Episode 12: Finale

In this episode I'll talk about how we bring these additional elements together, and then we'll consider the subject of trading for income.

Transcript: 

'Successful Trading' - Episode 12: Finale

Presented by Jeff Bryant, HomeTrader.

Hello – and welcome to Episode 12, the final in our series on successful trading.

In the last two episodes, we reviewed some of the more advanced aspects of trading - short selling, and using CFDs - as well as different styles of trading: Mean Reversion and Rotational. In this episode I’ll talk about how we bring these additional elements together, and then we’ll consider the subject of trading for income.     

Firstly, let’s look at how we can combine the different aspects we’ve talked about. Let’s say we start off with $20,000 trading a Trend Following system on the long side of the market - using CFD’s. We will be leveraged, but we will NOT be using all the leverage available. This means we will have what we call Free Equity.     

Next, we decide we want to take advantage of the opportunities available to us on the short side of the market.  We put another set of rules in place. But, do we need to put more money in our account? The answer is no. These 2 sets of rules will come into play at different times, depending on the direction of the market. While there may be some overlap where we hold positions in both directions, such instances will be rare. So we can use the original $20,000 for both systems.     

Provided we don’t take on the expectation of additional drawdown, the profits from our trading on the short side of the market become a pure bonus! Then along comes Mean Reversion trading, very short term, not trading too frequently - it doesn’t need (on average over time) a lot of cash. In fact it can be traded, both long and short, from the free equity we have available from our trend following systems above.

This table might help clarify this concept for you. We start with $20000 for example, trading trend following, on the long side, using CFDs.  We can add a bear market system without needed extra cash.  One float, one style of trading, 2 sets of rules. Since we will have free equity at this point, we can add Mean Reversion - both long and short, without the need to add more cash.

Now, there may be the odd occasion where some additional capital may be required, albeit only briefly, so having a reserve somewhere that can be accessed in the short-term is a good idea. The result of being able to combine these sets of rules, is what we call, hardly surprisingly, the Grid.

Let’s look at an example of this at work. Here we can see the profit curves for the testing for 4 different sets of rules - Trend following CFDs on the long side; Trend following CFDs on the short side; Mean reversion long; and Mean reversion short. As you would expect, they are all quite different, reflecting different activity in a variety of markets. But when we put them all together, we not only see a higher profit  without greater drawdowns, we see a much smoother curve.

That is my cue to move on to the next part of this episode - Trading for Income. Invariably the ultimate objective of trading is to use it to generate income - either as a supplement, or to become financially independent from it - to have it as your primary, or sole source of income.

The smoother profit curve I showed just before resulting from the grid is important because as a full income trader, you want to reduce the length of your drawdowns. Trading a grid means that when one part of it goes into drawdown, you are looking for one or more of the others to kick in and either offset it or simply get you out of it earlier. The grid is one way of doing this. Another is to diversify your trading. You will Obviously look at trading both sides of the market, long and short, but you would want a variety of styles of trading as well. You might also include rotational trading, again, long and short. You could even consider hedging.     

Another consideration for income trading is to set up a buffer that might represent, say, a year’s worth of costs. You can set this aside and not let it be affected by any drawdowns - it’s just for the basic living expenses. Before you make the decision to sack your boss however, you need to consider the two key variables. Decide on, the level of income, on average, over time, you need. Then decide, given your risk profile, the rate of return you would be comfortable trading towards.

Let’s say for example that the objective, average-over-time annual income for you would be $40000. At 20% per annum, you’d need a trading float of $200,000. At 40% per annum, you would need a float of only $100,000. BUT, and yes, it is a BIG ‘but’ - the fluctuations at this sort of level will be greater, and could be simply too much to tolerate.

This brings me to the final words on trading for income or in fact, just trading itself: Be conservative! If you are not yet sure where your tolerance for risk really lies, take the lower number. If you think you know where your tolerance for risk lies, take a lower number. When you know where your tolerance for risk lies, give yourself a buffer.  Caution is King!

On that note, we conclude this series on successful trading.  To those of you who are new to the market, there is a lot to think about.  But regardless of where you might go from here, make sure you see actual results. Not theoretical, not hypothetical, but real trading results. Don’t take anyone’s word for anything. Ask for the contract notes, get the proof.

If you are like many who have found that there is more to it than you thought - well done. That in itself is a big step forward. You can’t get all this from books, websites or the odd seminar.

At HomeTrader, we teach people how to pull it all together, creating strategies that can traded with confidence.

If you’d like further information, visit our website at hometrader.com.au, and book into one of our free, 2-hour information sessions.