When trading with a small account, you are restricted to trading a single position in any market at least, if you want to have any chance of preserving your capital.
Let me show you what I mean. Let's say you have a £4,000 account and you want to trade theDow Jones Index. Using the 3% rule, your maximum risk on a £1 bet is £120, and on a £2 bet it is £60 (60 points).
In the latter case, 60 points is equivalent to a move from 10,200 to 10,260. In today's volatile market, 60 points is nothing more than noise. You are very likely to get stopped out using such a stop, and so end up with an almost-guaranteed loss remember 6 May, when the Dow fell by almost 1,000 points in less than an hour?
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So in order to prudently trade at £2 a point in the Dow, you would really need a larger account than £4,000. But let's say you have such an account and are able to trade at £2 a point. What strategy could you use to best effect? I have a few ideas
The dangers of pyramiding
In older trading textbooks, reference is often made to 'pyramiding' positions. That refers to building a base position of, say, four units. Then, as the market moves your way and you are in profit, you add three units, making a total of seven units held.
Then, as the market moves even further your way, you add two units, making nine in total.
Then, as the market moves even more in your favour, you add the final unit, making ten units in total all in the shape of a pyramid.
You then ride your ten units to the moon and sell out near the top.
I think we all know in practice that things do not ever go according to that plan. For example, unless you were trading gold from late July to September, where dips were very minor, then even a moderate dip would give you a big loss on ten units, wiping out all your gains and maybe your account with it.
Most markets have major ups and downs over fairly short time-frames, thereby killing the idea of pyramiding.
A better, safer way to make money
Since I believe the most secure trading gains are made by trading the intermediate swings, I have a strategy for capturing most of the gains in a swing, and also allowing any further gains to be captured as well.
The reason I like trading swings is that you don't need to ride out intervening large drops in your gains.
It is a relatively quick 'hit-and-run' style, which mostspread betters seem to favour.
But, of course, the really big money is made by riding a long trend most of the way what a dilemma!
So how can you get the best of both worlds? My strategy is quite simple. Here's an example. After researching the Dow in July, I concluded that a long trade was indicated (see my earlier blogs for the various tools I use to find a promising trade).
On 7 July, I went long £2 a point at 9,850. The £2 bet I am treating as two separate £1 bets.
The first £1 bet I will use as a short-term trade, and hopefully use the other as a longer-term trade, which offers greater profit potential.
7 July Long £2 rolling Dow @ 9,850.
Stop @ 9710.
As the market rallied strongly thereafter, I quickly moved my protective stop on both bets to break-even using my break-even rule.
As the Dow advanced quickly to the 10,400 region, I noted that that level was an important Fibonacci retrace area, and the market would likely stall.
That would be a great place to take profit on my first £1 bet.
15 July Sold £1 Dow @ 10,315
Because that was a great profit, I decided to let the other £1 ride, keeping my stop at break-even. At worst, it would go out at break-even, giving an overall profit of £465. If the market went my way, I could make even more profit on the second bet.
And so it turned out. The market dipped, then rallied into a third Elliott wave (as you'll be able to see on the chart above, this third wave peaked in early August). I decided to move my trailing stop to just under the minor lows in turn first on 30 July, then 6 August, and finally to the 10,500 level on 10 August. I was stopped out the very next day for the very nice result:
11 August Sold £1 Dow @ 10,500
Total profit £1,115 on risk of £280
If I had simply been trading the £1 bet alone, the profit would have been £465.
All of this happened over a month or so, which is around the optimum time period for swing trading these very volatile markets. Of course, markets may turn back to being trending markets, but there really is no way I have discovered to signal this ahead of time only in retrospect can you know if a market is trending.
It's a better bet to trade the swings and let part of your position loose, if you wish, to sniff out any possible trends that may develop.
John is is a British-born lapsed PhD physicist, who previously worked for Nasa on the Mars exploration team. He is a former commodity trading advisor with the US Commodities Futures Trading Commission, and worked in a boutique futures house in California in the 1980s.
He was a partner in one of the first futures newsletter advisory services, based in Washington DC, specialising in pork bellies and currencies. John is primarily a chart-reading trader, having cut his trading teeth in the days before PCs.
As well as his work in the financial world, he has launched, run and sold several 'real' businesses producing 'real' products.
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