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MONEY MANAGEMENT


Realistic Trading

12/31/02 03:29:27 PM PST
by RM Sidewitz, Ph.D

Your trades can't all be winners.

A wise man once said, "Prophecy is a difficult game, especially as it pertains to the future." This is clearly true when it comes to forecasting price in the futures markets. I remember a student in 1992 who was absolutely convinced that lumber had a fair value of $450. She saw a nearby contract at $250 as a huge opportunity, so she established her long positions.

When the price slipped to $235, it was clear that buying lumber was even more attractive now than it was at $250. So she bought some more.

At $225 it was clearly the deal of the century, so she doubled her position. By the time it approached $210, however, she had to admit she had exceeded her pain threshold and closed her positions out at considerable loss.

A few months later, lumber topped out in excess of $490. Her deal of the century had been everything she thought it would be. But she was not in the trade at the right time to reap the rewards of her accurate forecast.

TWO LESSONS

We can learn not one, but two lessons about timing your trades. The first lesson: If you're right about value but wrong about timing, you are still wrong. The corollary to this is that in futures trading, you have to be right twice: you must be right about the direction of the price and right about the timing. It will do you no good to be correct about only one. If you are correct in your assessment of the market's direction but initiate your position too late, your trade may lose money. Of course, if you are wrong about the direction of the trend, the timing issue becomes moot.

The second lesson: the key rule to long-term success is the astute allocation of your assets. Valuation, trend direction, and timing are all important. If the student had not loaded up so dramatically in the lumber trade, she could have ridden out the short-term decline and finally enjoyed the benefits of her correct analysis.

Many traders lose everything in the markets because they wager an inappropriate percentage of their trading capital on a single position. If the trade goes badly, the adverse effect is crippling.

Staying power is the linchpin of successful trading. Any savvy trader will tell you that he/she learns more from losses than from wins. When I first realized that asset allocation, or position sizing, was as important as entries and exits, I searched for a way to keep myself from getting carried away as I traded. I decided to treat each trade as if it were going to be a loser. "Power of positive" thinkers will argue that this attitude sets traders up to fail, but I disagree.

NEGATIVE THINKING HELPS

Without a doubt, a positive outlook is important. To that end, believing that your overall trading will be profitable is certainly valuable. However, immoderate fervor about the result of any single trade can cause you to mismanage it by taking on undue amounts of risk. If you believe every trade will be a winner, the need to confirm that belief may cause you to stay too long in a trade that has moved against you. It may also prompt you to take a position size that is simply too large. Staying in a trade longer than you should or having too much money (in relative terms) at risk is the surest road to disaster.

The loser's approach has several benefits:

  1. You have a diminished attachment to the outcome. Since you don't have to be right, you can be much more detached as you manage the position. You can give yourself permission to exit without all the emotional charge that you might have otherwise.

  2. You will have an appropriate amount of your capital on the line, so even if a trade loses money, you still have plenty of reserve to continue on.
  3. You can ride out short-term price moves that go against your analysis without feeling financially squeezed.
  4. You will be certain to establish clear and cogent stops.

Losing trades are an inherent part of the winning process. All traders go through them. Handled correctly, they become learning opportunities. Mishandled, they are the seeds from which defeat and significant loss are sown.

R.M. Sidewitz is chief executive officer and founder of Qi2 Technologies, LLC, an investment management company, and the managing member of Qi2 Partners LP, a domestic hedge fund. His website is www.cybrlink.com.

Current and past articles from Working Money, The Investors' Magazine, can be found at Working-Money.com.





RM Sidewitz, Ph.D

Dr. Sidewitz is the President, Chief Executive Officer and founder of Qi2 Technologies, LLC, an investment management company and the Managing Member of Qi2 Partners LP, a domestic hedge fund. Dr. Sidewitz began his career on Wall Street in the mid-1960s with Moody's Investors Service. He then served as the Assistant Director of Research for a registered broker/dealer until 1971. In the ensuing years, he continued his pursuits as a private investor during which time he developed the proprietary methodology that is used by the Limited Partnership. Dr. Sidewitz is the author of two books, "How I Double My Money Annually in the Market" and "How to Stop Sabotaging Your Trading Success: Mastering the Inner Realm". He is a frequent contributor to numerous financial publications and continues to work closely with private clients.

Qi2 Technologies LLC has not added any product or service information to TRADERS' RESOURCE.
Title: Managing Partner
Company: Qi2 Technologies LLC
Address: 4800 Baseline Road, Suites E104-370
Boulder, CO 80303
Website: www.cybrlink.com
E-mail address: roy@cybrlink.com

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