March 29 - Portfolio Control

Whenever someone hears of my trading the first question they ask is..... "what's a good stock for me to trade?"

A lot of people see trading as the buying and selling of stocks; pick the right stock and you make money. In fact there is much more involved... so much more!

Picking the right stock/option/commodity to trade is not even half the battle. Aside from the main buying and selling side of trading, there is another part..... not as sexy as the thrill of buying and selling and seeing the profit appear in your account, but this hidden side of trading makes sure that your account doesn't get out of control and that the money stays in your account.

This other hidden side is the portfolio control. It consists of many things, one of which is position sizing. This means if you have $100k in your account, you don't put $70k into a Google trade just because you think it will go your way. The risk on any trade should be in the range of 1-3% of your total account. This assures that if the market should go against you, and the trade ends up in a loss it does not put a big dent in your account (or ego) and you can go on again.

Based on this risk limit, you can size your positions. There are many different ways to calculate position sizing. I will discuss one here. The formula for the number of shares you want to buy is:

# of shares = risk $ / (swing price average/2)

, where,

# of shares - is rounded down to nearest 100 shares

risk $ - is your amount of cash at risk (for a 3% risk in a $100k account, this is $3,000)

swing price average - is the approximate swing in price you expect from the stock

The swing price average depends on what kind of trader you are and what kind of trade you're taking, if you plan to close out position within the day, the week, or possible hold for a long trade.

Let's say that you want to go long on AAPL, and let's also say that this is not a day trade and you've spotted a longer term-trade that you expect to work out in the range of a couple of weeks. To determine the average daily swing that you should think about, you want to calculate the 2-week or 14-day Average True Range of that stock. Stockcharts calculates and plots this for you.

The 14-day ATR is around $4, which indicates an average daily movement of $4/day. The ATR is not constant, it chances as the daily prices become more or less volatile. You can see that back in early February the range was as $6. During the volatile days of 2008/09 this range had gone up to $15/day. But it is a good measure of recent prices changes.

1

Based on this information, a good position size would be:

size = $3000 / ($4 * 2) = 375

since we don't want to buy in odd lots, we round this down to 300 shares. This ensures that your position can endure the ups and downs associated with normal daily volatility within this stock and you don't hit your risk limit prematurely. Be careful of news heavy days, for a short-term position the ATR may not be a good judge of what a price swing may look like on a news heavy day.... for example AAPL could move way more than $4 on a news heavy day like earning release day.

More on portfolio control to come....

March 25 - BIDU BIDU BIDU

Wow, this is just incredible. BIDU is up almost 6 fold since its bottom early 2009 at around $100. The long-term weekly chart is shown here:

This has gone from a buy to crazy panic buying frenzy! I don't like how fast it's going up, it's unsustainable!

I'm looking for downside here, but I can't tell when the downturn will begin and that makes buying puts a little harder. One thing is for sure that once this bubble bursts (in the short-term) there will be down side, and it will come fast! Below is the daily chart:

I'm going to start selling calls here for JUN 800 level. Today I sold some for $4.00/share or $400 per contract. I expect that this stock may climb more as more bad news about Google's battle with the Chinese Government hits the wires. So I expect to sell more calls at a higher level.

I expect that the uptrend will break to the downside with the slightest favorable news for Google. More on this soon...

March 22 - USD.CAD Closing Trade

This morning I am closing the USD.CAD trade almost at 1.0240 at a small loss. The break below the recent supports shows me that this trade is not working anymore the way I originally intended it to. An easy break of the support makes it easy for it to be broken again and shows that there is no longer a hard support there at around 1.0200. Here is as the chart looks right now:

March 19 - BIDU Trade Setup

BIDU, the Chinese search engine, has been benefiting much from the rumors that Google may close operations in China. According to an analysts estimates, this means 30% more business for BIDU which is certainly sizable. On all this BIDU's price has increased dramatically. Let's look at the one year plot on a daily chart with trend lines. I've also plotted volume and option volume for puts and calls. We can see the spikes in option volume.



The channel is visible and the break-out above it. Good rumors always drive up a stock's price, but the news release may disappoint. I don't think Google will just leave all operations in China and deprive itself of huge revenues associated with the Chinese operation, but then again.... This is Google! Will they put morals before revenues? We will see on Monday!

For now I see a huge run-up in BIDU and am thinking about a short position incase the news isn't as good as expected. I will obviously never short the stock as the risk is HUGE! I'm looking to buy puts for limited down side exposure. I've put in a bid for the JUN 340 puts for $1.35/share. If BIDU should skyrocket from Monday's news I will lose my premium which is $135 for every contract, the price of the contract will look as the plot below, depending on the price of the underlying (BIDU stock):


The returns are exponential if the prediction is correct. If BIDU should continue to go up then the price of the contract will move towards zero. I should mention that I do not wish to hold these until June, this is a leverage play. If BIDU goes down fast, the options will increase quickly and I can sell at a high premium (as seen in the plot). I don't expect that the stock price will go to $340. But anything below $500 will get a nice return.

March 19 - GOOG and USD.CAD Follow-up

The Google trade is still on and I'm still short the JUN 450 puts. The price on these contracts have been stable around the $3.50 - $4.50 range - the erosion in the time value of the contracts has been balanced by the added volatility coming from the decision on whether Google will close its operations in China. I may look to close the position here to lock in profits as the decision of Google will come out Monday.

The USD.CAD trade has gone against me so far, with the ratio around 1.01 this morning. If there is a bounce towards the 1.02 area I may look to close the position at break-even. Watching this closely.

March 16 - Life and Trading Lessons from BLACKBERRY POKER!!!!!

This post might seem a little "out there" at first, but read on, there is a serious lesson about life and trading in here!

The Game:
I've been playing around with the poker app on my blackberry and recently I've been playing it more often - whenever I have some time to waste; on the subway, waiting at the doctors office, etc.
For those not familiar with the poker app, it's just a computerized no-limit texas holdem poker with 5 players where you start the app with $500 in the bank and play others with the same amount in their starting bankroll. If you keep winning and taking other people's money then you keep going to the higher stakes tables where the blinds go up and people have more money. If at any point lose all your money or go "all-in" and lose then you're OUT! You must restart the game and start with $500 again playing people with the same bankroll.

I should also mention that as other people go all in and lose, they are replaced with new players with a starting bankroll; so the money staying at the table keeps growing.

The Pattern:
At first you keep betting, you may win a couple of hands and lose a couple, but almost everyone has the same amount of money and if you go ALL-IN on a perceived good hand and someone is better then you lose everything and must start again. So you can imagine that at the beginning you will be OUT many times and must start over before building a big enough bankroll which is significantly higher than the other player. This way you can go ALL-IN more often and take bigger risks because even if you lose the hand you have enough to keep going.

Eventually after having gone bankrupt and having to restart I built a huge bank roll...... about $1 million!!! At this point, I dominate. Even if I'm not playing well and lose many hands I can recover by winning big on one large hand and keep going and eventually through enough hands I bankrupt all the other players and win with a massive bankroll.

The Trading Lesson - Capital is King
The dynamics of the game were very different when I had just $500 and to when I had $1 million. This is directly analogous to trading, if you start under capitalized you cannot take risks, and without risk there is no major return. But if you take major risks you may lose all your capital upfront and go bankrupt. But unlike blackberry poker, starting up again may not be so easy as it requires more hard-earned money, not to mention that the discouragement from the last loss effects your decisions!

In the poker game I went bankrupt over 30 times and had to start again with $500 before getting big enough to take more risks and work my way to $1 million. BUT when I had the big bankroll, I didn't have to play as skillfully as I had before, and I could risk more, which ultimately led to more money. It is the same in trading! It is very discouraging at first, especially if you start with little capital. That is why my advice is NOT to start under-capitalized. With an under capitalized account, if you can't take risks. With risk comes return, but also possibility of loss and your account should be able to handle a big string of losses should it occur. That is why.... Capital is KING!!!

As a side thought, with $500 in your pocket would you sit at a poker table where there were 2 players with $1 million bankroll and 3 others with $5 million??? The trading game is the same as the poker table, but you cannot see the other plays or their chips!! Institutional players have virtually UNLIMITED funds compared to small retail accounts. The barriers to getting ahead are high!!! This is not to discourage you, but to shed some light on the situation so we can play smarter.


The Life Lesson - Why the Rich Get Richer
As I pondered the trading lesson, I noticed the bigger lesson in life... "Why do the rich get richer?" Well there are many reasons, but without getting into all of them I think the same principle is at work here. With bigger money comes the ability to take bigger risks. Many big investors make big mistakes but still come out on top.... Look at Donald Trump!! This is because enough capital is there to risk many times over and the losses don't put a big dent in their overall investment capital. Eventually the right risk will earn a return many times higher than the sum of all the previous losses.

With this I leave you with some food for thought
If you had $100k how would you play it? Safe? Risky? Diversified???
Think about this: if you had the chance to invest $10,000 into 10 securities that were risky and each independently could give you 10 times your money or zero. Would go with this? Or think of it as gambling and choose a mutual fund with gradual long-term minimal returns?

March 15 - AAPL Post Trade

Well that was a fast one... Capturing over a $4 move to the downside in a couple of hours was great, but it wouldn't have been so fast if it wasn't for general market weakness helping it along.

Even though I think that there is more potential downside here I realize that some news heavy days are ahead for AAPL. The release of the iPad on April 3rd and the anticipation and hype may drive up the prices again. And I don't want to be caught on a short position, if they announce stellar sales results pre-market and the stock skyrockets before opening bell.

So I have closed out the position at $220.89 today, for a total of $4.12 / share.

March 15 - AAPL Trade

Quick update here.... My Apple trade was taken this morning and a short position was initiated at $225.01 / share....

March 12 - AAPL Trade Watch

Hi Everyone.... here we go again with a local price bubble....
Many of you who have been reading my comments regularly know that I've been watching Google and Apple for a contrarian counter-trend trade as my thought was that they were over-bought. Over the past month, I pulled the trigger on Google by selling calls on Jan 7th. Soon after Google had a correction and is now in the stable stage. AAPL however, seems to be making new highs everyday.

I see a panic-buying pattern emerging here which as a contrarian short-term trader I want to play against. Below is the daily plot of AAPL with my trendlines:


The indications for local bubble are all here. AAPL is making new highs fast on lower volume, the 14 day RSI indicator is in over-bought position, and the MACD has started to tick down. Furthermore, for the past couple of days we've had small candle sticks at the top trading at a tight range.

I will look to short the stock or buy puts. Shorting will give me better mobility in and out of the stock should it turn against me. The reason I will short the stock or buy puts versus selling calls is because the potential for profits for selling calls is limited to the premium while the upside is virtually unknown; if the stock skyrockets, I'm on the hook as far up as it goes, similar to shorting the stock... so why not just short it and maximize potential profits.

March 9 - USD.CAD Trade Setup

Of the currency markets I've been looking at the USD/CAD patterns. Following the volatile swings of currencies in 2008 and early 2009, it has come into a calmer trading range. Below is a 1 year plot of the USD/CAD currency exchange:


In this recent trading range we have a resistance level at around 1.075 and support around the 1.025 level. With USD and CAD trading near parity, there are a lot of fundementalists who beleive that CAD is still undervalued to the USD and that it will once again trade higher than the USD - in the long run.

This, however, is not a blog dedicated to long-run fundementalists. Short-term swings are what I'm interested in!

With the tripple bottom pattern set up here at the support level, I look to enter into a trade long USD against CAD. I will enter into half my intended position today and look for further confirmation for the other half.

In this scenario, as with any breakout scenario, there may be a false breakout before coming the trends go back to their original patterns. A good trader will always keep that in mind when trading breakouts or against them. Here I am looking for price action to stay within the band and stay in range.

March 3 - Google Trade Followup

Following the Google trade posted on February 12, the stock has been range bound between $520 and $550. The 50 day simple moving average is trending down at around $565 while the 200 day moving average is up trending and currently around $505. The price is moving towards a squeeze by both the moving averages from above and below.

The RSI is rising from over-sold and crossing the 50 mark which is bullish (in the short-term). The action on this stock has settled and the volatility has decreased as the 14 day Average True Range (ATR) is now down to around $10.


On February 12th we put in a trade to sell an amount of naked puts on Google at $450 level for $9 premium/share ($900 per contract). As of today's close, these contracts are trading at around $4.00 / share. This creates a paper profit of $5/share or $500 per contract. These are still unrealized profits as I intend to hold on to the positions a while longer.

If the price breaks above the current channel I will keep the contracts longer so I can buy them back cheaper for more profit, if we break the lower support of the channel, I may re-assess the position depending on timing.

March 2 - Follower Mentality

Hi All... I saw this caricature depicting a simple truth in the markets and wanted to share it.... Enjoy!