Validea is an advisory service which assesses stocks based on the investing criteria of many of the ...
A Great Trading Plan in Action (Part 2)
10/19/2011 8:00 am EST
This article series continues with a review of the stringent risk and trade management decisions that allowed the trader to meet and actually exceed the initial profit targets set forth prior to this trade.
This is Part 2 of a multi-part article series. Read Part 1 here.
Let’s see how the trade we discussed yesterday looked after the weekend.
Price gapped open lower again on Sunday night by 50 pips. On Monday morning, she took a partial profit on one half of the position at 1.0180, booking 190 pips. As price climbed back out of the hole early Tuesday, she entered an order to sell back out the half she had taken profits on at 1.0302, with an initial stop loss of 1.0333 (or 31 pips) and was filled on her limit sell order quickly.
It is important to note that she is treating this second entry as a separate order, with its own stop loss. Though it is not apparent on this chart, she moved to a breakeven stop loss order on the open half of her first trade.
She is now playing with the market’s money, and even if she is stopped out of both of the current open positions, she will make money on this idea and the two positions combined. She framed her trade, and as price unfolded, she adapted it to the market conditions, taking profits on one half and then reinstating the full position at a better price.
She is continuing to use the open gap to show where the selling pressure remains. That is the key to the original trade, as well as the secondary entry at 1.0302.
Let’s take a look at how the trade progressed on Tuesday and Wednesday:
Take a close look at this last chart and read her comments as the trades unfold. She started with a carefully framed trade, looking to reach a potential four-to-one risk/reward ratio, but by taking partial profits and then re-entering at the open gap resistance area, she was able to successfully adjust her plan as price unfolded after price opened on Sunday afternoon.
Here are the profit objectives she planned and achieved:
- 1.0180, on one half of the position, netting her 190 pips, reached on 9/19/2011 at 10 am
- 1.0150, on one half of the position, netting her 220 pips, reached on 9/21/2011 at 2:30 pm
- 1.0088, on the one half she re-entered, netting her 214 pips, reached on 9/21/2011 at 2:30 pm
Her total risk on this position was 113 pips and total profit for this position was 624 pips. This gave her a total achieved risk/reward ratio of better than five-to-one, which was even better than her originally planned ratio of four-to-one.
As she did her post analysis of this trade on her last chart, note that she chided herself for what she considered a mistake: She believed price would test the prior low (“look to the left and be right”) and her original order was to take profits on her entire position at 1.0090, but the anxiety of holding the position made her change her plan and take half off at 1.0150.
All in all, however, this trade was planned and executed well. She had very logical entry points and did a wonderful job collapsing her risk, moving her initial stop loss entry to breakeven as soon as price moved well below her entry level and then finding logical areas to leave her limit buy orders to lock in profits.
NEXT: Another Important Lesson from This Trade|pagebreak|
We stress the importance of planning your trade before entering your trade and then trading the plan you have made. If you wish to trade like a professional trader, you have to learn to think, manage, and execute like a professional trader. Our upcoming seminar, Building a Professional Trade Plan, will focus on this extremely important topic, taking you step by step through all the essentials a solid trade plan needs if you wish to be consistently profitable.
Let’s use this trade to highlight one last important thought about trading: The results of our students speak for the results of our efforts to teach traders to be consistently profitable using what they have learned from us to find and enter their own trades in any market, on any time frame.
We teach live, we use live charts, we point out potential trade areas in advance, as diagrammed in the trade above. We are not a “chat room” that is there to call out mindless trades.
Let’s compare the results of this single trade with an entire month’s results from a “chat room” style Web site.
Before I begin this rate of return analysis, let me state up front that I am not taking these results from one that I consider to be a “shady” Web site, one that misrepresents their results. I am using their results because they are stated relatively clearly, their numbers seem to be accurate, and the results they show on their Web site look quite impressive.
Here are their results for the same month our student made her Australian dollar trade:
According to their risk disclaimer, subscribers must have a minimum of $200,000 in their account and this amount will be fully margined. At minimum, they trade two full-size gold futures contracts and two silver futures contracts at all times.
For the month, on $200,000 worth of margined positions, they made a gross profit of $73,060. This looks like a very handsome profit, indeed! In their disclaimer at the bottom of the page, in smaller print, they note they are currently in a drawdown of $42,300 from that profit and are apparently still holding the open position. According to my calculations, that leaves them with a net profit of $30,760 for the month, based on $200,000 of margin. But let’s assume they finished the month with their entire $73,060 intact.
Now let’s see how our student’s single trade, lasting about three trading days, holds up to their month of trading. To compare “apples with apples,” we will normalize the leverage used by adjusting the amount of contracts she used when entering her planning and executing her trades to match their leverage.
To make the math easier, we’ll convert her trades from cash forex to CME Australian dollar futures contracts. Each Australian dollar future requires she put up a minimum margin of $2,363. If she used the maximum $200,000 as margin, she would be able to trade $200,000/$2363 = 84 contracts.
Since she made 660 ticks, she would have netted a profit of over $554,000 on her $200,000 account in three trading days (a simple rate of return of over 750%). Now stop for a moment and look at these numbers, please. Are they possible? Yes. Are they repeatable over time? No.
NEXT: What Are Realistic, Sustainable Results?|pagebreak|
If you used maximum leverage on your account, as many “chat” and “trade touting” sites show in their flashy numbers, when you hit a losing streak, you will quickly lose all the money in your account and more.
Let’s assume a more conservative stance: The Web site we referred to stated they traded at minimum two gold contracts and two silver contracts. Because of a recent margin hike by the CME Group in August, it would take $72,700 in margin to trade two gold futures contracts and two silver futures contracts. If our trader had used $72,700 in margin, she would have been able to trade 30 Australian dollar futures contracts and she would have netted $198,000 in profits before brokerage, compared with their stated net maximum profits for the month of $73,060.
But are those numbers realistic and sustainable? Of course not! Our trader would have made over 270% on her over-leveraged account, but any run of losers would quickly wipe her account out. These numbers are unrealistic and not sustainable.
We teach traders to be consistently profitable. We want them to learn their craft and then be around for years to come, as their accounts grow at a sustainable pace.
Let’s look at a “sustainable” rate of return. If our trader had $200,000 cash in her account and traded eight contracts, using a total maximum margin of $18,904, she would have used less than ten percent of her account on a margined basis and she would have netted over $52,000 on her three-day trade. She would have realized a 26% simple rate of return.
These numbers are more realistic, and had she taken a loss, she would not have lost her trading account. Had she been stopped out at her initial stop loss order, she would have lost $3,280—roughly 1.6% of her account.
But let’s look at her trade using an even more conservative approach: What if she used no leverage in her trading, simply trading $200,000 unleveraged in the cash forex markets? If she sold $200,000 worth of Australian dollars at 1.066 and bought them back at 1.000, she would have made a net profit of $13,200. On a single trade that lasted three days, she would have netted a simple 6.6% rate of return.
Is this realistic? This is absolutely a realistic rate of return, though I would caution everyone, including her, that the best traders in the world lose at least one-third of the time, so solid money management is extremely important, even when you are trading using low or no leverage. Top money managers average 15%-35% rates of return, not 200% or 300%.
The key to becoming a consistently profitable trader is to begin with a solid trade plan, based on quality money management principles.
Only take trades with good risk/reward ratios (I suggest three-to-one or better as a starting place for most traders) and set a maximum stop loss you are willing to take on any trade, then never take a trade requiring a larger stop loss.
Lastly, once you plan your trade, keep that trade plan in front of you and follow it religiously. “Plan your trade and trade your plan.”
By Tim Morge, founder, MarketGeometry.comIf you want to learn how professional traders plan their trades, we’re hosting a seminar on Saturday, October 22 via the Internet. You can see all the details by clicking here.
Related Articles on STRATEGIES
The Roman philosopher Seneca wasn’t talking about the stock market when he wrote that “T...
The Dow Theory was originally referred to as “Dow’s Theory,” since it was based on...
When stocks are selling at valuation extremes and consumer optimism is at one of the highest levels ...