Are you sick of doing all your Stock Due Diligence only to press the buy button and the price seems to immediately start working against you? Whilst fundamental analysis is very important and you should always do your due diligence sometimes a little bit of ASX Trading Information can help you time the perfect entry and exit into the market.

Whilst we have continually stressed that typically stocks are for the long run, we thought it would be a good idea to put together the Complete Guide to ASX Trading. So that you don’t YOLO your money into a stonk for it only to crash moments later.

It’s very important to note that Trading and Investing are typically two very different skill sets, with the latter requiring a focus on Due Diligence and fundamentals whilst the foremost requires control, understanding of probabilities and repetition.

Prophets Trusted Affiliate Partner

The ASX Trading Myth

You more often than not hear your fellow investing friends saying that they have heard of this magic trading formula or the holy grail of day trading only for you to give the same thing a try and fail once again. However, what you probably don’t see is the sheer amount of losses that your friend is taking behind the scenes to gain a couple of really good tickers that actually do break out.

In Trading, the Aim of the game is to make more money than you lose, to do this you typically need to limit the amount that you will win and lose. This is a similar concept to what we hold for our normal stock buying and selling which is to Bet heavily when the odds are stacked in your favour. This means that if a gamble is not in your favour what is the point of taking it. Also if you have to risk 100% of your capital to make a small amount, is the risk really worth the rewards here?

Stock Trading Risk and Reward Principal

When you toss a coin, you have a 50:50 chance of receiving a head or tails. However, if you flip a coin only 5 times you might get 3 head results and 2 tails which is a 60% result of receiving heads, likewise you would more often than not receive results that do not actually gain a 50% result of getting a result of heads. This is depicted in the below illustration. This model can be found at the link here.

ASX Trading Model Coin Toss
Coin Flip 5 Times with a 60% result to Tails

As you add more and more coin tosses into the equation, the resulting trend more and more towards the theoretical probability of the model. This time we have added an additional 200 coin flips into the model. This would be similar to making 200 ASX Trading bets and letting them play out.

Coin Toss Model with 200 Trials

You can see as the number of coin flips increases the more likely the result is to trend towards the theoretical probability of the model. i.e 50:50. You can see early on the proportion of heads starts out at about 0.4 and gets as high as 0.63 before evening out.

The important lesson here is, that with any probability model you need a sufficient number of trials before you get an accurate representation of the result. This is applicable to ASX Trading as you need to know the theoretical probability of any model that you intend on Stock Trading with.

The Coin Toss Model Now with Stock Trading

Let’s suppose that for each coin toss, you decided to bet $1 on each coin flip. Once again let’s have a look at a smaller case first. For this we are going to bet on Tails, however, you could bet on the head and also get the same result.

From the above, we received a head result 3/5 times and a tail results in 2/5 times. Meaning by betting on tails we actually lost 3$. Let’s complete the coin flip again another 50 times.

We have now bet a total of $50 on the coin toss game and won a total of $21. This doesn’t seem to be a very worthwhile game to play and demonstrates once again our point of only betting when the odds are stacked heavily in your favour.

Let’s say the rules of the game have been changed, and for every time you win the game pays out two dollars but for every time you lose you only have to pay the game 0.5c, bet sizes are still 1$. This now changes the game and puts the odds slightly more in your favour.

Using the same result above for the 5 tosses and 50 toss games (i.e 2/5 tails and 21/50 tails). In-game #1 you would have lost a total of $1.5 but made a total of $4 and in game 2 you would have lost a total of $14.5 and made a total of $42. This demonstrates a game where the odds are stacked in your favour. But the lesson to learn here is that even though the game is stacked in your favour if you only ever bet once, you could still end up losing money.

I.E you bet $10,000 on the above games once and receive a losing result. You would have to pay out $5,000, however, if you stopped there you would have lost $5,000 to a game that is stacked heavily in your favour. Let’s say you bet again and lose you would now have $2,500. Betting again, you lose, and your ten thousand is slowly dwindled down to $1,250 dollars. If you stopped then you would walk away, likely to never bet in this game again, However, let’s say your next coin tossers are 3 winners in a row, you would then be sitting back to your $10,000.

This is why, although a game may be stacked in your favour you need to portion your position sizing wisely otherwise you simply won’t have enough capital to play the full game.

If you played out the game 200 more times you would in theory trend towards the 50:50 probability of the coin, but because the payout is stacked in your favour you would win massive amounts of money in this example. The end result in this example is depicted below:

We received a heads result in 98 times and tails result in 102 times, meaning that your $10,000 starting capital could be worth over $2 million however had you stopped playing early on, you wouldn’t have given the model a chance to play out and the trend towards the statistical probabilities. If you don’t have enough capital and size your positions correctly your ASX trading dream may be over before it starts.

The only thing that can change in the above game is the payout ratios. The probability model is fixed in this instance. The most important lesson above is that position sizing plays a critical role in your trading experience.

Developing and Testing a Trading System

Now that we have covered the basics and positioned your headspace slightly, let’s take a look at some typical trading systems. It is here where many people claim to have found the holy grail of trading and look to sell “their systems” at considerable prices. However, they do not provide any information about the overall profitability or expectancy of the system. This is crucial information that is left missing that you would need in order to backtest their claims. But, it is almost always never provided.

Prophet Invest Trusted Affiliate Partner

We at Prophet believe that almost any System or Indicator can be made into a profitable trading system. You simply need to take an idea and test that “idea” sufficient enough time to develop a win/loss rate of that particular idea. We need to identify the win-loss rate as without it we will not have enough information to calculate our position size. Which from the previous chapter was “CRITICAL” in our trading success.

So go ahead, research any ASX trading system and get started in testing the win-loss rate. This can be anything that works for you. There was a very profitable trader, who use to print out an A3 version of a chart, tape it onto the wall and then go stand at the back of the room. He would then open his eyes, look at the chart and see which way the trend was going. He would then make a trade based on that principle.

However, there are many other strategies available out there for budding traders, we have listed a few below:

  1. Trend Following
  2. Band Following (I.e Bollinger Bands, etc)
  3. Arbitrage
  4. Fundamental Analysis
  5. Value Trading
  6. 200/20 EMA Crossovers

Also, it’s important to note that we also listed Fundamental Analysis as an option here. As typically even though your DD will complete there is a likelihood that it doesn’t play out, hence position sizing comes in handy here as well. This is the reason we bet so much money on our BOEING Trade. 1. Because the odd’s were stacked soo heavily in our favour!

Once you have figured out an ASX trading system, test the system using $0 first and test it a reasonable amount of times to be able to figure out the actual indicated probability of the model. This would be no less than 200 times. Once you have tested a number of models you will have a table that looks similar to the below:

ModelNumber of Wins (/200)Number of Losses (/200)
System 112080
System 213070
System X40160
Example of the Win/Loss Table you might develop to test a model

Once you have developed the strategy, pick the one that works best and move onto the next section.

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ASX Trading Expectancy

Now that we have covered the basic principles, let’s have a look at how this translates into real money. This can be done by looking at the expectancy. If you take the above table have a think about the size of your profits compared to the size of your losses at thee smallest scale what would this look like?

This here we like to think in terms of Risk Vs Reward Rations or R.

When you enter a trade you should always know at what level you should exit the trade and take profits or take a loss depending on which it may be. Remember its not bad to take a loss here and there as long as the size and frequency of your wins far outweigh your losses you will be profitable.

Lets suppose you instead of having a 50:50 head tail coin, this coin was infact rigged to have 60:40 chance of winning, that is heads has the advantage. In this example you loose if you get a tails. Lets say you win what you put in back each time you receive a heads.

Now in this example you can expect to win in theory 60 times and loose 40 times in the game. If we win and loose exactly what we put in each time we can say we would win 60R and loose 40R where R is the minium amount you put in, which in this case is $10. So in theory the total expected winnings is 600*$10 – 40*$10 or $2,000. In reality from the above, the actual result would be $1,200 but the more times you play this game the closer you will get to the expected theoretical result.

We like to think of R in terms of the minium amount that you risk per trade.

It’s critical here and what we have tried to demonstrate between the examples are that actual results and theoretical results will differ, however the more times the play is made the closer you will get to the expected theoretical result. Hence the amount of capital you have available to risk should be sufficient enough to allow you to play out the game the required amount of times to get close to the expected result.

There is no point playing a game where you cannot afford to reach the expected result. Which is why over time casino’s always make money because the odds are stacked slightly in their favour and they have more than enough capital to play the game. The same can be said for Stock Trading, Crypto Trading, Bitcoin Trading, the list goes on.

Calculate Your R Multiples for Stock Trading

From the above you should now be able to calculate your R multiples, this would once again be done by backtesting or forward testing from real world data. In order to calculate the R multiple for ASX Stock Trading you would assume an initial investment in each stock of say a round arbitrary number of $1,000 or $10,000, it doesn’t really matter what you pick just make it easy.

Prophet Invest Trusted Affiliate Partner

From Van Tharp Institute

R-value: The initial risk taken in a given position, as defined by one’s initial stop loss.
R-multiple: All profits can be expressed as a multiple of the initial risk (R). For example, a 10-R multiple is a profit that is 10 times the initial risk. Thus, if your initial risk is $10, then a $100 profit would be a 10 R-multiple profit.

  1. Pick a Round Arbitary Number for a trade size, i.e $1,000 or $10,000 for ASX Trading or Crypto Trading
  2. Use the System you developed as part of Developing and Testing a Trading System and add information into a table similair to below:
  3. Once you have sufficient real world value to figure out the expected R value Sum the Total of The R-Value Column, in this case it will be 2.15-0.45+0.69 => 2.39
  4. Calculate the expectancy by taking the total and dividing by the number of trades made i.e 3 in this case. This would give an expectancy of 0.79 for Stock Trading, this method is similar for Crypto Trading
TickerRiskProfit or LossR Value
WBC.ASX$1000$2,1502.15
HUM.ASX$1000-$450-0.45
AS2.ASX$1000+690+0.69
Total R2.39
Expectancy0.79 x R
Example of R Value Calculation

The result is that we can expect to make a total of 0.79 x R (the amount we risk per trade). The higher the R value here the better the system.

It is very important to note that 3 trades is simply not enough data on which to accept the system, this should be tested on many more trades, i.e sufficient number for you to be able to confidently say, yes I am happy with the results, this may be 200, 500 or more than 1000 trades. As you saw in the coin toss examples this is extremely important as in stock trading we don’t actually know the expectancy or formula for the game we need to try and figure this out by testing.

If you already have a trading system that you have been using for some time, reach out and we can help you with another formula that will allow you come up with a R value without the initial risk outlay. You would need to send us a log with your ASX trading data.

Position Sizing in Stock Trading

Now for the interesting bit, we know the expectancy of our system and the amount of times we can in as close to theory expect our system to win or loose. The only thing here is now we need to ensure that we have enough capital and size our positions correctly so that we can play out the entire game.

Using the coin toss analogy with the 60:40 again, there is no point betting 100% of our money on the first toss as we would likely loose all our money to never play the game again. We need to be smart in how we size our positions to ensure longevity in playing the game. This is applicable to ASX trading and Crypto Trading just as much as it is in the coin toss analogy if we run out of money we would have to give up our dream of stock trading.

Long term gamblers typically have two common strategies when it comes to position sizing, increasing ones bet when equity decreases or increasing ones bet size when the equity increases. This typically doesn’t work in the casino or the market though! Hence the reason they are called long term betters.

There are once again many decent position sizing strategies, which you should research and this article should just be the beginning of any research into ASX trading. Some strategies are listed below:

  1. One Unit Per Fixed Amount of Money
  2. Equal Units Model
  3. Percent Risk Model

There are also likely be many other models out there so you need to research and adopt a model which is best suited for your trading style.

In playing this game you want to develop a position sizing algorithm which is supportive in exploiting the expectation. In addition, you want it to be linked to the initial risk for each trade and the on-going account equity.

For starters, consider a percent risk algorithm where you decide to continuously risk a constant percentage of current account equity. This sort of position sizing algorithm basically means that a 1R risk becomes the same, no matter when it is take or in what stock or market it is taken. This is because your position size is always a constant percentage (i.e., 1%) of your equity no matter how big the initial risk (R) is. However, always do your own research and find the optimal solution that fits your trading style.

ASX Trading Prophet’s Take

This is just a starting point for beginners, it’s not going to make you rich overnight but it will serve as a method of benchmarking your future investments. From here you should have some of the basics to go away and do some more research on.

If we’ve helped even one investor from getting Fooled into purchasing overly expensive ASX trading courses or stung by their mate’s trash speccy trading signals then this article has been a success.

Not a Fan of Trading: Check out Our Ultimate DD Stock Checklist Instead

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