Friday, December 4, 2009
Thursday, November 19, 2009
Get high leverage with low risk
Traders make money from fluctuations in price levels. By using leverage, traders can maximize return on capital. Leverage involves using margin to make more money than you can with your own funds.
Margin trading provides high rewards when you are right, but may also cause huge losses if you are wrong.
Traders are then confronted with some confusion: Leverage or margin trading can enhance return but carries high risk. This becomes a difficult decision since traders should not go for any increase in risk, but should at all times try to leverage their money for more profits.How can these two opposing viewpoints be reconciled.
The Answer:
If margin trading can be used with an always known and strictly limited risk, it becomes High Leverage with Low risk. (HLLR).
The instruments of HLLR are Put and Call options.
Buyers of puts and calls gain an enormous amount of leverage while applying only a small amount of capital. They also have limited and well defined risk.
Advantages of Option buying:
You do not have to possess large amounts of capital. (Remember, all trading activities require that you should be well capitalized.)
As an option buyer you enjoy all the benefits of margin trading when your are right, without the risk associated with leverage, if you are wrong.
Total risk is always known and limited. The maximum risk is the cost of your option.
A Trading Plan:
Successful trading depends on knowledge, courage of conviction, the discipline to execute your plan, and hard work required to develop the knowledge, courage & discipline.
In trading options, you must have the financial and the psychological strength to face adverse situations when they arise. (This applies to all trading methods).
Margin trading provides high rewards when you are right, but may also cause huge losses if you are wrong.
Traders are then confronted with some confusion: Leverage or margin trading can enhance return but carries high risk. This becomes a difficult decision since traders should not go for any increase in risk, but should at all times try to leverage their money for more profits.How can these two opposing viewpoints be reconciled.
The Answer:
If margin trading can be used with an always known and strictly limited risk, it becomes High Leverage with Low risk. (HLLR).
The instruments of HLLR are Put and Call options.
Buyers of puts and calls gain an enormous amount of leverage while applying only a small amount of capital. They also have limited and well defined risk.
Advantages of Option buying:
You do not have to possess large amounts of capital. (Remember, all trading activities require that you should be well capitalized.)
As an option buyer you enjoy all the benefits of margin trading when your are right, without the risk associated with leverage, if you are wrong.
Total risk is always known and limited. The maximum risk is the cost of your option.
A Trading Plan:
Successful trading depends on knowledge, courage of conviction, the discipline to execute your plan, and hard work required to develop the knowledge, courage & discipline.
In trading options, you must have the financial and the psychological strength to face adverse situations when they arise. (This applies to all trading methods).
Improve the performance of your Trading System
Trading Systems offer profitable opportunities for making money. The Profit Test feature in Trend Mechanic allows you to test and them implement systems in real time trading. But, all systems go through periods of drawdowns. Often, the periods of drawdown are so severe that the trader abandons the system, or even system trading. While losses are inevitable, here are some suggestions to change the trading style to that we can remain in the business. There are two aspects to trading systems which can be adjusted to increase our chances of winning consistently.
First, we can try to reduce losing trades. This is not possible in a casino, but trading is a mind game, so it is possible in trading. We can try to identify conditions that are more favorable to our winners and include them in our system. We should also identify circumstances where a loser is more likely, and skip those trades. For example, if we notice that most of our winners are entered on days where the overall market has moved in the same direction as our trade, then only enter trades when the overall market is moving in the correct direction. This means that our trade is in the same direction of the overall market, rather than against it.
Another example might be that trades that are entered just before major news announcements, like the union budget or quarterly earnings, often get stopped out as losers due to increased volatility, so you should skip those trades. A study of past trades can be rewarding. It should be possible to identify many patterns of profitable & losing trades.
Second, we try to improve the average size of winners versus losers. Increasing the ratio of profits to losses so that the winners win more on average than the losers lose depends on the way you handle your stops. Having large winners in relation to losers can make up for a low win percentage, and mean that you will still make money playing the game. One method is to have a trailing stop that moves up as a trade becomes a winner. If you have fixed stops for losing trades that limit losses, but trailing stops for winning ones that allow winners to grow, then you are increasing your chances of your average winner being larger than your average loser. Generally it is better to be strict on losers by having ttighter stops that keep losses to a minimum and generous with winners by having stops that allow profits to grow. In any case you want to make losers small and winners large, so never add to a losing trade – that would be doing the opposite of what you want to achieve.
As traders, we should do whatever we can to improve the performance of our trading system, in the manner described here.
First, we can try to reduce losing trades. This is not possible in a casino, but trading is a mind game, so it is possible in trading. We can try to identify conditions that are more favorable to our winners and include them in our system. We should also identify circumstances where a loser is more likely, and skip those trades. For example, if we notice that most of our winners are entered on days where the overall market has moved in the same direction as our trade, then only enter trades when the overall market is moving in the correct direction. This means that our trade is in the same direction of the overall market, rather than against it.
Another example might be that trades that are entered just before major news announcements, like the union budget or quarterly earnings, often get stopped out as losers due to increased volatility, so you should skip those trades. A study of past trades can be rewarding. It should be possible to identify many patterns of profitable & losing trades.
Second, we try to improve the average size of winners versus losers. Increasing the ratio of profits to losses so that the winners win more on average than the losers lose depends on the way you handle your stops. Having large winners in relation to losers can make up for a low win percentage, and mean that you will still make money playing the game. One method is to have a trailing stop that moves up as a trade becomes a winner. If you have fixed stops for losing trades that limit losses, but trailing stops for winning ones that allow winners to grow, then you are increasing your chances of your average winner being larger than your average loser. Generally it is better to be strict on losers by having ttighter stops that keep losses to a minimum and generous with winners by having stops that allow profits to grow. In any case you want to make losers small and winners large, so never add to a losing trade – that would be doing the opposite of what you want to achieve.
As traders, we should do whatever we can to improve the performance of our trading system, in the manner described here.
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