Over-trading Definition

[cpatte7372]

Hello All,

Can someone give me a simple explanation of overtrading?

The definition that I have read is "Overtrading is trading a size that is too large for you". So. lets say I have $20,000 for trading how can I trade a position that is too large for me?

Thanks

Carlton

[michaelm]

Hi Carlton,

Overtrading is simply trading too much. What does too much mean? Usually it means too many trades. I think what you're asking is what is an appropriate position size for $20k.

I will pass on what Josh Lukeman states in his book The Market Maker's Edge (c2000, McGraw Hill)...

He uses a 2% rule for losses...don't risk any more than 2% of your capital on any one trade...$20,000x.02= $400 (and should include commissions/slippage, and regardless of margin above cash). Why? A trader can afford to be wrong numerous times and still afford to see the next trading day. It's about risk management...another way of taking the emotion/greed out of trading.

How to allocate capital per position:
Say you want to trade 2 stocks...
Capital per Position = Risk Capital / Number of Positions (eg, stocks)
CPP = $20,000 / 2 stocks = $10,000 (is maximum CPP)

How to calculate Max Shares per Position:
MSpP = CPP / Stock Price
CPP = $10,000
Stock Price = $50 and $25 (for example)
$10,000 / $50 = 200 shares
$10,000 / $25 = 400 shares

How to calculate 2% Dollar Risk:
Max Dollar Risk = CPP x .02 = $10,000 x .02 = $200

Determine Stop-Loss Point (from initial entry):
(this is more tricky, and you may want to read more from Lukeman's book about how he determines initial stop loss, but in general...)
for the $50 stock, if you trade the 200 shares, and your Max Dollar Risk is $200, then stop would be around 1 Point, or $49 (you may want to include cost of commissions and slippage...maybe add .10 or so).
for the $25 stock, if you trade the 400 shares, and Max Dollar Risk is $200, then stop would be $24.50 (again, maybe add for slippage/commissions).

Calculate Maximum Position Size:
MaxPositionSize = %2 Max Dollar Risk per Trade / Stop-Loss Point per Trade

2% MDRpT = $200
Stop-Loss Point = 1 (or 1.10 with slipp/comm)
MPS = $200 / 1 = 200 shares (or 200 / 1.10 = 181 with slipp/comm)

if Stop-Loss Point = .5 (or .55)
MPS = $200 / .5 = 400 shares (or 363 shares using .55)

Hope this helps...I would suggest reading his book.

Best,

[cpatte7372]

Wow,

Thats great mate.

This info I will keep.

Cheers.

Carlton

[soylent]

This is an interesting topic...

Does overtrading really mean 'too big a position' or does it mean 'buying / selling too frequently'?

Are these different topics?

If you look at O'Neil (the Investors Business Daily), he suggests no more than 4-5 positions on a $250K portfolio.

That would be overtrading by the strictest sense of the 'too big a position' nomenclature (note: as pointed out later, it'snot really too big, unless you are using leverage)

O'Neil also suggest a 7% drawdown / hard stop and a 20% target gain (this is a very simplistic description -- but, just an example).

The important thing about all this, in my opinion, in trying to gain an understanding of this business:
A) Most systems can work. But, don't confuse the different trade styles -- that's where I think things go wrong (for me, especially!)
In O'Neill, he recommends only buying growth companies meeting a slew of criteria that break a solid base on high-volume.

In AdvGET type 1, you look for profit-taking and buy the dip. Target profits are usually 5-10%. Stops losses usually 2-3%. (depending on time-frame... Daily bars in this example)

B) Trading in your timeframe
Everyone would be an overtrader compared to Warren Buffett -- if hold-time is the definition.

But, I think it's important to realize that: If you are trading the 5-minute bar -- your hold time might be 20-40 minutes. That's about as much information as you can forecast in a 5-min period. You're not overtrading if you hold for 40Mins. (And, for 1-min bars, you're looking at 5-10-min).

C) Leverage
And, this is where I'd say overtrading is best defined and easily done. Because if you have a system with a stop loss and a stock meets your criteria 100% and the 'market conditions' are right (uptrend index, no earnings reports, etc), you should take the trade -- always.

But, if you leverage your portfolio and you've built a system that gets you out at 2-3% loss -- if you have 10:1 leverage, you just lost 20-30%.

As an earlier post points out, to maintain a 2-3% loss of 'entire portfolio', you'd never trade more than 10% of your portfolio on one trade.

Whether you trade 1-Min bars or 1-Day bars. (Though, that would be something to see trading 10 positions on a 1-min bar). The system should work the same.

From my perspective:
- If you can only look at stocks once a week:
I highly recommend O'Neill's system. (And, 7% loss / 5 positions =1.x% of total portfolio on a total loss... So, it coincides with the figures michaelm posted)

- If you can look daily or better:
Advanced GET -- (on AGET your stop-loss is usually @ the 2-3% drawdown level -- so, you could trade 100% of your portfolio on one trade -- but, consider if you will use leverage... (And, I wouldn't do 100% on one trade -- but...)

If you follow their recommendations and don't pull in external influences (i.e. don't listen to me!), you should do well.

I'd love to hear anyone else thoughts on this? In particular, AGET doesn't really describe 'leverage' in their system (though, it can be implied on the futures). Any money-management system someone else uses on AGET -- especially when it comes to leverage?

Thanks all!

[cpatte7372]

Thanks Linus.

Carlton

[cpatte7372]

Originally posted by michaelm
Hi Carlton,

Determine Stop-Loss Point (from initial entry):
(this is more tricky, and you may want to read more from Lukeman's book about how he determines initial stop loss, but in general...)
for the $50 stock, if you trade the 200 shares, and your Max Dollar Risk is $200, then stop would be around 1 Point, or $49 (you may want to include cost of commissions and slippage...maybe add .10 or so).
for the $25 stock, if you trade the 400 shares, and Max Dollar Risk is $200, then stop would be $24.50 (again, maybe add for slippage/commissions).

Can someone please tell how Michael arrived at the stop of 1 point, or $49 for the $50 stock and the stop of $24.50 for the $25 stock.

Appreciate it.

Thanks

Carlton

[AllenCook]

It is the same logic for both situations in that the maximum amount of loss is already determined (Max Dollar Risk is $200) and it appears that the number of shares is also already determined. Thus, if the maximum dollar amount that you want to risk is $200, then just divide this amount by the number of shares you will trade. In the first case, $200 divided by 200 shares is 1 point (case 2: $200 divided by 400 shares is 0.5 pt.) and this means that your stop should not be farther than 1 point from your entry.

This is one way to approach it. Usually, you have already determined your maximum amount of risk so it is fixed as in the case given (based on your capital or whatever). However, you may determine the stop point first (instead of the number of shares) using some technical logic (support/resistance, etc.) and then determine the number of shares.

Same logic but in reverse. For example, you determine that $48 is a better stop point based on your interpretation of the chart. Thus, your stop will be 2 points away. $200 divided by 2 points would then result in 100 shares being traded rather than 200 shares in the original example. In either case, your hypothetical exposure will be $200.

[cpatte7372]

AllenCook,

Great explanation.

I feel a little stoopid now.

Cheers

Carlton

[fabrizio]

OVERTRADING

The semantic observation of Soylent is correct.

By and large nowadays :"overtrading" is a negative psic. state related to someone who "abuse" the practice of trading.

But WD GANN meant differently. In the sense of exceed your risk management limits.

So both the meaning -IMO - can be used.

[pj909]

soylent,
Great comments on overtrading. Would you define your use of 10:1 leverage. Margin, some derivative, or ???

[soylent]

>> Would you define your use of 10:1 leverage. Margin, some derivative, or ???

For 10:1 leverage, I'm refering to Options (derivatives).

The biggest 'problem' I've found w/ leverage is that the danged stock market moves as a herd. So, even when I split my orders over 10 stocks, they all tank on the same day -- especially if they have anything to do w/ Nasdaq. Sure, I get out w/ a quick loss (1-2% translating into 10% overall) but it's never just 'one' stock that tanks making the rule of 'no more than 2% loss' nearly impossible to follow when leveraged...

(I'm digressing a bit but...)
This has led me alternative ways of looking @ stuff. I've been exploring non-stock positions (commodities / bonds / currency) that move in ways completely unassociated w/ Stocks. I really think that's the only way to protect your assetts & not overtrade in a single area.

I count 'stocks' in general as one-in-the-same regardless of their ticker symbol. The only thing I really consider is BETA.

[pj909]

Soylent,
I believe it's better to concentrate your forces, so to speak. Instead of diversifying into 10 stocks that are all going to tank at the same time, I like picking one or 2 at time and doing options on them. If risk is properly managed then 2% loss is possible. There is power point presentation about managing risk and position sizing with options located at:

http://share.esignal.com/groupconten...r=&groupid=392

[gspiker]

pj909,

The link you posted seems to be broken, so I couldn't read the article, but in general if you are swinging overnight it is almost impossible to keep option losses that low...and even intraday it is very hard due to the games of the MM's a price of options can swing 2-3% without the stock price even moving.


Garth

[pj909]

If you mean 2-3% of the trade you're absolutley right. I'm focusing more on getting a good Reward:Risk ratio such that I'm never RISKING more than 3% of the portfolio on any one trade. I fixed the link. Sorry for the confusion.

[gspiker]

I should have known from the context...sorry about that. Yes 2-3% of portfolio is possible, assuming you have good rules about option price vs. your accounts value.

Thanks for clarifying!

Garth