Money Management is the KEY in this Business

Q.: Can you tell me more about timing buys/sells or is it something that comes with experience?

I have no trouble identifying good potential companies, but find it difficult timing it correctly re. price. For instance I bought FENR in January (2009) after much research on the company, sector and reading through the trading statement. After a drop from the 80s earlier in the month, it seemed like good value. My original stop was at 64p, I lowered it fearing a tree shake and was closed out this morning at my new 60p stop loss.

My idea for FENR was a medium-term recovery play with a target of 91.8p or 12%, looking head to the annual report in August. For now i'm in cash evaluating what next, but I always feel I have missed the boat on trades I like.

A: I can't quite see when you bought it but presume it was around 14th Jan 2009. I'm afraid the trading statement was awful! How so? 'satisfactory', 'cutting jobs', 'deteriorating markets'. However good the rest, the word deteriorating is the key to avoiding a stock for now. Ditto 'difficult' or 'challenging'. I think one can only learn this by experience and we are all having to learn afresh for this extraordinary market.


Now, FENR fans may jump down my throat and say it's under-valued by any measure, and maybe it is but how do you assess the 'e' in earnings....? As for timing entry and exit - well, if I have your timing correct then you were buying from all those who, like me, bought at 55p ish.

Charts and stuff not so important if you aim to hold for the long term but at the moment buy and hold is gravely wounded. At some point it will be right to hold again but as things stand it's very tricky knowing whether the market is going to rise or fall. As I always say, what looks cheap can always get cheaper. I think it's better to pay more and be sure!

You also need to think about the size of your stop. 20% 5 times and you're bust. Rethink needed.

I have discussed stops here many times and there's no one solution fits all but if you're starting out then making sure you can stay in the game is a bit key. So, let me give you an example of money management...

Starting pot £5000.

You've done your homework and FENR looks good @ 75p.

Your target is 91p.

Your stop 64p.

We have ourselves a problem from the off. Let's ignore costs.

You are hoping to make 16p, you are willing to lose 11.

No, no, no. If every trade you take is done on this ratio you will make money very slowly. Your win:loss ratio is 1.45:1 (divide 16/11). Take into account costs/spread and I suspect you won't make money.

You really need to plan for a win:lose ratio that exceeds at least twice the amount you are willing to lose.

Target 91.

Stop 67.


But we still have a problem...we're still on to lose 10%. Do that 10 times and we're wiped out.


So...what about this?

Pot is £5000. We like the trade with a target of 91 and a stop of 67, the now secret is to make sure that we minimise the loss to our portfolio. So...

If we buy £1000 of stock and it goes tits up (pardon me), then we lose £100. £100/£5000 = 2%. We've still got £4900 to play with.

How many trades can we get wrong before we are wiped out? Someone get me a spreadsheet.....! You see, next time you plan your trade around only losing 2% of £4900 and so on. And if you have a winning trade, your stake goes up.

Light bulb moment!

In other words, it's not really the stop that's important, it's the impact on the pot.

My worst trade by a mile this year lost me 24% (or some such, I posted in on here but too tired to look back). Total impact on portfolio was something like .25%. Why? Because I was very careful to make sure that my riskier trades couldn't do me much harm when they went wrong.

Professional traders rarely risk more than 1% of their pot. In other words, plan your trade size around your stop and ensure you don't ever lose more than 1% of the total. Then you can have 5, 10 or 20% stops (if appropriate as is sometimes the case) and still know that you will be able to fight another day.

Think steak [SIC].

Food for thought.

Talking of which, time for Eastenders!

Q.: The problem with this is that the gains per trade also go drastically down when you are using a trading system which risks just 2%...(continued from above example of FENR)

What I mean is when you are so certain on a trade why should you risk only 2% - after all there are only so many stocks you can research and researching a stock is expensive in terms of time invested?

A: Good luck admire your certainty, glad you did your research though, fancy a game of Russian Roulette?

Load number of bullets (1-6):


To answer your question:

Going back to our FENR example.

We've risked 2% by buying £1k at 75p. The trade goes in our favour and we're now at 90p. This is where the wise trader doesn't sell but buys more. You see, our target helped us define our risk : reward ratio but it doesn't define the trade.

At 90p we are no longer managing a loss but managing a profit. We raise our stop on trade 1 to 81p. We can still lose £100 or 2% of our portfolio but this time it's profit we're losing, not capital. Nice. Now we can add another £1k to the trade. We do that with, say, a stop of 82p and a target of £1.10.

What happens if the trade is stopped out?

Trade 1 - profit of £80.
Trade 2 - loss of £100.

Total for trades, broadly flat.

What happens if the trade continues to go our way and we close at, say, £1.05?

Trade 1 - profit of £400.
Trade 2 - profit of £200.

Total for trades, 600 or broadly 12% of portfolio.

Now, if we had bought £2k in the first place @75 and the trade had gone tits up straight away then we would have lost £200, or 4% of the portfolio.

Had the trade worked and gone all the way to £1.05 then we would have made £800 or 16%.

Yes you win! You made 4% more than I did.

Had it gone to 90p and then back to 81p (as per our example) you would end up with 160 or 3%. You win again.

I'm never risking more than 2%, you are risking up to 4%. If we both get our trades wrong, I will remain in the game at least twice as long as you. If we both get our trades right then I can still make 75% of what you're making.

The table below illustrates the various position sizing percentages and how they pan out how after as many as 20 losses in a row, if you risk only a small portion of your capital per entry, say 1%, you're still in the game. By risking 5%-10% on each trade you risk wiping your account.

Money Management

So, the question is, which strategy is right for you? As they say on Big Brother 'you decide'.

 ...Continues here - Using Charting Tools to Predict Future Price Movements

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