Friday, 26 October 2018

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.

Friday, 12 October 2018

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

Friday, 5 October 2018

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