F Trade and Some Basic Risk Management

We've talked about trade ideas, a few different entries, I just want to touch on the F trade with a little risk management perspective.

When we look at trades, it's natural to think about "How much money can I make on this trade?"

However, I'd like you to start thinking in terms of, "How much money can I lose on this trade?" first. Like we all know from simple math, you lose 50% of $100, you need to make 100% to get back to break even so it's infinitely easier to keep it then to make it back. The great trades will come, your job is to minimize losses until you hit the huge winners. You've seen we have them every week, you don't have to wait a year, but you do need to be a little patient. Minimize risk every time and you'll be ahead of many of the pros on Wall Street.

Here's F's charts:

 We don't need moving averages to see lower highs/lower lows, better known as a downtrend. The red arrow as of today signifies our Swing trigger candle as it has made the highest high/highest low, so tomorrow if we saw a move below the $14.89 area, we could enter a swing short and we could use a tight stop based on the signal candle around $15.31 or so.

 Here my Trend Channel is on a 1 day setting and it captured the uptrend and stopped out at the small red trendline. So we'll still use the same if we want to use a trending stop rather then a swing stop. The trending stop is at $15.80 (there's no judgement call here, there's no guessing, this is the standard volatility F has been trading at.

 3C daily sows us the negative divergence when distribution started in late 2010/early 2011, we also see that attempted move in the red box, that head fake is a good indication of the end of distribution, but so are our shorter term charts.

Here on the 10-min we see the possibility of some continued upside as there was an accumulation event on 2/23-2/24, that position needs to be distributed. Since it was only 2 days max, we know this is a bounce and not something more serious at this point. The 1 min chart (not shown) is starting to show the distribution so we are getting close.

We are going to assume that tomorrow is the final day of the bounce and we get a reversal down through today's signal candle which would give us an entry as mentioned above, around $14.89.

Let's assume our portfolio's total worth (never count margin) is $10,000.  If we were to go with the most aggressive risk management because of the smaller portfolio size, we'll assume 2% risk. 2% risk of $10k =$200, that does not mean we can only buy $200 worth of F, that is our risk money. Now we must determine our risk.

We have two potential stops, a tight swing stop at $15.31 (mentioned above) or our Trend Channel stop at $15.80, we'll look at both.

For our swing stop we have $.42 risk per share ($15.31 stop less our entry at $14.89). Now we divide our risk capital ($200) by our risk per share ($.41)= 487 shares of F. If we purchase 487 shares at $14.89 we have $7250 in the trade, more then 70% of our portfolio. We can not guard against gaps with such  heavy load of F in our portfolio so it may make more sense to use our trending stop. However, lets assume we don't want to use our trending stop, we want the tighter swing stop. Then we need to bring our portfolio exposure to F down to 15-20% maximum (I prefer 15%), but at 20% ($2,000) divided by F's selling price, $14.89 we can pick up about 135 shares of F and have 20% of our portfolio in F. Our risk (not inclusive of gaps) is still $.41 a share which puts our total portfolio risk in F at $55.35 which is of course about half of 1 percent of portfolio.

Using our wider (which I prefer) trending stop at $15.80 less out entry on the swing trade at $14.89, we have $.91 risk per share. Divide our 2% risk capital of $200 by $.91 and we can buy 219 shares-still too high as we have nearly 32% of our portfolio in F. We want to lower that to 20%, so $2,000 divided by our entry of $14.89 135 shares-same as before, but our total portfolio risk is now about 1.2% of portfolio-still manageable and we have a wider stop and a trade more likely not to be stopped out.

I know this is a lot to take in and it doesn't seem like a lot of shares, but succeeding in the market is about protecting your portfolio and compounding your gains. With 1.5% risk of portfolio we can be wrong a lot of times and still hit those 300% moves and see a nice return.

This was one example of risk management, for bigger portfolios I'd be a little more conservative and look at our second example which you can find here at this link.  Also read this one about placing stops.



Any questions on risk management or any other subject, you know I'm an email away, but this is very important, especially at transitional, volatile periods like we are seeing now. So do the work now before the trade comes and you have to move fast. Protect your capital, be steady, be patient, you will get there.