ABB Stock Market Trading continued, Proper comparison

Rather than add to one of the previous posts, here is a note on comparing one trade size to another followed by a bit about account size and trade determination.

My initial simple trading plan included trading at least one lot (100 shares) of a stock. This produced a particular return, profit or loss.

Adding levels of complexity that introduces additional concurrent trades or splits up the initial trade make it a little bit more complicated to compare one against the other. At least on a dollar for dollar basis.

In the first plan I trade one lot, 100 shares bought, 100 shares sold at target or at stop loss. In the second plan it is the same entry but the first 50 shares get sold at target and the second get the VTSO treatment, or the whole lot stops out and is sold for my Maximum Loss Allowance (MLA) for that trade.

Easy enough.

In the subsequent alterations the entry trades go from the above guide to one entry at the initial target, perhaps a second and perhaps a third at subsequent targets. The farther along in the sequence the more shares traded due to the second and third possible trades. Cutting the altered trade sizing to 1/3 lots or tripling the initial plan isn't a fair comparison as many of the second entries do not set up and even fewer of the thirds. Then again, counting three trades with a combined size of 300 shares is not fair to the initial plan only using 100 shares.

It boils down to a subjective assessment of the win rates and returns that fit a particular account size and applying appropriate money management rules to determine which style fits both the account and the risk tolerance of the individual. This should be completed up front and in writing in order to have a guide to stick to. Making these up and the fly is not a great idea and can lead to problems later on, although not necessarily with a successful and profitable plan.

Here are two particular examples for an attempt at comparison, ABB at around $14 in the middle of 2009.

Simple trade plan, 100 shares in and all out at targets.Typical initial target is for $1.50 but how much of that is aimed for depends upon the price movement following the entry.

Buy at $14, sell at $15. $1 per share = $100 gain (7.1%)

VTSO applied with $1.50 trailing stop, 100 shares in, 50 shares out at target, 50 shares to trail.

Buy at $14, sell 50 at $15 and sell 50 at $17.50. $1 ps + $3.50 ps = $225 gain (16.1%)

Multiple entries and exits according to the final plan setup.

Buy at $14, sell 50 at $15 and sell 50 at $17.50. $1 ps + $3.50 ps = $225 gain (16.1%)
Buy at $13.50, sell 50 at $15 and sell 50 at $17.50. $1.50 ps + $4 ps = $275 gain (20.4%)
Buy at $13.00, sell 50 at $15 and sell 50 at $17.50. $2 ps + $4.50 ps = $325 gain (25%)
Total gain = $825 (20.3%)

Worst case loss for the respective plans:

Simple trade plan, 100 shares in and all out at stop loss.

Buy at $14, stop loss at $12.50. $1.50 per share = $150 loss (10.7%)

VTSO applied does not matter as the initial stop is always $1.50 on this priced stock, same loss.

Multiple entries and respective stops assuming the worst case according to the final plan setup.

Buy at $14, stop at $12.50. $1.50 per share = $150 loss (10.7%)
Buy at $13.50, stop at $12. $1.50 per share = $150 loss (11.1%)
Buy at $13.00, stop $11.5. $1.50 per share = $150 loss (11.5%)
Total loss = $450 (11.1%)

Keeping the worst case scenario in mind and using the typical account loss allowance of no more than 2% Maximum Loss Allowance on any single trade, this trade alone would require an account balance of $22,500 even though the trade only used $4050 in capital. Going with the smaller 100 share trades and keeping to the simpler single entry and VTSO half trade exit, the account could be $7,500.Of course these assume that this is the only trade on the map.

I'm breaking this into another post, again due to the length and this is a good place to break as the topic is shifting a bit.

Based on the numbers that I am looking at now, I think that the best comparison may just be no direct comparison and to consider the account and go from there. Starting with a small account may mean restriction to initial entries only and perhaps targeting lower priced stocks. Adding more stocks to the mix as the account grows then adding the second trade setups and thirds will allow the account and methods used to grow accordingly.

The win rate and overall returns will govern where I think the money is best applied which leads me into the more complex trades. Ideally taking every trade setup as it appears and making every trade at every level is the best overall action for this trading plan, it just may not work for everyone.

Jeff.

ABB Stock Market Trading continued, Short Sell

My last post gave a brief overview of some of the results of my past studies applied on a current trading plan using only long trades, buying then selling.

This time I want to look at the short selling of the same stock.

I have run into the odd time when I was forced to cover a short position due to the broker's requirements but those are few and far between enough that I don't think I'll worry about it happening that much. Worst case, if a particular stock is difficult to short, I will drop that facet of the plan for that particular stock.

Short selling is basically you borrowing stock from the broker in order to sell it to someone else. The value of the stock at the time of "borrowing" will be the same value that your buyer purchases it at. The purchase transaction is held by the broker until the stock is returned. The idea is that if the price goes down, it is bought back by you (covered) at the now lower price and is returned to the broker. Technically you have managed to borrow an expensive item, sell it only to buy it back for cheaper. You get to keep the difference. This difference is deposited to your account once the transaction is completed.

The old adage of buying low and selling high remains the same except that it is also true to say that you can sell high and buy low.

The reason nobody likes to do this, less than 2% of traders ever short sell a stock, is that the implication is that if the price goes up, the difference now comes out of your account. While buying a stock the value could drop to zero and you lose 100% of the investment, shorting has no limit on the loss, in theory. Once it is short sold, the price has no technical limit and the loss could be greater than 100% of the value of the stock.

Of course this is why stop loss orders are used and adhered to.

The other side of the argument is that typically price moves down are much faster than moves up and a short sale tends to be a much shorter duration trade than the long. This means that the price moving against you is not likely to get away very fast.

On to ABB and the application of the newer methodology.

I'll use the same ideas as the long trading plan but I'll skip all the proving of single entries vs staged entries and fixed profit targets vs VTSO partial exits from the last post. Suffice it to say that trading with the trend, multiple entrys, VTSO exits all work whether the price is going up for a profit or going down for a profit.

With a win rate of slightly higher than 80% and a return of $7.13 per share The idea of short selling a stock certainly makes it worth considering. Compared to the 162% ROI from the long side, 142%, is nothing to ignore particularly when the combined return is $15.26 per share or 305%.

Off to apply this same methodology to all of my other data charts to see, hypothetically, what my returns could have been.

Jeff.

ABB Stock Market Trading

I've been playing around with one of my old trading plans for the last couple of weeks and pulled out my tracking chart for ABB. They happen to be a power and automation company (robots and power converters) but that really has no bearing on why I was following them as I had to look them up in order to find out what they really were.

Basically I feel that the charts tell the whole story and the price reflects that story. The issue I have always had with fundamental or value investing is that you must try to discern the story ahead of time. While some of the company's fundamental data will reflect it's overall health, it does not indicate what will happen tomorrow and certainly does not predict the future price. Although some make out well with this style of investing I just don't have the patience to sit on something long enough to find out that I was wrong in my assumptions.

If you look at Apple (AAPL), everyone thought that with the demise of Steve Jobs, Apple stock would drop. While it did for a short period, it certainly was only a blip in the price as it quickly surpassed the price that it had reached during Steve's reign. I sometimes give my butt a little kick for not buying it when I first looked at it, around $85. Meanwhile, it is not one of the stocks that I follow for the purpose of trading, the price is too high for my style of trading and account size.

Back to ABB.

This has been one of my worst performing selections so I figured what better one to choose for setting up my spreadsheet to re-run the old numbers through my improved simplified plan. Performance is relative to the plan implemented afterall. Of course I expected an overall loss based on the look of the historical chart and my previous simplified plan. Something like a $9.50 loss per share over a 10 year period while only trading long and running every setup. With a win rate of 37.5%, no wonder.

In almost all of my studies, trading with the trend has a better win rate. Simple trend determination just using a couple of simple moving averages and their cross overs. It doesn't need to be complicated as these are not trade indicators, just a quick guide to remove the subjective decision of whether or not a trend is up or down.

Switching to simple trend following, this loss drops to $2 per share with a 54.6% win rate.

Adding more trades using varied or staged entry targets bumps the total returns to $3.50 per share.

Part of the higher profitability of this version of the plan has to do with taking more trades overall with the idea that if the first trade stops out for a loss, the remaining individual trades based on the same trigger may not. This creates a greater edge, 14% greater as the new win rate is 68.6%. There are 72% more trades so in order to better compare them, the average return per trade was a $0.17 loss vs an $0.18 profit per trade.

Next, using the same plan but implementing a half trade trailing profit stop. A Virtual Trailing Stop Order (VTSO) will work well in this particular application. This could be applied a few ways but I would choose to enter the trades using the same method as above with the VTSO applied to half of the total trade. If the price proceeds to run up past the initial profit target, the VTSO will capture more profits than otherwise might be had. The very worst case once the initial profit target is hit is that the remaining half of the trade could stop out at break even, it will never turn into a loss at that point. Of course in all cases where the initial target is not hit, the entire trade stops out for a loss. The upside potential is greater than the downside which makes this style of trade worth the added complexity.

VTSO partial profit stop, $8.13 per share profit with the same win rate of 68.6%. Same trades, just managed differently.

Seeing as the stock started out around $5 when this plan starts, the overall Return On Investment... if you want to call this an investment... is over 162%. That, over 10 years, is certainly worth the effort.

It is worth mentioning that all of my results are based on nice even price numbers, 25, 50 cent increment or $1 depending upon the value of the stock at the time of the trade. Using the VTSO provides that the profit may be at a price relative to the penny increment moves of the price but will be above break even in all cases when the initial target is attained. This puts the real VTSO at a non-zero profit value almost immediately. Entries and exits are subject to a certain amount of slippage and variations in opening prices can affect the entries, although this, like the VTSO, would be in my favour as I use limit orders to enter and exit at targets. The real odd factor might be the overnight gap in price. Those occur but can go in either direction so they are tough to try factor in ahead of time. I figure that the odds are, while trading with a trend, better that the gap be in my favour but will concede a 50/50 shot at getting them right.

Next up, the short sell. This post is already too long.

Jeff.