of that wild statement. Same filter - different number of stocks being purchased and held. In the first results set above it was 1 stock a day with no more than 4 in the portfolio at any one time - now it is 2 a day with no more than 8.

Tweezer Bottom - $15-35 - 130 entered - 67% win rate - Equity appreciation - 14354
Tweezer Bottom - $35-55 - 88 entered - 63% win rate - Equity appreciation - 5860

Everything else held exactly the same as the last set of tests and the equity decreased. I can't make this stuff up - reality is just too good.

So you see it isn't just a good filter or scan that wins the day - it is also money management and money management includes not only risk and reward, but position sizing too.

Naturally there are other ways of sizing a trade than just some percentage of whatever my current portfolio value is but regardless of how you do so it will always come back to the same idea - the more shares of a winning trade that you buy the better off you will be.


Mike said...

Check out Popular blogs - I left a comment for them to add you!


Some more interesting posts thanks.