Wednesday, June 21, 2006

How To Double Your Profits Trading The Same System

Most traders, quite understandably, concentrate more on getting their trades right than their stakes correct. After all, if you can't pick winning trades then the rest doesn't count for very much, does it?

However, if you ARE a winning trader, even if only occasionally, then the correct staking approach can turn loss into profit, and profit into real wealth. Before I start, however, it’s important to establish one thing right away. You will often read elsewhere that it doesn't matter how you stake or what method you use - winners will always make profits and losers won't.

Well, as someone who trades the markets every day I can say that the only people who write that kind of nonsense are those individuals who don't have to trade for a living, but who still feel the need to tell others about what they obviously don't understand. In fact, just like the psychology of trading, correct staking is a critical element in trading success, and I shall be covering it in detail in a series of articles following on this one. The correct staking approach can easily DOUBLE your normal profits (and I'll show you exactly how) and similar care taken over the handling of risk to your trading capital can maximize your profits even further, whilst avoiding the possibility of the dreaded ‘wipeout’.

The Trading Bank

The notion of the ‘Trading Bank’ is so misunderstood, or so ignored, by so many people, that it’s important to reiterate the point now.

First of all, you must put aside an amount of money just for trading. This sum does not vary because of the amount needed for the housekeeping, or holidays, or birthday presents. It is treated the same as if you had deposited the money 'in the bank', hence it’s name. The Trading Bank is your particular deposit account which will accumulate ‘interest’ (profits) through your own success.

As such it has to be considered an amount that you could lose in its entirety. The lot. Kaput! Gone for ever. If that hurt is just too much then reduce the amount until it reaches a sum that won't cause such pain.

It is also a sum that you don't dip into. It is not to be used for paying the housekeeping or the kid’s pocket money. Remember, this is a ‘deposit’ account, not a ‘current’ account, and there are costs associated with withdrawal - a loss of future earnings.

Trading Points

This series of articles will be all about money - buying it, selling it, etc. - but it’s actually very important that early on you stop thinking about it as the commodity you know and love.

Take a dive on $50,000 in a day then think about what you might have bought with that kind of money and you'll never step up to the plate the next day. Similarly if you make $50,000 profit - you'll be too busy out spending it to bother again with the nasty business of trading.

So, right from the start, it’s important to move your thinking from something tangible, like dollars, to something very intangible, like points.

How To Divide Your Bank Into Points

You can call them what you like - widgets, carrots, it doesn't matter - but the principle of calculating their real value always has to be the same. At its simplest, a point is a fixed percentage of your total trading capital. A 100 point bank, for example, comprises all of your money divided by 100, each 100th, or 1%, then being 1 point. Similarly a 1000 point bank is all of your money divided by 1000, each point then being worth 0.1% of your bank.

Points Make Profits

If you've taken on board the concept of dividing your trading bank into points the obvious question that should then arise is, "Well, how much do I divide the bank by?".

The snappy answer is to say, "It depends", but that doesn't get you anywhere. I'll be looking at specific situations later in the series but just to say for now that the divider is dependant upon the level of risk of the trading method you're using.

This is a concept that has been turned into a ‘holy grail’ of staking under the name of the Kelly system, but I know very few people, including the best traders, who truly understand how to use it. The simplest way of thinking about it is to say that the Bigger The Risk, the Bigger The Divider.

At its very simplest that means that a strategy that is twice as risky as another (i.e. half as successful) should be staked using points of half the value of the other.

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