This page is an archive page for several of Trader Mike’s (TraderMike.net) most widely read blog posts from 2004 and 2005 on day trading. TraderMike.net was originally launched in 2003 by Michael Seneadza. In January of 2011 the site was acquired by StockTrader.com.
With Mike being a Stanford University graduate and full time trader, he quickly grew tradermike.net into one of the most premier resources for independent traders. His stock market recaps and in depth analysis of the market was easy to understand, fresh, and spot on.
By mid 2006 the site was attracting tens of thousands of visitors and upwards of 200,000 pageviews each month. By mid 2007 though Mike was becoming busy in other facets and was not able to post as often. As the market crashed in 2008 and 2009 posting continued to decline. By 2010 posting was at a stand still.
In the fall of 2010 Blain Reinkensmeyer, a fellow blogger and original fan of the site, began discussions with Mike about transitioning the site to re-spark its original flames. By mid January 2011 a deal was struck and the site was sold to StockTrader.com.
Day Trading Thoughts
I’ve been exclusively day trading for almost three months now. The switch from swing trading has been quite an experience and I’ve had a few ‘light bulb’ moments along the way as you’ll see below.
The switch was definitely the right move for me to make. I think most people will probably be surprised to hear me say that day trading is much less stressful than holding stocks overnight. Mind you, I never ‘lost sleep’ because of my overnight holds but it’s a nice feeling to be able to start the morning in cash and not care what the market’s doing at the open. One of the things that sucked the most about swing trading was walking into a morning move against my positions. I’ve also taken advantage of being able to just shut things down for the day if the market’s not acting well. When I was swing trading I’d typically just sit there watching all day on days like that because I had some positions on.
One of the biggest changes for me was switching my commission structure to a ‘per share’ basis vs. the ‘per trade’ structure I was on previously. Now I’m paying $0.006/share instead of my old $9.95 per trade. That change impacts my trading in a couple of ways. First, it’s just much easier to break even (or even to make money). I could easily do $100 to $200/day in commissions with the $9.95/trade structure (that’s basically $20 round-trip on a stock) With my new commission structure those same trades could cost me well under $40 depending on the number of shares. The per share structure also allows me to scale in or out of positions without racking up even more commissions. So that’s made it even easier for me to take partial profits or to just cut & run if I see danger on the horizon.
One thing I’d like to note here is that I should have switched my commission structure back when I was still swing trading. My broker (CyberTrader) announced the per share structure last fall but I never looked into it because I knew that I didn’t trade enough shares to qualify for that plan. They require you to trade 40,000 shares per month or you have to pay a $250 fee. Back in April I did the math on my commissions for 2004 and I was shocked and appalled to learn that I would have come out far ahead on the other plan even if I’d paid the $250 penalty each month. So the lesson here is do the math and keep those costs down!
The main ‘light bulb’ moment(s) had to do with position sizing, risk management and buying power. I’ve already told you that I’m now using the percent risk model to size my positions. It made perfect sense to me when I read about it and even when I started using it in real live trading. But it wasn’t until a Google day trade that the light bulb really lit up for me. I remember when the SEC changed the margin requirements & rules for day traders several years ago. Part of the change was that day traders could have 4 times their equity as intraday buying power. I never understood why they gave people so much margin but even more than that, I couldn’t imagine who’d be foolish enough to use that much margin. Well now I try to be that fool as often as possible.
The thing that the Google trade taught me was that if I go after high-priced stocks I can put a lot of money to work. As long as I have a tight stop I can still risk X percent of my equity per trade. Here’s an example:
Let say there are two stocks that are setting up entries for me. One is $8/share (let’s call it ABC) and the other is $80/share (XYZ). For simplicity I’ll just say that I want to risk $200 per trade. So let’s say that the setup given by ABC dictates a 25 cent stop and the stop on XYZ is one dollar. In order to risk only $200 on each trade I can buy 800 shares of ABC and 200 shares of XYZ. That means that I have $6,400 worth of ABC and $16,000 worth of XYZ. Let’s assume that both stocks move 2% higher. So I’ve only made $128 with ABC but I’ve made $320 in XYZ. That’s 2.5 times the profit even though my risk was the same on both trades.
Hopefully you can see why I’m really trying to focus on high-priced stocks now. I’ve already had a few days in which I’ve used all of my intraday buying power on just a handful of trades. I would have never imagined myself doing that just a few months ago. Day trading allows me to use much more buying power compared with swing trading, yet my risk is actually much lower than it was when I was swing trading.
My decision to finally start keeping a detailed trading journal has been a huge help. (I guess I should also give credit to Getting Things Done (GTD) for convincing me that writing things down can be a good thing!) I went through June and most of July just breaking even. But I was noticing recurring problems in my journal that I’d work on correcting. One problem was me initiating positions when the major indices and other general market indicators were telling me to stay out. I remedied that by adding rules about market ‘tone’ to my trading plan. The biggest problem I had was getting out of winning trades too soon. I always like to push my stops up to break-even when I can but my journal was screaming at me that I was adjusting my stops too aggressively. I kept getting stopped out of stocks that would have been big winners for me. What I noticed was that those stocks would typically have strong moves in less than 30 minutes or so and I’d push my stop up only to get stopped out and then the stock would turn again. So I made a rule that I can’t touch my stops until at least 60 minutes after entry. It was one week after I made that change that I had my biggest day in years. And I haven’t had the ‘stopped out too soon’ problem since.
For those that want some numbers — My expectancy since June is 0.23R, where R is my initial dollars at risk per trade. I made that change to how I manage my stops on July 21st. Before that day my expectancy was 0.09R, since that date it is 0.40R. So I feel good about the positive (and increasing) expectancy and I’m working on getting that number higher. My win ratio is 45.05% right now. (Yes, you really can be wrong most of the time and still make money!) As for P&L, I’m up 19% since June. (Note that I’m not trading bigger as I make more money. I try to keep my equity level the same so if I drop below my initial equity level I’ll work to get back to even and if I’m above that initial level at the end of a week I’ll pull the excess money out of the account.) I should add that August has been a very slow month. I’ve had 8 days with no trades at all.
Finally, here are some books that I’ve found helpful in making this transition to day trading:
- Van K. Tharp’s “Financial Freedom Through Electronic Day Trading” — Don’t let the title of this book fool you! This book isn’t just for day traders, it has some great stuff about creating a business plan for trading as well as covering position sizing, expectancy, keeping a journal, etc.
- “Tools and Tactics for the Master DayTrader: Battle-Tested Techniques for Day, Swing, and Position Traders” — Tons of great info in this book. I’d actually flipped through this book years ago and didn’t think much of it. It was highly recommended it to me so I decided to give it a second chance. I’m glad I did.
- A couple of books to help me get my mind right 🙂 — Way of Warrior Trader and The Trading Athlete
- Mark Douglas’s “Trading in the Zone“. I try to listen to the CD at least three times a week to make sure my mind stays right. 🙂
Day Trading Concept: Expectancy
Expectancy along with position sizing are probably the two most important factors in trading/investing success. Sadly most people have never even heard of the concept. Out of the 30 or so trading books I’ve read only a few even touch on any aspect of money management. Only one of those handful of books discussed expectancy. In simple terms, expectancy is the average amount you can expect to win (or lose) per dollar at risk. Here’s the formula for expectancy:
Expectancy = (Probability of Win * Average Win) – (Probability of Loss * Average Loss)
As an example let’s say that a trader has a system that produces winning trades 30% of the time. That trader’s average winning trade nets 10% while losing trades lose 3%. So if he were trading $10,000 positions his expectancy would be:
(0.3 * $1,000) – (0.7 * $300) = $90
So even though that system produces losing trades 70% of the time the expectancy is still positive and thus the trader can make money over time. You can also see how you could have a system that produces winning trades the majority of the time but would have a negative expectancy if the average loss was larger than the average win:
(0.6 * $400) – (0.4 * $650) = -$20
In fact, you could come up with any number of scenarios that would give you a positive, or negative, expectancy. The interesting thing is that most of us would feel better with a system that produced more winning trades than losers. The vast majority of people would have a lot of trouble with the first system above because of our natural tendency to want to be right all of the time. Yet we can see just by those two examples that the percentage of winning trades is not the most important factor in building a system. As Dr. Van K. Tharp points out:
… your trading system should have a positive expectancy and you should understand what that means. The natural bias that most people have is to go for high probability systems with high reliability. We all are given this bias that you need to be right. We’re taught at school that 94 percent or better is an A and 70 or below is failure. Nothing below 70 is acceptable. Everyone is looking for high reliability entry systems, but its expectancy that is the key. And the real key to expectancy is how you get out of the markets not how you get in. How you take profits and how you get out of a bad position to protect your assets. The expectancy is really the amount you’ll make on the average per dollar risked. If you have a methodology that makes you 50 cents or better per dollar risked, that’s superb. Most people don’t. That means if you risk $1,000 that you’ll make on the average $500 for every trade – that’s averaging winners and losers together.
In ‘Trade Your Way to Financial Freedom‘ Dr. Tharp defines the following four components of expectancy (In the same section of the book Dr. Tharp also discusses how the size of you investing capital and your position-sizing model must be considered along with expectancy. I’ll talk about position sizing in another post, but I highly recommend reading Tharp’s book for a thorough understanding of these concepts.):
- Reliability, or what percentage of time you make money.
- The relative size of your profits compared with your losses.
- Your cost of making a trade. (commission & slippage)
- How often you get the opportunity to trade.
The fourth item in that list is a very important and often overlooked aspect of trading. If you had two systems that both had the same positive expectancy, let’s say $100, the system that produced more trades would make more money over time. For example, system A produces 3 trades per week while system B produces 10 trades per week. After just one week B would have made $1,000 while A would only have made $300. Gary B. Smith has discussed this before:
I think of my equity as inventory. In that respect, my goal is to maximize not profit per dollar, but profit per dollar per day. In essence, I try to make a small percentage on my equity each day, but compound that amount as rapidly as possible.
And in another article Gary said:
Q: What aspect of trading took you the longest to learn?
GBS: I’d say the view that my equity is the same as a retailer’s inventory. Your profit per piece doesn’t matter if you never turn your inventory. And your turnover doesn’t matter if you’re losing money on each sale. What matters is the turnover times profit per piece.
That’s the same concept I try to apply to my trading. I start with $1 and want to figure out how to quickly turn that into $10. Most people focus on buying a stock at $20 and selling it at $40, and they rarely care how long it takes them to do that.
However, if during that time I can buy 10 $20 stocks and sell them each at a 10% gain, I’m way ahead if I continue to compound my equity.
To touch on the importance of the size of your equity and position sizing I’ll use part of a snowball fight metaphor that Tharp uses in his book:
Imagine that you are hiding behind a large wall of snow. Someone is throwing snowballs at your wall, and your objective is to keep your wall as large as possible for maximum protection.
Thus, the metaphor immediately indicates that the size of the wall is a very significant variable. If the wall is too small, you couldn’t avoid getting hit. But if the wall is massive, then you are probably not going to get hit. The size of your initial equity is a little like the size of the wall. In fact, you might consider your starting capital to be a wall of money that protects you. The more money you have, assuming all the other variables (the components of expectancy listed above) are the same, the more protection you will have.
Now imagine that the person throwing snowballs at you has two different kinds of snowballs — white snowballs and black snowballs. White snowballs are a little like winning trades. They simply stick to the wall of snow and increase its size….
Imagine that black snowballs dissolve snow and make a hole in the wall equivalent to their size. You might think of black snowballs as “antisnow.” Thus, if a lot of black snowballs were thrown at the wall, it would soon disappear or at least have a lot of holes in it. Black snowballs are a lot like losing trades — they chip away at your wall of security…
Tharp continues walking the reader through different scenarios and possibilities. Like considering the relative sizes of the snowballs of each color. What happens to your wall after being hit by some black boulders of snow? Or considering how the rate at which snowballs are thrown affects the wall. You can see how important each aspect of expectancy is as well as the huge importance of both the amount of equity (the size of your wall) and position-sizing (which will determine the size of the snowballs).
Expectancy, position-sizing and other aspects of money management are far more important than discovering the holy grail entry system or indicator(s). Unfortunately entry techniques are where the vast majority of books and talking heads focus their attention. You could have the greatest stock picking system in the world but unless you take these money management issue into consideration you may not have any money left to trade the system. Having a system that gives you a positive expectancy should be in the forefront of your mind when putting together a trading plan.
- How to Setup a Profit Vs Loss Ratio
- Expectancy Versus Accuracy
- Profiting From Your Profit-Per-Day Calculation
- Good News for Bad Traders
- Losing To Win
Position sizing could very well be the most important aspect of a trading system, yet, like expectancy, it’s rarely covered in trading books. A position sizing model simply tells you ‘how much’ or ‘how big’ of a position to take. Position sizing can be the key factor in whether or not you stay in the game or whether your gains are huge or minimal.
Here are some position sizing resources:
- Van Tharp’s books are by far the best work I’ve seen on position sizing, expectancy and money management. I’ve read “Trade Your Way to Financial Freedom” and “Financial Freedom Through Electronic Day Trading” and recommend both highly.
- Money Management or Position Sizing or Bet Size… No Matter What You Call It, Better Know It
- Michael Taylor on his position sizing trials.
- Stephen Vita on his position sizing model.
- Jon Tait’s argument for trading many small positions. (I don’t necessarily agree with Jon’s conclusion but he covers some important topics in this post.)
- Position Sizing: Why Size Matters to All Investing Greats
- TradersCALM – Introduction to Position Sizing
- Position Sizing – The Most Powerful Investment Concept
- Size Really Does Matter! Position-Sizing Management Can Make a Difference Between Profit and Loss – (Free subscription required)
- T.I.P.S. – Trading is Position Sizing
- TradeStars’ position sizing calculator
- Dave Laplander’s position sizing calulators
My Position Sizing Spreadsheet
The other day Marcos asked where he could find a position sizing spreadsheet. I just uploaded mine in case anybody else wanted a copy. It’s nothing fancy at all and it’s based on the percent risk position sizing model. Just enter your account equity and the amount you want to risk per trade (expressed as a percentage, so 1% would be entered as 0.01) on row 2.
The way I use it is I enter the tickers and stop loss amounts (in cents) in columns A and B. The number of shares to trade will appear in column C (rounded off to the nearest 25 shares). Another way, which is probably better would be to have ‘enter’ and ‘exit’ columns which would then compute the stop thus eliminating any human error in figuring out the stop (which I do once in a while).
Alternatively, you could just use the spreadsheet as a simple table, listing various stop amounts and the corresponding number of shares.
There are links to other, online, position sizing calculators in my position sizing comments further up the page.