Confused about some aspect of trading? Professional trader Don Bright of Bright Trading (www.stocktrading.com), an equity trading corporation, answers a few of your questions.
When do you add to a position?
I’m an intraday stock trader. I’ve never had a problem cutting my losses, but I could use a little guidance when it comes to taking more advantage from my winners. I know one option is to add on dips. Do you ever add to a position if it starts working right after you buy it? — JKlar
Trading decisions are based on all the variables involved, not just the stock’s price movement. One variable, of course, is the time frame the trader is accustomed to. If you are a short-term, high-frequency trader, then you may choose to take small profits, or losses, several times per day. If you look at multiday time frames, then you should set price targets, for profits and losses both.
In either case, you should look at overall market conditions. Assume you bought 500 shares of Xyz at 28.40 with the premium to the day’s fair value for futures is a plus $0.50, for example. Now the stock price is $28.60 and premium has turned to a discount of $0.50, you should consider selling the long position. We also look at ticks (the net of upticks vs. downticks, pivot points, peer pricing, and the value of the most correlated pair). All of these indicators should be right at hand to help you with your entries and exits.
Similar but different criteria apply to longer-term, yet still not investments-type trading. In multiday time frames, you still look at the indicators for the best time to actually pull the trigger on a trade, but you also need to watch a few other things. Things like exponential moving averages (Emas) come into play. The “pair and peer” relationships become even more important. And good luck with fundamentals, especially earnings and price to book, come into play.
Now back to your original question about adding to a winning trade. Let me use pairs as an example of my thoughts about this. Say we want to buy a pairs spread (long Xyz, short Abc) for a $3.00 differential, basically buying the spread for $3.00. Many newbies will sell the spread at, say, $3.50, and be done with it. But if it goes down to $2.50, then they add a layer (which is fine in most cases), and if it goes down to $2.00, they may even add another layer.
So if the pair trends against them, they are “adding to losers” for the most part. At some point, they will sell a layer back, and buy again to adjust the overall position (we can discuss this at another time). But if the trade trends in the right direction, they are out with only one layer’s worth of profits. Talk about cutting profits while letting losses run, no way to run things. How do we handle this? We start our pairs with two layers, taking a profit on one (the trading layer), adding back when it is called for, and keeping the other layer until the trending is done (when the pair is now neutral vs. biased long). So if the market calls for more, then add more. A long answer to a short question, but I hope it helps to see the bigger picture.
Hedging an iron condor
I have a question about hedging an iron condor (IC) position. Let’s say you have $100,000 available to allocate to an IC. You still want some protection in case things turn south. Would it be better to use only half of the money ($50,000) for the position and keep the rest in cash, or use the full amount and use half of the premium to buy extra puts and calls to serve as units? What would give the best hedge? — heiasafari
All these strategies I played with back in the 1970s and 1980s on the trading floor (for quarter points, not pennies) have some risk, no matter what. If you negate too much risk, the actual transaction costs will overcome any possible profits — sort of like buying insurance on your insurance policy.
I suggest keeping some money to adjust positions based on price movement. Some make the mistake of leaving the initial position intact, when adjustments are called for. Overall risk reward should be the prime factor based on your tolerance, in my opinion.
Looking for clues
I have been trading for about a year, really small but enjoying it. I try to read all the news I can find to select a stock to trade. I look at a chart to see how the price relates to moving averages, and I am doing okay, but not great. What else should I be looking for?—tradindude
First of all, you might read my other response about indicators for entries and exits — that might help a bit.
But also think about this. If you watch trades on trading floors (on TV, on the web, or even in person), you’ll see that they tend to trade the same stocks or instruments daily. They don’t necessarily search for something new everyday. I teach new people to focus on two or three “children” stocks. They pick 10 symbols and do all the fundamental and technical research on them all. Then they pick two “peers” for each stock based on sector and industry groups. Then I ask them to line up all the major variables for all 30 — things like price to book, price/earnings, price/book to industry, and so on. Then do a layover chart to see how their initial picks have traded compared to these peers. And then lay over the entire market (Spx or Indu, S&P 500, Djia) to see how their picks fare against the overall market movements.
By doing this, they can better see which stocks they would prefer to trade from the long side and the short side. Check for volatility, perhaps avoiding high-beta stocks initially until they achieve a comfort level with their trading.