Should you to Add to Winning Positions?

If you catch a great trending move, scaling into it is a great trade adjustment to increase your max profit.

In my trading over the years I have found that the easiest way to build good and fast returns is to be in a larger position when correct in my market call that when I am incorrect. This sounds simple and trivial but it’s exceptionally difficult to do. As with all things in financial markets it’s the difficult things emotionally that makes the money.

Most of the trading books and sources advocate scaling out of positions and that means that when you call the market with precision the big move is held with only a 1/3 or ½ of the initial position. If your market call is poor then you take a hit with the full position. That’s not the way to get ahead. Over the years I have used both methods. Scaling out is emotionally easier as it’s quite easy to take lots of small profits. I struggled to get ahead because the losses were much bigger than my gains. At best my account stayed around the same level with no progress, but at the same time no drawdown.

Adding to winning positions take strength and I will address the psychological reasons for this a little later in this blog entry. For a good read on adding to positions and how it made a group of traders’ world famous and rich, please search for the “turtle traders” on the net. This group of youngsters were taught how to trade by veteran futures trader Richard Dennis in the 1980,s and adding to winners was a large part of their success. There are many books and even a very expensive course on their methods. The entry they say is the least important part of their system and for the record, the entry was a break on an intraday basis of a 90 day high. If the position went well they simply added via a pre-defined plan which is fully disclosed in the free “turtle trading rules”. If you can’t find these please let me know and I will send you the details. I found the story and legend of the “turtles” very motivating in my journey as a financial trader. There were most definitely much bigger in position size when they were correct in their calls than when they were proved incorrect.

Let’s look at a simple VectorVest system

1. Select a Unisearch to find shares that suit you. For example my “small cap rockets” search finds shares that have a high earnings potential (RV>1.4) that are in the throes of a strong trend (CI>1.4). In this search I only look at shares with a market capitalization of less than 500 million. I then sort the shares by the Master Indicator VST (value, safety and trend).

2. Wait for a Market Timing signal to enter. This can be any of the 5 signals that occur as the VectorVest Composite turns from down to up. We have signals for very aggressive traders to signals for conservative investors. The most conservative signal is called a Confirmed Call and it’s shown clearly on the front page of VectorVest. A slightly less conservative signal is named the DEW. With a single mouse click the BUY and Sell, Market Timing signals are displayed on the chart of the VectorVest Composite and on each share within the entire market if desired. I enjoy the DEW signals as they are reliable and they also enter and exit the market close to the turn. For new VectorVest people and non VectorVest people I have covered a lot of material here. On Monday 25^th I will be conducting a webcast at 130 PM UK time and will devote most of the time to the study of all the VectorVest Market Timing signals. At present as I write on Friday 22^nd January 2016 all of the VectorVest Market Timing signals are saying DOWN save the most aggressive which turned UP after the close. It’s NOT a time to be buying shares but it’s getting close.

3. Let’s assume we have found both a Unisearch that suits our capacity for risk and a Market Timing signal such as the DEW has fired a BUY signal. In the third part of our simple plan we should wait for the shares in our search to break up with the market. In Unisearch there are HI LOW searches that can automate this. This technique was discussed in an excellent strategy of the week that was done about a month ago by VectorVest education. If you can’t find it please call support and they will get you the link. As any share from your Unisearch breaks up through a 26 week high or 52 week high (the choice is yours and should be in your plan) a purchase can be made. Many traders use a moving average cross to time the entry when a Market Timing signal has fired and they argue that this technique frequently gets onboard prior to the breakout. An 8 ema crossing above a 50 ema gives robust signals which are easy to see visually and with the PROTRADER add-on to VectorVest can be a part of the initial Unisearch.

4. How many shares to BUY is the most important question we can address. This concept is known as position sizing and it’s a critical part of your trading plan. I keep it very simple as follows.

Initially I don’t like to risk any more than 1% of my capital in any single trade. In very large accounts I start with ½% risk on any single trade. If I have 50000 pounds in my account, 1% risk amounts to 500 pounds. The Dart group makes a good example. The breakout level to BUY is at 6 pounds and I estimate that when the breakout occurs the VectorVest stop loss will be around 5.20 pounds

Thus the Risk/share is 0.80. Just subtract the two numbers.

Let the number of shares bought =N

N *(Risk/share) =1% of my account size

N=1% of my account size/ (risk/share)

N=500/0.8=625 shares

If I BUY 625 shares in Dart at 6 pounds and exit at 5.20, if the call is incorrect, then I will have lost 1% of my portfolio. To survive as a trader applying this simple equation in each and every trade is vital.

5. Let us assume all goes well and the share starts to move upwards strongly. Invariably the position will break and then come back and “kiss” the old resistance at 6 pounds. After the break and kiss the upward movement should restart and when the market breaks above the last new high then I get interested in adding to the position. Firstly and most importantly it’s vital NOT to add to any position until the stop loss on the first tranche of shares can be brought to entry. If I add to the Dart position at around 6.80 and then adjust the stop on both positions to the initial entry at 6 pounds the risk remains at 1% of my capital. I am now twice as big in a winning hand as I will be in a losing hand. I don’t have any problems in adding again but being twice as big when correct will have an enormous effect on your bottom line. If I add again then the stop on all positions should be placed at the entry level of the 2^nd round of buying.

 

6. The VectorVest valuation on Dart is 9 pounds. If I bought the share at 6 and let that single position run to 9 the reward to risk would be 3/0.8=3.75. If I add once at 6.80 the reward to risk is now 3.75 on the first position and 2.75 on the second. This pushes the reward to risk to a combined 6.5. Adding to winning positions pushes the reward to risk through the roof. In most texts the reward to risk is incorrectly referred to a risk to reward. In shares like JD Sports that have moved strongly adding to positions can result in a portfolio rebalancing problem as the profits roll in. It’s a grand little problem to have.

 

The above is a very simple set of rules with little subjectivity. Why is it that most of us have difficulty in following a simple set of trading rules? I could write for days on this and in the past have done 3 day workshops to institutional traders on this topic. Here I wish to just discuss a simple adjustment in your thinking that may help to hold on to winners and cull losers. Please meditate on the following thoughts.

 

When a typical trader has a winning position they tend to become FEARFUL in their thinking. They have an enormous fear that the profits will disappear. When a typical trader has a losing position they tend to become OPTIMISTIC. They become optimistic that the position will turnaround.

If there is a secret to trading it’s the following.

When you have a winning trade become optimistic and when you have a losing position become fearful. Become the silent watcher of your thoughts in your next trade and practice this. It’s a small fix but it can change your bottom line positively in a very short period of time.

David Paul

January 22^nd 2016

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