Swing Trading CHAPTER 4. RISK MANAGEMENT, VOLATILITY AND CHOOSING THE RIGHT STOCKS

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Justina Hubbard
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1 Swing Trading CHAPTER 4. RISK MANAGEMENT, VOLATILITY AND CHOOSING THE RIGHT STOCKS

2 What is risk management and why does it matter? - Risk management is a two-step process where an investor 1) determines their risk exposure in an investment and 2) uses techniques to mitigate that risk in line with their investment objectives. We use risk management to avoid blowing up our portfolios and over leveraging ourselves in trades. This gives us the ability to keep our losses minimized and puts us in a position to capitalize on winning trades. What are some ways we can manage risk to our portfolio? - Never use more than 10-15% of your equity/portfolio in one trade (can add to strength if need be, also room to average down. Harder with small accounts.) - Avoid using margin when you can. Margin calls will RUIN you in a flash crash. - Defining and setting stop losses and profit targets. Avoid the deer in the headlight. ALWAYS have a plan - DO NOT micro manage your swing trade. Don t hover, don t wish and don t hope. Walk away from it, trust the chart/trend and your stops. Cutting losses is key, but letting winners run is just as important! If you hover or micro manage, you WILL screw it up. - Use Options when applicable. A good carpenter has multiple tools in his tool box. Why shouldn t a trader? - Risk/Reward ratio: Ideally, we want at least 1:2 when swing trading. We can accomplish this with limiting our trades to the best setups and furthermore when scaling in with size once we are in the drivers seat. Risk Management is something we practice everyday. We don t cross the street without using it. When you cross the street, you look both ways, make sure it s clear, and that the light is green, right? These are the steps we take to avoid being splattered on a bus windshield. As humans, we take risks to get rewards, we cross the street (risk) to get to the other side (reward). Why should trading be any different?

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5 How I manage risk - Personally, I like to scale into a trade going in my favor once I am in control. This minimizes my losses to a smaller starter position, should I be wrong about the trade, or the market suddenly moves against me. - Set a max loss for yourself in EVERY trade before entering. I have a max loss of $ in swing trades, depending on the strategy I am using and my conviction in the trade. - Scale into trades to avoid stopping out early (1k shares using a $1.00 stop on a 1.50 ATR stock isn t wise to start out a trade with, given my max loss of $1000. But taking 600 shares gives me that room to cover the 1.50 ATR and stay within the $1000 max loss) Know your ATR! This is a critical and very useful indicator for swing trading. - Stop placement: We know that half dollar and whole dollar levels hold a lot of stops. Algorithmic traders and big money traders know this too. Be flexible with your stops. Consider more random placements below these key levels. (Stop at $55.49 may be better off at $ This is most important with profit stops. As trades move up, they take breathers to consolidate. Don t get stopped out of a winner because you were playing it to tight with your stop. Only put your stop in an area that you WANT to be stopped at. - Scaling out of trades and taking profits is equally as important as scaling into trades. By not entering and exiting with full positions, we are able to maintain a lower net average throughout the trade, and therefore, remain in control of the trade as long as it moves in our favor. Use resistance/support levels to identify add spots and sell spots. - Use your broker or charting software to set alerts while you are gone. Technology is a trader s friend. There is no reason to miss an entry or exit notification.

6 SLF trade is a perfect example of scaling and using major moving average s/r to identify add spots and sell spots. Long at the EMA test, add on the breakout. Sell on the failure at the next EMA.

7 How to calculate position size to manage risk basic math Research previous history for events (earnings, news, etc.) to evaluate potential for moves Finding initial stops when entering a trade, finding add spots and using moving averages - Zoom the chart out, go BACK in time - 20, 50, 200 EMA - If buying into a trending stock, look for violations of previous days lows for initial stop. If chart is clean, you can trail the daily lows for awhile, before you reach a profit target and sell some of your position.

8 What kind of risks do we face in swing trades beyond the trade itself? - Market Risk: The possibility for investors to experience losses from factors that affect the overall performance of the financial markets. Market risk is also known as systematic risk. #Brexit - Operational/Business Risk: The possibility for investors to experience losses from factors directly related to the industry or company itself. CEO gets fired, SEC investigation, employee strikes, earnings/guidance, downgrades, new debt, etc. This type of risk is known as unsystematic risk. - Legislative/Legal Risk: The possibility for investors to experience losses from factors associated with politics, FDA approval, law suits (like LL), legal actions and new or unexpected industry regulations that can adversely impact companies. - Interest Rate Risk, Credit Risk, and Liquidity Risk: Important to know that they exist, but generally speaking, they are not the most important when swing trading, if we focus on non junk stocks.

Understanding market risk, sector risk and BETA - If the market tanks, there aren

Having a buffer on the trade and being flexible with our stops can help us avoid

- Sector risk can unfairly bias stock prices of unrelated companies.

9 Understanding market risk, sector risk and BETA - If the market tanks, there aren t too many stocks that will shrug off the selling. Having a buffer on the trade and being flexible with our stops can help us avoid getting caught in the market chop. - Sector risk can unfairly bias stock prices of unrelated companies. This is commonly seen in the biotech sector. We call these sympathy plays. When one company s stock move affects everyone else s. Some stocks have more sympathy than others.

Beta: A measure of volatility that affects your portfolio. Beta measures the volatility, or systematic risk of a security in comparison to the market as a whole.

10 Beta: A measure of volatility that affects your portfolio. Beta measures the volatility, or systematic risk of a security in comparison to the market as a whole. Beta is a ratio also called the beta coefficient. A beta of 1, means that the security will move with the market (1:1). A beta of less than 1, means that the security will be less volatile than the market. A beta greater than 1, means the security is more volatile than the market. For example, if a stocks beta is 1.5, it is theoretically 50% more volatile than the market. How can we use this to our advantage? Stops, targets, quicker profitablilty

11 Trader psychology and trade management - Overtrading We have all been there - Avoid speculative plays with attractive reward profiles (calling tops/bottoms is very difficult and a good way to blow up an account). Stick to the break and butter - Remember, base hits win ballgames, not homeruns. - Know you risk reward profile and stick to it, systematically (every..single..time) - Cover up your P/L window if you need to. Don t worry about the tick by tick changes. Let the trade work and trust your orders. - Set an alarm on your phone to walk away. Staring at charts and ticks all day is not healthy. - Use a different broker for day and swing trading. Close out your broker when orders have been made. Again, trust your stops/orders and instincts. - Don t micromanage a swing trade! If you stare long enough, you can convince yourself on ANYTHING! - Revenge trading - Seek higher percentage gains, versus dollar gains. This will help you understand and maximize the trades you are taking. Slowly build up your size to increase your dollar wins. - Over sizing - You MUST have confidence when entering a trade (know why you are doing what you are doing at all times!) - Patience - WAITING for quality setups with the right conditions (there will always be another good setup to take. Don t feel like you missed out.) - Keep a written trade log of what is working for you and what isn t. Note what you did wrong and what you did right. Tracking your metrics will help you improve on many levels as a trader - Have a WRITTEN trading plan (goals, max loss defined) - For each trade, each trading day, and each month, etc. ALWAYS have a plan

12 Questions, comments, concerns? me:

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