Saturday, 26 November 2016

Manage your money

Money management tasks

You need to perform the following important money management chores to do the job properly:
• Determine how much you are willing to risk on each trade.
• Understand the risk of the trade you are about to take and size the trade appropriately.
• Track the trade going forward.
• Pay attention to your risk points; take small losses before they become big losses.
• Review your performance.

Determining per-trade risk

The most important decision you need to make is how much you are willing to risk on each trade relative to your entire portfolio. For example, many of the top traders said they limited this amount to less than 2 percent of their stake.

The reason to keep this number small is to protect yourself from a series of losses that could bring you to the point of ruin. Losing trades are a fact of life when trading — you will have them. The key is to limit those losses so that you can endure a string of them and have enough capital to place trades that will be big winners.

Expectancy along with position sizing is probably the two most important factors in trading/investing success. Sadly most people have never even heard of the concept. In simple terms, expectancy is the average amount you can expect to win (or lose) per Rand at risk. Here’s the formula for expectancy:

Expectancy = (Probability of Win * Average Win) – (Probability of Loss * Average Loss)

As an example let’s say that a trader has a system that produces winning trades 30% of the time. That trader’s average winning trade nets 10% while losing trades lose 3%. So if he were trading R10,000 positions his expectancy would be:

(0.3 * R1,000) – (0.7 * R300) = R90

So even though that system produces losing trades 70% of the time the expectancy is still positive and thus the trader can make money over time. You can also see how you could have a system that produces winning trades the majority of the time but would have a negative expectancy if the average loss was larger than the average win:

(0.6 * R400) – (0.4 * R650) = -R20

In fact, you could come up with any number of scenarios that would give you a positive, or negative, expectancy. The interesting thing is that most of us would feel better with a system that produced more winning trades than losers. The vast majority of people would have a lot of trouble with the first system above because of our natural tendency to want to be right all of the time. Yet we can see just by those two examples that the percentage of winning trades is not the most important factor in building a system.

Understanding trading risk

It’s easy to determine how much risk there is in a particular trade. The first step is to decide — before you put the trade on — at what price you will exit the trade if it goes against you. There are two ways to determine this price level. The first is to use a trading method based on technical analysis that will provide a reversal signal or a stop-loss price for you.

The second is to let money management determine the exit when you don’t have a technical or fundamental opinion about where the “I was wrong” price point is. This is where you draw a line in the sand and tell the market that it cannot take any more money out of your wallet.

The point is that no matter what your approach — whether technical, fundamental, astrological or even a random dartboard pick — you should not trade or invest in anything without knowing, at all times, what your exit price will be. You need to know this price ahead of time so that you don’t have to worry about the decision when that price is reached — the action at that point should be automatic. You won’t have time to muddle it out when the market is screaming in the opposite direction you thought it would go!

If you are using the first method, you can use this formula to determine how many shares of stock to buy:

s = size of the trade
e = portfolio equity (cash and holdings)
r = maximum risk percentage per trade
p = entry price on the trade
x = pre-determined stop loss or exit price

For example, Belinda has a trading account with a total value (cash and holdings) of R100,000 and is willing to risk 2 percent of that capital on any one trade. Her trading system gives her a signal to buy XYZ stock trading at R100 per share and the system says that the reversal point on that trade is R95.Plugging this into the formula tells Belinda that she can buy 400 shares of XYZ. The cost of this investment is R40,000, but she is only risking 2 percent of her capital, or R2,000, on the idea.

Belinda then gets a tip from her brother-in-law that ABC is about to take a nose dive from its lofty perch at R40 because he heard from his barber that earnings of ABC will be well below expectations. She’s willing to go short another R10,000 of her stake on this idea. She studies a ABC chart and can’t see any logical technical points that would be a good place to put in a stop, so she uses the money management method to determine the stop according to this formula:

x = pre-determined stop loss or exit price
p = entry price on the trade
i = investment amount
e = portfolio equity (cash and holdings)
r = maximum risk percentage per trade

Since she’s shorting ABC, the value for i, R10,000, should be negative.

Plugging these values into the formula above would tell Belinda that her stop price on the short sale of ABC should be R48. If she didn’t want to assign a high confidence on this trade she could reduce the max risk to 1 percent (r=0.01), which would bring the stop down to R44.

Tracking the trades

It is important to watch your positions as they progress and adjust your stop prices as the market moves in your direction.

In the first example, if XYZ moves from R100 to R120 and the stop is left at R95, what started as R2,000 or 2 percent at risk is now R10,000 (9 percent of the total equity) at risk.

The mistake most people make is to consider trade winnings on open “house money” — that somehow this money is less painful to lose than the money in your back pocket.

This is a bad mental habit. If losing 2 percent of equity on a trade would be painful to Belinda when her account was at R100,000, losing 9 percent after the stock has moved to R120 should be several times more so.

Moving your stop loss up with the price on a winning trade does several good things: It locks in your profits and if you are using core equity to size new positions, it will allow you to take more risk on new trades.

Never move a stop backwards from its initial price — stops should always be moved to reduce, never increase, the amount of risk on a trade.

Past the initial risk you are willing to take, stops should be a one-way valve for the flow of money from the market to your account.

Terminating with prejudice

A money management plan will only be useful if you do what it tells you. This means planning your trades as outlined above and trading your plan. If a stop price is hit you must take that hit.

If you find that your system is giving you stops that are constantly getting hit, then perhaps you should re-examine the rules of the system — but don’t mess with your money! Second-guessing the approach will cause you to take on more risk than you planned, increasing the chances that a bad trading system will ruin you. Once your stop is gone, how will you know when to get out next?

Take your losses when they are small because if you don’t they are sure to get large. In this regard, discipline is of the highest importance. It is a cardinal mistake not to take a stop if it is hit. It’s even worse if the stock comes back and turns the trade into a winner because now you have been psychologically rewarded for making the mistake.

Get out quickly and re-assess the situation. If you think it will come back, put on a new trade with a new stop.

Faith, hope and prayer should be reserved for God — the markets are false and fickle idols.

Saturday, 12 November 2016

Ichimoku Kinko Hyo Cloud

Ichimoku Cloud Trading Strategy

(Clouds are for trending markets)

Traditionally, the Ichimoku Cloud is known for its ability to pick up trends and keep traders in them until they are over.  Ichimoku Kinko charting is about the two halves of the market, plus time.

Moving averages (Tenkan-sen & Kijun-sen)

Tenkan-sen (Blue Conversion Line): (9-period high + 9-period low)/2))
  • On a daily chart, this line is the mid-point of the 9-day high-low range, which is almost two weeks.
Kijun-sen (Red Base Line): (26-period high + 26-period low)/2))
  • On a daily chart, this line is the mid-point of the 26-day high-low range, which is almost one month.
This is by far the most popular of the trading methods in the Ichimoku Cloud arsenal.
It is simple, elegant and great at picking up trends and trend reversals. If you like trading trends or momentum trading, the Tenkan/Kijun cross is a great method to use.
The most common usage of the Tenkan and Kijun are the ‘cross’ or what we call the TKx (Tenkan-Kijun Cross).  Similar to how a MACD uses a cross of its two lines, the Ichimoku Cloud does the same.  It is interesting to note that the Ichimoku uses the same periods as the MACD, however it was created over a decade earlier.
As usual, the shorter moving average whips around the longer one, giving points at which positions should be switched from long to short and vice-versa.
  •  These moving average crossovers are giving buy or sell signals.  A position is held until these reverse. 
  • Moving averages as support and resistance levels
  • The degree of slope reflects the strength of the trend or displaying the price momentum
Remember there are many important factors to consider when trading the Tenkan/Kijun cross such as time frame, Kumo shape/configuration, previous moves-series of crosses, angle/shape of the cross, etc.

The Cloud (Senkou Span A & B) - Market's sentiment

Senkou Span A (Leading Span A): (Conversion Line + Base Line)/2))
  • This is the midpoint between the Conversion Line and the Base Line. The Leading Span A forms one of the two Cloud boundaries. It is referred to as “Leading” because it is plotted 26 periods in the future and forms the faster Cloud boundary.
Senkou Span B (Leading Span B): (52-period high + 52-period low)/2))
  • On the daily chart, this line is the mid-point of the 52-day high-low range, which is a little less than 3 months. The default calculation setting is 52 periods, but can be adjusted. This value is plotted 26 periods in the future and forms the slower Cloud boundary.  It’s similar to a 50% retracement level and is the mid-point of the last 52 days.
Kumo's thickness gives, most of the times, valuable clues about the current movement, if the stock is in a correction or, on the contrary, in an impulse. If it is in equilibrium or balance. Trend power and forecast.

On impulsive moves, it has a very narrow band and on the correct ones is narrow or even flat.

So the Tenkan line (which is the momentum line) and the Kijun line (which is the trend line) that are based upon price action are moving. Their valued added together, divided by 2 and sent 26periods ahead is what forms the Senkou Span A or Span A. So the first portion of the Ichimoku Cloud or Kumo is based upon evolving price action lines which are half momentum, half trend monitoring. When you put these two together, you get the Span A which is always changing based upon the acceleration or deceleration of price based upon how they affect the Tenkan/Kijun lines (and in turn, the Senkou Span A).

The second line is the Senkou Span B which is a little different. It’s based solely upon price action, particularly the last 52 candles of whatever time period you are on. If you are working with a daily chart, we are talking about the last 52 days, for a 1hr chart, the last 52 hours of price action. After taking the high and low for the last 52 candle range, it takes their values, divides them in half, and shoots them 26 time periods ahead.

Cloud offers you a good location and method to time a reversal which is one of the hardest things to do in trading.

Because the Kumo will often hold price on one side of it, when price breaks it, such a move can often signal a reversal. There are various factors which will increase the likelihood of a reversal such as:
  • Thickness of the Kumo when broken
  • How long price has been on one side of it
  •  How far price has moved before touching/piercing the Kumo
  • What time frame you are working on
These are all critical when assessing whether a Kumo break is signifying a reversal or not.
The Kumo Break method is one of the key systems used by Ichimoku traders for spotting key reversals, qualifying them and giving traders a unique opportunity to either take profits or reverse positions. It’s great for timing trends, reversals and trading key reversals when they are in play. Because of its unique ability to measure support and resistance, the Ichimoku Cloud and its Kumo construction offer the trader some unique trade opportunities.
Another clue hidden in the Cloud can be the flipping of the Senkou Span A and B which can indicate a reversal but do not always.

The shading in between is called the Cloud or Kumo.
  • The top of the Cloud is the first level of support and the bottom is the second level of support or resistance for a bearish chart.
  • The thickness of the Cloud is important. The thicker the Cloud, the less likely it is that prices will manage a sustained break through it. The thinner the Cloud, and a breakthrough has a much better chance.
  • Thin sections in the Cloud give us an idea of when the market is likely to change trend.  Similarly, if the Cloud is getting fatter and fatter, the chance of a reversal in trend lessens looking out into the future.
  • The crossover point of the Senkou Spans is not important, only the fact that at that point the Cloud is at its thinnest.
  • The distance between the Cloud and the current price is not significant.

Chikou Span (Lagging Span)

  •  It’s today’s closing price plotted 26 days behind the last daily close.
The Chikou Span (Green line, used in combination with today’s candlestick):
  •  if Chikou Span is trading above the candlestick of 26 days ago, then today’s market is said to be in a bullish long term phase; conversely,
  •  if Chikou Span is trading below the candlestick of 26 days ago, then today’s market is in a long term bearish phase.
Same idea for Chikou Span itself and the Clouds: above the Cloud of 26 days ago, then today is bullish - and vice versa.

Bullish, Long signals
1.    Price moves above Kumo, Cloud (trend)
2.    Kumo, Cloud turns from red to green (ebb-flow within trend)
3.    Price moves above the Kijun-, Base Line (momentum)
4.    Tenkan-, Conversion Line moves above the Kijun-, Base Line (momentum)

Bearish, Short signals
1.    Price moves below Kumo, Cloud (trend)
2.    Kumo, Cloud turns from green to red (ebb-flow within trend)
3.    Price moves below the Kijun-, Base Line (momentum)
4.    Tenkan-, Conversion Line moves below the Kijun-, Base Line (momentum)

How To Trade The Ichimoku Kinko Hyo

Manage Your Risk

To learn how to manage your risk is the first one, maybe only one most important aspect of trading.  This way you will stay in business.


The first thing one should do when making money management
parameters is determine how much one should risk.
The following three steps might seems simple, but effective:
  1. Let's start with the  total  available  capital,  that  should  not  be  how much you trade with. Instead, you should take your available trading capital and divide it in half or whatever percent you feel comfortable with. If it’s one-half, this is what you will use to trade with; let’s call it the at-risk capital.
  2. Next take a fixed percentage of one’s capital on each trade. This is known as fixed-fraction money. The typically accepted amount one should risk per trade is 5 percent or less of one’s total at-risk capital. This will give you 20 losses in a row before the at-risk capital is wiped.  Then you still have the other half of capital left for a second change.
  3. Position  size  is  a  very  important  part  of  trading  and  can  hurt
    traders.  Not  knowing  how  much  to  trade  is  something  that  can

    really end up hurting you. Markets should be judged by risk or average true range (ATR). Using this number or a multiple of the ATR, or look at the ATR of a weekly chart to determine how much is at risk.  Divides the fixed-fraction money from step two by the ATR. This will give you the maximum number of share to buy. Keeping a simple table can be very helpful.


A Few Things One Can Look at When Deciding How Much to Risk:
  • Are you trading with trend?
  • How close is the market to its trendline or moving average?
  • Has the market moved too much already?
  • How far away is the stop?
  • How much can you lose?
  • How much can you make?
  • How do you usually do with this type of trade?
  • How confident do you feel?

Useful links to older posts and to read more about Risk Management:


Sunday, 6 November 2016

A Simple Retracement Strategy

This simple retracement strategy is very effective and easy to apply.

We only using two standard moving averages, the 20 and 50 days. Going long when the faster one is above the slower one and visa versus for a short position.
Trading the moving average cross-overs are normally to late, as the price has already advanced in a certain extent. The second best option is to wait for a retracement back to the moving average. Finding stock that has retrace back to the fast 20 day moving average and trade them in the direction of the underling trend, the slower 50 day moving average.  Pullbacks to the 50 MA also gives good entry points.  Going long at the blue circled arias and short at the red circled arias.

Current stocks trading close at the 20 day moving average:

Keep trading simple and do not over analyses with to many indicators. 

Saturday, 5 November 2016

The Big 5 - Fundamentals

A summary from Simon Brown’s: Taming the big five. Starting by looking at fundamentals, understanding and starting with these basic five points:

1.       A low Price Earnings (PE) ratio value is best

Earnings per Share (EPS) = Profit / Shares

PE = Price / EPS

2.       Price Earnings Growth (PEG), a number below 1 implies vale and above potentially expensive

PEG = PE / EPS expected (the risky part, it might not realise)

3.       Dividend Yield (DY) around 5%

DY = Price / Dividend

4.       Dividend Cover %, how much of the profit pays out

Operating Profit = Profit / (All Revenue – All Direct Cost)  {cost exclude tax and interest and others}

5.       Operating Margin is compared to previous years and peers in the same industry

These five are a great start for anybody wanting to analyse a company to decide if it’s worth investing into.

When fundamentalists (those analysts and investors who believe they can determine value from such fixed verities as earnings, cash flow, etc.) are confronted with new paradigms. Are stock prices (values) to be determined by dividing price by earnings to establish a reasonable price/earnings (p/e) ratio? Or should sales be used, or cash flow, or the phase of the moon? Technicians are not obliged to worry about this kind of financial legerdemain. The stock is worth what it can be sold for today in the market. See the following post:  How to Trade Chart Patterns

Tuesday, 1 November 2016

Evaluating and Backtesting your system

This is the nitty-gritty part of evaluating and backtesting: How to read the results and determine if you have a good system with a positive expectancy. A positive expectancy is needed to determine if a trader has an edge; without an edge one should not be trading.
Total net profit is the overall bottom line of a system: Does it make money? If the results had been negative, it would be back to the drawing board, as you couldn’t expect to make money by using the system. Total net profit is something all people will look at when evaluating a system, but by itself it is not that great of an indication. Yes, you want a system that has a net profit and not a loss, but you also need to know how many trades it made, how big the swings were, how large a drawdown there was, what the average trade made, and so on.
A trader may be tempted to jump into a system that shows a R50,000 return rather than one that shows only a R10,000 return, but the second may be a better system. Maybe the first one made 1000 trades in a year with a drawdown of R35,000; maybe some months had large losses and others had large wins. Meanwhile the second system made only 50 trades with a drawdown of only R3000 and showed a small profit every month. In that case the second system is a better, safer system even though it returned less. You need to decide what is more important: large potential profits or safe, steady returns. A smart trader will always choose the latter.

Total Number of Trades
In choosing between two systems that have similar results, stick to the one that has a lower number of trades in the same time period. This will reduce the damage done by slippage and commissions, which can be substantial. A system that trades less may be boring for some people, but if you can get the same results, always take the one with fewer trades. Not only does System 1 have a lower net profit, it makes 3 times as many trades as System 2. This means you are working harder to get worse results. Though making fewer trades is desirable, make sure your test has at least 30 trades in it or there is a decent chance that your results were due to chance. If you don’t have 30 trades, you will need to get more data to test it properly.
Percent Profitable
This number means so little, yet people take so much notice of it. The best traders make money only 50 percent of the time, yet in real life people see 50 percent as failure. If people see a system with a 40 percent win/loss ratio, they instinctively think it is a loser because they are conditioned to think of it that way. Don’t pay much heed to percent profitability, but some traders may not feel comfortable using a system with only a 40 percent win/loss ratio. It doesn’t matter if a system is right 30 percent, 40 percent, or 60 percent of the time. What is important is how big the average loser is compared to the average winner. If one has good risk management skills, even a system with a 30 percent win/loss ratio can be quite robust. Both of the systems here have percent profitability numbers in the low 40s, and this is what I typically shoot for.

Largest Winner Versus Largest Loser
This is something that to look for to see how valid a system is. First, look to see if the total profit of the system was due to just one or two trades. In System 1, the total profit was R7025 and the largest winner was R7000. Take away this one trade and the system is profitable by R25 over 182 trades, which is not very good. If a system doesn’t perform well after you take one or two of the largest trades away, it is not very reliable. The other thing to look for is that the largest losers are not bigger than the winners. The key to trading is to keep your losers smaller than your winners; the opposite situation can lead to disaster. If the largest losers are too big, you need to work on your exits and stops some more. I look for at least a 2:1 or 3:1 ratio between the largest winner and the largest loser but will settle for a 1.5:1 ratio before I’ll consider trading a system. The same ratios hold for average winning trade versus average losing trade; unless the average winning trade is bigger than the average losing trade, I won’t use the system. I also look to hold my losers shorter than my winners, so I like to look at the average number of bars in winners versus those in losers to make sure the system fits my trading methodology.

Consecutive Losers
How many losers in a row were there? Many traders can’t handle 10 bad trades in a row and will abandon a system before it has a chance to work. By knowing how many losers in a row this system has had, you can decide not to trade the system because it may be more than you can stomach. Or if you are trading it and are going through a losing streak, you may stick with it because you know that it is common to have a six-trade losing streak. If you don’t know what the largest consecutive losing streak was, you may abandon a system after four straight losses even though this is considered normal for the system.

Average Trade
This is one of the more important numbers to look at as it can compare two systems to each other or one system to itself when changes are made. The average trade measures how the system does on a per-trade basis. This is the number that tells you how much on average you will make or lose every time you trade with the system. System 1 has an average trade of R38.60 (and this is before commissions), while System 2 has an average trade of R564.66. It doesn’t take a genius to realize that it is more profitable on average to take a trade on the second system. If the average trade is negative, don’t trade with the system; that’s easy enough to figure out. What’s harder is determining when the average trade is positive but too small to be worth using a system. Each trader must find an average trade he is comfortable having and then not trade systems with a lower amount.

Probably the most important factor in a system is the drawdown. The drawdown will tell you how much money you will need to start trading with this system in a particular market and give you a basis from which to measure risk. It tells you how much it would have cost you at its worst to use this system. This number will give you an estimate of how much starting capital is needed for each stock or market traded. You may think you have something good, but when you test it over extensive data, you may find that it would have lost R25,000 during its worst period. Don’t think it won’t happen again; the worst losing streak is always just around the corner. If you can’t afford to go through a losing streak twice as long as the biggest drawdown, you shouldn’t trade with the system.
Risk-averse traders are more likely to look at the drawdown than at any other statistic. If they can’t stomach the drawdown they’ll abandon the system or make changes to limit the losses. Money management plays a huge role in trading and should be considered in every aspect of trading. If two systems have similar results and one has a smaller drawdown than the other, it is probably less risky. If a system is too risky, one should avoid it.

Profit Factor
The profit factor is total gains divided by total losses. It tells you the amount that will be made for every dollar that is lost. If the profit factor is 1, you are breaking even. To be on the safe side, the profit factor should be at least 1.5. If you have a profit factor of more than 2, you have a very good system. In System 1 the profit factor is barely 1, and so this is a system that should be avoided.  The profit factor of 1.64 in System 2 is considered decent, and so one could feel comfortable trading with it.

Distribution of Returns
Finally, one needs to see how volatile a system is. How did the system make money? Was it a steady flow of good returns, or were there wild swings in the system’s equity over time? If you have enough data, look for steady monthly performance; if you are testing an intraday system, see how it does on a daily basis. A system with a steady positive return day after day with little variance from the mean is better than one that makes more but has wild swings. If the standard deviation is too wide, this may not be a good system to use, as the drawdowns could be large. If too many trades, days, or months fall more than 2 standard deviations outside the mean on the losing side, be cautious about using the system. Stick to systems that have smaller equity swings, as they are more reliable.
You also can use Excel or another statistical program to get a month-by-month or trade-by-trade breakdown, and so you can see if the performance was steady. It’s not a simple task, but it’s one that a serious trader wants to do to make sure his system does not have wild swings.

Commissions and slippage
No one likes to talk about commissions and slippage, but these two items can really make the difference between a winning and a losing system and a winning and a losing trader. One thing to consider when developing a trading style is that every trade that’s made—win, lose, or break even—will cost a trader some money. These are costs a trader can’t do anything about, and they need to be considered in his system design or his systems will be unrealistic. First, one needs to include every trader’s favorite thing, commissions. The second cost, slippage, is something some traders tend to (or would like to) forget about when considering their trading decisions.
Basically, slippage is the cost associated with paying more for or selling for less than what a trader intended. It may be caused by the market moving away or may be due to the difference in the spread between the bid and ask prices. Ideally, a trader would like to buy on the bid and sell on the offer. Unfortunately, he tends to do the opposite, putting himself into a losing position from the start. On a per trade basis, commissions and slippage are trivial, but when added up over the course of time, they can be astronomical and can have a huge impact on a trader’s profit and loss (P&L) statement. They can easily turn seemingly profitable trades into losing ones. When designing a system a trader needs to make sure it will cover his trading costs or else it will become a losing system.

Become a better trader

To become a better trader you must backtest your trading ideas and systems properly before you trade them. If you do not do this, you will never know if you are trading with a sound system until you are risking real money. If your system is not profitable, you don’t want to find out by losing money. You are better off learning this by spending the time to backtest it. To backtest a system properly
you will need to have enough data to give you 30 sample trades and cover all the different market conditions. You don’t want to test a system just on a trending market, not knowing how it will react in a choppy market.
If you don’t test over different conditions, you are not backtesting properly and may end up with a system that was curve-fitted to work in a trending market.  You should use different data when writing a system and when optimizing your parameters. This will lessen the chance of curve fitting around the data. When you are ready for a final test, make sure you do this on an out sample of completely new data, preferably covering different market conditions and long enough to be statistically valid (30 trades). One of the worst mistakes a trader can make is writing, optimizing, and testing the system on the same data. If it’s been optimized for a set of data, of course it will work great, but you will never know how it will work in the future.
One thing to keep in mind is that no matter how great a system did when it was backtested, it can never predict the future, as markets change. After you are happy with the results you may want to go over a chart visually and see where trades would have been made to get a good feel for how the system worked. You also want to check that your results weren’t due to one or two strong wins. You want to trade with a system that is more predictable and steady over time. These are the kinds of systems that end up doing best; ones with wild swings can be unpredictable and dangerous.
The last thing you need to do is to understand the backtesting results and know how to compare different systems. Overall profit and win/loss ratio are not as important as the average win and the profit factor. Look at the drawdown: Can you afford to trade the system? Don’t assume that the drawdown won’t happen right away, because it might. Make sure to account for commissions and slippage when you are figuring out total profits, as they will make a big difference in the results.
Take your time when backtesting and evaluating your system. Don’t ignore it or get lazy about doing it, as it is a crucial part of making you a better trader. And never trade a system without backtesting it thoroughly first.

Taken from High probability trading by Marcel Link