Every trader would love to enter only winning trades, right?
This isn't realistic, though. Stocks fluctuate for many reasons, often inexplicably. I have found over the years that the real challenge to trading success is sticking with losers and hoping that the trade turns around. They don't. Similarly, many traders don't stay with a trade long enough, slapping themselves on the back for a single that could have easily been a double, to use baseball talk.
While there are trading systems that seek to identify more winning trades than losers, with the hope that the net result is positive, my approach is different. Instead, I try to find situations where I think that the downside in the short-term is limited but the upside is 10% or so within two weeks, depending on the volatility of the stock.
When I structure a trade, which is designed to expire after two weeks and usually does so more quickly, I look for situations where I think that the up/down ratio is at least 4X. This is typically, then, trying to make 10% but risking 2.5%. The beauty of this philosophy is that that one can be wrong more often than right, but still do very well. Here is the math, based on trades that close right (10% gain) or badly (2.5% loss):
In this example, as long as the trades work just once every five times, we break even (before consideration of commissions). On the other hand, the two-week return is 1.7% if we are right only one out of every three times! 1.7% may not sound like a lot, but there are 26 two-week periods in a year. Just multiplying the 1.7% and not compounding it, this would be an annual return of 44.2%.
Now that I probably have your attention, it should be obvious to you that we don't expect to win more often than we lose. The reality is that when you control risk tightly, you will get stopped out a lot. We are able to win big when we do win, and we stick to our discipline at all times.
We are looking for short-term opportunities, willing to risk only a little and understanding that we may lose more often than we win, but the wins are so much bigger than the losses that they net result is a win where it counts - the wallet. We rely on both Technical Analysis and Fundamental Analysis to pick these trades, and we are always disciplined in how we manage them.
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