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How do you diversify yours, or do you?

Discussion in 'Investing/Trading/Cryptocurrency/Altcoins' started by Rawr, Sep 14, 2007.

  1. Rawr
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    Rawr Gold Contributor Speedway Pass

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    As of today I am to the point of where I have a small amount of money in my account. To be honest most of the money had been made trading the stock I knew - LVS. I would put all my money in it and let it go up, take profit, re-buy at a low point. This was a decent strategy when I had no money, but if I did this now a swing either way could be critical, and I am not sure where my risk levels are at this stage.

    In your opinion what are some good tips on diversifying your portfolio. What is the preferable number of stocks?

    :thankyousign:
     
  2. piranha526
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    piranha526 Contributor

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    You need to learn position sizing so you don't run the risk of ruin. below is a simple example (I also have a calculator on my blog that shows you how to figure out proper position sizing). You should never risk more than 1% or 2% per trade. If you have $10,000, risking $1,000 should be the max. you may buy $10,000 worth of shares in LVS but you must stop out at the 1% rule or a $1,000 loss if you would like to play another day. See below:

    How do we Calculate Position Size?
    We can determine how much to place on each trade by assuming a $100,000 account with 1% risk on each position. Using a basic trading approach, I will place my stops approximately 8% below the ideal entry area or pivot point. Please use more advanced methods for locating the ideal stop rather than a general 8% (I am doing this for example purposes only). Look for the ideal risk-to-reward setup based on recent support and resistance levels and set your stop and potential target accordingly.

    $100,000 Account
    1% Risk = $1,000
    8% Stop Loss
    Position Size will be $12,500
    We calculate the position size by dividing the 1% risk by the 8% stop loss or $1000 / 8% = $12,500.

    If the stock we are watching has an ideal entry of $50, we now know that we can buy 250 shares or $12,500 worth of stock. Our stop loss is $46 or 8% of $50 and our maximum loss is $1,000 of the original $100,000 portfolio.

    Hope this helps.
     
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  3. Rawr
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    Rawr Gold Contributor Speedway Pass

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    That was excellent, and I am curious, why 1% or 2%

    Rep+
     
  4. piranha526
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    piranha526 Contributor

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    ***EXAMPLES ARE SIMPLE AND THEORETICAL SO EVERYONE CAN FOLLOW***

    Think about it: Even the best systems can and will have losing streaks of 10 or more (not often but it can happen). Historical testing shows us that extremely profitable systems can and have lost 20 times in a row. If you are risking 5% without proper position sizing: YOU ARE TOAST! DONE! Very hard to come back.

    Fortunately, my longest streak ever was 8. But, I have only been trading for 10 years. I can and will assume that I will beat that streak one day (it’s the way the market works).

    At 1% (good for accounts above 6 figures), it would take hundreds of losing trades to bring on ruin. You bet 1% of total equity, not the $100,000. So, if you lose ten consecutive trades, you will still have approximately $90,000 minus slippage, trading fees and other commissions, etc… So at $90,000, your risk is now $900 maximum!

    Using 5% losses, you will be below $60,000 capital from $100,000 after 10 consecutive losses. You now need to trade and make back 65% on your money to break even. Do you make 65% a year in the market now? Most people don’t.

    Ten losses at 1%; you are only down 12%. That is very obtainable!

    Now, let’s look at 18 losing trades and 2 winning trades over a 20-trade period.

    At 1% risk with trade 5 and trade 18 winning 4% and 7% respectively (all other trades losing 1%): ~$92,000 account (only down 8% with 18 losses and 2 small winners)

    At 5% risk with trade 5 and trade 18 winning 10% and 12% respectively (all other trades losing 5%): ~$48,000 account (I upped the winners but the account was slashed in half – you now need to make 100% to break even). You say 18 losses over 20 won’t happen: then you are in lala-land because it happens to the best in the business.

    If you risked 5% and lost 20 consecutive times, you would be left with $35,000. How long will it take you to break even? At 1% risk, 20 consecutive losses bring you down to $81,000 (a tough string of losses but you are still in the game)! A 25% account gain breaks you even.

    Now, image what most people start with: $10,000 or less! And then add the fact that they don’t know or understand how to properly position size – they are usually broke with a few trades because they bet the house on every trade and freeze when things go wrong, taking losses of 25%, 50% or greater!
     
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  5. Rawr
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    Rawr Gold Contributor Speedway Pass

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    what are the stats on people who this happens to?

    At the same time, how many stocks are you going to need if you are marginalizing each at 1%? Wouldn't that mean you have to have at least 5 different ones going at the same time to actually get some decent gains?
     
  6. piranha526
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    piranha526 Contributor

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    It depends.

    Another quick example using a $100,000 account.
    Say you want to buy two stocks at $50 (XYZ and ABC)

    XYZ has major support at $48.50 with reward near $60. So the trade looks like this:
    Buy 667 shares
    3% stop loss
    $33,350 position size
    Stop Loss: $48.50
    Risk (1-R): $1.50
    Reward Target: $60
    Risk-to-reward: 6.67-to-1

    ABC has major support at $45.00 with reward near $65. So the trade looks like this:
    Buy 200 shares
    10% stop loss
    $10,000 position size
    Stop Loss: $45.00
    Risk (1-R): $5.00
    Reward Target: $65
    Risk-to-reward: 3-to-1

    As you can see, you will buy both at $50 per share but due to stop areas and possible targets, the actual position sizes change from $33k to $10k. It’s all about the risk, the reward and the correct position size. You could have a large $30k or $40k position due to a tight stop or a small $10k position due to a larger stop. Depending on the trade and your style, you may have 3 or 4 stocks for a $100k account or you could have 7 to 10 (I wouldn’t do more than this at one time).

    Hope this helps!
     
  7. kidgas
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    kidgas Contributor

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    I am still working my way through Van Tharp's book and am learning much about expectancy. Position sizing is covered in Chapter 14.

    I would ask: What is the purpose in diversification? I feel that it is to protect capital since as pointed out a 50% loss would require a 100% gain to get back to even. Thus, in order to protect capital, I have taken the approach of using protective puts. That seems to work better for me since I cannot always have access to trading the markets. A mental stop of 8% for example requires knowing where a stock is trading fairly frequently. A stop loss order will not protect from a gap down. One 35-50% gap down would wipe out some of the benefit of position sizing.

    Of course, every method has pros and cons. The cons of puts would be the cost involved. Con of position sizing is gapping down. I think you have to find what works best for you and most importantly, cut losers short and let winners run while figuring out the method that you will use to determine when to sell.

    I am still working on my system and making refinements. I try to take the ideas that make sense to me and make adjustments and see what works continually attempting to improve my investing results. I enjoy the discussion because it stimulates new ideas.
     
  8. Rawr
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    Rawr Gold Contributor Speedway Pass

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    Two questions if I may.

    How do I tell where stock is getting much support (resistance levels)

    How does that affect the 8% figure.


    Thank you
     

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