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Sunday, June 27, 2004
Good evening friends,
Market Recap
The markets were mixed on Friday with the NASDAQ up +9 points, the S&P down -6 points, and the Dow down -71 points. This disparity in direction does not happen often; normally the markets will trade in the same direction whether up or down. What does the disparity mean? Probably a small rotation into tech stocks is my guess. Although the NASDAQ was not up much, this was the first “up” day in over two months where over 2 billion shares were traded. However, the Dow traded less than average volume during Friday's decline - so another disparity there.
Action to Note
There was some very unusual action in several stocks in the last few minutes of trading Friday. As I looked over charts this weekend, I found many stocks with sudden extreme drops with an immediate spike back up within seconds. This happens once in awhile on a particular stock but rarely does it happen to a lot of stocks and at the same time. This was probably due to the Russell 3000 shake up. I am not sure what else would have caused it. Nevertheless, if you were lucky enough to have limit orders placed on any of these stocks you are in the money in the trades already. Sometimes it pays to have limit orders already set. Congratulations to all those who made some fast cash.
Looking Ahead
I believe we will have a decent rally in this market soon. If you are short in this market, watch your shorts closely and start covering some of them. As well, consider going long by entering some positions in the stronger stocks on the Bulletin. Some in particular that look very strong are DITC, RRI, RRC, PLXT, POSS, NAVR, YHOO, DHB, EAGL, and PLMO. Our short watch list is dwindling, and this is another sign to be ready to go long.
The 3% Risk Trading System
Last week I mentioned the 3% Risk Trading System which is much more aggressive than the 5% Rule used with the TWPD portfolio. (5% Rule – 5% of the portfolio value is placed in each trade. As the portfolio value increases, the dollar value placed in each trade also increases, compounding gains while minimizing risk).
I have used the 3% Risk Trading System in the past with great returns; I have not used it recently though. Fair warning: it is for aggressive traders only. You will need tough skin and nerves of steal to use it. If you have a heart condition, you may want to consult your physician before entering any trades using this system.
The 3% Risk Trading System requires more capital to be allocated in each trading position compared to the 5% Rule. Please do not get this system mixed up with the 5% Rule. The trade record is based on 5% allocation in each trade, and it will stay that way. I am disclosing the 3% Risk Trading System as an alternative approach some members may find attractive. If you decide to use this system, please set up a separate account and do not blend this system in with your TWPD trading account.
In the 3% Risk Trading System, the money allocated to each trade will vary based on your buy point and your stop price (more on that later). What is important is to limit losses to a maximum of 3% of your portfolio. This means that in a $100,000 portfolio our maximum loss of 3% will be $3,000 in our first trade. If we are starting with a $25,000 portfolio then our maximum loss of 3% will be $750 in our first trade.
Here is how it works:
Let's say you want to enter stock XYZ as it breaks above a resistance of $25.00 so you set a buy stop order at $25.10. Once you are filled you MUST IMMEDIATELY set a stop loss order. This stop loss is not an automatic 3%. Instead, the stop loss is based on previous support. Let's say the support for XYZ is at $20.00. Our stop would then be just under support at $19.90.
To calculate the number of shares to purchase:
1. Take the difference between the buy price and the stop price you have determined: $25.10 – $19.90 = $5.20.
2. Divide the difference into your risk level of $3,000 (3% of $100,000) $3000 / $5.20 = 576 shares
To calculate the value of your trade:
Multiply the 576 shares by the buy price of $25.10 to get a total of $14,458 (14.5% of your 100K).
Let's look at this example more clearly below along with two others.
Example 1
Buy Price = $25.10
Stop price = $19.10
Risk per share = $25.10 – $19.10 = $5.20
Max loss of 3% = $3,000
$3,000 / $5.20 = 576 shares
576 X $25.10 = $14,458
$14,458 = 14.5% of $100,000 portfolio balance
In Example 1, you have to use 14.5% of your trading capital and you risk 3%.
Example 2
In this example we will use the same buy price but a different stop price for XYZ. The different stop price will depend on the chart and where you see the support levels. Again, you will risk 3% or $3,000 of your $100,000 portfolio.
Buy Price = $25.10
Stop price = $22.10
Risk per share = $25.10 – $22.10 = $2.20
Max loss of 3% = $3,000
$3,000 / 2.20 = 1,363 shares
1,363 X $25.10 = $34,211
$34.211 = 34.2% of $100,000 portfolio balance
As you can see in Example 2, you will use 34% of you portfolio balance because of the tighter stop you have placed on the trade. You risk the same amount ($3,000) but you must use more cash in the trade.
Example 3
In this example we will use the same buy and sell points as Example 2, but the risk will be narrowed to 2% instead of 3%. This system can be adjusted to risk any percent of your portfolio you wish. You can bump it up to 5% risk if you wish. It is the same formula; you will just be adjusting the dollars you want to have at risk.
Buy Price = $25.10
Stop price = $22.10
Risk per share = $25.10 – $22.10 = $2.20
Max loss of 2% = $2,000
$2,000 / $2.20 = 909 shares
909 X $25.10 = $22,815
$22,815 = 22.8% of $100,000 portfolio balance
As you can see, it does not matter what you pay for the stock or how much of your portfolio goes into each trade as long as you risk only 3% (or whatever % you are comfortable with) of your total portfolio. Some trades will cost more or less based on where you determine the stop price to be on the chart to insure a maximum loss of 3%.
This is obviously a much more aggressive approach then our 5% Rule. Let's take Example 1 again using the 5% Rule. We will assume we will be stopped out of the trade with a 10% loss.
Buy $25.10
5% of $100,000 = $5,000
$5,000 / $25.10 = 200 shares
Stop $2.50 (10% below buy price) = $22.60
Sell at $22.60 = $4,520
$5,000 - $4,520 = $480
$100,000 - $480 = $99,520
The loss of $480 = 10% of your 5% position but only 0.48% of your total $100,000
As you can see, the 5% Rule is more conservative compared to the 3% Risk Trading System. The 3% Risk Trading System is ideal in Bull markets, but performs poorly in flat markets. It is too easy to get whipsawed out of you position in a flat market, and those losses will add up quickly. However, in a Bull market, the 3% Risk Trading System results will blow away the 5% Rule. Using the 3% Risk Trading System, only four or five positions are open at any one time.
Example 4
If you bought PLMO when it showed up on our Bulletin at $21.50, you would have you would have done very well when it closed Friday above 33.00. Let's use the 3% Risk Trading System with this real example. Keep in mind, PLMO is still running and should move higher next week.
Buy Price = $21.50
Stop price = $19.50 (based on $20.00 support on chart)
Risk per share = $21.50 – $19.50 = $2.00
Max loss of 3% = $3,000
$3,000 / $2.00 = 1500 shares
1500 x $21.50 = $32,250
$32,250 = 32.2% of 100K portfolio balance
Sell at $33.08 x 1500 = $49,620
$49,620 - $32,250 = $17,370
$100,000 + $17,370= $117,370
The gain is $17,370 and your risk was only $3,000. This one trade could balance out almost six losing trades with a 3% risk level. This shows that you can lose 4 out of 5 trades and still make money in the market if you keep your losses to a minimum. Remember to risk 3% of the new balance. This means, if the PLMO trade was your first trade you now would risk 3% of $117,000 instead of $100,000. This is how you compound your gains very quickly.
To Reiterate
I can not stress this enough, it is imperative with this system to PLACE YOUR STOPS IMEDIATELY AFTER YOUR BUY ORDER IS FILLED. You are risking substantial loss if you fail to place stops on a 34% position as with Example 2.
I hope you have enjoyed tonight's Commentary and the introduction of the 3% Risk Trading System. If at some point in the future we decide to open an aggressive portfolio, this is the system we will be using. We currently have a long term portfolio that we will buy and hold for a year or two and our short term swing trading portfolio that is the heart of TWPD. I have described the 3% Risk Trading System in advance so you will be familiar with the system if we do decide to open an aggressive portfolio at some point in the future.
Please tell a friend about our service. Word of mouth is a great way to get our name out, and to continue our service based on referrals would be the ideal way to build our TWPD family. As always, thank-you for your support past, present and future! Have a great night everyone; we will see you all Tomorrow evening.
OTC BB Watch List
- CCLH
- TFCT
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