Margin Efficiency as a Critical Component of Profitable Stock Market Trading
Jan0
I started trading in 1984 and like many novice traders I lost a few thousand dollars. But in 1985 I started to get the hang of it and I managed to make a few HUNDRED dollars. And by 1986 my bottom line was close to 6 figures. I really never looked back after that. I have traded accounts of about $3,000 and I have traded accounts in excess of $6,000,000. And I have traded them all about the same way.
Curiously I found my success a little perplexing. I used a simple break out system that got me in one day and out the next. I did not day trade. There are many published variations of this simple system and it clearly was not rocket science. This trading style did not seem too risky and yet, for me, it was yielding annualized gains approaching 100% year after year. This kind of performance flew in the face of conventional thinking regarding performance and risk.
I gradually began to develop theories regarding market behavior and money management that might help explain why this simple approach to trading did so well.
I am going to discuss in this article one of the most critical of those theories, my theory of margin efficiency.
To explain my theory of margin efficiency I am going to discuss a simple study I did using only one market over a 34 day period of time. In and of itself this study proves nothing and it is used here only to illustrate my theory of margin efficiency.
I tested two systems I shall call simply LONG TERM BREAK OUT SYSTEM and SHORT TERM BREAK OUT SYSTEM. The single NASDAQ market I used was SEED, Origin Agritech Limited.
I tested the systems over a 34 trading day period, 11/24/09 to 01/12/10. Using my money management strategy both systems bought and sold 80 shares for all trades. This number of shares is calculated to limit the cash margin requirement to approximately $1,000 per trade. During this time period SEED put in a range of about $6 to $14.50 per share. I consider this to be a very volatile market and hence a very good market for my trading strategies.
These are some of the numbers coming out of this study:
Two systems:
Long Term break out system
Short Term break out system
Test from 11/24/09 to 1/12/10 (34 trading or “Study” days)
LONG TERM SYSTEM made one trade lasting 34 days.
It bought 80 shares of SEED on 11/24/09 at 11.74 (cash margin requirement $939)
It sold 80 shares on 1/12/10 at 14.14
Net Profit $192 – $10 transaction costs = ACTUAL NET PROFIT = $182
SHORT TERM SYSTEM Made 6 trades buying and selling 80 shares each time.
The 6 trades lasted two days each buying at an average price of 12.00 (average cash margin requirement $960)
3 win totaling $451
3 losers totaling $259
Net Profit = $192 -$60 transaction costs = ACTUAL NET PROFIT = $132
Now this is my formula for calculating margin efficiency:
Margin efficiency (ME) = ((Study Days / Days in Market) * (Actual Net Profit/ cash margin)) * 100
That should read number of Study Days DIVIDED BY days the trade is in the market TIMES Actual Net Profit DIVIDED BY the required cash margin (price times number of shares) TIMES 100.
Now let’s plug in the numbers for each system:
LONG TERM SYSTEM:
ME = ((34/34) * ($182/$939)) * 100 = 19.38
SHORT TERM SYSTEM:
ME = ((34/12) * ($132/$960)) * 100 = 38.91
The ME for the SHORT TERM SYSTEM is twice what the ME is for the LONG TERM SYSTEM. What does that mean? IN THEORY it means that a portfolio of ME 39s should make twice as much money as a portfolio of ME 19s.
In order to understand this better let us return to our study. The LONG TERM SYSTEM makes $182 in 34 days but there are no unused days. During those 34 days a trader can only trade ONE market using the allocated cash margin requirement.
The SHORT TERM SYSTEM, on the other hand, makes less, $132, but it is only in the market for 12 days. That means that during the 34 study days there are 24 unused days and that means that other markets can use those blank days without increasing the margin requirement.
Now if we fill up those blank days with short term trades from other markets that means we can make a lot more money in the same amount of time with the SHORT TERM SYSTEM than we can with the LONG TERM SYSTEM without increasing our margin requirement. How much more can we make?
If the LONG TERM SYSTEM makes $182 in 34 days it is making $5.36 per day. If the SHORT TERM SYSTEM makes $132 in 12 days it is making $11.00 per day.
If we fill in the 22 blank days with markets that also make $11 per day we can add $242 (22 * 11) to our net profits of $132 to get total net profits for the SHORT TERM SYSTEM equal to $374. Now we are comparing $374 in profits for the SHORT TERM SYSTEM against $182 for the LONG TERM SYSTEM. This is of course a theoretical value because markets never fill in those blanks perfectly.
Another way to arrive at a theoretical value is to use the ME numbers we have already calculated. If we divide the SHORT TERM SYSTEM ME of 38.91 by the LONG TERM SYSTEM ME of 19. 38 we get 2.01. Now if we multiply our original SHORT TERM SYSTEM profits of $132 by 2.01 we get $265.
Now we have two theoretical numbers $265 and $374 for projected profits for the SHORT TERM SYSTEM over period of 34 days. Reality probably falls somewhere in between because the reality is that the blanks will not be filled by markets as volatile and trading as well as SEED.
But regardless of volatility and performance how do we fill in the blank days with other market trades? This starts to get into money management theory that is a little too long and complicated to cover in this one article. However the simple answer is that I trade a lot of markets, currently 96, to assure that all the blanks are filled. And you now should understand of course that with a SHORT TERM SYSTEM I can trade many more markets with the same amount of money than I can with the LONG TERM SYSTEM and that by trading more markets I can reduce risk through market diversification.
This then in the most simple of terms explains my theory of margin efficiency, how it applies to stock market portfolio construction, and explains in part why these simple short term break out trading systems can produce such high yields with limited risk.
When deciding a strategy for trading the stock market you should carefully consider margin efficiency when selecting a time frame (long term vs. short term) for your trading strategies.
http://einsteinstocktraders.com Fifteen years ago, Robert Buran wrote, “How I Quit My Job and Turned $6,000 Into a Half Million Trading”. Bob set the system vendor industry back on its heels by publishing all his broker statements to prove the validity of his methods. Bob went on to trade European money in the U.S. stock market and pushed nearly two billion dollars in trades through the stock market in less than two years with annual yields close to 100 %. Although he is quite familiar with trading millions of dollars his interest remains with what he describes as the greater challenge of trading a few thousand dollars into a small fortune and his current work is geared to the small investor. Bob posts all his real time trades twice daily on his website, http://www.einsteinstocktraders.com along with news and market commmentary. Bob is a TradeStation programmer and his current interest is working with intra-day data and multiple market data streams to develop “hit and run” short term trading strategies that combine high yields and low risk. Bob insists that the current U.S. economy and its stock markets present an ideal environment for his methods and he presently refuses to short any U.S. stock market. Einstein Stock Traders.com http://einsteinstocktraders.com is a unique real time stock trading site geared to the small investor and short term trader interested in high investment yields and limited risks. Real time trades and some market commentary by “Trader Bob” is posted twice daily every market day.
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You Will Never Obtain Financial Freedom!
Jul0
The title of this article is not very appealing, is it? The truth is that it is does not have to be true for you. Financial freedom is obtainable, but not unless you are thinking about the components of reaching that goal from a bird’s eye viewpoint of your financial life.
Financial goals and what freedom means obviously varies from person to person. For some people just having the freedom to take a vacation every year is their idea of freedom. More likely however, the goal is a bit higher for many people, and the focus to obtain it needs to be a bit more intense.
One factor that is often overlooked in trying to build wealth is the large portion of your income that is required to service the interest due on your borrowing. If you can lower or eliminate your cost of borrowing, obviously you can make a much more vigorous effort at building your net worth.
Even if you are very conservative in your efforts to really build a life of freedom financially, you have to invest and make decisions that will leverage your efforts. So, it is hard to avoid borrowing money, and even unwise if you are using it to grow your business or investments.
So, hopefully you can agree that the cost of growth is a big factor in accomplishing your desire for financial independence.
Even if you are taking a “no-debt at any cost” philosophy, you are still not really getting the full efficiency your assets could be delivering for you.
The reason for this statement can be demonstrated in the following example. If you buy a vehicle for your business and pay cash, you have lost the benefit of that cash to earn you money. Most people refer to this as the lost opportunity to earn. So, in essence you have slowed down your quickest route to financial independence.
These are just some of the challenges you should be thinking about if you are truly on the quest to remove the bonds of financial need. There are answers, but you have to explore your options to find them.
If you’ve enjoyed all the exciting information you read hear about, you’ll love everything else you find at financialfreedom9.wordpress.com/2009/06/24/you-will-never-obtain-financial-freedom/
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Do You Have A Serious Financial Plan To Create Wealth? It Is Never Too Late
Jul0
Possibly with all the economic upheaval we are seeing in the economy you are becoming more concerned about your own economic future. However, if you have a solid financial plan you do not have to be in a state of ongoing worry.
One of the more scary current problems involves the sad condition of the banking system. If you happen to have a business you are probably very aware of the lack of capital being lent for improvements, expansions and equipment. The whole situation is quite frustrating knowing that the government is injecting funding into the banks and they are not using the money to help their good customers.
Because of this it would seem that you might want to come up with new ways to function in your business and personal life that removes the banking middleman. I am sure you would agree that if you could avoid paying interest on all your loans you could significantly increase your wealth quickly.
At this point you are probably saying, “How could that be a possibility?” The answer really is simpler than you would imagine. And the beauty of the idea is that you can assemble the pieces with probably little effort.
The goal in this exercise would be to become your own functioning bank. Some far-sighted financial advisors have come up with a way to use a common financial services product in ways that it was never imagined to be used. But, the end result is a marvel of efficiency in saving you money and providing a great investment model.
In this dynamically changing world, the more you can do to control all aspects of the financial factors that influence you is a smart strategy. If that sounds right to you, then you might want to start researching how to build your own personal bank.
If you’ve enjoyed all the exciting information you read hear about, you’ll love everything else you find at http://financialplan9.wordpress.com/2009/06/24/do-you-have-a-serious-financial-plan-to-create-wealth-it-is-never-too-late/
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