Are we in a primary bear market? Between Monday 11^th April and Monday 8^th August the All Ords index fell by 19.9%, just 0.1% shy of technically making a crash. Since then its recovered ground, but is still more than 18% below its last peak.

The occasion of a death cross (when the market’s 50 day moving average falls below its 200 day moving average) is a bad portend for the market since its occurred only three times in eight years. But half of death crosses prove false alarms as we saw in mid 2010.

Analysts are debating whether conditions now are better or worse than they were on the 1^st November 2007 after which the All Ords descended by 55% until the 6^th March 2009.

The case for Better is:

• The last share market peak in April 2011 was still 26% below its previous peak in Nov 2007 so the market has less to fall.
• The forward price/earnings (PE) ratio for the Australian share market is around 10 which is 30% below its 10-year average suggesting shares are already cheap.
• Investors are less leveraged in shares and theUShousing crisis has stabilised though not improved.
• Companies and banks both here and abroad have recapitalised and deleveraged so their balance sheets are much stronger than in 2007.
• Most banks now know their counterparty risk so are lending to each other which they weren’t in 2008.
• The world economy is still growing albeit it slowly. Many companies are enjoying record earnings thanks to cost cutting and productivity improvements.
• The world’s leading central banks by offering 3 month US dollar loans to European banks have demonstrated a resolve to avoid a Lehman Bros like collapse.
• World leaders are much better briefed and prepared for an economic crisis than they were four years ago.
• Germanyhas no choice but to rescue the Euro if it wants to avoid a financial contagion that could plunge it and its neighbours into depression.
• The Chinese craving for Australian resources is set to remain strong helping to prop up our economy even if domestic demand for goods and services is weak.
• America’s Federal Reserve Bank has promised to keep interest rates low for another 2 years and is likely to come to the rescue with more money printing (QE3).
• Australia’s government debt and deficit relative to the country’s GDP is much lower than that of almost every other developed country making us a safe haven. See chart below.

The case for Worse is:

• The global financial crisis (GFC) never went away – the excessive and toxic debt of banks was merely shifted to governments and central banks.
• Large economies likeItalyandSpainrisk a debt trap likeGreece,IrelandandPortugal, yet are too big to be rescued by the European Central Bank.
• Many European banks are heavily exposed to the debt of Mediterranean countries which if they default will leave the banks insolvent.
• Americahas lost its triple-A credit status and could be downgraded further proving it’s no longer too big to fail especially if the US dollar lost its reserve currency status.
• Governments now have too much debt and too large deficits to afford another round of stimulus and rescue packages.
• Central banks have cut their interest rates to almost zero so can’t cut them further to avoid a double dip recession.
• Central banks risk more asset bubbles like those of commodities, precious metals and shares if they turn to the printing presses once more.
• Three in four German voters oppose their government rescuingGreeceor any other country so their Parliament may not approve further action.
• Political leaders around the world no longer have the political authority or fiscal ammunition to act decisively should there be another meltdown.
• Chinais already battling high price inflation (6.4% per annum) so won’t resort to a massive fiscal and monetary boost as it did in 2008.
• P/E ratios only look low because earnings have been boosted by government stimulus which now is going into reverse inAmericaand elsewhere (see next chart).

How the ongoing GFC drama pans out from here on no one knows. But what we can say is that being out of the market at present is being out of harm’s way. Should it crash further a trend-timers like myself shall continue to stand back and watch it fall until the trend reverses. Should it bounce back we will catch the uptrend for as long as its lasts. Bear markets are manna for market timers because they eventually allow us to buy back shares (i.e. exchange traded funds) at fire sale prices.

Investors without an objective and disciplined market timing system intently watch the news and worry whether to exit the market or hang on. And if they have already left the market they are not sure when to return.

It’s interesting to observe the contradictory opinions of so called market experts since it corrected. Most fall into the category of “we have been telling you the market is sick for a long time” or “everything will be OK as long as you hang on for the long term”.

The first group never alerted their readers when to actually get out of the market. The second group refuse to acknowledge we have been in a secular bear market since late 2007 (Americasince 2000) which based on precedents (1929-42 and 1966-82) could last for a long time.

During such periods ordinary share investors experience a rollercoaster ride only to accrue dividends assuming the companies they have invested in survive. In real terms (after inflation) they lose capital. By contrast a trend follower uses exchange traded funds (that diversify company risk) catch the market’s upswings and avoid its downswings having a smoother ride and making good money.

Note in the next chart how even an ultra-conservative trend-timing strategy (which issues the very few buy and sell signals) avoided the worst of the 2008 crash yet got back into the market in s time to enjoy the strong rally of 2009.

Trend traders that adhere to a proven strategy can relax knowing they are on the right side of the market whether it’s soaring or correcting. Yes, there are occasional whipsaws, but these are small insurance premiums for staying out of every crash and catching every rebound.

Percy Allan is Chairman of Market Timing Pty Ltd. For more information about trend-trading visit www.markettiming.com.au

In the last article I discussed two examples of how and why volume can show the changing face of supply and demand. When the order of supply and demand is change we will get a change in market direction, sometimes a significant change in trend or otherwise some degree of retracement of the prior move. We will now continue on from that discussion and show larger periods of transition which can lead to quite substantial turning points in the major trends. These can be easy to identify, but do require some patience. If you did not read the prior article it would now be worth reviewing that before going on.

Let’s firstly take a look at AWB Limited.

Since early 2006, the price of AWB had been in a downward spiral. The story that eventually came out suggested AWB was doing some bad business against the UN sanction in Iraq. The initial shock sent the shares plunging by 18% in a single week.

This is a sure sign of a change in sentiment and it’s not exactly rocket science to know there must have been some kind of bad news that changes the outlook.

But what is important here is that this significant sell off is actually the first sign that strength may start to appear in the near future. As I discussed in the first article, demand strength actually starts in price weakness and here is a sign of capitulation. A wide ranging bar on increased volume is a sign of panic and when we see panic we can usually expect that a bargain could be in the offering, but this is where the patience is required. What we usually start to see after capitulation is a transition from sellers to buyers. This transition has two important characteristics; firstly it takes some time and secondly prices do tend to drift lower. Let’s zoom into the AWB chart at Area 1 and also add our volume indicators.

Bar 1 is the capitulation; a very wide ranging bar and ultra high volume. Remember that ultra high volume is signaled when the volume histogram penetrates the volume Bollinger band. Bar 2 gaps lower but closes on the weeks high and does so on high volume. This is a sign that the Smart Money is interested in buying. There is no other way that prices can close higher on increased volume if buyers were not involved. Bar 3 however shows sellers returning; a push lower, a low close and another increase in volume. Bar 4 is the turning point and is a sure sign that buying interest is occurring. This is the time to start thinking that this market will turn higher soon. This bar shows a move to new lows but a complete rejection, i.e. a high close and very high volume. We’re seeing the Smart Money taking positions, even though the stock is drifting lower. Now take a close look at bars 5 and 6. What happens? Essentially they are inside days with a slight downward bias but look at the volume? There is none. Volume has dried right up. This means that sellers are done; they’re exhausted. Those that wanted to sell have either been fulfilled or do not wish to chase prices any lower. Bar 7 sees another probe lower, another high close and yet again a rapid increase in volume. Combined with bars 2 and 4, both of which show background strength, this is continued evidence that the stock is being accumulated. It’s only a matter of time before enough of the supply has been accumulated that prices will start to rise again.

For the next 2 months AWB rallied 34% off that exact low. The first signs of upward price momentum would be the signal to initiate longs. We have the Smart Money footprints in the volume so we just need to time the entry for our own comfort. Take a look at the bars from that low. All down bars had low volume; all up bars had high volume. There was a specific transition from sellers to buyers which led to a reasonable, albeit unsustainable, price rise.

The following chart shows that advance in more detail. Bar 8 was a very promising bar indeed; a wide range higher, a high close and a good increase in volume. With the high close we can deduce that buyers had the control. Bar 9 is an important bar for current longs. It shows an attempted push higher, a reasonably tight range but more importantly a weak close and solid increase in volume. This is the first time that sellers had come back to the market. Now these sellers can originate from two sources; either profit takers that bought at lower levels, after all, it was a rapid rise in quick time which will always create profit taking; or it is very old longs who were waiting for the evitable bounce to get out of their positions. We’re not to know which, but what we do know is that selling has emerged and that caution is required.

Bar 10 shows a rise into new recent highs but a close on the absolute lows. This is of paramount importance – what does it mean? Bar 9 identifies sellers because we had a weak close on high volume. Immediately following, Bar 10 shows a low close on low volume, which suggests buyers have disappeared. If buyers have gone, who is going to support the market if those sellers from Bar 9 decide to chase prices lower? Nobody. If there is no buyer demand or buyer support then prices have the risk of falling until buyer demand comes back again. And that is exactly what has occurred.

Let’s move forward to Area 2 where prices fall through the early lows set in Area 1. Please refer to the following chart.

Bar 11 makes a low at $3.57, has a close off the lows and shows a mild increase in volume. The $3.57 level is important because the lows made on Bar 7 were at $3.55 which is where the prior buying entered the market. It could be easily argued that we will see those buyers back again at this level. So the minor increase in volume and a close off the week’s lows is an important sign when they correspond with an old low to the left. Prices continue to drift lower as weaker hands stop out below the lows made earlier in the year. However, although Bar 12 closes off the lows it’s quite a low volume bar not quite conducive to a significant change in supply and demand. Prices move sideways on low volume until we see Bar 13 take out the major lows and close on those new lows. The difference here is that volume is poked up through the volume Bollinger band suggesting ultra high volume. Again, this is probably a sign of capitulation as it’s a clear break to new lows suggesting sellers in control. But look at bar 14. Is that not the very same thing we started to see on Bar 2 of the first chart? A wide ranging bar down, a high close and massive volume. In fact this could almost be construed as a blow-off low, although the range is not quite wide enough for a text book example of such. Nonetheless it does show that buyers are in again. The following bar is a down close but volume has dried up – sellers exhausted? Bar 15 takes out the lows of bar 14 by 2c before rallying hard and closing high. Again, volume was very high suggesting that buyers are stepping up to the plate.

Interestingly enough this current price/volume activity is occurring immediately before the findings of the Cole Inquiry. Does the Smart Money know the outcome already? Remember in article 1 I suggested that good news tends to precede a fall and bad news a rally? Would the release of the report be considered potentially damaging news? Yes it could. We know the old adage that things look the worst at the low and best at the top but it is possible that volume is suggesting that the worst is over and that quite possibly we’re going to start to see prices trade higher.

The very last bar on this chart was the release of the report to Parliament. We have a probe above the small ledge but a lower close than the open and a rapid increase in volume. This is not an immediately good sign because it does suggest strong selling. Therefore we’d need to assess the volume/price relationship of the coming few weeks to better measure the willingness of the buyers seen at bars 14 and 15.

All in all, the relationship and volume/price is a very strong measure of subtle changes in supply and demand and can lead to both minor and major changes of trend. Therefore it’s beneficial for both traders and investors alike to really understand these nuances so they can better position themselves for new trades or offer warning signs for current trades.

Nick Radge “The Chartist”

http://www.thechartist.com.au

The power of correct volume analysis cannot be overlooked. Unfortunately the ability to read volume correctly is not readily discussed or freely available. Off-the-cuff remarks such as, “increased volume on advances is bullish and increased volume on declines is bearish” are bantered around but that’s as far as it goes. The correct use and application of volume can make for some quite startling insights into price action, especially when one is swing trading or leaning against support and resistance points or zones of confluence.

I set up my charts with a couple of extra volume measures. I use a normal volume histogram that can be found with almost all software packages. However, if there is a larger volume spike skewing the ability to read the volume properly I will edit the data accordingly. Next, I add a 10-day moving average of the volume. This gives me a guide as to what is below average or above average volume on any given day. Lastly, I add in a 2- standard deviation of the 20-day volume average. Essentially this is like the upper Bollinger band of the volume average. This shows me when ultra-high volume occurs.

Figure 1: Chart Setup for Volume Analysis

With these added extras we can quickly gauge the personality of the day’s volume as well as benchmark it against the surrounding volume. The exact volume reading is not important. The concept of relative volume is the key.

I’m going to make reference to The Smart Money throughout this article. The definition I use for the Smart Money is:

A group of professional users that act in unison at very specific levels and points of time to change the order of supply and demand.

The Smart Money are the ones who constantly buy the lows and sell the highs. Let me say that this is not a bunch of traders ringing around attempting to manipulate the price. We don’t need to know who or why but these are the people we wish to follow. We do so by watching their footprints, and their footprints are shown within the daily volume. The Smart Money will show their hands by selling into strength and buying into weakness. As the Smart Money can change the order of supply and demand we can therefore ascertain that strong price action may in fact contain weakness and weak price action may in fact contain strength. I appreciate this may go against most things you’ve learnt about volume but it’s important to keep that thought in the back of your mind. Increased supply, and therefore weakness, may occur during price strength. Increased demand, and therefore strength, may occur in price weakness.

The first thing to understand about volume is that it’s not just the volume by itself we’re interested in. A major misconception is to think that for every buyer there is a seller and in turn volume is null and void. If that were really the case then prices would simply not move. What drives prices is the fear and greed of the buyers and sellers. It’s therefore the relationship and interaction between volume and price that shows us what is really occurring in the market. Think of volume as the effort of one side and the price activity as the result of those efforts. If sellers are desperate to exit then they will be more inclined to sell at the bid rather than sit back on the offer. If there is not much buying demand below the market then prices are going to be driven lower until those sellers are fulfilled or are unwilling to pursue prices any lower. Conversely, if buyers are desperate they will buy the offer and not sit on the bid. If buyers are desperate and there is not much supply above the market then you’re going to see prices move up until those buyers are fulfilled or unwilling to pursue prices any higher.

The mantra of volume analysis is:

“What is the result of the effort?”

The most basic example of a volume/price relationship pattern is a straightforward blow-off top or bottom. As technicians we all know what these are and we also know what they tend to mean. Figure 2 shows a perfect recent example of a blow-off bottom in Lihir Gold (LHG).

Figure 2: Typical blow-off low in LHG

The gap opening on that low day means sellers were indeed desperate. There is no other way to account for that gap except simple selling pressure. They over-ran all buyer demand until they were fulfilled. They even managed to keep pushing prices lower. But remember, previously I suggested that demand strength occurs in price weakness. LHG had certainly been declining up until that point. So, if there was no demand strength, how could prices rise from thereon?

The demand strength is shown by the effort and the result. Effort was certainly very high because volume was very high, in fact ultra high. This means a substantial number of transactions took place between buyers and sellers. But, what is the result of that effort? The result of that effort is that the market closed on its highs for that day which means that buyers have clearly over-powered the desperate sellers. When a lot of effort or a lot of volume takes place we know the Smart Money is involved because they are the big players and they are the one’s that can change the course of supply and demand. This is a prime example where the Smart Money has decided that LHG is a value buying proposition and they move into the market to absorb the selling volume. They are the stronger party. It’s the weaker hands capitulating. This is why I said that demand strength will appear on weakness. If the Smart Money have absorbed all the selling volume and the sellers are fulfilled, how can prices go any lower? They can’t, is the answer. And if prices can’t go lower then they will tend to go back up because now there is no overhanging supply capping the market.

Let’s look at the exact same concept but without the blow-off. Remember the core thinking; increased supply and therefore weakness may occur during price strength and what is the result of the effort?

Again we’ll use LHG but note this time the absolute high bar is a very small tight range and not the standard blow-off that we’re normally used to seeing.

Figure 3: The Smart Money appears at the absolute high

Firstly, the volume is extremely high, almost ultra high. We therefore know there are a lot of transactions taking place and in turn a lot of effort being put into the day. So what is the result of that effort? A very tight range with the close on the lows and below the open. What does it suggest? Clearly the sellers have overpowered the buyers. The buyers must have been desperate because prices have been gapping higher and they were most likely desperate from probable good news.

Ever heard the saying, “buy the rumour, sell the fact”? Do you ever wonder why prices go down after a positive announcement? Do you think the Smart Money knew the facts or the good news beforehand and the reason why they’re already long? I think so. So when the good news is announced to the market all the weaker hands jump in and start buying and the Smart Money take the opportunity to offload their positions into the demand strength.

Look at that LHG chart again in Figure 3. Prices were already trending higher. The Smart Money has already bought because they knew what was coming. When the announcement came they took their profits and sold their positions to all the latecomers. The force of buying from all the latecomers was large. We know this because the volume was high. But the force of the Smart Money selling and standing firm in the face of large buying was even larger and is why the days range was so small. If the Smart Money thought prices were going to travel higher, then they would not be selling and we would’ve had a wide ranging up day on light volume. But because the Smart Money knew that prices would most likely not go any higher, they stood their ground and simply offered their supply into the buying from the weaker hands.

Let’s think about what all those weaker hands are thinking at the close of that session. Good news has been announced. I bought the stock accordingly but it’s now closed below where I purchased it so I’m wearing a loss immediately. You can see them almost scratching their heads! Because the Smart Money had absorbed all the buying demand there is now no follow through buying demand. All the weaker hands are all of a sudden slightly nervous. Any slight weakness will see them exit their positions. They wait a day or so in wonderment but look at what occurred on the 3rd day after the high. A down day on increasing volume. Those weaker hands that bought the highs have had enough and are getting out whilst they can. They walk away with yet another loss but none the wiser as to why prices didn’t go higher on the good news.

So whenever you see a very tight range at new highs or lows that is accompanied with ultra high volume, you know the Smart Money is trading the other way. They are large enough to change the trend so you’d better listen.

These are two simple examples of reading volume correctly. There are many more to be aware of, but remember the mantra, “what is the result of the effort?”

The best book on volume/price analysis is Master the Markets by Tom Williams who is the Richard Wyckoff of the modern era. Its 190-pages packed with volume and price characteristics and I rank it as one of my top-5 trading books ever.

Click here for part 2

Nick Radge “The Chartist”

http://www.thechartist.com.au

In part 1 of this article I discussed two separate issues as to why people attempting to trade the markets fail; the first was knowledge, the second psychology. I will now reveal the observations I have made over many years, which are really sub sections of these issues.

“When it comes to trading the markets there is a vast difference between knowledge and understanding”

I was once told by a wise person that investing without knowledge was gambling. At the time I tended to agree, but it wasn’t until I started investing that I really understood the essence of this message. What I have learnt over the years is that gaining knowledge was one thing, but gaining the right knowledge was critical. It has been my experience that when learning to trade the vast majority of information and education is of little use to most people, and hence why so many fail. More importantly, what I found is that once I had gained the knowledge I wanted to know whether I really understood what I had learnt. Let me explain…..

I can intellectually tell you about many things, such as how to fly a plane, but do I really understand how to fly a plane and would you be safe flying with me? The short answer is no. People read books and attend free or weekend seminars in an attempt to learn how to trade, however, in my experience all they really get is a little bit of knowledge and very little understanding. Let’s face it, would you really trust your money and financial future to a person who has attended a weekend workshop, bought some DVDs or read a few books?

The cold reality is that trading is one of the few things you can do where you know from the outset you will lose money. The issue I find is that whilst all traders agree with this statement on an intellectual level, the majority never believe it will happen to them. They say ignorance is bliss, but in trading ignorance can be very expensive, and in many cases more expensive than getting a good education.

It is common for those new to trading to trade markets that are high risk, to take on more leverage than they can handle and to get their information from all the wrong places. Ignorance leads to over confidence, especially if the person has been successful in other areas of their lives. Over confidence leads to over trading, trading short term and making poor decisions based on a perception that the trader is ‘bullet proof’. Many only find out all this when they lose their money.

The common theme amongst many traders who fail is that they falsely believe they can get rich quick by using very little money or time. This get rich quick idea is perpetuated by the many ‘would be’ share market educators and their free seminars or DVDs. Sadly, whilst this is a romantic idea it is a fallacy to think that a trader can be successful without a proper education, the right skills and experience. The market doesn’t care how much you think you know or that you might only have a few thousand dollars, it just does what it wants to do irrespective of whether you make money or not.

Learning to trade is a journey, and after having taught share trading for more than a decade I could literally write a whole book on the mistakes that traders make. Some of the most common mistakes I see include:

• Failure to set stop losses or setting them too tight
• Over trading
• Over use of leverage
• Poor money management
• Relying on software to make decisions

Einstein once said that “Education is the progressive realisation of our ignorance”. In simple terms I believe this means that we don’t know what we don’t know. My experience is that the majority who trade the market do so with little knowledge, blissfully unaware of what they don’t know until it costs them a lot of money.

Whilst space does not permit me to fully explain the above common mistakes that traders make, what I will say is that the emotions of fear and greed rule all five of them. A major trap for traders is the tendency to act on emotions rather than logic. This means they don’t trust either themselves, their skills or trading plan, which stems from having a low level of knowledge, skill and experience. The end result is that the traders act through a fear of losing and end up taking a micro view of the market by watching their trades daily or even intra-day, worse still they make their decisions based on short term market volatility. This leads to the even bigger sin of ‘over trading’, as the trader chases the market in an attempt to regain lost capital or profit.

The fear of losing is amplified when there is little or no strategy in place and contrary to popular opinion, daily charts only show you the short term movements of the market as such I believe they are of limited value to the majority of traders. The use or over use of daily charts are a major reason why so many over trade, as many more short term triggers become evident, yet properly assessing the trend of the market is almost impossible on a daily chart and hence why so many fail.

I have often said that if you want to learn what the 10% of successful traders do, find out what the 90% do and don’t do it. You don’t have to be Einstein to figure out the majority of courses, books, software and websites out there espouse daily charts and trading daily or intra-day. They do so because it sounds sexy and therefore appeals to people’s greed or ‘get rich quick’ mentality. If it was as simple and easy as they make it sound then everyone would be a profitable trader. To be successful on the market I strongly suggest you don’t do what these pretend Gurus espouse.

The use or poor use of leverage leads unskilled traders to trade on emotion, set stop losses too tight and make emotional decisions. This is extremely evident in those attempting to trade CFDs, Currencies, Options and other leveraged instruments. Unless you can trade shares with cash, then in my opinion you should never attempt to trade a highly leveraged market like those I have just mentioned. Ignorance and overconfidence abounds in these areas as people often mistakenly believe that they can handle the fluctuating extremes that leverage brings. In these markets you could make or lose 100% in hours or minutes, and as such you need highly developed skills to handle this. For most, trading leveraged instruments is like giving the car keys to a 10 year old and telling them to play.

As mentioned in part one, successful share trading relies upon developing a simple plan and sticking to it. A trading plan must have your buy/sell rules, money management including stop losses, and how you intend to manage the trade. All too often I have asked inexperienced traders what their plan is and they either don’t have one or I get a very vague explanation.

Developing a good trading plan is critical to your success as a trader, and once it has been developed you need to rigorously test its effectiveness. Trading is not about finding a new indicator or tool that someone tells you will make you more successful, it is about having a simple plan and following the plan. I encourage everyone to learn more, but it is important to remember that if you change your trading plan you change its effectiveness, which may not be for the better. Therefore, each time you change a trading plan, you need to back test it. If you are not willing to back test your trading plan, you are gambling with your money and increase the probability that you will join the 90% of share traders that lose.

It may surprise you to learn that I do not trade using common lagging technical indicators such as MACD’s or moving averages. I find that relying on the latest techniques or computer software is of limited value and prefer to use the tried and tested techniques and strategies of masters such as Gann, Elliott and Dow to name a few. These techniques are leading indicators and as such they provide more consistent entry and exit signals than lagging indicators.

Using leading indicators means I am better placed to ‘time the market’, which ultimately results in more and consistent profits. I understand that it requires a little more work in learning how to apply and use some of these techniques, but you have to ask yourself do I want to trade the market successfully or not? If the answer is yes, then the effort is well worth it.

One of the biggest challenges facing traders is when to sell. Usually a trader will be armed with many theories on how to pick the best trades to enter the market, and in my experience they spend about 80% of their time trying to find these trades and very little time working out when to exit. When asked where they should exit these people often give a confusing array of examples that are, in most cases, more guess work than solid theory, or based on the fear of losing either profit or capital.

Traders dramatically increase their probability of success if they spend more time working on better managing their trades and where to exit. Trading for profit is about using sound money management rules and good exit strategies, in essence, following the golden rule of ‘let your profits run and cut losses short’.

When setting a stop loss it needs to be far enough away from your entry price to allow the trade to settle in, but close enough to protect capital. Everyone, regardless of whether you are trading or investing, needs to use a stop loss or have an exit strategy every time they trade. Failure to do so will result in taking unnecessary risks, less profits and larger losses. There are various stop losses you can use depending on what you are trading. For example, the stop loss I would use for a blue chip share is different to the one I would use for a speculative share or CFD. As a general rule of thumb, I always set my stop loss at 15 per cent below the purchase price when trading blue chip shares. Whilst I cannot go into stop losses in detail here, I have done many free podcasts that explain what I do in many areas of trading.

No matter what your goal is, it is essential to your longer term success as a trader to not follow the herd, or the 90% of traders who fail, but rather follow the rules and principles of the successful 10%. To this I will sign off, wish you every success with your trading and leave you with my top 10 tips, for traders and investors to profit from the share market.

• Don’t dollar cost average
• Don’t buy cheap small caps
• Don’t buy and hold
• Don’t over use leverage
• Don’t be affected by the herd mentality
• Use stop losses to protect capital
• Buy only top quality stocks
• Always manage your risk
• Diversify but not too much
• Lastly and most importantly – Educate Yourself!

Dale Gillham
www.wealthwithin.com.au

An ETF is a managed fund or unit trust that is quoted and traded on a stock exchange such as the ASX. ETFs are built like managed funds, but trade like shares, meaning that pricing is transparent and that the products can be bought and sold throughout any trading day just like ordinary shares. ETFs generally aim to track as closely as possible the performance of a given index or asset class. They are transparent, liquid, cost-efficient and flexible investment tools – designed to be attractive to both individuals and institutional investors.

ETFs are one of the fastest growing categories of investment products in the world, with over US$1 trillion of assets managed in ETF products globally.

One of the primary reasons for their popularity is that they have all the advantages of stocks, such as being easy to trade and liquid, along with the benefits of index funds, such as diversification and lower costs. With ETFs, it is possible to get a diversified exposure to a large number of securities or an otherwise difficult to access asset class via a single trade and at the same time avoid ‘active manager’ fees.

The Global Market for ETFs

Globally, the market for ETFs has grown exponentially. The graph below shows the growth of the ETF industry in the largest two geographies for ETFs globally, the United States and Europe.

The Australian ETF industry, while comparatively small, has recently grown dramatically. We expect this to continue due to new product innovation and increasing acceptance of ETFs as an asset class in the Australian marketplace

What are the key benefits of ETFs?

Depending on the asset class or index that is being tracked, ETFs can be an ideal long term or short term investment tool. ETFs are widely used globally by both individual and institutional investors.

Simplicity
ETFs help investors gain exposure to a range of investment strategies that can be implemented as simply as buying a share.

Liquidity
ETFs are open-ended funds, meaning the number of units on issue can be increased or decreased in response to daily demand. Units can be bought and sold at any time throughout the trading day. Multiple market makers and Authorised Participants enhance this daily liquidity and provide robust bid-offer spreads. ETFs have similar liquidity characteristics to the underlying shares that comprise the relevant index.

Transparency
ETFs aim to closely track the performance of a specified index or asset class. They have a transparent fund and cost structure. Information on index constituents and assets held by the ETF is published on the issuer websites, giving investors an up-to-date view of the index and assets underlying the ETF.

Cost-effectiveness
Because ETFs aim simply to track the performance of an index or asset class, there are no in-built “active management” fees and ETFs therefore have significantly lower fees than actively managed mutual funds.

How do investors use ETFs?

ETFs can be used by investors for a wide range of investment strategies. Set out below are some of the most common:

Portfolio Construction & Asset Allocation
ETFs can be used as core holdings in a portfolio and as building blocks for portfolio construction. For example, sector ETFs offer diversified exposure to a particular industry sector that could otherwise only be achieved by buying all the stocks in the relevant index.

Core/Satellite Strategy
ETFs are often used in active investment strategies to improve the risk/return of a portfolio. ETFs can be used to build a core portfolio of broadly diversified indices. Single individual stocks can then be added as alpha generating ‘satellites’.

Cash Equitisation
ETFs can be used as a substitute for cash pending individual stock selection. This is used to avoid ‘cash drag’ and as an efficient place to ‘park’ cash while investment decisions are being made.

Pairs Trading
ETFs offer a number of opportunities for pairs trading e.g. going long an index and shorting some of the constituents.

Alternative to Sector Swaps
Investors can use Sector ETFs as an efficient alternative to a sector swap. Using Sector ETFs will mean that investors are not tied to one counterparty for exit and entries and have limited counterparty risk, and they are easier to trade and administer than swaps.

Hedging
Since our products are traded on the ASX, investors can short the ETFs as they would any stock, subject to availability of stock lending.

How to Invest in ETFs

ETFs are traded on the Australian Securities Exchange. As such, they can bought or sold like any share through a stockbroker, financial adviser or online broker. There is no need to open a separate trading account. ETFs can be traded at any time during normal market hours, using all the trading techniques applicable to shares (e.g., market orders, limit orders, stop orders).

Prepared by Betashares

www.betashares.com.au

Unfortunately, many people who start trading find success difficult to achieve, certainly in the period of time immediately after starting. Trading is a challenging endeavour that has torn people from all across the world across generations, from every extreme of their emotions. It is our money that is directly involved in trading and therefore at risk, and the potential of making more money is our primary motivation for beginning this undertaking. Therefore any emotions that we may associate with other endeavours are heightened because money is something that seems to accentuate any natural human emotions that we have. Ironically, it is the money that encourages the vast majority to attempt to trade yet it is the money that causes most people to fail.

In his book, ‘Trade Your Way to Financial Freedom’, the renowned American psychologist Dr. Van Tharp discusses in several parts how important your psychology or mindset is to your trading success. He graphically depicts the significance of your psychology using a pie chart and explaining that there are three ‘Ingredients to Trading’. They are System, Money Management and Psychology. In the pie chart, the System is 10%, Money Management is 30% and the remaining 60% is psychology.

Why does a psychologist who has spent his entire professional life counselling traders of all experience levels say that so much of your trading hinges on your psychology?

The key is that your mind drives everything you do in your life and trading is no exception. Your emotions are a part of who you are and your decision making process. Decision making is a large part of trading, as you need to make decisions often and many of them are difficult decisions. Furthermore, people like to break rules, even ones they set themselves. There are some simple trading rules that have stood the test of time, and will always work yet most people cannot follow them. It is essential that you realise how important it is that you demand of yourself the highest level of discipline to ensure you implement the requirements of your trading plan ruthlessly and follow some of the time tested trading rules.

At a presentation I gave a few years ago to a group of about 50 fellow traders, I was asked several questions, as per usual. After discussing the items above about emotions, sticking to a plan and the stresses associated with trading, I was asked about how you overcome the stresses and emotion of trading that seem to jeopardise so many traders around the world. I answered, “Exercise”. I immediately received many puzzled looks and someone said, “you mean practicing trading?”

It appeared to me that many had never considered a regimen of physical exercise in order to prepare well for trading. You don’t have to run in order to trade – you just have to sit at a desk. However when you consider the demons that haunt many traders and the obstacles we face, then think about the benefits of physical exercise, shouldn’t we mention the two together more often? More and more today, people not only mention the physical benefits of physical exercise, they also include now the mental benefits of physical exercise. These are numerous.

Physical exercise can greatly improve both your mental and physical health. The physical benefits of aerobic exercise are well known and include improved muscle strength, flexibility, and cardiovascular endurance. Exercise also helps lower your blood pressure. My belief in the benefits of physical exercise with regards to trading is based on the ability of exercise to help combat stress, and help you think more clearly when you are facing adversity.

Generally speaking, the lives of many have never been busier and more stressful. It has become a driving force behind most visits to doctors for people of all ages. Medically, when a person is experiencing stress, adrenaline pours into the blood stream as part of a person’s ‘fight or flight’ response and muscles throughout the body tense in anticipation of a challenge. Immediate effects can range from a short temper and heightened emotions to difficulty sleeping.

Many traders would agree that you can experience certain levels of stress when trading and it is often at these times that we do not employ the best judgement in our decision making. John McCarthy, executive director of the International Health Racquet & Sportsclub Association (IHRSA), says, “Regular physical activity can help counter the potentially damaging effects of stress on the body and may help prevent stress-related illnesses. These activities provide a natural way to release tension in the body and will often lead to an automatic state of relaxation that naturally follows a good workout.”

Medically, during exercise the body starts to produce endorphins. Endorphins are chemicals that lead a person to feel peaceful and happy; they promote a sense of well being. This is a perfectly natural and effective tool in helping to manage stress. Exercise can also help some people sleep better and raises their self-esteem. By increasing your self-esteem, your self confidence grows and this can directly assist you with trading, as confidence is one of the more understated character attributes required by successful traders.

Of perhaps less importance, exercising can help you physically look better, as those who exercise regularly, look more toned than those who don’t. Exercise is one of the most important parts of keeping your body at a healthy weight, and people generally feel much better and confident when they see themselves in a positive light. Again, those who feel more confident in themselves are likely to have more confidence in a trading plan they develop. The flow on effect can be very positive for their trading.

Trading is generally decision making where we need to employ sound judgement on a regular basis. Along these lines, exercising can also help your brain to work better. There have been numerous academic papers and research done to support the notion that exercise can improve a person’s ability to think more clearly. Exercise has been found to increase a person’s mood state and an overall improved sense of well-being, which in turn helps to keep stress, anxiety and depression to a minimum.

Military forces all around the world engage in regular and demanding physical exercise in preparing for the demands of military operations. Officer training institutions generally enforce greater standards as officers are required to make difficult decisions and often do so under pressure and hardship. The physical exercise they endure enables them to think more clearly than the average person and remain level headed when the pressure is on and all seems lost. Could we as traders not benefit from a similar mindset where we are able to think clearly at all times and make sound decisions based on solid judgement? Wouldn’t this help us take a step towards overcoming the adversities we can face with our emotions and stresses?

Focussing on the type of exercise, it is important that people don’t exert themselves too much. It has been found that a steady aerobic workout will produce far greater results than those that exhaust the body and leave a person folded over in pain and out of breath. A steady aerobic workout will greatly assist the brain’s ability to solve problems and make decisions fast and effectively. Generally after exercise, people are able to concentrate and focus much better than before. They are better able to block information that is irrelevant to the task at hand, and respond much faster to information relevant to the task.

From a motivation perspective, it is important for those who have never really exercised before or where there has been a lengthy layoff, that they start off slowly. Many unfit people set out to begin an exercise routine with great ambition and enthusiasm and then find that they cannot stick to the routine and their motivation quickly disappears. These people end up on a never-ending cycle of great ambition, loss of motivation, and a steady slump back to where they started. This is often because they are not enjoying the exercising they are doing. This is a problem.

Exercise is supposed to be a fun activity, even for the whole family and when you arrive back home feeling terrible, the motivation to go back out and do it again takes a big hit. This is when you will begin to think of all the reasons not to go again and then, you have taken a turn down the wrong road. Naturally, the fitter a person is, the more they will reap the rewards from aerobic exercise. Physical fitness does not come easily. The best strategy is to gradually increase the duration of your exercise sessions and, along with enhancing your physical fitness, your mental muscle will also begin to take shape.

There is no doubt that regular and moderate aerobic exercise will help your brain to function more efficiently, and therefore reduce stress, think more clearly and remain level headed in times of emotion and adversity. In an endeavour where very few people succeed, it is in our very best interests to do everything we can to increase our chances. I strongly believe that physical exercise can greatly assist traders to think more clearly, reduce the effects of stress, and ultimately make better and timelier trading decisions.

Stuart McPhee
www.tradingasxshares.com

At Bellmont we often get asked about the minimum price steps that can be placed into the ASX.  The following content is taken from the ASX website and provides an outline of the various price steps for shares at different levels.

Price steps

Price steps are the minimum price multiples for a security. The multiple depends upon the market price of the security.

If BHP is trading at $17.65, its price steps are one cent. You may enter an order at $17.66 or $17.81 etc.

You cannot enter an order at $17.80.5, i.e. 17 dollars, 80 cents and half a cent or $17.80.25, i.e. 17 dollars, 80 cents and quarter of a cent, etc.

Opening and closing prices are an exception. This is due to the formula used to calculate opening and closing prices. The price steps for equities (shares) and redeemable preference shares are:

Traditional forms of technical analysis have been practiced for decades with limited success. Most of the technical analysis methods taught to the public currently have not changed much for many years.

The entry points on patterns and trendline breaks are fairly easy to predict and the stop loss calculations most traders use are limited to a few methods.

However, the nature of the market has changed and the speed with which price moves has made the implementation of a conventional trading strategy much more problematic than it used to be.

Algorithmic trading has delivered an eightfold increase in the number of share transactions on the Australian stock exchange in just five years – but sharply reduced the size of each deal as disclosed recently by the ASX.

Trading statistics published by the ASX show that close to 1500 transactions a minute are being processed, compared with barely 200 in 2005. The weekly range of motion or average true range of a stock like Rio Tinto has increased on average 4-5 times compared with its ATR in 2005.

However those averages disguise peaks of activity, most often observed at market openings and closes. In 2006, the number of changes in the order books (buy and sell orders) peaked at about 2000 per second, while in the last year they hit 12,000 per second. For comparison, the current system has the capacity to handle up to 20,000 orders per second. If it continues to increase at the current rate, it will reach capacity by the end of this year unless computing power increases at a greater rate and the ASX stays ahead of the game.

The ASX would like the trading market to believe that the steep climb in the number of transactions reflects algorithmic traders breaking up a buy or sell order into hundreds of smaller deals that can be executed simultaneously, so that the market price is not changed significantly by their activity.

However, as this article will show, the other use of algorithmic trading programs is to create rapid movement of price to ensure that traders using traditional (known) trading methods are either trapped into bad trades or have their stops hit before the price rises.

In short, algorithmic traders manipulate the price in order to disadvantage traders who are unaware of the danger to their trading balance.

In conventional trading methodology, traders are taught to enter and exit a trade in a finite number of ways. Trading methodologies are widely taught and freely available in print and from trading educators. Entry criteria normally include breakouts from flags, pennants and triangles, falling resistance line breaks and rising support breaks.

Exit criteria, including placement of stop points are also widely known. These include but are not limited to penetration of a rising support line or falling resistance line, the first major low preceding the entry point, and an average true range trailing stop. It is also widely known that most traders trade emotionally. After a trade has run past their entry level, many traders will put their stops at the entry levels to make the trade become “risk free”.

Given the limited number of trading methodologies that are commonly used, if you were in the position of a competitive algorithmic trader and you had the ability and capacity to move price on an instrument, you would move it to counter the commonly used methods, too.

If you were a football coach and you had the opposition’s playbook, you’d use it, wouldn’t you?

In today’s high frequency marketplace price can move very rapidly. This is often done to the detriment of traders using traditional methods as the following charts show:

Above is the chart of Watpac (WTP.ASX). I would like to draw your attention to the price action on the 17th and 18th of January. In two days, the price moved from $1.90 to $1.95 down to a bottom price of $151.5. That is a 28.7% movement in the price of a top 300 company.

Did the fundamentals of the business change 28.7% in 2 days? Did the market segment interested in Watpac jump schizophrenically from euphoria to despair about its future value in 2 days? How would the valuers who determine the price to earnings ratio explain this? What possible explanation could there be for the rapid upward movement and rapid downward movement followed by settling at long term average, other than price manipulation?

The price action on the 17th was designed to trap traders into poor long positions. The price action on the 18th was designed to trigger any stops long traders may have had. This price movement on the 18th was designed to take out all stops set below the long term trend line, any of the previous three major lows and any traders who had entered in the previous several months who panicked about being down by 20%.

And it worked as shown by the volume traded on the 18th.

Another common pattern of price action that indicates that high frequency traders are manipulating price is the rapid price movement of an instrument prior to an upwards run. Find above a chart of STW Communications Group (SGN.ASX). I would like to draw your attention to the price action on 7 May in the centre of the chart. This price opened at 84 cents and plunged rapidly down to 76 cents before closing at 88 cents. The range of motion doubled the daily average true range.
Since many traders set their stops at major lows, the major lows on the 22nd of April, 24th of March, and 19th of March would all have been triggered by this rapid price movement. Often these rapid price movements occur at lunch time when traders are away from their desks and are unable to prevent their stops from being triggered.

This type of price action is frequently used as the trigger before an increase in the price. Its purpose is to shake out stops and pick up cheap volume prior to the price being marked higher.

As can be seen from the above two examples, price can move very rapidly in the current market and is instigated often by high frequency traders. These are only two examples of the hundreds that can be found on the ASX.

While this represents a grave threat to the uninformed investor, to the informed investor it represents an incredible opportunity. If the market manipulators change the price of an instrument in repeatable ways, then this can be used to the advantage of informed and educated traders. Currently, market manipulators do manipulate the price in a recognisable manner. Therefore, if a trader works in harmony with them, the trader can enjoy the benefits of the manipulations, instead of having their stops hit just before the price is marked up.

Michael Brook
http://www.tradingstate.com.au

When most people start trading, they never consider whether they are well prepared and have the necessary skills and attributes to be successful.  This is likely to be one of the last things on their mind.  Somewhere along the path of trading however, most people come to a realisation that trading is probably not as easy as they first thought.

With this humbling realisation comes a search and investigation in to what makes a successful trader.  They seek out what they need to do and learn about, in order to make all of this money they initially dreamed of.   They attend courses, converse with other traders further along the path of trading than them and make a committed effort to learning this new craft.

Whilst all of the tools may be gathered together including the new piece of charting software, data provider, new broker account opened, magazine subscription started, successful trading still has it foundations deep within the individual themselves.  It is probably only when people start trading for real with their own real money, that they begin to feel the emotional strains and pressures and then realise that they themselves may be a bigger part of the overall equation than initially thought.

OK, so we have reached this point in our trading lives.  We have become very interested in trading, saved some money for our trading capital, gathered some tools together at our disposal, started to trade and then lost some money.  Now we start working on ourselves; preparing ourselves to make all of this work so we can achieve our ultimate aim in trading – to make money!  Isn’t that why most people start trading in the first place?

Now we widen our search – we need to now work out what we need to do differently in order to start making money.  Rightly so, people then seek out the most important character attributes of successful traders.  Great idea!   What will they find however?  What are the most important character attributes of successful traders?

In my trading time, I have heard numerous responses to this question.  Not just one or two, but more than 10.  It certainly seems daunting to new traders when they are exposed to all of these different responses.

What are some of the responses I have heard?

Perseverance or stick-to-it-tive-ness was a common theme.  As Calvin Coolidge, the 30th President of the United States said in one of my favourite quotes, “The slogan ‘Press On’ has solved and always will solve the problems of the human race.”  Other similar terms include perseverance, commitment and determination.  For traders, this provides us the ability to continue on in the toughest of times even when everything appears all too much.  It is the edge that allows us to climb the walls that are obstacles when everyone else around us, turns away from the wall and does something else.

Another important attribute is humility.  All traders enter trades that lose money – you can’t simply get every trade right.  You will find the very best traders are very humble and they are the best losers.  Successful traders never move stops and accept losing as part and parcel of trading.  They are also not afraid to learn from others and admit they don’t know everything.

One attribute I don’t hear a lot about is patience.  You are not provided with great trading opportunities every day and the best traders are patient enough to wait long enough for high probability trades to come their way.  Financial markets are here to stay – they underpin the corporate arena in every country around the world, so they are not going anywhere.  Trading success is not going to happen overnight.  For most people, this is a life long endeavour so does it really matter if it takes you a few years to start trading profitably?

Another attribute is responsibility.  Successful traders make their own trading decisions based on their own analysis and trading plan but more importantly don’t blame anyone or anything else when it doesn’t work out and they lose money in a trade.  In a world nowadays where there is a clear trend of people looking for someone else to blame for their own actions, this is probably becoming less obvious.  The key is to be an adult and take responsibility for your own actions – you are solely responsible for your own success.

Successful traders are also conservative and very defensive.  Even though their primary motivation is to make money (as it is for all of us), they adopt a very defensive mindset and focus not so much on making money, but moreso on protecting the money they have.  This means they set and stick to stops and risk very little of their account on any individual trade.

With anything in life, confidence is important – trading is no exception.  Confidence in your self and the trading plan you develop.  One thing that will help with your confidence is your own knowledge and understanding of the markets, the products you are trading and various tools you use in your decision making.  Most importantly however, competence yields confidence. If you are not competent at something, it is highly unlikely that you will be confident doing it.

There are many other attributes that could also be listed here to include emotional control and stability, organizational skills and honesty.  There is no doubt that all of these are correct and valuable to possess, however I think there is none more important than the big D – Discipline.

Discipline is the level of self-control you have.  Trading all boils down to decision making and often the decisions that need to be made are difficult.  Let’s consider the options we have.  For any individual decision, there are often two options available to us.  The first option is the decision that will make us feel most comfortable and the one that we really want to take.  The second option is the one that follows our trading plan.  Most often these will be two very different outcomes.

There is one thing that assists us to take the second option and not the first – discipline.  I believe a key separator between successful traders and the rest, is they will act first upon their trading plan and not what they feel like doing.  Most traders make the decision that makes them feel the most comfortable whether this is letting a loss continue or to cut a profit short in order to realise some money.

When they feel super-confident about a trade, successful traders don’t allow greed to consume them and commit more money into the trade.  They trade according to their trading plan – they adhere to the money management rules in their trading plan.

“Discipline is the bridge between goals and accomplishments.”

Jim Rohn – motivational speaker

Here is what happens … we have our mind set on long term successful trading however other things influence our actions/trading decisions like emotions, our short term needs and our present mood.  These tend to overpower any long term goals we have, so we will often pursue short term pleasures and by doing so, avoid short term discomfort, at the expense of our longer term goals and rewards.  It’s human nature.

I was contacted recently by a colleague in Malaysia who had just watched a workshop DVD by psychiatrist Dr Ari Kiev on discipline and trading plans.  He asked the audience the question “What is the most important quality to be a successful trader?”

As there were many professionals in the audience, some said discipline, other a plan, some risk management.  Dr Kiev answered, “Yes, they are important but the most important thing is to tell the truth.  With integrity and truth in the way you approach the market and follow it, and run your trading business, you will be successful.”

My colleague continued and asked me what I thought about Dr Kiev’s comments.  Well, I can understand where Kiev is coming from with telling the truth, however I still believe that discipline is the most important.  Can you have honesty/integrity without personal discipline?  I would argue no.  If you lack discipline, then you probably won’t have what it takes to be truthful all the time.  Take that another step further, can you have any of the attributes listed here without discipline?  For example, can you be patient without a certain level of self-control?

Personally, I will be the first to admit that my time in the military starting way back at the Royal Military College, Duntroon has provided me some great skills and attributes to trade well – none more important than discipline.  Discipline has helped me greatly with my trading as well as other areas in my life.  It is discipline that makes me feel comfortable with deciding on what has to be done in accordance with my trading plan, as opposed to what I really want to do.

Whenever I talk about risk management in my workshops, I will always show a quote from Dr Van Tharp which says:

“Most successful market professionals achieve success by controlling risk.   Controlling risk goes against our natural tendencies.   Risk control requires tremendous internal control.”

For me, his ‘tremendous internal control’ equates to discipline.  Therein lies the key, doesn’t it?  If you want to achieve trading success, you need to manage your risk.  However, the problem is that to manage your risk goes against all the things we naturally want to do as people.  Often, we don’t want to cut losses and we do want to commit a lot of money to a trade that we feel super-confident about. In other words, to manage your money well, you need to be disciplined – this is how your mindset and money management are linked together.

By having your mind tuned into the trader’s mindset, you will be disciplined and committed to making all the right decisions.  Be disciplined and make it happen – it is a key to profitable trading.

Stuart McPhee

www.tradingasxshares.com

Many traders do their trading apprenticeship on shares and then move on to some form of leveraged trading instrument(s). This may be in the form of leveraged shares, CFD’s, margin foreign exchange, options or futures. Very early in their trading life they realize that no matter how skillful they become at timing trade entries and exits the real challenge, skill and discipline is in risk management and position size.

Unfortunately, too few traders realize that you cannot simply migrate the risk management and position size practices from share trading to trading on leveraged instruments. Any attempt to do this leaves the trader wide open to what Tania Oakley from Fintel has labeled “Disappearing Money Syndrome”.  This is painfully demonstrated in one particular trader reporting that he had managed to carry out 23 consecutive trades where each one had a sell price higher than the buy price. The 24^th trade was a loss … and it completely wiped out his trading account (plus some more on margin call). Although share trading risk management and position size techniques were applied he had made no allowance for the impact of leverage.

In a series of articles the various risk management and position size disciplines will be discussed. What follows here is a very brief overview of risk management and position size tools as they apply to non-leveraged share trading. Later articles will outline important adaptations that apply to leveraged instruments.

Shares – Summary of Risk vs Management Tool

Risk #1:

No control over direction of share price once a trade is entered.

Management Tool:

• Accept the fact that you cannot control the direction of the share price.
• Acknowledge that you can only control the impact that an adverse share price movement will have on YOUR trading account balance.
• Pre-determine the percentage (e.g. 2%) of your total account balance for each trade that you are prepared to lose if the market turns against you.
• Always trade with a stop loss in place.
• Consider using guaranteed stops … especially in the early days of your live trading

Common Name:

2% Risk Management Rule

Risk #2:

“All your eggs in one basket” so that one company going broke can wipe out your entire account.

Management Tool:

• Diversify according to your trading account value.
• If your balance (portfolio plus cash) is $100,000 or more, never spend more than 12.5 % of your account balance on one company.

Common Name:

12.5% Capital Spend Rule

Risk #3:

Over-exposure to any one market sector can have serious impact if the sector “goes bad”. (e.g. Tech-stock crash of April 2000)

Management Tool:

• Diversify among the sectors.
• Do not have more than two companies in the same market sector.

Common Name

Market Sector Rule

Risk #4:

During a market crash or severe correction there can be significant trading losses.

Management Tool:

• Weight your exposure towards the more highly capitalised (blue chip) companies so that you are more likely to get a buyer when you want to sell out of a position.
• Allow yourself some access to the more speculative opportunities.
• Allocate your trading capital in the ratio of 4 parts Blue Chip, 2 parts Midcap and 1 part speculative.
• Define blue chip, midcap and speculative as they are to apply to your trading.

Common Name:

4:2:1 Capital Allocation Rule

Compare the numbers derived from each of the above rules and also see how much cash is available. Whichever provides the least amount to spend is the one to use. These rules and disciplines should be tested as part of paper trading BEFORE going live in the market.

Learn to manage the risk and position size and everything else will take care of itself!

Rob Lennox

www.fintel.com.au

www.acofe.com.au