The Successful Stock Trader

Level of diversification There is one more element to consider - how many positions to have on.

Again, using a risk management tool we can correctly define this, rather than having to take a wild guess according to our confidence levels. When the stock market is moving along strongly, as it was from 2003 to 2007, the inclination is to get onto anything that moves. Because of the leverage available from CFDs, this can be a very dangerous proposition and one that must be controlled. The question is how many positions should you take? Five? Eight? More?

The answer lies in the amount of margin being used. In the previous XYZ Stock example, we put up $632 in margin to cover the position. The $632 represented 3.16 per cent of our $20000 account. This percentage is known as the margin to equity ratio and, ideally, it should not exceed 30 per cent to 35 per cent to remain on the safe side. As prices move around and your protective stops are adjusted, this ratio will also move, so you should keep monitoring it in case it starts to creep beyond the 35 per cent level. If it starts to get toward 50 per cent, the exposure to the market should a nasty price reversal occur is starting to become dangerous.

Some CFD providers offer a guaranteed stop loss (GSL) facility that enables the margin to be lowered even further and again helps you reduce your risk. The GSL facility is a great idea when you are going against the major trend or shorting a very low-priced stock that may be a takeover target.

Capital restrictions with non-leveraged trading Before the days of CFDs, when the market was extremely bullish on the coat-tails of the US technology boom in the late 1990s, I came across the problem of having too many trading signals and not enough capital to trade them all. I needed some type of filter that allowed me to make an educated guess as to which of two stocks might be a better performer should they both be winners. I named the filter 'Bang for Buck' and it 54