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Top trading tips

Photo of Louise Bedford, Author By Louise Bedford, Author

min read

Four steps to survive and thrive when trading shares.

Can’t catch a break in the markets? Getting stopped out (forced to sell) so often it’s making your head spin? Take heart. Help is on its way.

You can lean on my shoulder and tell me everywhere that feels raw, the places that have been sand-papered by the markets. Your head, your heart, your pride.

I will understand, because I have been there. I have experienced the pain of a losing trade, the exhilaration of a winning one, the grind of following your plan when the markets are not co-operating, and the pleasure of hope for a brighter future.

What you need is practical support. Here is how to survive and thrive right now.

1. Set stops carefully

The golden rule of trading is “Keep your losses small and let your profits run”. Stop-losses  (a pre-determined price at which you sell, to limit losses) tell you to exit your position, as the trade is no longer co-operating with your initial view. Every successful trader has premeditated the point of exit, prior to entering the trade.

There are several methods available to set a stop-loss.

  • Pattern-based stops are very popular. When the share is no longer trending upwards, exit your position. An appropriate exit can be made if the share price closes below a trendline or below a support/resistance line.
  • Volatility-based stops imply that you should exit your position when the volatility of the instrument increases dramatically, or beyond a pre-defined level. Volatility is a measure of movement, not a measure of direction. Shares can be heading in an overall direction upwards, or downwards, but this general direction is characterised by dramatic peak-to-trough drawdowns. This is typically characteristic of the current market.
  • Use an indicator called Average True Range (ATR). A simple definition of ATR is the move in cents that a share could reasonably be expected to make during a particular period. On a daily chart it shows how much the share price is likely to go up or down in a day. It typically shows a figure compiled from the last 15 to 20 days of price activity. You may choose to exit if the share moves by greater than a multiple of three or four times ATR. For example, with a 10-cent ATR, a drop in share price of 30 cents would suggest you should exit your long position.

During volatile periods, set a wider stop-loss, otherwise you will exit your position only to see the share continue in the expected direction, without your involvement.

You can use a hard-dollar stop for bought options. For example, when you have lost a maximum of 2 per cent of your allocated trading equity in any particular trade, exit that position immediately. You may decide to exit when your position has a drawdown of $1000, for example.

Alternatively, for a trailing stop, you could exit when the option has pulled back your equity $500 from the maximum profit peak that you had attained in that position at any time. This is an effective method of controlling your losses and letting your profits run. A wide initial stop, but a tighter trailing stop, tends to be the best strategy in the present market conditions.

Volatility and pattern-based systems tend to work well for short-selling, or trading shares. Hard-dollar stops are terrific for option positions.

2. Learn how to scan the markets

I was recently asked about scanning the market using software to help locate winning trades. A trader was wondering whether he should loosen up his search parameters as he couldn’t find any shares to buy that fitted his criterion. Obviously he was frustrated.

However, the goal of running a scan is to cut out the majority of trades that do not fit your trading rules.

Can you see the problem with applying more liberal searches during periods of volatility? By changing our trading system to supposedly more accurately reflect market conditions, sometimes we just end up kidding ourselves about the calibre of opportunity available.

If your trading system is telling you to buy shares, you should buy them. If your system is suggesting it would be more effective to sit on the sidelines and not trade because of insufficient opportunities in the market, ignore this advice at your own peril.

3. Use margin (borrowing) wisely

I recently had lunch with a trader who could be characterised as a bit of a “cowboy”. From the early conversation I knew that he had a problem. He excitedly explained a new online system he had discovered that allowed him to trade long and short, using minimal margin to open substantial positions.

“They only want to take 20 per cent margin from my account to open any position. That means I can leverage myself up to the hilt! I can open up as many positions as I want. My $100,000 will allow me to trade up to $500,000 worth of shares. I’m going to be rich.”

I decided to curb his enthusiasm, lest he couldn’t afford to pay for coffee the next time we met.

Too many traders decide to position-size based on the margin they are requested to deposit, instead of the total exposure of their position. Especially when you’re starting out, beware the dangers of leverage (borrowing to trade shares).

The current market chews up and spits out non-conservative traders with ruthless efficiency. Only use leverage when you have developed your skills as a trader. If you insist on doing otherwise, your career as a trader will be short-lived.

4. Limit contingent liability positions

Writing naked options involves collecting a small fixed premium, yet incurring a theoretically unlimited loss. This is the meaning of contingent liability. Written naked options can surprise novices with their effectiveness to deplete trading equity.

Many traders are attracted to this concept because the chances of success are high. Approximately 80 per cent of options are only traded once and never exercised. On the surface, this sounds like a great chance to make money. However, when you look at the risks involved, which contain contingent liability, this strategy should be left to sophisticated traders.

Trading during volatile times can multiply your rewards. Take advantage of this trading environment, but remember to use caution and common sense.

If you don’t yet have an effective written trading plan, get one. Those who trade without a written trading plan deserve to starve.

The game is on. The market is getting stronger and building up a head of steam, so upgrade your skills now and don’t be left behind. Nobody knows how long your ride will last, but I can tell you that without a trading plan your chances of survival are zero.

About the author

Louise Bedford (www.tradinggame.com.au) is a full-time private trader and author of several best-selling books, including The Secret of Candlestick Charting, Charting Secrets and Trading Secrets. A refresher on the basics of trading is available – a free five-part audio course called Trading Made Simple that you can download.

 

From ASX

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The views, opinions or recommendations of the author in this article are solely those of the author and do not in any way reflect the views, opinions, recommendations, of ASX Limited ABN 98 008 624 691 and its related bodies corporate ("ASX"). ASX makes no representation or warranty with respect to the accuracy, completeness or currency of the content. The content is for educational purposes only and does not constitute financial advice. Independent advice should be obtained from an Australian financial services licensee before making investment decisions. To the extent permitted by law, ASX excludes all liability for any loss or damage arising in any way including by way of negligence.

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