Back to YouTube videos starting page - STOCATA HOME

Training Video_27

 

Money Management

In this part I am not talking about technical analysis, but about money management. The best technical analysis will not be successful without a good money management system.

Maintaining good money management habits is perhaps more important than correctly applying technical analysis! Good money-management habits ensure that you’ll survive much longer in the stock market, even with a number of trading failures in a row. Practicing good money management habits helps limit losses in losing trades and helps create more profit in winning trades.

Special offer: "Capturing Profit with technical Analysis"

 

This is the video:

This is the text:

Hallo, Sylvain Vervoort with technical analysis part 27. In this part I am not talking about technical analysis, but about money management. The best technical analysis will not be successful without a good money management system. Pay a visit to my website at stocata dot org and buy my new book “Capturing Profit with Technical Analysis”, a complete technical analysis reference and a winning trading system.

Maintaining good money management habits is perhaps more important than correctly applying technical analysis! Good money-management habits ensure that you’ll survive much longer in the stock market, even with a number of trading failures in a row. Do not forget that behind every stock is a company that can go broke! You may lose all of your money by investing it in one stock only.

Let's first mention some good basic money management practices:

• Only use money that you do not need for living expenses.
• Do not put more money at risk than what you have.
• Investing and using a credit line or leverage like with futures or options, should only be done with money you can afford to lose in full.
• Depending on the amount of starting capital, you must spread the money among several stocks.
• You must limit the loss in a single trade to 1% up to a maximum of 2% of your portfolio’s total value.
• You must limit the loss in one trade on a daily chart to no more than 15% of the trade value.
• If your starting capital is too low to invest in more stocks, you can use an ETF, Exchange Traded Fund tracker of a stock index. The index takes care of the necessary stock risk spread.

A first money-management method would be to trade in a limited number of stocks out of an unlimited list of stocks spreading the available capital evenly between the stocks, sharing profits and losses. A second method, which we will discuss later on, would be to trade a fixed, limited number of stocks with no profit or loss sharing. A $25,000 starting capital could be divided to invest in 10 stocks at any moment in time, limiting the capital per stock at the start to $2,500 or 10% of the available capital. An average loss per stock of 10%, or $250, would only constitute a 1% loss in relation to the total capital. Of course, you would have to calculate your buying power with each purchase in relation to your cash value and the value of the stocks in the portfolio. One-hundred percent of the cash value above the $25,000 starting capital will be available for new investments.

 

Search the Internet

 

The actual value of the 10 contracts in the portfolio will be reduced by 10%, the average stop loss value, as an extra precaution when calculating the new maximum allowed contract value. The maximum buying value for one new contract will then be the available cash and the value of the open contracts divided by 10, for 10% of the total capital. In the table you can see the result for consecutively buying 10 stocks with the $25,000 starting capital. The first buy is with $2500, but the tenth buy is limited to $2284.

As an example, let’s close trades 1 and 4 with a 30% profit, while all of the other contracts remain open. Adding this profit to the capital gives a new allowed buying value of $2,458. In the table you can always see the total invested value and the remaining value when all trades would suffer a 10% loss.

The important question is, is this Setup Sufficiently Crash Resistant? Let’s apply this system and calculate the maximum allowed buying value for each contract. Next, let’s assume the most negative scenario: Each of the 10 contracts ends up as a losing trade with a 10% loss. This happens 10 times in a row for a total of 100 consecutive losing trades. There still is a remaining capital of $9,151. It looks like good money management; you can survive for quite a while, and it’s possible that just a few trades will make up for all of the losses very quick! In the table, you can see the remaining capital after each 10-stock losing trades.

Another possibility is to select just a limited number of stocks and not sharing profits or losses. I prefer this method because it is much easier to follow-up a very limited number of stocks with technical analysis techniques. With a fixed, limited number of stocks, it is possible to keep individual charts with specific notes over longer periods of time. We can start with a fixed capital per stock. Assuming a starting capital of $25,000, we could divide this money over 20 stocks, each of which gets a starting capital of $1,250. Each of the 20 stocks is traded individually, with no profit or loss sharing. All profits or losses are attributed to the individual stock. This means, of course, that each stock must be followed individually because it can only use its own private capital.

Applying this kind of money management is effective and has a number of advantages:

• With a starting capital of $25,000 and a spread between 20 stocks, each with $1,250, the total loss of one stock only creates a loss of 5% in the total portfolio.
• A stock doing well will generate maximum profits, thereby re-investing all profits.
• A stock producing bad results will have less capital to spend, thereby limiting losses when things continue to go the wrong way.
• The profits of a stock doing well are not lost when they are invested in stocks not doing that well.

To find the results using a portfolio with or without profit and loss sharing, we can run a test with the same stocks over the same period and with the same buying, selling, and cost of trade conditions. I used one of my automatic expert buy-and-sell test systems. Although the system used is not necessarily important, it is important to use the same system test under the same circumstances and during the same time period. In this example, we only took long positions. For the first test, we have a starting capital of $25,000 to be divided between the 20 stocks. But there is profit and loss sharing, so each stock will get 5% of the portfolio value at any moment in time. There was an average of 25 trades per stock in the total time period. The total profit was $128,872.

The result without Profit and Loss sharing; there were, on average, 25 trades per stock during the entire period. The total profit was $265,356. Meaning, the final profit has more than doubled. Trading a selected, limited number of stocks and not sharing profits or losses is clearly the better choice! So, this is the system I would recommend as a very good money management system.

This is the end of the part about money management. Next time we will have a look at risk management. Tell your friends about these videos and while visiting my website order my new book “Capturing Profit with Technical Analysis”, a complete technical analysis reference and a winning trading system. See you in the next video!

Back to YouTube videos starting page

STOCATA Stocks Technical Analysis HOME