The Kirk Report Interview Part 8

The Kirk Report

Q&A With Sylvain Vervoort

Thursday, December 17, 2009 at 8:16 AM

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Interviewed by Charles E. Kirk from "The Kirk Report"

In fact, only a couple of days later it looked like a much better setup. In the following you can see what I mean:

Now there is 1) a closing price above the downtrend line, 2) the closing price is above the resistance line, 3) the price is breaking out of a descending wedge to the upper side, and 4) all indicators are diverging. Buying at $9.70 with an initial stop closing price at the previous low of $8.70 keeps the risk at an acceptable level.
How did it develop further? Here we go:

I made a Fibonacci historical target projection between the low point and the previous top in the downtrend. This gave price targets at $11.50, $13.00, and $16.00. Since price made very strong continuously higher prices, the position was closed at the setting of $15.50, just below the third Fibonacci price target. That is more than a 50% profit in about a month’s time!

Kirk:  Excellent. I think that provides a great overview of how you trade, Sylvain. Thank you.
It is interesting and I think quite important that half of your LOCKIT strategy (3 steps out of 6) is focused strictly on risk management. In fact, in your book you say that “good money and risk management habits are more important than correctly applying technical analysis!” That’s quite a statement! So, what do you feel are the “must know” principles traders must learn about risk management?
Vervoort:  As far as I know there are still a lot of people out there who invest with a buy and hold strategy. In almost all of those portfolios you will find stocks with losses over 50%. Tell me, how many 50% losses can you afford? So, one way or the other you must make sure that the loss on any single trade stays within prescribed limits. As a rule of thumb, and of course, a bit dependant of a stock’s volatility, I accept at the upper side 10% to 15% for daily prices and 3% to 5% for hourly prices for stops.

Kirk:  What is the single most important thing you think is integral for proper risk management?
Vervoort:  Only risk a small percentage of your total capital on any trade and limit the risk on every single trade with an acceptable initial stop based on technical analysis.

Kirk:  Many traders believe that position sizing is also an important part of risk management. What is your method?
Vervoort:  In my case, the position size is an equal amount for all stocks at the start. Assume $50,000 starting capital. I then make a selection of 25 stocks I want to trade. Now every stock gets $2,000. To protect the total portfolio and to make a maximum profit, there will be no profit or loss sharing between these stocks. This gives the best end result simply because a stock doing well will have more and more capital available (a bigger position size) to make more and more profit. A stock not doing that well will have less and less capital available until eventually nothing is left. However that means that one stock going broke will only represent 4% of the starting portfolio, and less once you start making profit with the total portfolio.

Kirk:  In the June 2009 edition of Stocks and Commodities, you wrote an article on using stops based on Average True Range. In your view, how useful is this when used in combination with other indicators and analyses?
Vervoort:  As mentioned previously, I use trailing stops only as a last warning that the position must be closed. But in my normal trading this will rarely be the case. In normal circumstances the position will be closed based on technical analysis before the trailing stop is reached. I will keep an initial stop with the broker which I eventually will adapt to a level of support or the trailing stop.

Kirk:  Excellent. So, what are the downsides of using the Modified ATR for stop loss positioning?
Vervoort:  Just use it as an indicator that gives you an active support level. But even if it is broken, make sure there is no other important support at perhaps a few cents away. In general, do not make a decision based on one indicator. Not even a stop!
The downside when waiting for the trailing stop to be broken is that most of the time selling signals are evident in technical analysis before any type of stop is reached. So, waiting for a stop to be broken will cost you money.

Kirk:  I agree completely based on my own observation and use of the ATR. As you might expect, one common complaint of using ATR analysis is that there are whipsaws (i.e. false sell signals). What are some tactics if any that help you determine when an ATR sell/buy signal should be ignored?
Vervoort:  I do not know any indicator that would not give any “false” buy or sell signals now and then. The best remedy? Never trade based on one signal as there should always be other signals that confirm what one signal suggests. And, even then, it will never be 100% perfect. Remember, this doesn’t even include the little mistakes made by all of us as emotional traders!

Kirk:  Have you backtested using ATR analysis using different time frames – like weekly versus daily for example?
Vervoort:  Not specifically. What I can say in general is that in a profitable automatic trading setup, applicable in different time frames, it is the hourly trading that generates the most profit, then the daily and then the weekly. This is simply due to the multiplication effect of winning trades, especially with my setup of no profit or loss sharing between stocks. Tests I performed combining both long-term and short-term events have never been more successful than just looking at the short term. However, by stretching out the time period, you will probably obtain a better win/loss ratio but you will be missing some very good trades at the same time which diminishes your bottom line performance.

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