SIX KEYS TO INVESTMENT SUCCESS (part two)

  1. 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.
  2. 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.
  3. 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!