This Week’s Battle Plan

Well, it’s that time again. The Spring softball season started today.
My daughter was lucky enough to get picked last season by Coach Mike,
the man everyone in our community knows is the best coach around. You
may remember Coach Mike. His idea of a successful team is to not only
dominate every game, but he also wants to make sure that all the
fourth and fifth-grade girls on the team are tough enough to handle
Hell Week should they decide to become the first females in the Navy
Seals.

Tryouts were a few weeks ago and then we waited for the call to see
which of the eight teams she would be on. And son of a gun, when my
wife answered the phone, who was on the line? It was none other
than Coach Mike! He selected my daughter again for his team. I came to
the phone quite pleased about this and then Coach Mike told me what he
expected of his team this season. “It’s time to dig in” he
says. That Winter League stuff is just screwing around. The Spring
League is what really counts. It’s time to get serious!”

Now considering our team won every game but one in the Winter League
and finished first for the season, it’s hard to imagine he was just
“screwing around.” But here he is, telling me this. And I’m
excited. I’m not quite sure why I’m excited, but I am. His enthusiasm
is contagious. And then he drops the bomb on me…would I be
interested in being one of his assistant coaches? Imagine that, me
being one of Coach Mike’s assistant coaches!  I coached my
daughter’s basketball team a year ago. We won the city championship
(trust me, it had nothing to do with me…when you have the girl who
is the best player in the city on your team, even a dummy like me
can’t screw things up) and after we won the final game, I told myself
I was done coaching. No more. I would go out on top. But here I was,
being offered the chance to assist Coach Mike. It was like having
Patton ask you to fight with him, or Lombardi asking you to play for
him. I was honored. How could I possibly say no?

So yesterday found me out there for the first day of practice.
Two-and-a-half hours of non-stop drilling, Coach Mike style. It was
great! And I did well…very well. Coach Mike only yelled at me twice,
which was less than he yelled at the other assistant coach and the
players on the team. I’m really proud of myself!

Last week we talked about the importance of keeping account size
drawdowns to a minimum. This is not only important if you manage
money, but it is also important for your personal account. Losing 33%
of a portfolio value requires about a 50% increase to get back to
even. And doing 50% on your money is not the easiest thing in the
world to do. And with war in Iraq now looking to be imminent, and the
likelihood that volatility will increase, there are ways to lessen
your daily swings (and risk), while still giving yourself the
opportunity to make money.

We discussed that there are four strategies that lessen drawdowns and
volatility. They are:

1. Position size

2. Stop placement

3. Trading non-correlated markets

4. Adjusting for the daily volatility of the underlying security or
market you are trading

Let’s look at each one:

1. Position Size

Obviously, the more shares you trade, the greater the gain or loss
will be. And you can cut your daily account value movement in half
simply by cutting your share size in half. And, as obvious and simple
as this sounds, many traders do not take that into consideration. They
get in the habit of trading 1000 shares, no matter what the market
volatility is, the securities volatility is, or what the price is.
This makes no sense. Successfully trading 1000 shares today of a $20
stock will give you half the returns of trading a $40 dollar stock
with equal volatility. And, let’s look at this another way. If that
$40 stock sees its volatility double (because of the war or for any
reason), you will now be assuming four times as much risk as you were
by trading the same amount of shares of the $20 stock!

Here’s the solution. Look at the historical volatility of a stock (use
25 days). And look at the price of the stock. Start with a baseline.
If you are comfortable trading 1000 shares of a $20 stock with a
volatility of 30%, then trade 500 shares of the $40 stock that has the
same volatility. If the $40 stock has half the volatility of the $20
stock, then you can trade the equal amount of shares. You can do these
calculations all the time and they will tell you if you are assuming
greater risk in one stock versus another. And, by simply lowering your
share size, especially when you go in higher priced and/or higher
volatile stocks, you will lessen the amount of risk you are taking.

If you need help here, please email
on this.

2. Stop Placement

Adjusting stop placement will alter your profit profile. Some traders
keep their stops too tight. Some use none at all. If you want to
lessen your volatility, ask yourself if your stops are too far away or
too tight. There is no perfect rule for this. But, I’d rather keep
losses to a minimum by erring on the side of the stops being too
tight, especially with overnight positions, should war break out.

Look at what you are are buying or shorting. If you have stocks in the
same industry, your likely doubling or tripling your risk, not
reducing it. And, in the case with the three stocks I just mentioned,
why not just take one position,
(
SMH |
Quote |
Chart |
News |
PowerRating) for example. Your risk is
likely lessened (as will be your commissions).

4. Adjusting For Daily Volatility

We touched on this in number one, above. Volatility changes. I’ve
written about this a number of times. Go back to KLAC. The 25-day
volatility is nearly 1/2 today than it was in the fall! If you were
trading 1000 shares back then your risk was much higher than it is
today. And your profit potential is likely lower today than it was
back then. Simply by adjusting your position size, you can keep the
risk the same. And, should war breakout and volatility skyrockets, you
can adjust your position size immediately so you are not assuming any
further risk!

Lowering position size, adjusting your stop placement, trading
non-correlated markets and adjusting for daily volatility can all, by
themselves, lessen the risk you take every day and allow you to be in
the best position to take advantage of set-ups that have edges. And as
Nelson Freeburg said in his interview, combining strategies with an
edge, along with proper risk management, is what ultimately makes a
superior money manager and trader.

Again, if you need help here, please email
me.

Possible Gems

Just a quick reminder that Don Miller is doing a one-week live trading
seminar via the internet. If you’d like more information, click
here. Also, Derrick Hobbs’, Mark Boucher’s and Chris Tyler’s
interactive training modules are now live. If you’d like information
on all the modules that are available, click
here.

It looks like war will be here soon. If that happens, volatility will
likely increase. This is not necessarily bad. In fact, increased
volatility usually means more opportunities, especially for
professional traders. Just make sure you understand how to properly
position yourself, when these opportunities occur. If you do, you’ll
have a far greater chance of trading through what will hopefully be a
very short war.