Prestone,

You ask some interesting questions. I want to start by saying that what follows represents what I do, but it shouldn't be taken in literal fashion as a model of how anyone else should operate. One of my basic beliefs about trading is that one's strategy must match one's goals, beliefs, values, and personality. All of us have goals, beliefs, etc., and we need to attempt to understand them (and why they motivate us) before we start trading. As stated in an earlier posting, the last half of the Sperandeo book has some great information on understanding oneself, and is as good a place to start as I know. Likewise the “Mind Game” segment at DB's Burrow. Tharp and Elder also have some guidance on this subject. So what follows in this post is the result of years of self-study and actual trading experience. I've found that my results have greatly improved the farther I've journeyed down the road of understanding the inner game of trading. My foremost recommendation is that traders should spend more time understanding themselves and why they do what they do. The mechanics of trading are relatively easy compared to that endeavor. Anyway, on to your questions:

<My overall question pertains to a goal that you may set as a percentage return, for a given timeframe. The specific goal does not matter to me, the rationale behind determining a specific goal does though.>

I don't set percentage objectives for trading. My objectives are fairly simple:
(1) To follow my methodology in an emotionally disciplined manner
(2) To analyze and understand the results of each trade
(3) To do a quarterly accounting of my trading results
(4) To continually improve my trading results over time
The analysis of each trade tells me if I'm following the methodology, and if not, where I went astray. I ask questions like “Did this stock do what I expected it to do? If not, what did it do and can I explain it? Were my expectations valid? Did I consider all feasible alternative things the stock could do prior to taking the position? Was I surprised, and if so, in what way and why?” and so forth. I also look at the actual return of the trade in terms of $, %, and the reward received vs. the original risk taken on.
The quarterly accounting lets me review my trading results for the quarter based on actual trades closed during the quarter. I look at a few things here. First, are my quarterly results consistent with my trading history over the past several years? If my quarterly results are starting to decline over a couple of quarters, then there may be something to look into more deeply. Or maybe the market has not presented me with the types of opportunities I look for. Or maybe they were there and I didn't see them. Next, I look at my historical results in similar markets (using the major indices as a benchmark) to see if my results for the quarter are consistent with my results in similar market conditions. Again, I'm looking for consistency. Next, I make sure my actual reward:risk ratio is staying above 3:1. If not, I need to look into the reasons why. Finally, I look at the win:loss ratio, again for consistency and continued improvement. This quarterly accounting is more focused on how well I'm executing my methodology than on the actual $ or % returns. I've always believed that if you have a proven methodology, if you execute it with discipline, and if you continually improve your execution, then the $ will follow. And so far this has proven to be true.

<You stated that you will hold no more than 12 positions, but all positions are equal size. Are you saying that each position you take will be a maximum of 8.5% of your portfolio?>

I hold up to a total of 12 positions (including both long and short positions). Since I do this full-time, I can manage that number of open positions. Actually, I prefer limiting this to about 8, but will go up to 12 depending upon market conditions. I guess to be fully disciplined about this I would pick a number and stay with it, but I have allowed myself this little bit of flexibility. My average open positions at any one time would be hard to calculate, and I'm not sure it would be a meaningful number. My positions are equal in size, usually about 8-10 % of my total trading account (depending upon the total number of open positions). However, sometimes I hold no positions at all. It depends upon market conditions and group movement. If I see a great opportunity and am currently fully invested, I'll look hard at all of the open positions and consider closing the one which is the current worst performer or which has the lowest current upside potential in terms of reward and risk (this is an entire subject itself).

<What I would like to get some dialogue on for this particular question is why you do not risk more capital when the risk of loss is less? For example, if you are 2% away from support, you could put up 25% of your portfolio and still be risking less than the .6375% of your overall portfolio. >

I've done some thinking and analysis in this area, and at present I prefer to keep things as simple as possible. Well, OK, on occasion, when a really attractive situation comes up (with lots of upside potential and very little downside risk, whatever that means), I'll take on a larger position, perhaps as much as double my normal position size. However, in no case will I let the total amount at risk exceed 2% of my trading account. As an aside, these types of situations, at least for me, don't seem to return results any better than other situations which aren't quite as attractive but still adhere to my trading rules. Maybe it's just me…………

<… the win-rate of 2-to-1. What percentage of your wins meet your target of 3-to-1 Risk/Reward?…What percentage of your wins actually hit your 3/1 target?… would your average win be 18% vs. an average loss of 6%?>

This is starting to get personal, so I'll answer that question to the extent I feel comfortable. In my methodology, the win:loss ratio is easy to calculate. A winner is a stock which has a positive return after expenses, even as little as one dollar. A loser is a stock which returns a loss, no matter how small. The win:loss ratio, while important, is less important than reward and risk. The key (for me) is to maintain an overall reward:risk ratio of at least 3:1 for all trades. So, a winner with a return of only 5% would reduce the reward:risk ratio. Of course, a winner of 55% would increase the ratio. Over the past several months, about 75% of my winners have reached or surpassed the 3:1 ratio. None of my losers have gone below the original risk threshold of –7.5% per position. I've been able to maintain a total reward:risk ratio of at least 3:1, meaning that in the aggregate the gains from all winners have been at least three times the losses from all losers. This includes those winners which were closed at lower profit percentages. I should note that about half of the winners over the past few months have been short positions. Please note that I'm not recommending that anyone start shorting stocks just to increase their returns. However, with significant study, analysis, and most of all discipline in staying with your trading rules, shorting can be a valuable addition to one's trading methodology. There unfortunately aren't many good sources of information on shorting, but the discussion in Weinstein's book is probably a good place to start. My recommendation is to read the charts, understand what you see, and do lots of studying in order to get comfortable with shorting.

<I am just curious if your "Business Plan" has led you far enough that you have forecasted percentage return goals and been able to meet them. If so, what pitfalls have you found with this? Perhaps you went down this path in the past and abandoned it for some reason?>

I don't try to forecast anything. I just watch the market, try to be a good listener, and try to hear what it's saying. I do believe that markets (and groups and stocks) tend to move in trends, and that chart patterns repeat themselves over time. To understand chart patterns and trends, I believe it's important to understand what causes them. This brings us back to understanding investor psychology. In my opinion, investor psychology, when taken in the aggregate, results in positive or negative interest in a stock, which result in demand or supply, which are expressed in trading behaviors, which can be detected in chart patterns. And I believe that aggregate investor psychology tends to be somewhat consistent (I'm not saying predictable, just consistent) over time. Thus, chart patterns tend to repeat. Again, just my opinion, but this can be useful in increasing the probability of success in trading. By reading lots of charts from lots of different timeframes, one can start to “see” the trading behaviors in the charts.

Now, to answer your question specifically, I rely mostly on support and resistance to identify upside and downside potential. Again, I don't try to predict what a stock will do; I merely study its chart to see what it has done by using the historical chart patterns of a specific stock. I'm not forecasting a target price, but merely coming up with a set of alternatives relating to what a stock might do. For example, if there is significant support at a level 5% below the current price of a stock, then one alternative is that the stock will stay above that level. Another alternative is that it will break through that level. If there is also strong overhead resistance at 22% above the current price, then a third alternative is that the stock's price will rise as high as that level, especially if it has done so in the past. A fourth alternative is that it will break through that resistance. A fifth alternative is that the price will do nothing and stay where it is. Etc…………. Then, for each alternative, I study the chart to determine, at least in my own analysis, the likelihood of each alternative based upon the chart's history, the type of chart formation, the stock's group, the market, and so forth. If the likelihood of an advance to the overhead resistance at 22% appears to be as good as a drop below the 5% support underneath, then the stock meets my criteria of at least 3:1 reward to risk, and I'll take the position should a breakout occur. This is certainly over-simplified but I wanted to make sure not to understate the issue.

<If you have set specific goals for a set timeframe, have you found yourself making more trades or less?>

I try to make only as many trades as I need to make based upon the opportunities presented to me by the market. I agree with whoever said that most money is made in the markets while we are waiting (I think it may have been Mamis). When I find myself over-trading, my returns usually drop. Again, it's a matter of discipline in following one's methodology.

I must apologize for two things. First, this was a very long post. I hope at least one person makes it all the way through. Second, I don't feel that I provided fully adequate answers to any of these questions, but that would have taken several more pages, and I would not have made it through myself. I wish you well. Thanks for your interest.

-tradermike