This is a GUEST POST by Steve LeMoine @Turtle_Follower
One of the biggest steps I took in becoming a more robust trader was learning how to deal with uncertainty. I wrote a post about something I call the Uncertainty Principle which I urge you to check out…after reading this post of course. In a nutshell it talks about how trading is everything but logical and the same trade on a different day can react completely different. As traders we know first hand exactly how this works and it can lead us down the path for that elusive Holy Grail…the perfect trading strategy, which in time will prove to be a fruitless adventure.
In my time as a young trader, I took the very same adventure which lead me to something that does help in dealing with the uncertainty. It is by no means a Holy Grail but just a small technique that uses that very same uncertainty to my advantage.
Traders…please meet the Portfolio Technique…your new best friend.
Sounds like a load of BS right? Well, I am here to tell you that some of the best traders use this strategy without even knowing it.
Knowing that the outcome of all trades is uncertain, the Portfolio Technique takes advantage of this uncertainty by putting on as many trades as possible so we are almost guaranteed to be in a couple nice winners. The key is to keep the risk for each trade on the smaller side so the losers do not outweigh the winners.
Option traders do this very often…
If you watch Rachel Fox on Tastytrade you have most likely heard the phrase “trade small…trade often”. This is an option traders Holy Grail because the probabilities of the trades they are deploying for any given strategy require as many instances as possible. The more instances, the closer their strategy reaches the intended probability of profit.
I like to think it works the same with stock trading. On any given trade my best chance for profit is around 50% but if I continue using a strategy that has proven over time to be more effective and continue to trade a large number of these trades I can gradually skew those percentages in my favor.
Now that we know what the Portfolio Technique is, the next question I’m sure you all have is how to deploy it. Here are five keys to making the Portfolio Technique work for you.
Trade Small – This is at No. 1 for a reason…it’s very important. You are going to have losers and since we are putting on so many trades we need to make sure the losers are contained. Trading small is the best way to keep losses in check. I typically risk anywhere from .50% to .75% of my portfolio value on any trade. That means my positions are very small. This allows me to let the trade play out by giving it the room it needs.
No Room for Favorites – Each and every position is just a means to an end. That means each one needs to be put on just like the last and managed just like the last. Just because it’s Disney or Apple doesn’t mean it gets any special treatment. If your stop is hit, take the exit and move on to your next trade.
Take Every Trade – This may seem counter intuitive but the more trades you have on the more likely you can start skewing the probabilities in your favor. We never know which trade is going to be the big winner so if it sets up and triggers an entry, take the trade. Your risk is small so the worst that happens is you get stopped out for a small loss. This also means there may be times where logically, the trade doesn’t seem like it will work, don’t think, just take the trade.
Swing Both Ways – If possible, try to take trades in both directions. You may find times where your longs outweigh your shorts or vice versa but as the markets ebb and flow your positions will be able to follow the market. For instance, over the last few weeks my personal portfolio was predominantly long and the shorts I was putting on were getting stopped out for losses. As the market started to turn, my process quickly exited those long trades for profits and started adding short trades for what was a quick move down in the markets. If you can let your portfolio be as dynamic as the markets, you can make money in both directions
Stick to the Plan – Ultimately there are going to be times where nothing seems to be working. Longs are going down, shorts are going up and the whole world seems upside-down. Don’t get discouraged. This is where novice trades start tweaking their process to find the Holy Grail we spoke about above. Each and every system goes through periods of under performance but if you are trading a proven system at some point it will come back in favor. You just need to keep your money in these periods so you can continue trading when your time comes.
If you can manage your process and follow these keys to following the Portfolio Technique you can liberate yourself from caring about what the markets do. Instead you can just follow your winners to profitability.
Here are my actual trading results over the last six months:
Notice how I had one or two great months with the rest somewhere around even. That’s all it takes to significantly grow your accounts. Keep losers small and let winners run as long as they possibly can. When they stop running, cut them mercilessly and move on to new trades.