Publish date:

Back in the Trading Fold

Gary charted a different course on his vacation.

It is good to be back. Very good. Frankly, I missed the writing. And, oh yes, the trading, too.

The fact is, I'm really not much of a vacation guy. Oh, it's nice to get away for a few days, if for nothing else, to catch up on my sleep. But to be away eight days, like my wife Nancy and I were? Uh, that's a bit much. Especially on a cruise ship. Of course, it might have been different if I had dial-up access in my room, but

Royal Caribbean

(RCL) - Get Report

isn't there yet. At least it isn't there on the "Monarch of the Seas."

The fact is, when people talk about a vacation allowing them to get away from the world, that's definitely not for me. I

like

reading the paper in the morning. I

like

seeing what

Cramer

has to say each day. I

like

ribbing

Adam

each week on the "TheStreet.com" on

Fox News Channel

. Shoot, I even like getting up at 4:15 a.m. to take my girls to swim practice.

I guess what it boils down to is that I just like the daily comings and goings of my life. And eating seven meals a day -- even on a ship as luxurious as the one we were on -- just isn't "my life." And I doubt it ever will be.

(Sidebar I: Our ship did have a nifty "Internet Cafe" and I'd be lying if I didn't say it was an impressive little facility. I checked it out a few times, and found the satellite hookup they used pretty darn fast.

Sidebar II: I use the term "vacation" liberally. I played spouse while Nancy was the host executive to about 40

Digex

(DIGX)

employees and their spouses. Other than the folks at

TSC

, this was my first in-depth exposure to a real, live "Internet company." I don't think of myself as old, but I still was amazed how young the average employee was, whether it be rookie salesman, or top executive. They were a nice group of folks though, and at least no one called me "old man"!)

TST Recommends

In any event, you've heard enough from Mr. Vacation Expert, so let's kick off the rest of the year by tackling some relevant questions posed by loyal reader,

Ran D. St. Clair

.

Gary: You speak of "money management," primarily meaning what you do after you have taken a position. Personally, I would think that is an important but narrow portion of money management that I would call an "exit strategy". What I haven't seen addressed, except perhaps in bits and pieces within various columns, is the part of money management having to do with the size and proportion of the various position entries relative to the value of your account. For example: I am not asking for myself. I have my own answers to each of these questions, not necessarily the same as yours, mind you. I am mostly suggesting topics for your general discussion of how you build your own trading systems. Thanks, Ran D. St. Clair

    What minimum account value would you consider appropriate for GBS Classic Trading? To what degree do you leverage that account value to take positions? Do you vary the use of leverage depending on market conditions? How strongly do you feel about the prospects for your most recent picks, or whether you have a more market-neutral basket of picks to execute? How many picks do you have in the hopper at any one time? Do you split your available cash (multiplied by your desired margin/risk factor from No. 2 above) into some number of equal units and then apply them equally to your various hot prospects? Do you somehow weigh the size of the bet according to the estimated risk/reward ratio for each of the prospects? Do you just buy fixed lot sizes? Do you attempt to balance your picks with long and short positions to remain at least somewhat market neutral? As positions cash out, either winners or losers, do you immediately roll the cash into the next day's hot picks, or do you hold some cash aside, especially on days when you don't like what the market is offering?

OK, good questions Ran, so let me tackle them one by one.

    In general, I think you could tackle the "GBS Classic" with about $50,000 if you used a discount broker. The problem, of course, is that my method takes a lot of small gains, so commissions become an important factor. If you have a reliable method, with a positive expectancy, my feeling is you should use the full extent of your buying power. Given that, I approach each day's trading as if I had twice my equity to spend. However, I vary how much leverage I use, not based on market conditions, nor on how strongly I feel about each pick, but simply on how many candidates I have each day. If I have a lot of candidates, I use a fair amount of leverage. If I have few candidates, I might not use any leverage at all. A good rule of thumb for my trading is to make each lot size about one-tenth of my buying power. Therefore, if my equity is $100K, making my buying power $200K, my lot size would be $20K per position. This formula usually ensures I have enough buying power to take all good candidates each day. However, you should experiment with how many trades you usually take to come up with your own formula. The approach I always use is to look for both longs and shorts each day, without prejudice. Therefore, I never "try" to make sure I'm market-neutral, but rather let the number of good long and short candidates dictate how weighted I am to either side. This is similar to No. 4. Every time I cash a trade, that money is available for the next day's trades. If there are no good candidates, that money sits in a money market account. If there are many good candidates, that money is immediately put to use.

That pretty much takes care of Ran's questions. However, two more points:

First,

no matter if I'm trading with a rigid percentage stop or more "free form" (see my

columns from last week), I always try to ensure if I get socked for a loss, that loss is a very small percentage of my overall equity. A good rule is to try to keep your losses at about 1% or 2% of total equity. My percentage is even more conservative at slightly less than 1%. That way, no loss is too big for me to worry about, and it would take repeated losses to make a major dent in my portfolio.

Second,

Ran broached the topic of being market-neutral. And as I said above, I don't strive to be market-neutral, but rather let the market dictate my trading. However, if I'm feeling particularly bullish or bearish, I will make a determined attempt to ensure I look closely at the opposite side. That way, I'm at least prepared for any sharp U-turns in the market.

Well, I'm glad Ran brought this topic up, as I've been meaning to get to it sometime soon. The important thing to remember, though, is -- as always -- many of the rules I've outlined are perfect -- for my own personal trading. They may or may not be perfect for you. But, that's not the point. No, the point is to have some kind of overall trade and money-management philosophy, that ensures you will be: a) profitable over the long term, and b) be able to stay in the game when you get knocked down.

If you do, I guarantee you will be a much better trader, and head and shoulders above 99% of everyone else playing this game.

Gary B. Smith is a freelance writer who trades for his own account from his Maryland home using technical analysis. At time of publication, he was long Digex, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Smith writes five technical analysis columns for TheStreet.com each week, including Technician's Take, Charted Territory and TSC Technical Forum. While he cannot provide Investment advice or recommendations, he welcomes your feedback at

gbsmith@attglobal.net.