Money management is critical to any trading approach. There are numerous strategies that are directed at maximizing profits while limiting losses. Some of these are designed around sophisticated programs that are adjusted as the volatility of the market changes. What we need is a system of money management that we can understand and use. I will start of with the basic idea, which you can modify a number of ways to suit your own unique situation. It’s as simple as 1, 2, 3.
Rule #1:
We will only consider a trade that has a 3:1 reward risk ratio or better.
Rule # 2:
We will not lose any more than 8% of the value of the stock on any one trade.
Rule # 3:
We will not lose any more than 2% of our trading account on any one trade.
Example:
In the Wyckoff Method, we are taught to place our stops in logical places. We then look at the Point and Figure chart and determine how much potential has build up (how many points the stock is expected to move). Normally, you will want your figure chart to show that you have the potential to gain three times or more profit as you stand to lose. If you purchase a stock that is trading for fifty dollars, and have a logically placed stop at forty-seven dollars, then your risk is three points ($50-$47 = $3). Therefore, your Point and Figure charts should show at least three times your risk which would equate to a nine point profit potential (3 X 3 = 9) or preferably more. If it does not, you don’t take the trade. Wyckoff’s 5 Step Method is really a filtering mechanism. Every aspect of it is important.
Rule # 2:
We will not lose any more than 8% of the value of the stock on any one trade.
Now that you have determined what your risk is (three points), make sure that your risk of three points does not represent any more than eight percent of the value of the stock. For the fifty-dollar stock, three points represents 6%….so we are okay there. If it was greater then 8%, we would not take the trade. We would never move the stop to make these numbers work. The stop must be place in a logical place, and kept there until the market action suggests that it should be moved.
Rule # 3:
We will not lose any more than 2% of our trading account on any one trade.
Lets say you have ten thousand dollars in a trading account. Two percent of ten thousand dollars is two hundred dollars. So the most we will lose on this trade is two hundred dollars (don’t count commissions). To determine how may shares to buy simply take the number of points we are risking and divide it into $200 (200/3 = 66.67 shares or simply 66 shares).
So, when you purchase 66 shares at $50 a share it will cost you $3,300, leaving you $6,700 for other trades. I know this sounds a little complicated but if you stick to this type of money management, you can have five losing trades in a row and only damage your account by 10%. In actual trading, you will be raising your stop when the market tells you to, and you won't normally suffer a 10% loss with five losing trades...it most likely will be much less.
Now that you know how much of your account to risk, and how many shares to buy based on that risk, here are some Wyckoff exit strategies on when to close your position and take a profit.
Wyckoff Exit Strategies
In Order of Degree of Desirability
EXIT STRATEGY # 1
Take profits, eliminate positions, exit the market upon a climax action in the price objective zone (figure charts). You cover your position when you see the climax in the price objective zone
EXIT STRATEGY # 2
Exit the market when there is repeated evidence that the current trend will not continue, and indeed may reverse.
Periodically monitor the market, the group and the stock for price and volume clues that warn of trend exhaustion.
Larry Livingstone : “Act on warnings. Don’t wait for the breaks.”
EXIT STRATEGY # 3:
Exit the market automatically upon the hitting of a trailing stop (loss) order…this is the back up strategy.
Wyckoff looks upon the placement of the stop order as though it were “catastrophic loss insurance with a large deductible.” The large deductible being the distance between the current price and the stop price. Hence, if the trader sees a hazard developing he/she should opt to avoid the hazard and protect the position through active intervention rather than passively waiting for the distant stop to be hit. Far away training stops during an outgoing trend allow the trader to ride the winners without the risk of needlessly becoming unseated.
Again, the placement of stops should be no more than 8% of the value of the stock. The stop must also be place in a logical place that would protect it from normal market action.
You should also reevaluate a position and consider exiting when:
There is loss of relative strength compared to the market and a rival stock within a group
Ascending bottoms in a trading range (short sale outstanding).
Descending tops in a trading range (long position outstanding).
Sign of weakness (SOW) especially the # 1 spring.
Overbought condition or against the upward channel line
Thrusts shortening
½ way point exceeded or a rally in a downtrend, reaction in an up trend
Failure of support / resistance.
Price spread and volume
Trend lines and support / resistance lines in a trading range
The Nine Buying and Selling Tests
Comparative Strength and Weakness
Point and Figure Objectives