Pristine Quote: "I hear and I forget. I see and I remember. I do and I understand."
- Chinese proverbMoney Management
Question: If someone told you that their percentage of successful trades for the day was only 40% and they had lost .70 that day, would you consider that a successful day? Let's assume they took five trades with the following results:
1. Lost .20
2. Won .60
3. Lost 1.00
4. Lost .40
5. Won .30
So, only 40% batting average and lost .70 in "points".
Good day or bad day? Well, the correct answer is that you do not have enough information yet. Let's add a few ingredients from their trading plan. Let's say their maximum loss per day is $1000 and their maximum loss per trade is $200. Under this scenario, the maximum number of trades they can be in at any one time is five, because if all five were stopped out, they would be at their maximum daily loss. Let's also assume that every trade has a 3:1 reward to risk ratio. With this additional information, you can now answer the question posed above. In fact, if I tell you that every one of the above trades either hit the stop or the target for the entire position, you should be able to tell me EXACTLY how much money this trader made or lost from these five trades. I didn't say "points", because we know that these five trades lost a combined total of seventy cents. So, what is the result in dollars?
Well, you may have figured out that share size has something to do with the answer, but you have been given enough information already to make that determination. If every trade hit either the stop or the target, and we know that the maximum loss per trade is $200, then we know that the three losing trades lost a total of $600. It doesn't make any difference at all that one lost .20 and one lost 1.00. The dollar amount of the loss was the same. The point I want you to get is that share size is a function of the stop. If the chart says the stop is .20, then the maximum share size is 1000. If a swing trade setup indicates that the proper stop is 1.00, then the maximum share size under this person's trading plan is 200 shares.
I have heard new traders say that the reason they didn't take a trade that had a beautiful setup is because the stop was "too far away". What does that have to do with anything? You simply adjust your share size so that if the play is stopped out, it does not exceed your maximum loss per trade. There is never a need to be more concerned about the financial risk of one trade over another since the financial risk is the same for all of them. This article may not make sense to the trader who is in the habit of playing the same share size for every trade. Even if we use the same $200 loss per trade, if they trade 1000 shares for all their trades, that means they have a .20 stop on all their plays. That is a terrible mistake. The chart dictates the stops. It is not arbitrarily pulled out of the sky because you don't want to lose more than a certain amount of money and don't want to change your share size. That is certainly not taught anywhere in the Pristine philosophy, but this material is covered in Trading the Pristine Method Part 2. You find a chart appropriate stop and then determine your share size. This is a simple explanation and yes, I am aware that there may be circumstances under which there may be changes to the above scenario, but the concept is what I want you to think about.
So, back to the 5 trades above... did you come up with the answer yet? This trader, using proper money management, made $600 gross profit from these five trades. If they had traded the same share size on every trade, say 1000 shares, they would have lost $700. That is a $1300 difference with the same batting average and the same total points. If this is a new concept for you, I highly recommend that you consider implementing it as part of your trading plan. Here is what the finished chart looks like:
Stop |
Target |
Size |
Result |
$ |
|
1. |
0.2 |
0.6 |
1000 |
-0.2 |
($200.00) |
2. |
0.2 |
0.6 |
1000 |
0.6 |
$600.00 |
3. |
1 |
3 |
200 |
-1 |
($200.00) |
4. |
0.4 |
1.2 |
500 |
-0.4 |
($200.00) |
5. |
0.1 |
0.3 |
2000 |
0.3 |
$600.00 |
-0.7 |
$600.00 |
By Bill Knotts, Senior Pristine Certified Trainer (PCT), Junior Moderator of the Pristine Method Trading Room, Member of the Pristine Research Team, and a Trader Coach.