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Money Management and Trading Strategies

Money Management & Trading Strategies

MONEY MANAGEMENT
Trader must look into three important factors : price forecast, timing and money management to trade successfully. Price forecasting indicates which way market is expected to trend. It is the first crucial step in trading. Forecast process determines if trader is bullish or bearish. If price forecast is wrong nothing else will work. Trading tactics determines specific entry and exit points, ie., timing. Money Management covers allocation of funds. Price forecasting tells what to do (buy or sell), timing helps decide when to do it, and money management determines how much to commit to trade.

Industry is full of advisers and services telling what to buy or sell and when to do it. But how much to commit to each trade is very important as well. As a thumb rule, break your trading capital into 20 equal parts. Keep exposure to maximum of 50% of trading capital, other half of capital should be kept for reserve during periods of adversity and draw down. Always maintain protective stop losses on every trade. Also maintain balance of diversification and concentration of trades. Its also important to know that you can be wrong in markets more than half of the time and still make profits ! For this you should always have risk:reward ratio of 1:3. You let your profits run and cut short your losses.

Letting your profits run is not as easy as it sounds. Example - You have a long in trending markets, your trade is in profits. Now there is some resistance and its overbought. There could be small correction, what to do. Take profits or ride the possible down move, risk paper profits, for the trend to again pickup and take out resistance. One solution is to trade in multiple units. Those units can be divided into trading and trending positions. Trending position is hold for long pull, you risk your paper profits, give market plenty of room to consolidate and move higher. Trending position produce the largest profits in long run. Trading portion of the trade is booked at first target objective. This liquidated positions can again be reinstated.This increased flexibility of trading multiple units can have a significant difference in trading results.

What should a trader do in periods of success and adversity. Suppose traders equity is down 50% after loosing streak. Trader has now to double his capital just to get break even. If he looses confidence and becomes conservative it would become more difficult to win back losses. Similarly if traders equity has doubled after winning streak, should he double his stakes to put money to maximum use. However losses are inevitable after winning streaks. So better to take profits out from trading capital.

TRADING  STRATEGIES
After analyzing the market technically, trader knows whether to buy or sell. Trade size is decided by Money Management. Final step know is execution. Following are trading tactics :-

BREAKOUT

Trader is forever faced with dilemma of taking position in anticipation of breakout, taking position on breakout or waiting for the pullback after the breakout to take position. IF position is taken in anticipation, payoff is better due to lower entry, but odds of bad trade are higher. Waiting for breakout increases the odds of success but penalty is higher entry price. Waiting for pullback after breakout is sensible but dynamic markets often does not give second chance. Best is break the trade into few parts, take some position in anticipation, some on actual breakout and add some more in pullback. Thus multiple units traded would give a good average entry price. The exits can be also done in multiple broken trade.

TRENDLINES

This is most useful early entry or exit signals. Trendlines give good entry points at supports and resistances. Breaking of trendline is often first sign of trend reversal, it acts as excellent action signal.


SUPPORT AND RESISTANACE

Breaking of resistance can be signal for new long position with stop just below nearest support. Rallies to resistance in downtrend or declines to support in uptrend can be used to initiate new positions or add to existing ones in direction of the trend. Supports and resistance are most useful to keep protective stops.

 

MISCELLANEOUS  TIPS


RETRACEMENTS

40-60% retracement from current trend is often a good zone to add positions in direction of former long term trend. Gaps in prices often act as key support or resistance. Gaps can be used for entry or to keep protective stops just above or below them according to trade taken.

TYPES OF ORDERS
Choosing right type of trading order is key in execution of the trade.


Market order is simple instruction to buy or sell at current market price. This is usually used in fast markets when trader wants to ensure that position is taken thus ensuring missing potentially dynamic market move.
 
Limit order is executed only when the specified price is met. Buy limit order is placed below current market price and sell limit order is placed above current market price. For example a buy limit order can be placed by a  trader to buy in downside reaction or sell limit order could be placed by a trader to book profits around resistance in current uptrend.

Stop order can be used to establish new positions, limit a loss on existing positions or protect profit. Buy stop is place above the market, Sell stop below the market. Once the stop price is hit, order becomes market order and is executed at best possible price. Stop limit order is also a stop order, but the order gets executed only at a particular price. Market if touched (MIT) is similar to limit order but becomes a market order if limit price is touched.

Each of the order are appropriate at certain times in trading and also have there limitations. Market order guarantees entry but result in chasing markets. Limit orders provide more control and better prices but risk missing the market. Stop Limit also stand risk of missing the trade if prices gap beyond the limit price. MIT is useful but not allowed on many exchanges.

CHARTS
Analysis start with monthly,weekly, daily and then intraday charts. Long term charts give telescopic view of market, intraday charts given microscopic view of the market. Shorter time frame moves can be used to take positions in direction of the trend in larger time frame.

SUMMARY
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Trade in direction of the intermediate trend.
In uptrends buy dips, in downtrends sell bounces.
Let profits run,cut losses short.
Use protective stops to limit losses.
Dont trade impulsively, have a plan.
Use money management principles.
Diversify but dont overdo it.
Employ at-least 3:1 reward to risk ratio.
When pyramiding(adding positions), never add to loosing position, always add to winning position only. Each successive layer should be smaller than before. Adjust protective stops to break even.
Never meet a margin call, never throw good money after bad.
Close out losing positions before winning ones.
Work from long to short term.
Learn to be comfortable with minority. If you are right in the market, most people will disagree with you.
Keep it simple, more complicated is not always better.