[B]THE SIX KEYS TO INVESTMENT SUCCESS[/B]
[B][/B]
Let’s think about trading or investing in terms of the following
variables:
- Reliability, or what percentage of time you make money.
For example, if you made 10 stock trades and made money on 6 of
them, then your reliability is 60 percent. It’s the number of winning
trades you make divided by the total number of trades. Sometimes,
reliability is called the “hit rate.” Basically, it is the percentage of
time you get to be “right” in your system. - The relative size of your profits compared with your
losses when traded at the smallest possible level (i.e., one share of
stock or one futures contract). For example, the relative size of your
profits and your losses would be the same if you lost $1 per share
on losing trades and made $1 per share on winning trades.
However, the relative size would be quite different if you made $10
per share on winning trades and only lost $1 per share on losing
trades. It would now be 10 to 1.
You can get a good idea of the relative size of your profits to
your losses by taking the average size of your winning trades and
comparing that with the average size of your losing trades. This
will give you a rough idea of relative size. However, you might
have one giant profit and many small losses, so this is not an exact
measure.
A more exact measure would be to think of your gains as multiples
of the initial risk ® that you took in the trade. Thus, your
gains might be a whole series of R multiples. For example, let’s say
you are willing to risk $500 on a trade (i.e., you’ll get out immediately
if you have a $500 loss so that it doesn’t get any bigger). Your
basic risk is $500. Thus, a $1,000 gain is a 2-R multiple and a $5,000
gain is a 10-R multiple. And if by some misfortune, you have a
$1,000 loss, then you’ll have a 2-R loss. You’ll learn more about R
multiples later in this chapter. - Your cost of making an investment or trade. This is the
destructive force on your account size whenever you trade due to
execution costs and brokerage commissions. Quite often, people
simply include these costs when figuring the average gain or the
average loss. However, it is also wise to be aware of just how big
these costs are for you.