good system to use to buy stocks yet protect your capital. It's a very good system.
1. Decide how much you are willing to lose of your total investment fund on an individual stock if the market goes against you. How about 1%
2. Find out what the average true range is for that stock (ATR) for say a 20 day period
3. Add....hmmmm.....10% of your buy price to that number and subtract that answer from the price you plan to purchase at.
(What you have now is the price you'd sell for after considering the volatility and an extra 10% clearance that indicates a market clearly going against you....but we're not done. Now here is the interesting part. You're thinking that you've really sold at a great lost subtracting the ATR plus another 10% from the price you bought in at. Not really.... read on.
4. If you have determined that you would only lose 1% for a given stock and you have 20K to invest, then you would only allow a $200 loss on that stock (20,000*.01=200). Now you have to figure how many shares you can buy at your entry price .
5. If your stock is $2 and your ATR is .10, adding an additional 10% of the purchase price, you would bring your total allowable loss to .30 cents per share (2.00*20%+.10=.30)
(So now you know that you would sell your shares at a loss of .30 cents/share or at 1.70)
6. Now let's find out how many shares you can afford with a stop loss at 1.70. Since you only want to lose a max. of $200, your equation would be :
# of shares X .30 = 200 or # of shares = 200/.30 or finally... # of shares = 666
So you can buy 666 at $2 and set a stop at 1.70 which keeps you well away from the daily noise and only allows the stock to lose the $200 when your trade goes against you or prove if it's in an uptrend at which point you can trail your stop after the rising sp. How many of you have any stops on NOT at the moment?????
I learned this from the example of others and the setting of stops, although not an exact science, gives you a good understanding of how it can be based on something more than just whim. No system is perfect nor do they work in all environments but this one can be tweaked to advantage and does a good job of protecting your capital and exposing you to the market in one of the safer ways.
