High Heeled Traders

What I’m going to tell you is probably something not discussed in most Trading books. I know, there are books about “Secrets”, “Edges” and others using marketing buzz words but guess what, they missed this! hehehe

Trading as we’ve talked about before, is fluid, sometimes erratic business. Yep it can get crazy. So you want to learn what will help you to be profitable, (not lose all of your money first of all) and eventually with the right skills to go for the stars! So the very first lesson I ever ever everrrrrrrr want to share with you is to Learn to Last.
Here’s what helped me to keep going :
1. Financial concepts
2. Psychological well-being
3. Physical activities
I will first discuss the Financial components in this article. Otherwise you won’t finish reading this until tomorrow 🙂

Learn to Last FINANCIALLY

I mentioned introducing myself in this blog that I started to attend seminars on Financial Freedom after starting to work in IT with long hours and getting slapped with high taxes. I think it is very valuable to get financial education through books, seminars and talking to people about their experience.  Not all of them might be useful, analyze the information,  doing so will improve your knowledge and sophistication.  I came across these 3 concepts that I feel greatly helped me in my Trading and Investing, as I started out with very limited funds.

Velocity of Money

I first heard this idea in a Robert Kiyosaki CD series on building wealth. The Velocity of Money is an economic term that the St. Louis Fed (part of the US Federal Reserve System or central bank of the US) defines as “the rate of turnover in the money supply” – OR the number of times one dollar is used to purchase final goods and services (included in GDP).  For example, a hairdresser and a dentist has 100 between them. The dentist goes to the hairdresser for a haircut paying $20 every time, and goes every month.  The hairdresser has teeth cleaning done every 6 months and pay $100 each time. For one year, together they made $ 440 from their services  with $100 to start with.
http://research.stlouisfed.org/fred2/categories/32242

Back when we started in Sydney and was living in one income, with limited funds to use, I hung on to this idea everytime I look at something to invest. I thought I should aim to use my 1 dollar several times to buy my investments. So when investing, use a combination of products or strategies, aim to get your money back quickly and use it to similarly buy / create another investment. Do it again and again and again. You can do magic with this idea! 🙂

Infinity

When making an investment, we calculate how much we can get back, we meet the terms Return on Investment (ROI) or Yield. That presumes that we still have money invested and it is “returning” money back to us. What about if we don’t have money invested anymore (we’ve taken it already), but we still hold the investment and still we get money coming to us? WOW! That’s a return of Infinity. This is an old old old concept in Mathematics that basically mean “no limits” … Try this : take the calculator and get the Return for this investment — For monthly rental income  put in 150 multiplied by 12 months, divide it by zero.  What did you get?   Mine says – Can’t divide by 0. That’s because the calculator has no imagination. Whereas humans, we are equipped with great minds to make money from nothing 🙂

Position Sizing TM
As you can see, I’ve had to put the letters “TM” after the word – it is to denote that this term is a registered trademark (by Dr. Van Tharp) .  In my opinion this subject should be one of the VERY FIRST concept to ever be studied by traders. Because it’s one that would help traders to survive the learning process. I lost all my capital in 3 months when I first started to trade. The account balance just started to dwindle when I lose on my trades and eventually got wiped out.

To make it easier, think that  it’s like buying shoes… (really?!)   We buy a lot!  Formal shoes, running shoes, many styles of sandals, boots,  according to color, material etc.     You have to have a range of shoe options for your lifestyle.  Point is you have got to budget for all this kinds of “shoe  situations”.    You shouldn’t  spend too much on one shoe.   So this important  lesson in Trading is that you have to keep how much you risk  at an amount that does  not blow out your budget and be able to fund next opportunities.

Position Sizing TM is a way to determine “how much” to risk in any one position.  To clarify, this is not the amount you spend on a trade, but rather the amount you are willing to lose for that trade.   You decide on this prior to trading anything, telling yourself how much you are willing to lose per trade, as a percentage of your capital.    And when you are just Learning, the “how much” should be small so that you preserve your capital while still be able to profit from an opportunity. Say for example, you have $5000, you want to preserve 80% of your capital or $4000, you then have 1,000. Of this 1000, you want to budget for a string of losses (say 10) which will give you $100 to risk in a position. (fees are excluded here for simplicity but note it could cost $45 to open so $90 to open and close the transaction).
5,000 capital
4,000 amount to be preserved, at 80% of capital
1,000 amount to be risked at trading opportunities
10 number of successive losses you are willing to tolerate
100 the amount you will risk in a position

$100 or the 2% of $5000  is your  position size(tm)

Is this a small enough risk for you?   100 is already 2% of your capital.  If not,  you should probably build up your capital, gain more knowledge and test your system and skills  until you are comfortable to risk this amount.

Position Sizing TM   to preserve and grow capital is discussed extensively by Dr. Van Tharp in his book “The Definitive Guide to Position Sizing” .  He also has a free trading game that can be downloaded from his website www.vantharp.com.  If you haven’t done so already, please go to the website and get your trading education on the right track!

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Show Me How It’s Done!

Here’s my experience using all the above concepts – Note that the market when we were doing the transactions may be different from the prevailing market. Do not do this without TESTING and if you want to talk things through with me, send me an email!

Trading Stock Options

I was looking at Oil stocks because  Oil  moves a lot (up / down) plus it’s getting more expensive and want to be protected from Oil price increases by earning money from the stock trading.  The stock I was trading at that time is  Santos (STO ) priced at around 12.50 per share.   I bought 1000 shares which will allow me to “write”  1 Call Options contract.  (1 contract = 1000 shares).   I will just make it very simple here for now – with “writing” a Call Options contract, I am giving someone else the right (but not the obligation) to buy my 1000 shares at the “strike price”– for example  13.00, this contract will  expire in 2 months.  To have this right, the other party (called the Taker)  will pay me 30c per share (called the premium) which I keep no matter what happens.   I will also hold the shares (and  earn the dividends that may be payable  which is 42c per year for this stock).

The Taker believes the stock will move up strongly in 2 months, however will only be profitable above 13.30 (the strike price of 13.00 and  the 30c premium spent for the Options contract)

Move in Favor of Position

If the price moves down or up but below 13.00 when the contract expires,  I keep my shares.  In this case,  I will get  30c profit per share and can write another Call Option Contract for another 30c per share premium payment.  Getting 60c per share altogether for 4 months.   I can repeat this several times, say 6 times a year (write contracts every 2 months).

12.50 – price I bought the share

13.00 – strike price at which I am selling my shares

.50 profit when price reaches strike price

.30 payment received from the 1st Options contract = 300 for  1000 shares

.30 payment received from the 2nd Options contract = 300 for 1000 shares

.60 total of premium payments received = 600 for 1000 shares  for 4 months

Move Against Position

If the price moves above 13.00 when the contract expires,  I may have to give up my shares.   In this case,  I will get  80c profit per share

12.50 – price I bought the share

13.00 – strike price at which I am selling my shares

.50  profit = 500

.30 payment received from the Options contract = 300

.80 total profit per share = 800 profit for 2 months

** Since I own the shares, I can choose to keep my shares and instead write another Call Option at a higher Strike Price, say 13.50.  To close an earlier transaction, I buy back the Option that I sold. More on this on an Options discussion later.

When Prices Go Down

I take some of the   income  (Velocity of Money concept)  from writing Call Options to buy Put Options to protect the value of my stock.  Put Options gives the right but not the obligation to sell stock – you use the strategy if you think prices are going down.   In this strategy, I am the Taker and I am paying the premium to sell the stock to the  Writer of the Option at the strike price.  Say STO price has moved up to 13.60 and despite good news from the market the stock has not moved up further from this price after a continuous rise (maybe investors think it’s gone up too much and already expensive and unwilling to pay more).  I think the price will go down below $13  in the 1 week to expiration of a Put Options contract  and I am looking at risking very small – 5c per share  to this position or  $50 per contract.  I spend $100 for 2 contracts which  conforms to my  Position Sizing TM      rules.    In the next days, the price moved sharply down to 12.80, the value of my Put Option is now 20c which I sell to close the transaction and receive a profit of 15c per share or 300% return.

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The Important Thing

Note that since I own the shares, I can do the 2 strategies together.  With the aim of using income earned  by the Shares in Writing Calls (Velocity of Money concept)  and Buy Put Options which I  limit  to $100 to observe my Position Sizing TM rules .    With  this Low-Risk High Returns strategy, I can build up capital,  even take original capital out and  just use all the profits to use in the business which can give me a return of Infinity.

Even if you don’t generate the same returns as the examples above, whatever happens, you receive money from the Call Option so even if you don’t profit from Buying Put Option (at which you only risked small – $100) – you still have money left over  plus the shares, your original investment.   You will be able to continue your learning process with your capital. You will survive!!!

To quote Buzz Lightyear, To Infinity… And Beyond!

TRADING STOCK OPTIONS
Purchase of Shares  
12.50   purchase price of STO
1,000   number of shares in 1 Options contract
12,500   total investment  to buy 1000 shares of STO @12.50
     
Income from Writing Call Options
13.00   strike price at which I will have to sell the shares
0.50   profit from strike price less purchase price
0.30   premium payment  per share – 1st Contract, expired
0.30   premium payment  per share – 2nd Contract, new
0.60   total premium received for 2 Contracts
     
Return on Investment
1,800.00   income fr writing Call options in 1 year (every 2 months)
500   profit from sale of 1000 shares  @ 50c
420   Dividend payment for 1000 shares @ 42c
2,720.00   Total income from sale of Shares, Dividends and  Options
21.76%   Rate of Return on original investment (of 12,500)
     
Income from Buying Put Options (to profit from view of prices going down)
13.6   share price, which you deem high and would go down
0.05   premium paid per share for buying Put Option
1000   number of  shares per contract
50   premium paid per Put Option contract
2   number of contracts
100   total amount risked in position to Buy Put Options
     
13   Strike Price of Put Option
12.8   last share price (few days later)
0.2   value of  premium at 12.80
0.05   premium paid per share when buying Put Option
0.15   profit from selling Put Option
300   Total profit from trading Put Option (total proceeds was $400 = .20 x 2 contracts)
300%   Return on Investment  on Buying Put Option
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