Win / Loss Ratio in CFD Trading

Among the questions often asked by clients when selecting an adviser or a system for CFD trading is what percentage of recommendations they can expect to be winners, and how much should they expect to make each month, year or whatever. These form part of a natural psychological comfort zone, but may be part of the reason why so many people fail as traders.

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In any area of speculation, whether it is stockmarket investment, spreadbetting, forex trading or CFDs, if the underlying system has a small edge, it is only the first part of potential success. The key to achieving constant returns lies with a correct approach to the win/loss ratio and not in expecting any particular level of gains, which can distort the underlying methodology. CFD traders have the ability to go long and short at will, and online trading makes it easy to adjust stops and targets at any time.

An example of a good win/loss ratio that fails
Consider this example: a CFD trader selects a system where there is a supposedly proven record of seven out of each ten trades proving to be winners. The idea might be that each trade has a target return of 3%, and if it is achieved the position is closed. If the trade however shows a loss of 3%, the expectation is that it should recover and the position is doubled up, with the hope of returning to parity or even making a 6% gain. Now if market or share movements were a random sequence, it would not make any difference where one entered or exited. The overall returns would over time be neither a gain nor a loss, but costs and the spread on trading would result in a virtual guaranteed loss in due course (the casino approach).

Having a slight edge is not enough
If this system had an edge though, the expectation might be that the 3% target would possibly be hit six out of ten times, thus making it a virtual winning approach. But the problem lies in the fact that although markets and shares do have short term periods when there appears to be random action, they can both trade a range and trend strongly at other times – this is what is known as regular irregularity, which might seem a paradox, but happens all the time in financial markets.  Shares often move very quickly in one direction, and this trend can continue for far longer than expected, which creates two problems.

First, taking a 3% profit on a trade may appear to be very satisfactory, but it can often be seen in hindsight that the profit was taken too early, so despite achieving a winning trade there is an element of regret that more was not taken. Second, if the position is showing a loss, then the trade should in the real world be deemed to be incorrect and closed out. But in using such a system as this, by doubling up or averaging the position on losses, all that is achieved is an increase in risk – the trader might be lucky in some situations, but one or two trades out of the ten may cause severe problems. There is also the emotional capital that is tied up in losing trades.

This type of system typically might produce say six 3% winners, two evens (where one position was doubled up and returned to parity) and two 10% losers. Here the overall loss would be 2%, despite the good win/loss ratio, and this is clearly a dangerous way to play the markets, but many traders operate exactly in that way.

Improving the risk/reward
The first point is to set a stop loss on each trade and stick to it. Doubling up simply doubles the risk – that is fine if there is another system signal that reinforces the first trade, but generally that is not the case. The problem that then occurs is that if the stop and targets are quite close in percentage terms, the bouts of short term randomness mean that it can almost be like coin tossing, which with costs is a futile approach.

The key is therefore to ensure the gains are much greater than the losses, so that even if one only achieves four wins out of ten, there may be two big winners in there. If a trader decides that a 3% average loss is acceptable, then what average gain should be sought? This is the $64 question, and the key is to let profits runs as much as possible within a clearly defined trend. The following rules are part of the methodology used at Blue Index for the longs and shorts CFD portfolio, and the long term results have so far proved more than satisfactory.

Some simple rules for a consistent winning approach

• If searching for stock trades, try to choose high volatility or beta shares – these have a higher chance of being in a trend rather than trading a range or exhibiting random action.
• The expected initial target should always be at least twice the stop loss. If the average stop loss set is 3%, the CFD trader should look for 6%-plus gains on each trade as a starting point.
• Try to set individual stops and limits with reference to the underlying action. If a share has moved 10% one day, it is likely to exhibit an intra-day range of much more than 3%, so the stop and target should be widened accordingly. Also support and resistance levels are very useful reference points for setting price targets.
• If the trade hits the initial target, either close the position if support or resistance around that area is seen to be valid, or move the stop up to protect profits and let the position run.
  5. If there is a sudden reversal in share price trend, close the position, whether it is winning or losing.  The swings and roundabouts of trading usually mean that these unexpected trend changes even themselves out.
• Make sure you are never exposed too much in one direction. If for instance the market falls heavily from the open, then it doesn’t matter, as even if there are more longs and shorts in your list of open positions, the huge gains on the shorts should outweigh the stops hit on the longs.

Target returns
As for target returns, many traders have unrealistic expectations. A system that can offer huge returns inherently has to have a higher risk, but bear in mind this simple fact. Warren Buffett has achieved just over 20% per annum returns on his investment fund, and he did not need to use leverage to become the world’s second wealthiest man.

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Advantages of Investing your Money Globally

Investors in the United States are blessed with a number of advantages. Liquid equity markets, a large number of listed companies and comprehensive disclosure combine to make the US equity markets exceptionally attractive. However, that attractiveness inevitably leads to lower returns for investors because of the overall efficiency of the market.

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In contrast, international markets offer greater opportunities simply because they are smaller and not as widely pursued. For an investor willing to dig a little deeper into an investment, international investments can be a goldmine. But investing abroad can still offer substantial benefits for the investor who prefers leaving the heavy analytical lifting to a mutual fund.

The first and most obvious advantage of international investing is diversification. Other economies, be they in Western Europe, Russia, or Southeast Asia, will have a different set of economic circumstances than the United States at any given point in time. If the United States falls into a recession, Ukranian or Chinese equities may nevertheless be roaring along. A broadly invested portfolio will not be as adversely affected by negative movements in any one of its component companies or countries.

An internationally invested portfolio also allows an investor to capitalize on the higher growth rates available in developing economies. Many developing economies in Europe and Asia are currently growing much faster than the United States as they "catch up" to more developed countries. Companies operating in these countries have a built-in growth advantage. They have the "wind at their backs" - a growing economy will increase most business' revenues without any increase market share.

International companies are often significantly cheaper than US companies. This means that the same dollar of capital invested will often return substantially more in operating earnings and earnings per share than a comparable company in a comparable industry in the US. The price discount reflects the risks of investing abroad, but there is often also a discount for illiquid or hard-to-understand investments. This discount compensates investors for the increased research and complexity involved in international investments.

Finally, international investments can offer quite a few psychological advantages. Investing abroad means putting capital where it is most needed. Particularly for developing countries, foreign investment allows the kind of accelerated growth that lifts people and countries out of poverty. Furthermore, ownership of international investments will encourage you to keep up on current events in that country and make you into a more informed global citizen.

The exact nature of the company and country you are investing in will affect the balance of these advantages. Investing in developed western European nations is a good diversification strategy, for example, but you may not enjoy the higher-than-usual growth rates of investing in a developing country. Likewise, less developed countries frequently offer high discounts in relation to their US competitors, but the increased volatility of these investments will make them less useful as a diversification strategy.

The potentially high rewards of investing internationally are balanced by risks. These risks vary by country, but there are a few common threads. International companies frequently offer less disclosure. A company's website, investor information and news may not be available in English, which makes it difficult to keep tabs on portfolio companies. Investors also face currency risk - for example, if the dollar is appreciating strongly it may be difficult for your overseas investments to keep up. Finally, legal issues and country issues are always a concern in developing countries, as these countries may enact regulatory, tax or ownership laws that adversely impact investors.

However, there is indisputably money to be made abroad, and smart money will follow the opportunity. After weighing advantages and disadvantages, informed investors can frequently buy a very profitable stake in the global economy.

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Creating Cash Flow Formula for Your Investment

Many of us invest in the stock market for long term growth. However, there may be times when you need to generate some cash flow and there are some relatively safe strategies you can use to produce income. One of these strategies is known to many stock brokers as channeling.

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There are certain stocks that move within a specific price range in a repeatable pattern and while this can be frustrating for a long term growth investor, it provides a wonderful opportunity for those who could use some extra cash.

The following is an example to show you how this plan works. You bought a stock we will call “xyz” at four dollars a share. In a few weeks, the stock moves up to around six dollars a share before falling back down to the four dollar price range. How is this going to make you money you ask? Simply by selling the stock at six dollars. And when it falls back down around four dollars, buy again. Repeat this method over and over again, of course each time you will have more money to buy more stock.

Let’s say you bought 1,000 shares of xyz at $4.00. That would mean you had to come up with $4000.00 for your initial investment. Several weeks later, the stock has moved up to $6.00 and you sell. You now have $6,000.00 which means you have made $2,000. The stock falls

back down to $4.00 a share and you buy in again, only this time you buy 1500 shares at $4.00 which equals $6,000 cash out. When the stock rises back up to $6.00 sell again. This time you will have made $3,000.00. 1500 shares X’s 6.00 a share equals $9000.00 minus $6,000.00 equals

$3,000. See how it works? Eventually, you will build up quite a bit of money from doing this play over and over again.

However, there are a few things to keep in mind. What if you buy the stock at $4.00 and then it falls down to $3.00 and never goes back up? You will have lost money then. One way to keep this from happening is to set a stop loss order. For example, place the order so that if the stock falls below a certain price, then the stock will automatically sell before the stock can fall any lower. You will lose a little bit, but you won’t lose the whole thing, and your money will be free to do something else.

What if the stock goes higher than $9.00? Won’t you lose out on the potential to make more? When you see the stock begin to climb close to the $6.00 mark, move up your stop loss order. Be careful to not squeeze it too closely, because sometimes a stock can fall back momentarily only to surge up higher and limit your potential by selling too soon. So when the stock climbs up to $6.00 place your stop loss order at $5.75 (example only) and then if it moves on up to $6.50 then move the stop loss up to $6.25 and so on.

You should however, have a pretty good idea of when to buy and when to sell. If you wait to sell too long, thinking it will go higher, then you could lose out because the stock can drop back down quickly. Just be sure to use these strategies to keep that from happening.

I am sure many of you are now wondering where you can find these stocks? One thing you can do is buy a Wall Street Journal and the use a free Internet stock chart and then start researching the stocks. It is important to realize though that when you are starting out, especially with a small amount of money to buy stocks within the $1.00 to $15.00 ranges. You can buy more stock this way and your returns are really not that much different from the more expensive stocks at this point.

On the charts you should be able to see a repeatable pattern of the stock fluctuating between a certain price. Of course it isn’t as clear cut as it never falling below 4.00 or rising only up to $6.00. You should take a piece of paper and place it horizontally across the chart and see how many times it has hit a certain price, also where the basic support line is at the bottom price range also.

Take your time and be patient. Research your companies well. Keep in mind here though that many lower priced stocks up to $5.00 don’t always have just a whole lot of information. Only use money that you can afford to gamble with a little bit. But if you will use these strategies, then you should be able to greatly reduce the risk of losing which will enhance your chances of creating a steady stream of cash flow.

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