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Joe Kunkle on building a trading strategy to match your strengths

One of the most important things to learn as an investor and trader is that the market is not one-size-fits-all. While many people take different approaches to selecting investments — whether it be macro, fundamental or technical — I believe it is best to use a combination of all them.

After stock selection, there is the more important task of execution, which tends to receive less attention but is pivotal to success. Timeframe is one of the most important components of having an execution strategy for entering and exiting a trade, as are return expectations and risk parameters.

Firstly, it’s important to analyse your strengths and weaknesses as a trader to help determine what strategies will support your strengths and mask your weaknesses. Each individual will vary but they will likely fall into four broad categories: timeframe, instrument, position sizing and risk management.

“Timeframe is one of the most important components of having an execution strategy for entering and exiting a trade, as are return expectations and risk parameters”

 

The idea of incrementally building partial sized positions is also worth considering if you notice that you are often stopped out on a position that would otherwise work if you had been patient and instead accumulated in less risky partial sizes.

Whether you’re a new trader using a paper account or a seasoned trader looking at historical results you can determine an approach that best suits your strengths by simply looking back at any historical trends in your trading decisions.

 

Analysing your trading habits

Typically, the first step to help determine your ideal position sizing and risk management is to analyse any statistical data relating to your trades. This will include win rates, average profit on wins and average loss on losses.

My next statement may be a generalisation, but is one I find to be true more often than not: those relying on technical criteria for stock selection are best suited for shorter timeframes, while those with a more fundamental view should utilise a longer-term approach.

As an example, I’ll share some of the things I have learnt about my approach over the many years I’ve been trading. Personally, I like to utilise a combination of options flow, fundamental analysis and technical analysis for stock selection.

Finding great investments by analysing the best-in-class names that will outperform the market for many years is where I thrive. My weakness is being overly active in taking profits or losses and reallocating those to new names. Indeed, I have often noticed some of my best weeks of returns are when I’m on vacation.

“Finding great investments by analysing the best-in-class names that will outperform the market for many years is where I thrive”

 

By not doing anything and letting my portfolio work for itself — under the basis of my fundamental research — I’ve found time and time again to have the ability to identify compounders.

Whenever I try to be too active — as someone who is at their desk watching the markets every minute they are open it is hard not to be — I tend to let my emotions control me. I find, like with most things in life, careful consideration rather than quick emotional reactions tend to lead to better outcomes.

I have also found a ton of success using shorter timeframes. However, it has been mostly through trading positions intraday or by removing the overnight gap risk. For this timeframe, the best approach to achieve outsized returns is to utilise short-dated options to capture those quick gains.

Analysing my own trading habits has shown me that I can use a combination of both approaches.

On the one hand, I can have a portfolio for short-term quick trades driven by technical analysis and option flow alerts. On the other, I can have a portfolio for longer-term fundamental-driven trades. I try to remove everything in the middle that becomes muddled without a clear pre-defined entry or exit strategy.

 

What happens when you trade to your strengths

An example of complimenting my strengths with the right strategy can be seen in a recent trade of mine — Fastly [FSLY].

I purchased shares in the cloud computing company in January. At the time, its shares were working out of a base formation near the $23 mark, which triggered a technical alert.

Luckily, I had previously done my due diligence and fundamental research. Fastly is a leader in edge computing, an area that I determined had a ton of long-term growth potential with minimal ways to capitalise on. It was a name I was convinced would work over the next few years.

“Fastly is a leader in edge computing, an area that I determined had a ton of long-term growth potential with minimal ways to capitalise on. It was a name I was convinced would work over the next few years”

 

Now the important part of this, currently successful, trade was that at the same time I was using a January 2021 collar selling the $35 calls and buying the $17 puts for a net credit. This slightly lessened the entry cost of the trade and from the start defined a potential maximum loss of 26% and potential maximum profit of 52%, a 2:1 reward/risk.

Collars are a great way to define reward/risk of a stock position and also have the ability to be adjusted to change the ratio. You also have the ability to put on after the stock moves in your favor for an even better ratio, though risking the position moving against you initially.

In the Fastly example, the strategy allowed me to weather the storm of the market sell-off in February and March — that dragged down shares $11 — as I knew $17 was the “stop” on the position from the collar and I trusted the fundamental view with the pre-defined timeframe (January 2021 options = 1 Year Timeframe).

At of the time of writing Fastly shares are trading near $47 per share and with nearly 133% YTD gains it is one of the markets’ best performers. Had I simply bought the stock I would have likely stopped out for a loss near $20 and never captured this upside move. However, shares are trading well above the short call strike where gains are capped, which gives the ability to adjust the collar if looking for further upside — at the cost of the new collar or extending the timeframe to minimize cost of the adjustment.

 

 

Although this is just one example, collars can be a very effective approach to define your portfolio risk from day. They allow you to easily sleep at night, avoiding any surges in market volatility and by not allowing for emotions such as panic-selling to lead to negative outcomes.

In closing, it is extremely important to self-analyze to determine your strengths and weaknesses as a trader. From there you can develop a strategy that best suits you. We are all different and customizing your own trading approach is the best way to have consistently strong performance.

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Disclaimer

Past performance is not a reliable indicator of future results.

CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although we are not specifically prevented from dealing before providing this material, we do not seek to take advantage of the material prior to its dissemination.

CMC Markets does not endorse or offer opinion on the trading strategies used by the author. Their trading strategies do not guarantee any return and CMC Markets shall not be held responsible for any loss that you may incur, either directly or indirectly, arising from any investment based on any information contained herein.

*Tax treatment depends on individual circumstances and can change or may differ in a jurisdiction other than the UK.

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