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| Trading Strategy: Pyramid Your Profits! |
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| Written by Jordan Weir |
| Sunday, 05 April 2009 08:24 |
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If your seeing wild fluctuations in your trading portfolio, and not of the upwards kind, then your forgetting a critical piece of knowledge. To be a successful trader, you MUST cut your losses short, and let your profits run. It is THE most important lesson to learn, right up there with using a stop loss, and key concepts like support and resistance. To be a highly successful trader, you need to learn to pyramid your profits, greatly amplifying your gains, and turning the big winners, into true home runs. In order to properly pyramid your profits, you must understand a basic tenant of risk management. This tenant alone is enough to bring many an unprofitable trader to profitability, but only once combined with the idea of pyramiding profits, can its true utility be realized. This tenant states that no more then 5% of your portfolio should be at risk during any trade. Thus someone with a $50000 portfolio can risk $2500 on a trade. This doesnt mean they cant invest more then $2500, but it means that when setting a stop loss, your initial position size should be based on the $2500 number. So if a company is trading at $20 per share, and our stop loss is at $17.50, we can lose $2.50 per share by buying. If were willing to lose no more then $2500, then $2500/$2.50 = 1000 shares. So we should purchase 1000 shares for this trade. Now lets say the stock then moves to 22.50, and you move your stop loss to $21. At this point, you've looked in $1000 in gains. To pyramid your profits, you then add shares to the position based on the profit made so far. At this point, you have made $1000 in gains, and your risk amount was $2500. Add these numbers together, and then divide by the difference between the current stock price, and the stop loss to get the number of shares you should add to the position. So 1000+2500=3500/1.50=2300 shares. By doing this, you greatly increase how much you make if it continues to go up, while still keeping losses minimal should it go against you. So to recap. Stop loss at 21, we bought 1000 shares at 20, and 2300 at 22.50. If it goes down to 21, we gain 1000 on the first 1000 shares, and lose 3450 on the batch of 2300 shares, for a total loss of $2500 " the original risk amount. However, if it goes up to 25 as we originally forecast as our profit target, we've made $5000 on the original 1000 shares, and another $5750 on the second batch of 2300 shares. This is a total gain of 10750, while never risking more then $2500 in capital. The same idea can be applied to shorting as well. Its all about doing more of whats working, and less of what isn't. This strategy is useful both for long term investors, and for shorter term traders. Long term investors can use this to scale into upwards trending stocks to safely generate massive profits, while shorter term investors can use this strategy to minimize risk, while maximizing their overall gains. This strategy is the natural embodiment of the saying, cut your losses short and let your profits run. Its also in stark contrast to another bit of conventional wisdom, you never go broke taking a profit. While its true that you never go broke taking a profit, the size of the profits in relation to the size of the losses is very important. Pyramiding your profits increases your stake in whats working, while cutting out what isn't, and that's how you make money in the markets. The key to success in trading is to have big gains, and small losses. By doing so, you can be wrong half the time, and still make money in the market. By pyramiding your profits, you insure big gains and small losses. Using this stock trading strategy, you can truly cut your losses short, and let your profits run. About the Author: Don't even THINK about trading another stock before checking out Jordan's website on Stock Trading Stategies. Learn about Stock Option Stategies, etfs, shorting and more by visiting the Stock and Options Guru! Kindly provided by LJ-Marketing.dk You are welcome to use this article on your own website, if you include the link just before this text. |
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