As a trend trader, it is likely that 20% of your trades will result in 80% of your profits so focus on riding winners and cutting losers. Learn to implement a proper position sizing methodology to your trading, ensuring that you can withstand a string of consecutive losses without going bust. A lot of people are going bust in many aspects of their lives because they are not focusing on the 20% that matters most. Forget the useless 80%, it’s bringing you down. Less is more, a popular aphorism coined by the famous architect , Ludwig Mies van der Rohe, is something I truly believe in.

It’s times like these when trend traders grow impatient and fail to cut losers and then impatiently take profits too soon (most likely shorts in early 2009). It doesn’t matter if you have multiple losing trades over the past several months as long as your overall risk on each trade is less than 2%. The Pareto Principle will even out your results in due time, assuming you have developed a known expectancy on your system and employ risk management (position sizing).

You may have an expectancy of 40% winning trades but I can almost guarantee that 80%-90% of your year-end profits come from 10%-20% of your successful trades. For example, you may have 4 winning trades out of every 10 but only 2 of those trades will supply you with at least 80% of your profits. The other two winners will be minimal or cancelled-out by commissions, slippage and taxes.

On the other hand, it’s probably likely that 90% of your losses will result from 10% of your trades because you ignored sell rules, threw good money after bad or had stops jumped. One or two in ten trades will be the culprit(s) for bringing on the most damage to your portfolio. The other losing trades will be minimal and cut quickly as you realize that they are not working out as expected.

So what is the Pareto Principle?
“The Pareto principle (also known as the 80-20 rule, the law of the vital few and the principle of factor sparsity) states that, for many events, roughly 80% of the effects come from 20% of the causes.

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The secret to winning big in the market is not to be right all the time but to lose the least amount of money possible when you are wrong. As long as you win larger than you lose, you will be a profitable trader at the end of each year. Pride, ego and stubbornness prevents a trader from reaching the levels that very few can master.

To become a profitable trader, you must:

• 1. Manage Risk: Learn to trade a manageable portion of you portfolio (I recommend to risk less than 2% of you overall portfolio equity on each trade). Always establish a risk/reward ratio before making a trade. Without the ratio, how do you know your risk?
• 2. Understand Position Sizing: All traders must learn to know “how much” to trade on each position. Do not overtrade or you will runt he risk of ruin. Position sizing is rule number one of managing risk.
• 3. Cut Losses: Do not allow losses to run wild. You must learn to cut losses and understand that losses are a part of the game, a large part of the game. Check you ego of winning at the door. We are here to make money, not go undefeated. Play sports if you want to keep score with a record rather than your bankroll.
• 4. Learn when to Sell: You must learn when to sell. Selling is more important than buying as it ties directly to risk management. Use stops if you haven’t yet developed the discipline to get out at your predetermined stop or profit goal.
• 5. Average up in Price: I will never hesitate to add shares in a stock that is moving higher (see Mastercard) but I always avoid averaging down. Remember, cut losses and never throw good money after bad because we know that’s a quick way to the poorhouse.
• 6. Have Patience: It takes years to master trading as an advanced skill; even then, you are never done learning or adapting.
• 7. Buy 52-week Highs, not 52-Week Lows: Don’t be afraid to buy stocks making new highs. The garbage sits at the bottom of the market along with poor earnings, weakness and further downward pressure. Buy strength and the momentum moving higher. Stocks are typically priced at the levels they trade for good reason. This applies to most premium items in life.
• 8. Ignore the Talking Heads: Do not listen to the stories, gossip and rumors flying around on network television, stock forums or the major financial newspapers. It a surefire route to bad information and clueless advice. Do your own research; you’ll come out much further ahead. This applies to crappy blogs and internet sites as well.
• 9. Understand Technical Analysis: Fundamental analysis is a solid part of my trading system but technical analysis brings in the dough. You must learn, understand and use technical analysis on a daily basis. Fundamental analysis tells me what and technical analysis tells me when, where and how.
• 10. Control Emotions: Enough said – You must control your emotions or the game is over! Understand you!

I have been hearing a lot about trading systems failing or not working properly over the past few months and it makes me smirk every time. A recent article in SFO Magazine states that traditional technical analysis no longer applies due to program trading or computer algorithms making the trades. The author claims that computers don’t have emotions, therefore they don’t buy based on patterns or make decisions the way a human would. He specifically states that moving averages are now useless. Really? I guess I am screwed. Maybe this has some merit but I don’t buy in to it completely.

Traders and investors always seem to blame their systems and/ or indicators for poor performance when 99% of the time they should be looking in the mirror. They need to look in-between the ears to locate the problem. As I have explained in the past, the system is not the Holy Grail of Trading. I wrote a post last year that was missed by many since it was written shortly after the fourth of July holiday. Now seems to be the time to discuss this topic, more so than last summer.

• What do you think?
• What is your Holy Grail of Trading?
• Has your system stopped working or have you disconnected with the changing market environment?

Original Post:
Do you have a wonderful trading system, one that consistently makes you money? You probably believe that you have found your holy grail but this couldn’t be further from the truth. Your system has very little to do with consistent profitability in the markets.

I often here amateur investors talk about that the “best way” or “only way” to invest and argue why their way is better than everyone else’s. The passion and energy exuded by these novice investors is wonderful but they are missing the point completely. No one can say that options are better than stocks, commodities are better than options or forex is better than everything, etc… Each investor develops a system that is suited to their own personal character traits and they use a vehicle (stocks, options, forex, commodities, real estate, etc…) that can help them reach their goals.

Investors also debate systems within a market such as: trend trading, swing trading, scalping, shorting, day trading, buy and hold, fundamental trading, technical trading, Elliot wave theory, moving average crossovers, etc… They all work if the “person” understands the holy grail of trading. And that is being able to understand YOU and how your mind works.

However, it is not the system that makes one successful. It is YOU that makes the system work properly. What do I mean? Each individual must master their own personal psychological impacts on their trading results. You must work on YOU to become consistently successful! I recommend reading The Disciplined Trader by Mark Douglas if you would like to understand the psychological trader in you.

To say that one system or vehicle is the “way to go” is ignorant.

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I went back and tried to pick out the best 20 posts that new readers can start with when coming to this website. I will be permanently placing them at the top right sidebar.

Top 20 chrisperruna.com Posts

• Listen to My Audio Interview
• My Interview at StockTickr
• Position Sizing and Expectancy
• The Holy Grail of Trading: It’s not your System
• How to Create a Successful Stock Watch List
• My CANSLIM Screening and Buying Strategy
• Fundamental Screens and Scans
• CAN SLIM Breakdown
• Understand the ‘M’ in CANSLIM
• Paper Trading: Nothing to Lose, Nothing to Learn
• Focus on Decisions, Not Outcomes
• Could you Trade Full Time?
• Position Size to Determine How Many Shares to Buy
• Trading Mistakes: Avoid at all Costs
• How to Calculate a Stock’s Pivot Point
• Do Not use Fundamental Analysis Alone!
• How to Short a Stock
• Learn to Focus when Investing
• Markets are not Efficient
• Point and Figure Charts

Let me know if I am missed an article that you believe should be on this list.

Let’s say (hypothetical): The market is trending higher. You find a stock to buy. You setup the proper risk-to-reward scenario.

So, how do you determine how many shares to buy?

Let’s setup a few hypothetical scenarios with three investors trading different size accounts.

• Trader A has an account with $100,000
• Trader B has an account with $50,000
• Trader C has an account with $10,000

This exercise will teach novice investors how to properly position size their trades, preventing you from blowing-up your account or risking too much on one position.

These examples will buy the same stock (XYZ in this case) but we will do so with different stops based on different trade setups: 5%, 10% and 15% sell stop. The positions will also be placed in three different accounts. My free excel position sizing spreadsheet is the only tool I am using to determine the size of each position based on the entry price, sell stop (risk) and size of the account.

The number of shares change but the risk stays the same! Let me say that again, the number of shares change but the risk stays the same for all three traders.

Please note that these examples don’t consider other variables such as commissions, slippage, etc. Please read the book by Van K. Tharp to study the detailed models of position sizing. I will also like to note that it is very difficult to employ position sizing strategies with accounts smaller than $10,000 (even this is a small amount and can blow-out if not traded carefully).

Total risk of the accounts will be 2% in each scenario!

Trader A ($100,000 account)
Example #1:
Stock XYZ is trading at $60 per share
Portfolio size of $100,000
The stop loss is 5%
Risk will be $2,000 = ($100,000*2%)
Amount to Trade at 5% stop: $40,000 = ($2,000 / 5%)
Shares to be bought: 667

Example #2:
Stock XYZ is trading at $60 per share
Portfolio size of $100,000
The stop loss is 10%
Risk will be $2,000 = ($100,000*2%)
Amount to Trade at 10% stop: $20,000 = ($2,000 / 10%)
Shares to be bought: 333

Example #3:
Stock XYZ is trading at $60 per share
Portfolio size of $100,000
The stop loss is 15%
Risk will be $2,000 = ($100,000*2%)
Amount to Trade at 15% stop: $13,334 = ($2,000 / 15%)
Shares to be bought: 222

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