Stock Exchange: You Risk How Much Per Trade?

The Stock Exchange is all about trading. Each week we do the following:

• discuss an important issue for traders;
• highlight several technical trading methods, including current ideas;
• feature advice from top traders and writers; and
• provide a few (minority) reactions from fundamental analysts.

We also have some fun. We welcome comments, links, and ideas to help us improve this resource for traders. If you have some ideas, please join in!

Review: Are Interest Rates Impacting Your Trades?

Our previous Stock Exchange asked: Are Interest Rates Impacting Your Trades? We noted that over the last few months, the Fed has shifted from anticipating multiple interest rate hikes in 2019, to the possibility for zero increases but instead a possible rate cut. And that there are varying opinions on how changing rates will impact the economy and the markets, both positively and negatively. 

This Week: You Risk How Much Per Trade?

Risk management is an important part of any trading program, and if you don’t think so then just check out this list of a few of the the worst trades off all time.

From this list, it seems obvious that you should never risk too much on any one trade. However, there’s always at least two sides to every story. For example, Bill Gates made his billions on one company (Microsoft), Sam Walton’s family made there’s on one company (Walmart), and even Warren Buffett used to risk very large percentages of his investment portfolio on a single stock back in his early private investment partnership years. But we’re not talking about “buy-and-hold,” we’re talking about trading. 

According to The Balance: 

Trade risk is how much you are willing to risk on each trade. Ideally, risk 1% or less of your capital on each trade. This is accomplished by picking an entry point and then setting a stop loss, which will get you out of the trade if starts going too much against you.

Of course, there’s always at least some art that goes along with the science, and Dr. Brett Steenbarger does an excellent job describing this balance in his blog post about The Two Ingredients of Trading Success:

There are two necessary ingredients of trading success and it sometimes seems as though they are at odds with one another: prudence and aggressiveness.

For example, when market conditions are favorable to your style, then perhaps you may want to get aggressive with your trades and perhaps your positions sizes too. However, when market conditions are not accommodative to your style, you might consider holding more cash, as we will do with our own trades from time to time.

Model Performance:

We are sharing the performance of our proprietary trading models, as our readers have requested.

Controlling Risk:

We find that blending a trend-following / momentum model (Athena) with a mean reversion / dip-buying model (Holmes) provides two strategies, effective in their own right, that are not correlated with each other or with the overall market. By combining the two, we can get more diversity, lower risk, and a smoother string of returns.

Since many clients combine the trading models with our long-term fundamental methods, they have additional diversity of methods without the need for short-term timing.

For more information about our trading models (and their specific trading processes), click through at the bottom of this post for more information. Also, readers are invited to write to main at newarc dot com for our free, brief description of how we created the Stock Exchange models.

Expert Picks From The Models:

Note: This week’s Stock Exchange report is being moderated by Blue Harbinger, a source for independent investment ideas.

Holmes: This week I bought shares of Wayfair (W). It’s an e-commerce company that provides about 14 million products for the home sector under various brands. I basically bought it on the dip, as you can see in the following chart.

Blue Harbinger: Nice job, Holmes. Wayfair was up 4.5% yesterday, so it looks like you’re doing alright with this trade so far. I know you are a technical trading program (not a human) and your strategy basically involves buying on the dip. You typically hold for around 6 weeks. Here is a look at some fundamental data for Wayfair in the following FastGraph, although I already know you’re into technical trading data, not buy and hold.

Holmes: You got that almost right, BH. Technically speaking, I am aware of a lot of “fundamental” data. I just use it differently.

BH: Thanks for sharing, Holmes. And how about you, Athena–any trades to share with us this week?

Athena: I bought shares of Weight Watchers (WTW) this week.

BH: Jeez Athena. Based on your chart, it looks like Weight Watchers has been in a death spiral for the last 10 months or so. Is that your strategy? Are you a death spiral bottom caller?

Athena: I run a best-ideas, “queen of the mountain” strategy, whereby I hold a somewhat concentrated portfolio of top ideas from across a variety of trading methodologies.

BH: Weight Watchers just launched a new Oprah Winfrey campaign last week, and the shares actually seemed like they were perking up a little bit. When Weight Watchers announced an Oprah Winfrey campaign many months ago, it was great for the stock–for a while, anyway. Maybe there will be a similar result this time. If you are curious, here is a look a Fast Graph which shows it’s had some funky price action in recent years, but it’s P/E ratio is now not particularly high relative to its own history.

Athena:  Thanks for that information. I typically hold for around 17-weeks, on average, so keep an eye on this one.

Road Runner: I sold my share of HubSpot (HUBS) this week. If you recall, I am a momentum trader, and I like to buy stocks in the lower end of a rising channel. I bought HUBS about a month ago, and I did alright with this trade.

BH: Not bad, Road Runner. Thanks for keeping us updated. I know you typically hold for about 4-weeks, so this one worked out okay.

Felix: I don’t have any specific trades to share this week, but I do have a ranking to share. I am a momentum-based technical trading model, and this week I ran the stocks of the Russell 1000 (large caps) through my model, and I’ve ranked the top 20 below.

BH: Twilio (TWLO) is probably the best pick on your list if you like amazing long-term growth. They don’t make much in terms of GAAP EPS, but the sales growth has been (and will likely continue to be) on fire. Just saying.

Oscar: I have some ETF rankings to share. As our resident sector/ETF rotation model, this week I ran our “High Liquidity ETFs with price-volume multiple over 100 million per day” through my model, and the top 20 are ranked in the following list.

Conclusion:

Determining the appropriate trade size for risk management purposes is very important. You don’t want to risk too much and end up like one of the guys on the list of worst trades of all time. Similarly, you don’t want to risk so little that it’s immaterial anyway. If you are going to trade, The Balance suggests starting with no more than a 1% position size may be prudent for you, but of course it depends on your personal needs and situation. There can be both an art and a science to trading, and balancing prudence and aggressiveness is very important.

Getting Updates:

Readers are welcome to suggest individual stocks and/or ETFs to be added to our model lists. We keep a running list of all securities our readers recommend, and we share the results within this weekly “Stock Exchange” series when feasible. Send your ideas to “etf at newarc dot com.” Also, we will share additional information about the models, including test data, with those interested in investing. Suggestions and comments about this weekly “Stock Exchange” report are welcome. Your can also access background information on the “Stock Exchange” here.

Trade alongside Jeff Miller: Learn more.