6 to 21 Part II Strategy by Daryl Guppy

Click here for Part 1

We start the strategy with a basic understanding of the relationship between risk and reward as shown in the diagram. Blue chip stocks are those which have the capacity to return 10% to 20% in a single trade. These figures are moved up a little in a bull market, but in general these are the types of returns we aim for with a blue chip stock. Trades may last months or longer with these stocks. Note that it is the return from the trade that defines the category. It is not the quality of the stock, although it is fair to say that most blue chip stocks also have a large capital base.

• The mid cap stocks are capable of returning 30% to 50% in a single trade. In a long term trend they may return much more, but our focus is on a single trade that may last weeks or months.
• A speculative stock is capable of returning 50% to 100% in a single trade. Typically these trades will last days or weeks. Some last months, but this is unusual.

As we move from blue chip trades to speculative trades, the risk increases. Speculative trading opportunities generally carry greater risk than blue chip opportunities. This is partly a function of volatility, and partly a function of momentum. Fast movers can also drop quickly. Slow movers can drop steadily for months on end as people discovered with banks in 2008. . The speed of the collapse does not diminish the risk in the trade. The risk is diminished by the activity of the trader. The trader who does not act on a stop loss signal automatically increases the risk, and the size of the loss, in the trade. The primary difference between blue chip and speculative stocks in this sense is that most times the blue chip trader will have more time to make a decision.

The obvious and enticing way to grow our capital quickly is to trade the speculative stock opportunities. If we only do this, and pyramid the returns from each trade into the next trade then we can grow capital very rapidly. Unfortunately it does little to protect our capital. With each new trade our capital and profits are exposed to the same level of market risk as when we first started. This is the gambler’s approach and is a short cut to ruin unless your luck holds.
The resolution to this problem, as covered in Share Trading, is to use only a fraction of capital in the high risk trades. This strategy uses speculative profits to add to capital.

The process is shown in the diagram. Our starting capital - $6,000- is divided into a 1:2 ratio. Two thirds of the capital - $4,000- is allocated to a blue chip trade. This is not going to earn a great deal, but it should earn better than bank interest which is the other alternative use of our capital. There are two objectives. One third of the capital is allocated to a speculative trade. This means the position size is $2,000 and this is about the minimum size trade that is realistically possible. This is the size of the RFE* trade example. It is this minimum size, coupled with the 1:2 ratio that gives us the minimum size for starting capital - $6,000.

To primary objective is to protect our capital. This is achieved by allocating more to blue chip stocks than to speculative stocks.

The next objective is to grow capital quickly by taking greater risk in the market. This is achieved by using a smaller proportion of our capital. This small proportion grows slowly as our total trading capital – profits and original capital – increases.

The profits from each trade are added to our trading capital. The diagram shows a successful speculative trade. The profit from this trade is swept initially into our bank account.



This profit becomes part of the total trading capital available. As a new speculative trade is opened the profit from the original speculative trade is added to the capital used in the next speculative trade. This is an aggressive Egyptian pyramid approach designed to fast track capital growth.

Although this is potentially a very profitable strategy, it is also a strategy that carries a higher level of risk. This is managed firstly by using tightly defined stop loss points and entering trades as close to the stop loss point as possible. We discussed techniques for this in recent newsletters.
The second way this risk is managed is by stopping this pyramid approach once we reach $14,000. The objective is to quickly reach the $14,000 level. Once this level is achieved, the capital ratio changes to the 1:2:4 ratio. This puts 1/7 of capital in speculative stocks, 2/7 in small or mid cap stocks, and 4/7 into blue chips. Again, the shift to this new ratio is based on the minimum acceptable trading size of $2,000. Applying 1/7 of trading capital to a $14,000 account gives a position size of $2,000.

Once $14,000 has been reached the next objective is to reach $21,000. At this level the combined impact of the speculative and mid cap trades can add significantly to the growth of trading capital. Growing capital is like pushing a heavy load. At first progress is slow, but as momentum builds the speed increases and it appears to take less effort to obtain a better result. As capital grows, the leveraged impact of speculative and mid cap trades increase and capital grows quickly. The difficult part is getting from $6,000 to $21,000. Over the next few months we will show some of these difficulties in real time. The skills learnt in this process underpin long term trading success.



As noted the speculative trade in RFE was closed with a 19.33% profit. This added $391 to speculative capital. The next speculative trade will use $2,391. The blue chip component of the 6-21 portfolio is yet to be opened. A new speculative position will be added when opportunities arise. This is not a process of close one trade and jump into the next. It takes time and care to build from a low capital base. We will show these trades in the case study report as they develop through the Guppy Newsletter.

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Article contributed by Private Trader, Market Expert, Trading Coach and Best-Selling Author Mr. Daryl Guppy. For more articles and commentaries from Daryl Guppy, click HERE.