protecting yourself against black swans
Swing Trading Large Caps - What is the Risk?
The main risk when swing trading is a gap down on earnings, guidance or a broker downgrade.
You will get caught out many times by surprise announcements so you must limit the damage that can be done.
I position size so I have 1/2% of my account maximum risk at my stop loss and if it moves in my favour I can add to my position.
A tight stop on an expensive share can have a large weighting on my account if I use fixed fractional position sizing so I use a guaranteed stop on a spread betting account to limit the amount of slippage. If the weighting is still too much due to the minimum distance of a guaranteed stop I might pass on the trade idea. At any one time I like to keep my total swing trade position heat under 5% of account if all stops get hit. A 5% heat limit lets me have a maximum of 10 trades open with untrailed stops at the same time. As I trail stops on winners it frees up heat so I can add more trades.
I trade longs in a bull market. Very rarely short. There are more gaps to the upside in a bull market which will more than offset gaps to the downside. When I do short I prefer larger cap stocks and I also prefer to use a guaranteed stop. Never underestimate about gap risk. It needs maximum respect.
Guaranteed stops are cheaper on large liquid companies and the small cost of a guaranteed can pay for itself when the market gaps through your stop as you have no slippage. You can also hold through earnings with a guaranteed stop. It's a great feeling when you build a large position and get your stop to break even before earnings.
Be very aware of your portfolio weightings when swing trading as a large gap against you will happen. It's just a matter of time. Guaranteed stops are worth their weight in gold when this happens. If your broker doesn't offer a guaranteed stop on the share you want to trade then seriously consider a potential 50% hit and how much it would affect your account. The risk is real.
Futures and FX - What is the Risk?
Gaps of 100 points or more are the norm when trading an index. You can buy a guaranteed stop on the FTSE100 for 1 point. Just one news spike would cost you many multiples of this and again it will pay for itself many times over when the market gaps through your stop with no slippage. You also sleep really well at night. The same goes for FX. Huge news spikes of 100 points or more are common and then the big Swiss Franc move!!!
Stops - Always put your stop order in before your trade. Always. (unless your account lets you put them in together). If the market makes a big move before you get your stop in you will lose big but if you enter your stop first and the market moves against your trade direction you will be stopped into a trade in the direction of the big move and could profit from it.
Small Caps - What is the Risk?
Huge gaps on news happen all the time on small caps. A 50% drop in price is common even on better companies that actually make money. Cheaper priced shares have smaller weightings on the portfolio but can fall twice as fast or gap down twice as far on a profit warning. For this reason I trade wider moves on small caps so I need to focus on companies with real growth that can trend up for 6 months or more using a trend following method. I trade the wide monthly swings and only trade shares that are rising on a monthly chart. I have stops under prior lows that can be up to 30% and I risk 1% of my account on the trade. Large monthly base breakouts work very well on small caps but most people struggle to buy them. Some brokers offer guaranteed stops on small caps and I will use them if the setup enables me to get a really tight stop but usually I buy the shares.
Micro Caps
All Risk, every penny you put in a micro cap is at risk. Full stop.
I trade micro caps often but they have the least risk on my portfolio. I only trade charts that are rising on the monthly.
I risk 1% of my account per trade maximum at stop and stops are under the lows and can be up to 50%.
Sometimes I just buy 1% of the account in shares with no stop so if the company goes bust I lose 1%.
My Account Breakdown
Mid & Large Cap Swing Trades - 30%
Small Cap Growth - 60%
Micro Caps - 10%
This is a rough breakdown. If there are great trend trades to be found I could have a lot higher percent of my funds in trending small caps along with a few trending large caps or if the market is choppy and rangebound I would be more active with swing trades. The market dictates where the money is put to work.
Compounding
I use fixed fraction growth and compound all profits.
When I get that big trade that comes around every now and then I only compound half of the profit. The other half gets withdrawn for living expenses.
Spread Betting Accounts
I only leave enough money in these accounts for margin for obvious reasons. If the company goes bust you lose less. The spare spread account money is put in premium bonds and on average you get a win every month if you're fully invested. Better than any bank.
Market Phases
You will find that the market is better suited to a certain trade style and forcing swing trades when the market is choppy is pointless. Buying small caps when the index is retracing after a big move is risky as the second half of 2014 was. Recognising these market phases is easy on a monthly chart. Just sit back and wait. When the quality small caps start breaking out of bases its time to dip your toe back in the water.
Portfolio Heat
I limit portfolio heat on open positions to 10% maximum. My heat is determined by market phase (trend & price action) I calculate this using my index trend model. It never lies. If the trend model drops below 50% I automatically halve my heat to a maximum of 5% across all trading methods. More recently I have started dynamically adjusting my maximum heat as the trend model ebbs and flows. Heat is the most important part of my risk management algorithm as it unwinds my exposure during a market sell off. I want my portfolio volatility to be at its lowest into a market sell down or crash and adjusting positions as the market environment deteriorates does this in a structured methodical way.
This Is how I spread my risk. it's not perfect and it's not for everyone but the idea is to stay in the game long enough to start reaping the rewards.
Next Tutorial - Position Sizing Versus Trading Psychology
Jase @stealthsurf
The main risk when swing trading is a gap down on earnings, guidance or a broker downgrade.
You will get caught out many times by surprise announcements so you must limit the damage that can be done.
I position size so I have 1/2% of my account maximum risk at my stop loss and if it moves in my favour I can add to my position.
A tight stop on an expensive share can have a large weighting on my account if I use fixed fractional position sizing so I use a guaranteed stop on a spread betting account to limit the amount of slippage. If the weighting is still too much due to the minimum distance of a guaranteed stop I might pass on the trade idea. At any one time I like to keep my total swing trade position heat under 5% of account if all stops get hit. A 5% heat limit lets me have a maximum of 10 trades open with untrailed stops at the same time. As I trail stops on winners it frees up heat so I can add more trades.
I trade longs in a bull market. Very rarely short. There are more gaps to the upside in a bull market which will more than offset gaps to the downside. When I do short I prefer larger cap stocks and I also prefer to use a guaranteed stop. Never underestimate about gap risk. It needs maximum respect.
Guaranteed stops are cheaper on large liquid companies and the small cost of a guaranteed can pay for itself when the market gaps through your stop as you have no slippage. You can also hold through earnings with a guaranteed stop. It's a great feeling when you build a large position and get your stop to break even before earnings.
Be very aware of your portfolio weightings when swing trading as a large gap against you will happen. It's just a matter of time. Guaranteed stops are worth their weight in gold when this happens. If your broker doesn't offer a guaranteed stop on the share you want to trade then seriously consider a potential 50% hit and how much it would affect your account. The risk is real.
Futures and FX - What is the Risk?
Gaps of 100 points or more are the norm when trading an index. You can buy a guaranteed stop on the FTSE100 for 1 point. Just one news spike would cost you many multiples of this and again it will pay for itself many times over when the market gaps through your stop with no slippage. You also sleep really well at night. The same goes for FX. Huge news spikes of 100 points or more are common and then the big Swiss Franc move!!!
Stops - Always put your stop order in before your trade. Always. (unless your account lets you put them in together). If the market makes a big move before you get your stop in you will lose big but if you enter your stop first and the market moves against your trade direction you will be stopped into a trade in the direction of the big move and could profit from it.
Small Caps - What is the Risk?
Huge gaps on news happen all the time on small caps. A 50% drop in price is common even on better companies that actually make money. Cheaper priced shares have smaller weightings on the portfolio but can fall twice as fast or gap down twice as far on a profit warning. For this reason I trade wider moves on small caps so I need to focus on companies with real growth that can trend up for 6 months or more using a trend following method. I trade the wide monthly swings and only trade shares that are rising on a monthly chart. I have stops under prior lows that can be up to 30% and I risk 1% of my account on the trade. Large monthly base breakouts work very well on small caps but most people struggle to buy them. Some brokers offer guaranteed stops on small caps and I will use them if the setup enables me to get a really tight stop but usually I buy the shares.
Micro Caps
All Risk, every penny you put in a micro cap is at risk. Full stop.
I trade micro caps often but they have the least risk on my portfolio. I only trade charts that are rising on the monthly.
I risk 1% of my account per trade maximum at stop and stops are under the lows and can be up to 50%.
Sometimes I just buy 1% of the account in shares with no stop so if the company goes bust I lose 1%.
My Account Breakdown
Mid & Large Cap Swing Trades - 30%
Small Cap Growth - 60%
Micro Caps - 10%
This is a rough breakdown. If there are great trend trades to be found I could have a lot higher percent of my funds in trending small caps along with a few trending large caps or if the market is choppy and rangebound I would be more active with swing trades. The market dictates where the money is put to work.
Compounding
I use fixed fraction growth and compound all profits.
When I get that big trade that comes around every now and then I only compound half of the profit. The other half gets withdrawn for living expenses.
Spread Betting Accounts
I only leave enough money in these accounts for margin for obvious reasons. If the company goes bust you lose less. The spare spread account money is put in premium bonds and on average you get a win every month if you're fully invested. Better than any bank.
Market Phases
You will find that the market is better suited to a certain trade style and forcing swing trades when the market is choppy is pointless. Buying small caps when the index is retracing after a big move is risky as the second half of 2014 was. Recognising these market phases is easy on a monthly chart. Just sit back and wait. When the quality small caps start breaking out of bases its time to dip your toe back in the water.
Portfolio Heat
I limit portfolio heat on open positions to 10% maximum. My heat is determined by market phase (trend & price action) I calculate this using my index trend model. It never lies. If the trend model drops below 50% I automatically halve my heat to a maximum of 5% across all trading methods. More recently I have started dynamically adjusting my maximum heat as the trend model ebbs and flows. Heat is the most important part of my risk management algorithm as it unwinds my exposure during a market sell off. I want my portfolio volatility to be at its lowest into a market sell down or crash and adjusting positions as the market environment deteriorates does this in a structured methodical way.
This Is how I spread my risk. it's not perfect and it's not for everyone but the idea is to stay in the game long enough to start reaping the rewards.
Next Tutorial - Position Sizing Versus Trading Psychology
Jase @stealthsurf