WITH the Philippine Stock Exchange Composite Index (PSEi) trendless and still range-bound between about 6,800 and 7,200, life is relatively boring for stock- market traders.
Certainly there are always a few “rocketchips” that take off and then crash, adding maybe some profits and excitement. However, there is a large segment of local stock-market traders that are active but are not interested in trying to catch the next stock ramp or are large enough that the thin liquidity in many of these issues do not provide sound entry and exit points. It is worthless to the million-peso trade to try and ride a stock that is trading P5 million to P10 million per day.
Nevertheless, the local stock market is not going to be a “stuck market” much longer. It is only a matter of time. Weeks or even months, it does not matter.
The “No. 1” rule that the experts are fond of quoting is “Do not trade too much.” Genuine experts with real-life experience say that the smaller trader has a large advantage over big traders in that the small guy (and P1 million is small) can pick trades more carefully. Small traders can pick trends and entry points better than the big boys as long as there is liquidity and volume.
“Do not trade too much” actually means to follow this idea of being more selective, but it does not mean that you should not limit the number of trades you make in a week, for example, to some sort of magic number.
In fact, with the great volatility that we have seen because of the lower average daily volume, there have been multiple short-term trading opportunities in stock trading several hundred million pesos per day. If you see a trend that can be traded, take advantage of it.
“Unprofitable traders risk too much to make too little.” Traders that are not able to make consistent profits are usually guilty of ignoring the reward/risk equation, which also includes the serious error of always thinking “How much can I make if I’m right, instead of “How much can I lose if I’m wrong?”
Trying to make a 100-percent profit when the probability of reaching that objective is only 10 percent is obviously not as good as trying to make a 10-percent profit when the probability is 100 percent. All right, there are no situations of 100-percent probability of being profitable.
However, you must decide a number for the probability of winning based on your analysis. Then select your profit exit point. The stock is P27 and you see a move to P32 as likely for an 18-percent profit. You assign a 60-percent probability of the price going to P32.
The downside cut-loss support is at P24 for an 11-percent loss, which has a probability of 40 percent based on the inverse of your profit likelihood. Multiplying the percentage of profit or loss by the probability gives you a “reward/risk factor” of 10.8 to the upside and 4.4 to the downside (18 times 40 percent and 11 times 40 percent). That is not very good because the reward/risk is 2.45.
Suppose the support cut loss was only 5 percent lower than your entry point rather than you being willing to take an 11-percent loss. Now the “reward/risk” factors go to 10.8 profit and only 2 loss. That is much better with a reward/risk at 5.45.
This goes hand in hand with another important thought. Unprofitable traders think trading is about being right. Profitable traders know that profitability is about putting the statistical odds in your favor. Every toss of the coin is 50-50 and every roll of a dice is one in six for any particular number. Although we know that stock-price movement is not a random event, we need to calculate “odds” to increase gains and lower risk. But we also know that stocks that “should” go higher too often do not.
If the odds on a roll of the dice is one in six, then you have to be able to win “six” for every “one” you bet. Otherwise, it is a terrible and foolish bet. If in the stock market you are risking 11 percent to gain 18 percent, then you need the “odds” of the price going higher at least 80 percent for a reward/risk of 3.3. Alternatively, you need a higher price target.
Unless you are a stock-market genius in predicting price movements—and no one is—then you need a method to determine if your investment is worth the risk.
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E-mail me at mangun@gmail.com. Visit my web site at www.mangunonmarkets.com. Follow me on Twitter
@mangunonmarkets. PSE stock-market information and technical analysis tools provided by the COL Financial Group Inc.