- How often you get the opportunity to trade. Now imagine holding the first three variables constant. Their combined effect
depends upon how often you trade. Let’s say’the combined effect
of the first three variables is that you make 20 cents per dollar
risked. That means that if you make 100 trades, each risking $100,
you will end up with a total profit of $2,000.’ However, now imagine
that it takes one day to make 100 trades. You’d make $2,000 per
day. Now compare that with a system that makes 100 trades each
year-you’d only make $2,000 per year trading. The opportunity
factor makes a big difference. - The size of your trading or investing capital. The effect of
the first four variables upon your account depends significantly
upon the size of your account. For example, even the cost of trading
will have a significant effect on a $1,000 account. If it costs $100
to trade, then you would take a 10 percent hit on each trade before
you’d make a profit. You’d have to average more than 10 percent
profit per trade just to cover the cost of trading. However, the
impact of the same $100 in costs becomes insignificant if you have
a million dollar account. - Your position-sizing model or how many units you trade
at one time (i.e., 1 share of stock versus 10,000 shares of stock).
Obviously, the amount you win or lose per share is multiplied by
the number of shares traded.
Different trades probably will have different risk levels, or different
Rs. Thus, a 1-R loss probably will not be the same for trade X
as for trade Y. Your reaction might be to say, “What good is the concept
of R if it varies all over the place?” The value comes in through
position sizing. For example, if you risk a constant percentage of
your equity, like 1 percent, then you will be equating each 1-R risk.
If you have $100,000, then you would only take a $1,000 risk (i.e., 1
percent) on each position. Thus, if 1 R is a single dollar on one trade,
you would purchase 1,000 shares. If 1 R was $10 on another trade,
then you would purchase 100 shares. In each case, your 1-R risk
would be a constant, representing 1 percent of your equity. We’ll be
discussing position sizing in much more detail later in this book.
Would you want to focus on just one of those six variables? Or
do you think that all six of them are equally important? When I ask
the question in that manner, you probably agree that all six variables
are important.
However, if you were to devote all your energy to focusing on
just one of those variables, which one would it be? Perhaps you
think this question is a little naive since all of them are important.
Nevertheless, there is a reason behind this question, so write your
answer in the space provided.
A N S W E R :
The reason I asked you to focus on one item is because most
traders and investors often only focus on one of the six items in
their day-to-day activity. Their focus tends to be on the need to be
right. People are obsessed with it to the exclusion of all else. Yet if
all six components are important to success, you can begin to
understand how nayve it can be to just focus on being right.
The first four variables are part of the topic I call expectancy.
They are the primary focus of this chapter. The last two variables
are part of what I call money management or position sizing.[B][/B]
Good post, helpful!