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I'll summarise what I've gained out of Van Tharp's book.
Trading float = Cash + Realisable value of current shares
Risk per trade = a percentage of Trading Float (eg 1.5%)
Stop Loss = 2 ATRs
Position Size (in # of shares) = Risk / Stop Loss
Don't let position size * share price exceed 20% of your trading float
(capital conservation)
eg. $40K float
1.5% risked = $600 risked in the trade (ie how much you will lose if the
trade goes against you).
Assume $30 stock called ABCD, with an ATR of $1.30
Stop = 2 ATRs = $2.60 (ie you sell when the stock is $30 - $2.60 =
$27.40)
Position size = $600 / $2.60 = 230 shares
Consideration = x $30 = $6900 (ie passes the rule of a consideration
less than 20% of our float).
ie buy 230 shares of ABCD, stop loss is set at $27.40
Advantages:
1. You buy less of the stock when the volatility increases (as measured
by the ATR)
2. You always know the exact amount you're risking on a per trade basis.
You'll find it near impossible to lose all your money if you only risk
2% on any given trade due to the rule #4.
3. We allocate < 20% of our money on a per stock basis, to guard against
bad things happening (like a stock losing 60% of its value in one day -
happens occasionally!)
4. As our float increases, so do our position sizes. The opposite
happens when our capital decreases.
Other things to watch:
1. Slippage (you can't always get out at your stop loss level).
2. Trailing profit stop - set these at your preferred levels
3. ATRs aren't always the most suitable stop loss mechanism. Some may
prefer to use a stop just below recent support levels instead.
4. On low capital levels, brokerage comes into play.
Comments?
RICHARD DALE
IT PROJECTS MANAGER
daytraderHQ Ltd
Level 4, 66 Kings Park Rd
West Perth
Western Australia 6005
Phone: +61 8 9226 0767 Fax (08) +61 8 9322 9998
Email: rad@xxxxxxxxxxxxxxx
Web site: www.daytraderHQ.com
YOU'LL NEVER TRADE ALONE
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