A Pro Trader's Guide to 'Risk Management'
Editor's note: "The No. 1 rule in trading is 'risk management, risk management, risk management'"...
Like considering location in real estate, Ten Stock Trader editor Greg Diamond says having a plan to protect your money is key.
That's one of the major advantages of using a "technical analysis" approach to investing, according to Greg... It combines a trading strategy and a risk-management system into one method.
And it's why he says technical analysis is such an important strategy. It can help protect you when things go wrong... and allow you to outperform when things go right.
In today's Masters Series, we're bringing you the second part of Digest editor Corey McLaughlin's two-part interview with Greg. In it, Greg will walk us through a sample trade... explain the risk-management strategy he recommends to subscribers... and reveal why technical analysis will "blow you away"...
A Pro Trader's Guide to 'Risk Management'
Corey McLaughlin: We talked yesterday about your background and what technical analysis is... I think it can be helpful to see it in action, though, to better understand it. Can you walk us through a sample trade?
Greg Diamond: Sure. In late March, for example, I started looking at semiconductor stocks. One of the "big boys" in this sector is Taiwan Semiconductor Manufacturing (TSM).
Among a few other things, I noticed that its recent correction was still in a longer-term uptrend and the relative strength index ("RSI"), an indicator I use often to measure the strength or weakness of price relative to history, was at an extreme "oversold" level...
Now, when I say oversold, I'm basically saying that within the RSI, there are levels that tend to mark (it is not exact) levels that warn of a reversal. Many folks like to look at the 70 level within the RSI as being overbought and 30 as being oversold.
I'll give away a little secret here today that I share with my subscribers a lot...
I take analyzing the RSI a bit further. We often look for RSI levels that apply to specific stocks and time frames. In other words, RSI measurements – different than 70 or 30 – have marked points of resistance and support on specific stocks and over a specific time in the past.
Depending on what the stock is, I might use a different number and use those levels rather than just the standard "70-30" measurements.
This brings up an important point... Each asset you are analyzing will tend to have its own characteristics in terms of how it moves up and down as well as what levels the RSI respects. Using the standard "70-30" can work, but if you research your favorite stocks and go back in history to find areas on the RSI that tend to mark inflection points, I bet you'll find a correlation that you can use in the future.
Here is the chart of TSM as I analyzed it. You'll see we bought calls when its RSI was around 50...
Now, here's something everyone should know about my Ten Stock Trader advisory...
Before I recommend a trade and send an alert to subscribers, I always try to outline the trade setups I'm watching in as much detail as possible.
Sometimes, I will see something quick and send out a trade. But the majority of the time, I have a game plan for subscribers about what new trades to expect... Subscribers are primed a lot of times for a trade before we pull the trigger on it.
In this case, I outlined the setup in TSM and then recommended buying call options, betting on the stock to rise.
The technical analysis proved correct, and the stock rallied sharply. And in just a few days, our calls were up nearly 100%. We exited half the trade with those profits, and the other half of the trade is still outstanding.
CM: So you tell subscribers what could happen, how much risk, price targets, things like that?
GD: Yes. Like I said yesterday, I'm a stickler for risk management. So I always recommend, based on a "mock portfolio," what percentage of that portfolio a subscriber should put into every trade I make.
The game plan and setup details I'm talking about outline price targets and where we will exit a trade. Again, it's all about risk management.
CM: Can you explain a little bit more about that? What do you mean specifically by "risk management"? It can mean different things to different people.
GD: If the No. 1 rule in real estate is "location, location, location," then the No. 1 rule in trading is "risk management, risk management, risk management."
No one and no system is right 100% of the time. No one. Thinking this way, you need to have a plan to protect yourself.
That is what risk management is – protecting what you have so you can stay in the game. Now, this next part is important...
My risk-management strategy in Ten Stock Trader is the position size I recommend.
Because I trade long options, the most you can lose is what you put into the trade. Using the TSM trade above as an example, if you bought $500 worth of TSM calls, the most you can lose is $500.
Since the stock rallied about 7% in such a short period of time, subscribers made nearly 100% on this trade because of the leverage built into options. Think about it another way... if you only bought $500 of TSM stock, you would have about a $35 profit.
But with buying $500 worth of TSM calls, you had about a $500 profit in just a few days.
For every trade I recommend, I have a specific position-size recommendation... so that no matter what, you know exactly how much you will lose should a trade go sour.
We are protected when things go wrong and outperform when things go right. That is great risk management.
CM: Do you recommend this approach for short-term trades or longer-term trades? Why?
GD: This is recommended on all trades, because whether you are trading 10 times a day as a day trader or 10 times a year like Warren Buffett, you must always control your risk and you must always have a plan.
CM: What's one indicator you use that might blow people away?
GD: I'm going to take a different approach to this question. I said yesterday, there is no magic formula in the markets. But this is what will blow you away...
By using a combination of various technical methods that I use to trade and educate my subscribers, what you will find isn't one indicator, but a system that will help make you a better investor and trader for years to come.
I can tell you from experience that a lot of folks come up with an indicator or model, and they claim to have it all.
It never lasts. Ever.
So out of good conscience, I can't tell you of one indicator that will "do it all"... because there isn't one. That wouldn't be right on my end to claim there is...
But what I can tell you is that I give a lot of professional tips and uncover difficult methods that I have learned over the years to all of my subscribers. The combination of these methods is what makes technical analysis so special, not just one indicator.
CM: Greg, one last question before we wrap up... If someone wants to learn more about technical analysis, what do you recommend they do?
GD: Aside from subscribing to Ten Stock Trader, of course, I highly recommend going to the Chartered Market Technician Association website. This is one of the best organizations around for learning more about all things technical analysis.
Editor's note: If you followed Greg's recommendations last year, you could have doubled your money eight different times – including a 256% gain in six days when the initial market decline began. Now, he's warning that something big is coming to the markets on or around May 10...
According to Greg, what he's predicting could wipe you out... or it could be one of the biggest moneymaking opportunities of your lifetime. And he just put together a two-minute public briefing to reveal all the details. Click here to watch it right now.