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fyi: Turn $20K into $80K with the 2.5% System

The 2.5 Percent System used in our daytrading newsletter
http://www.daytraders.com/day_trading_newsletter.html

Our 2.5 Percent Trading System is the result of many years of trading. This system has been designed and published here in an effort to help guide new, as well as experienced, traders in taking profits at realistic levels. We feel taking profits routinely is a very logical and straight forward method for being profitable in the markets when day trading.

For anyone that has traded the markets for any length of time, it doesn't take too much reflection on your trading activity to notice that, more often than not, after you purchase a stock you will see it spend quite some time bouncing back and forth between positive and negative territory. Often times you will see a stock move into the money, then pull back to either break even or a loss of some kind on paper. In most cases, at some point, this process will reverse itself and the stock will attract buyers and return to break even and/or a profit again (depending on your entry point and the quality of the stock itself).

So the question soon becomes: what is the best way to handle this situation to ensure that the least amount of time is wasted with stocks bouncing up and down, while at the same time working to produce the most realistically obtainable profits.

With our 2.5% Trading System, we submit that one of the most logical solutions to this situation is to discover at what level "most" of your trades become profitable. Once established, this level become your "profit taking point" where you either close the position out, or at least become alert to the fact that the stock is at a level where you may wish to sell it or install a trailing stop loss.

Before deciding at what level profits should be taken, let's imagine all of the trades we undertake on a line that travels from left to right. Each vertical "segment" of the line represents a specific trade and the up and down action of the vertical segment represents the action of the stock itself. We'll call the "zero line" the price at which you purchase the stock. From this point, some trades will go up (imagine a bar graph with the bar moving upward) while some trades will move down (picture the zero line (your purchase price) with a bar graph moving down).

Understand that the stock may go up and down within this vertical line for as long as you hold the trade. Baring any major down turns or up turns, you will have something that looks like the following:


[]
[] <--- zero line
[]


This "segment" represents a stock moving up or down past the zero "gain" line after it is purchased. The top of the segment would represent the high during the time in which you held the stock, while the bottom would represent the low.

Once you sold the stock, you'd close out this segment and move along to the right on the line which represents all of your trades. In the graph below, the next bar or "segment" of the graph would represent the next trade and so on. Assuming relatively normal up and down movement of stocks, a chart of this nature, over time, would typically look like the following:



TYPICAL TRADES OVER TIME: Gain/loss
----------------------------------> ---------


[] <-- 10%
[] []
[] [] []
[] [] [] [] [] <-- 5%
[] [] [] [] [] [] [] [] []
[] [] [] [] [] [] [] [] [] [][]
[][][][][][][][][][][][][][][][][][][][][][][][][][][][][] <-- 2.5%
[][][][][][][][][][][][][][][][][][][][][][][][][][][][][]
[][][][][][][][][][][][][][][][][][][][][][][][][][][][][]
------------------------------------------------------------ ZERO line
[][][][][][][][][][][][][][][][][][][][][][][][][][][][][]
[][][][][][][][][][][][][][][][][][][][][][][][][][][][][]
[] [][][][][][][][][][][][][][][][][][][][][][][][][][][] <-- (2.5%)
[] [] [] [][][] [] [] [] [] [] [][]
[] [] [] [] [] [] [] []
[] [] [] [] <-- (5%)
[]
[]
[] <-- (10%)



As shown above, you have a group of trades going up and down with each segment representing the high and low for any given trade. Some trades reaching higher levels, some trades reaching lower levels, but all basically hovering around the zero "break even" line for the most part - at least until such time as you close out the trade. This is actually very similar to real life. You buy a stock, it goes up a couple percent, then down a couple percent. At some point it's sold and you move to the next trade.

When undertaking trades, many times traders make one of two basic mistakes. Either they fail to have an exit point established prior to buying the stock (this leaves them floating long for who knows how long) or they do establish an exit point, however, the exit point is often too high to be readily realistic for quick profit taking.

In the latter case, you tend to spend a great deal of time "waiting" for your trade to hit some nearly mythical (and often rather greedy) price. This price will often times be based on a percentage such as 10%, 20% or even higher; which often is too far out of reach.

In some cases, there is inherently nothing wrong with this situation, except for the minor problem that it does not produce profits as often as one would like! Not only that, but the higher the exit point, the more time your trading capital is exposed to the risks of the market. Both negative situations to find yourself in.

In any event, you have to ask yourself honestly, how often do you really hit a 10% or 20% gainer when day trading? It's certainly not impossible, but it does take time to achieve and with this time comes exposure and risk. For the most part, gains of this size are rather difficult to achieve on a consistent and short-term basis. Keep in mind that even Warren Buffett only looks for around 26% PER YEAR. So if we let his success be any guide at all, then I think it's only fair to say that hoping for nothing but 10 to 20 percent gains from each of your trades is rather unrealistic at best.

Again, we are not suggesting that it is impossible, but for most, it's setting yourself up for failure in the markets.

So then what is the solution?

In our experience, with a typical market, what does happen most often is represented in the bar chart shown above. Typically you get a move of a few points (or sometimes even just a few fractions) to the up or down side and then it repeats. If you honestly analyze how most stocks move and do not let greed take control of your emotions, then you will see that most stocks (baring major, and often unexpected, news) move only a few percent to the up or down side on any given market day. If you then examine "typical stock movement" in and effort to isolate a realistic level for profit taking, we feel you'll see that some place around 2 to 3 percent is "generally" the range in which your average stock will trade up or down.

Of course, this may not be true of every stock in the market, but generally speaking, your typical stock will bounce around in this range. Some will be higher, some will be lower. We feel 2.5 percent is very obtainable and, as such, have selected it as our level for taking profits.

In fact, notice how often we get 2 to 4 percent on our stock picks in the short term model portfolio. True, sometimes the stocks move to higher levels, or exceed even our longer term price targets, but most often we opt for taking profits around 2.5 to 3 percent. This is not only very obtainable, but adds up quickly while also reducing our market exposure.

I'm sure some members say, "Look at them selling with 'only' 3% profits". But ask yourself (by looking at the chart above), "What would be the best way to make consistent money on these types of trades?"

We submit that the best way is to take 2.5% profits AS SOON AS you have them. This happens enough to allow you to move in and out of stocks quickly. And because it does happen (a lot more than waiting for the big home runs) you'll find that a lot of singles (and small gains) add up pretty fast! This is the key to being profitable in the markets, as well as having cash on hand to take advantage of those "unexpected" dips in the market. After all, you can't trade the market if you are stuck in it.

Likewise, if you find yourself below the zero line (into a loss from your purchase), doesn't it make more sense to hold longer and give your trade the opportunity to rebound? Just like large gains, large losses tend to not happen any more frequently than large gains do (of course to some degree this depends on the specific stock and overall market).

Some people always cut their losses at 5% or 8%, but if you always cut your losses at say 5 percent, then you are going to hit that much more of often. It is true that your losses may not be as large, but by racking them up much more consistently, your losses do add up. Certainly, it's a calculated risk, but then so is the market.

We feel if you sell at 2.5 percent profits (and get that consistently - thus returning profits) and are willing to hold until 10-15% percent on the down side (not as likely), then wouldn't you tend to sell at a profit much more often than you did at a loss? Remember, good stocks tend to bounce back from those oversold levels (the lower they go, the more of a deal they become). Again, some of this has to do with trading good quality stocks when the market is in your favor; but that's all part of the game (i.e. picking the right stocks to trade).

If done correctly, the results of this system should be fairly good, consistent, profits. In other words, trading. Of course, you would have to adjust these percents for different types of stocks, but I say it's better to find stocks that do work well with the 2.5 percent system than trying to find stocks which fit a different model. Read on to see why...

Keep in mind, as soon as you say to yourself, "well I'll just do this with stocks that return 5%, or 7%"... that's greed. And greed is bad. Greed will get you into dangerous situations in the market nearly every time and with our 2.5% Trading System, one of the things we are trying to do is avoid becoming overly greedy. Ask yourself how many times (over and over again) you have had profits and let them slip into losses?


GREED (n.) - An excessive desire to acquire or possess more than what one needs or deserves, especially with respect to material wealth.


In other words, more than you need to be successful at trading. It doesn't really take much to make a nice (very nice) living in the stock market. You know the old saying, pigs get fat, hogs get slaughtered.

Okay, now let's have a look at our 2.5% compounded profit chart below (using margin). This chart shows a person starting with $20,000 and (using margin) buying $40,000 worth of stock(s) that move 2 to 3 percent - finally being sold at 2.5 percent.

By returning 2.5% on $40,000 worth of stock, you should yield $1,000 on your first trade - not bad. Many people work all week for that. Then next time around you'd be using $21,000 in cash and buying $42,000 worth of stock (again, assuming margin). Keep in mind, if you reduce your risk by not using margin, your returns will be less.

The chart below was generated using a little compounding program that simulates a series of profitable trades. Keep in mind, however, that this example does not take into account commissions, nor does it take into account trades that may be stopped out at 10% or more. It's simply to give you an idea of the power of compounding and routine profit taking.


Enter real cash available in account : 20000
Enter margin use (1 equals 100%) : 1
Enter number of times : 30
Enter projected return (.10 equals 10%) : .025

Real$ Principal Yield Balance Times
----- --------- ----- ------- -----
20000 40000 1000 41000 1
21000 42000 1050 43050 2
22050 44100 1102.5 45202.5 3
23152.5 46305 1157.625 47462.63 4
24310.13 48620.25 1215.506 49835.76 5
25525.63 51051.26 1276.282 52327.55 6
26801.91 53603.83 1340.096 54943.92 7
28142.01 56284.02 1407.1 57691.12 8
29549.11 59098.22 1477.455 60575.67 9
31026.56 62053.13 1551.328 63604.46 10
32577.89 65155.78 1628.895 66784.68 11
34206.79 68413.57 1710.339 70123.91 12
35917.13 71834.25 1795.856 73630.11 13
37712.98 75425.96 1885.649 77311.61 14
39598.63 79197.26 1979.932 81177.19 15
41578.56 83157.12 2078.928 85236.05 16
43657.49 87314.98 2182.875 89497.85 17
45840.37 91680.72 2292.018 93972.74 18
48132.39 96264.77 2406.619 98671.38 19
50539 101078 2526.95 103605 20
53065.95 106131.9 2653.297 108785.2 21
55719.25 111438.5 2785.963 114224.5 22
58505.21 117010.4 2925.26 119935.7 23
61430.47 122860.9 3071.524 125932.5 24
64501.99 129004 3225.1 132229.1 25
67727.1 135454.2 3386.355 138840.6 26
71113.45 142226.9 3555.672 145782.6 27
74669.12 149338.2 3733.456 153071.7 28
78402.57 156805.1 3920.129 160725.3 29
82322.7 164645.4 4116.135 168761.5 30

Total account balance : 86438.83


The above print out shows that using $20,000 in cash and making 30 successful trades that yield just 2.5% you can turn $20,000 into $80,000 using margin and compounding your profits. This could be done over several months, or even a full year and the results would still be outstanding. Again, this is only an example and does not take into account the very real possibility of losses, but you get the idea. Even if you only strived for 2.5% per week, you'd still be able to generate very respectable gains by the end of the year. In fact, many of our members have written to us and said that after a year or so of using this system they see the true power of it.

Okay, now let's take a look at how much a stock must move to generate 2.5 percent based on the price of the stock. Of course one easy example is a $10 stock going up 1/4 point (2.5 percent). The chart below is very handy and shows most of the major prices and how much of a gain is required for a return of 2.5 percent:


2.5 percent of stock price
-------------------------------

5 x 2.5% = .125 1/8
10 x 2.5% = .25 1/4
15 x 2.5% = .375
20 x 2.5% = .5 1/2
25 x 2.5% = .625
30 x 2.5% = .75
35 x 2.5% = .875
40 x 2.5% = 1 1 point
45 x 2.5% = 1.125
50 x 2.5% = 1.25
55 x 2.5% = 1.375
60 x 2.5% = 1.5
65 x 2.5% = 1.625
70 x 2.5% = 1.75
75 x 2.5% = 1.875
80 x 2.5% = 2
85 x 2.5% = 2.125
90 x 2.5% = 2.25
95 x 2.5% = 2.375
100 x 2.5% = 2.5



The chart above shows stock prices of $5 graduations, but you get the idea. The hot spots that should be fairly easy to get are 1/2 point on a $20 stock and a dollar on a $40 stock. I would think on something like CSCO you could just about get this once a day if you are quick!

So in a month or two you'd be rolling along. Let's say you do turn $20,000 in to $80,000 (not counting commissions which wouldn't be much if you are using a discount broker). Now look at the same setup if you start with the $80,000 that you'd get from the example above and continue on doing just as well. (And you would continue doing just as well, because if you can get to this point, then you have mastered our system of trading).


Enter real cash available in account : 80000
Enter margin use (1 equals 100%) : 1
Enter number of times : 30
Enter projected return (.10 equals 10%) : .025

Real$ Principal Yield Balance Times
----- --------- ----- ------- -----
80000 160000 4000 164000 1
84000 168000 4200 172200 2
88200 176400 4410 180810 3
92610 185220 4630.5 189850.5 4
97240.5 194481 4862.025 199343 5
102102.5 204205.1 5105.126 209310.2 6
107207.7 214415.3 5360.383 219775.7 7
112568 225136.1 5628.402 230764.5 8
118196.4 236392.9 5909.822 242302.7 9
124106.3 248212.5 6205.313 254417.8 10
130311.6 260623.1 6515.578 267138.7 11
136827.1 273654.3 6841.357 280495.6 12
143668.5 287337 7183.425 294520.5 13
150851.9 301703.9 7542.596 309246.5 14
158394.5 316789 7919.726 324708.8 15
166314.2 332628.5 8315.712 340944.2 16
174630 349259.9 8731.498 357991.4 17
183361.5 366722.9 9168.072 375891 18
192529.5 385059.1 9626.477 394685.5 19
202156 404312 10107.8 414419.8 20
212263.8 424527.6 10613.19 435140.8 21
222877 445754 11143.85 456897.8 22
234020.8 468041.7 11701.04 479742.7 23
245721.9 491443.8 12286.09 503729.9 24
258008 516016 12900.4 528916.3 25
270908.4 541816.8 13545.42 555362.2 26
284453.8 568907.6 14222.69 583130.3 27
298676.5 597353 14933.82 612286.8 28
313610.3 627220.6 15680.52 642901.1 29
329290.8 658581.6 16464.54 675046.1 30

Total account balance : 345755.3



As you can see, if you do this over time and even if you only looked for 2.5% a week (not hard for an active trader) then in a little over a year of consistent trading you'd have turned $20,000 into over $300,000 with careful trading. Impossible? Not impossible, but you'd be surprised how hard it can be; especially when you factor in emotions and the occasional loss. That's where we come in. DayTraders.com tries to help keep you on the road to profits by showing you this basic system day-in and day-out in our morning stock market report.

While it's not easy, we feel if you have the will, desire and dedication, then it can be done over time. If nothing else, this system will get you into the habit of taking profits. And at the very least, it will help you see that in order to make money from trading, you don't necessarily have to hit a home run on each trade to be successful.

Again, this is just one approach to trading and even if you don't implement it in your actual day to day trading, at least it is here to make you think and as a reference. All we are suggesting is that it is one possible (and realistic) method of trading. We believe it's much more realistic than trying to buy a stock and have it go up 100 or 200 percent. That can be done, but getting a return of between 2 and 5 percent happens much more often.

To that extent, we try to follow this system in our newsletter in an effort to (if nothing else) educate and help guide members in taking profits. Certainly, when to sell is up to each member individually; our goal here is simply to provide a guide to what we feel is the road to profits.


Ray Johns
Senior Market Editor
DayTraders.com

http://www.daytraders.com/day_trading_newsletter.html