Position Equalization – One of The Most Important Stock Swing Trading Techniques
Today topic is going to be Stock Swing Trading Techniques – How to balance or equalize your positions.
Last week I wrote an article about relative strength between two related stocks or other related markets. I used the SP Stock Index and the Nasdaq Stock Index as examples of this. If you missed the article or the video, there is a link to both immediately below this article.
What Is Position Equalization and Why Is It So Important To Understand
Let me give you a quick example so you can quickly see why this is so very important for you to understand. Let’s say you trade stocks and you trade more than one stock at a time. Now let’s say for example that you trade two stocks using the same trading strategy. For the same of simplicity, let’s say you trade breakouts and you pick two unrelated stocks to avoid correlation. Your first stock is Clorox, the bleach manufacturer, here’s what the stock looks like before you enter your order to go long.
In addition to buying Clorox, another stock is also setting up for a breakout pattern and it happens to be an unrelated software company so there should be minimum correlation. You may have heard of this company a few times in the past too. They are the largest personal computer security company in the world.
One stock sells bleach and the other one sells security products for personal computers, totally unrelated which is great. Now we have to figure out the most important question, how many shares do we buy of each stock.
If you don’t make your positions equal, your profits and loss from each position will be different and your trading results won’t be balanced.
For example, let’s say you have 7 winners and 3 losers, if your winners are $1.00 and your losers are $3.00, your trading is not balanced. Your losers and your winners should be very equal in size to each other.
This way regardless of what market you trade against another market, it will appear dollar wise like your trading the same markets. When looking at your brokerage equity report, the size of your winners and losers should be approximately even between your entire portfolio. I know one trader who would bet 100 shares across all stocks but some stocks moved 4 points per day and others moved 2 points per day so his losers and winners were not balanced and there is no way to create a trading strategy when your positions are not equalized to each other.
Just imagine you trade two stocks and the one you bet the least on wins the most, this is not what you want, you want each position to be as equal to your other positions as possible. Here is the easy process that will help you trade any stock swing trading techniques using balanced positions.
Tool that I use to equalize my positions is the ATR indicator. The ATR stands for Average True Range and it’s simply a daily calculation of the average trading range of each stock. You can figure out this yourself, but most trading software online and offline has an ATR indicator already build in.
All you have to do is set the Average Range to 10 days, it’s usually set at 14 days by default. The ATR indicator will tell you what the average trading range is for each stock that you trade. In our example, Clorox has an average range of .74 cents per day while Symantec has an average daily range of .43 cents. You can easily see that Clorox is almost twice as volatile as Symantec, so trading equal shares wouldn’t produce a very even profit to loss ratio between both stocks.
1. Start with figuring out how many shares you want to trade for most volatile position out of the two stocks. In our case, Clorox is clearly more volatile than Symantec, almost twice as volatile, so we will figure out how many shares of Clorox we want to trade first and then equalize Symantec to that level as well.
To make this simple let’s say we want to trade 100 shares of Clorox stock and you want to know exactly how many shares of Symantec stock will give you the same “bang for your buck” as Clorox stock. 2. Simply divide the larger position by the smaller position and multiply that number by the shares.
In our example the larger positions ATR is .74 and the smaller positions ATR is .43. (You would divide .74/.43 = 1.69) and multiply the result by the amount of shares you chose to trade the more volatile stock. 3. Since 100 shares were chosen for Clorox stock, you would multiply 1.69 * 100 shares = 169 shares of Symantec stock for every 100 shares of Clorox Stock.
Many traders focus so much on being profitable, that they completely ignore the most basic and important principles such as making sure both positions have equal risk and reward profile. Regardless of the stock swing trading techniques you pick, you need to make sure your trading apples to apples and not apples to oranges. Take a look at how both trades would have worked out for you below.
Position equalization is one of the most valuable stock swing trading techniques I know of. Next time i will discuss using the ATR to help pick the best stop loss levels to avoid volatility.
For more information about different stock swing trading techniques, please visit our blog. Wishing you the best, Roger Scott Senior Trainer marketgeeks.com
For more information on this topic please go to: Technical Trading Strategies – The Tail Gap Strategy Revisited and The Best Technical Analysis Method
Wishing you the best,