Losing Percentages Make Money
Stockscores.com Perspectives for the week ending April 8, 2012
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In this week's issue:
I have finalized my Stockscores training classes for this Spring. I will be teaching in Calgary on May 12, Vancouver May 13, Toronto May 26 and Montreal May 27. I am offering two course options, one for position traders and the other for day and swing traders. Everyone starts off with the live classroom session where I teach the subjective elements. Then, each student is sent 12 weekly lessons and assignments to complete their training. For full details, go to www.stockscores.com/learn and watch the videos.
I will also do a Mentorship program with 10 students who want to "apprentice" with me to learn how to trade. This is a six month program and information on it is available at that page as well.
This past week, I worked my current Mentorship students on a day trading strategy called The Worm. This strategy gets its name from the fact that our work and entry points come in the first hour, giving the early bird the opportunity to work for an hour and then leave the market until the end of the day when we make our exit. It is a great strategy for people who can't spend the whole day watching the market.
This week, I sent my students the candidates that I found early while they sent me theirs. Since we are doing the same strategy, we should find the same stocks but it does take some practice so this exercise was good for confirming the process and building confidence.
Looking back over the week, I found 15 trade set ups. This included some that were pretty marginal, but for the purpose of this discussion I wanted to include any trades even if they would be considered mistakes with the benefit of hindsight.
Here is what is interesting, there were 15 trades of which 6 were losers, 4 were break even and 5 were winners. 5 out of 15 winners is only a 33% success rate which won't get you too far in school. However, because some of the winners were big and the losers small, the strategy still lead to nice profits.
To understand how this works, you have to first understand how we judge performance. The risk of a trade is the difference between the entry price and the stop loss price. So, if you buy a stock at $5 with a stop loss at $4.80, you have a risk per share of $0.20. Buy 1000 shares and your risk is $200.
If you end up selling that stock at $6, you make a $1 per share or $1000. This is five times your risk, so we refer to this trade as one that earned a 5 to 1 reward for risk ratio.
If the trade did not work and you get stopped out at $4.80, you earn a reward for risk of minus 1. You could have three trades that stop out for -1 and one trade that earns +5 and you make money, even though you were wrong most of the time.
This past week, the Worm strategy provided 15 trades. The six that were losers each lost -1 for a total of -6. Four trades broke even which gave us a reward for risk of zero but there could easily be slippage so let's call that a total of -1 as well, we are now down -7. The five remaining profitable trades earned reward for risks of 3.5, 1.2, 1, 6 and 7 for a total of 18.7. Subtract the cost of the losers and break even and you were left with +11.7.
If you were willing to risk $1000 a trade, you made over $11,000. But, how much money would it take to do this?
Consider the two big winners. The first one was HEAT on April 4 which made a reward for risk of +6. The risk on that trade was $0.40 and the entry signal came at $6.38. To take $1000 of risk required you purchase 2500 shares at a total cost of $15,950. If you trade with margin (which is not more risky provided you have the discipline to use stops) you could leverage that 3 to 1, meaning you need about $5300 of capital to make the trade. That trade earned 6 to 1 or $6000 giving you a return on required capital of better than 100%.
At the other extreme was BBBY which made its move on Friday, April 5. The entry on that trade was at $70.44 with a stop $70.20. For simplicity, let's call the risk per share $0.25.
That means you needed 4000 shares to carry $1000 of risk, requiring $281,760. With margin, that was $93,920 of required capital. This trade earned 7 to 1, giving you a profit of $7000 or a nearly 7% return for the day. Not nearly as good as the HEAT trade but not too many people will complain about 7% on their capital in one day.
You don't have to take $1000 of risk on a trade, how much you take will depend upon your capital base, tolerance for risk and trading experience. The trader who did these trades with $100 of risk would have earned a little over $1100 for the week but used far less capital.
This demonstrates the economics and mindset of trading. The same thinking can be applied to the sort of longer term trading that you might do in your retirement portfolio.
It is not about how often you are right, it is about how much you make when you are right versus how much you lose when you are wrong.
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The easiest way to make money in stocks is to trade the hot market. Right now, that is in US stocks, particularly large cap "real" companies and Technology. That will change in the future, the market goes through phases of favor and you have to be willing to change with the market.
This week, I used the Stockscores Market Scan to look for stocks that were up abnormally on Friday. I inspected their charts, looking for stocks that were not already well in to an upward trend and had big differences between the open and close of the day. These large trading range days out of a predictive chart pattern often lead to strong performing trends.
Here are some stocks to consider based on this approach:
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1. ITMN
Up strong on Friday and broke its long term downward trend line. The company received some good news from the French health authority on a drug that they are working to get approved, this may ignite some speculation that this treatment for a lung disease works. Support at $13.75.
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2. VALV
Chinese stocks were strong last week, HEAT and DANG were two strong performers that I followed. It looks like VALV is getting some promotion and could be a mover, pretty speculative but if you like that kind of thing take a look. Support at $1.09.
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References
Get the Stockscore on any of over 20,000 North American stocks.
Background on the theories used by Stockscores.
Strategies that can help you find new opportunities.
Scan the market using extensive filter criteria.
Build a portfolio of stocks and view a slide show of their charts.
See which sectors are leading the market, and their components.
Disclaimer
This is not an investment advisory, and should not be used to make
investment decisions. Information in Stockscores Perspectives is often
opinionated and should be considered for information purposes only. No
stock exchange anywhere has approved or disapproved of the information
contained herein. There is no express or implied solicitation to buy or
sell securities. The writers and editors of Perspectives may have positions
in the stocks discussed above and may trade in the stocks mentioned. Don't
consider buying or selling any stock without conducting your own due diligence.
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