Composite Leverage Index-beginners Must Know


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These are extracts from Edwards and Magee,"Technical analysis of stock trends"

In order to put your charts to work, you have to avail of the highly leveraged stocks, stocks which carry more opportunity for gain and hence more risk of loss. How we divide our capital shall make little difference unless we know how well we apply it. The various factors of price level, sensitivity and margin come into a concept called Composite leverage index.

Taking a hypothetical situation, supposing a man risks his entire capital with 100% profit or 100% loss, even if he is successful in the first venture he will be wiped out if the second venture is a loss. No matter how many successes he may have , he stands to lose everything in his first failure.

Similarly if you could have 40% profit and 40% loss on each transaction, after 10 successes and 10 losses you could end up with a loss of 10% of your capital. The sequence of gains is not important- you could have three gains, four losses, seven gains , six losses.

If you have only 8% loss in ten transactions and 8% gain from ten other trades, you end up losing 6% of your capital.

In the latter case you could have righted your boat but in the former case you would have sunk without a trace, a victim of overtrading. To prevent this, we have what we call the composite leverage indec( CLI):-

CLI= SNT/15.5*C

S= Sensitivity index of the stock
N= Normal Range for price
T= Total net paid or received
C= Capital reserved to finance this commitment. In the case of outright cash purchases or 100% margin, short transactions, this figure cancels out against T in the numerator.

(15.5 is the Normal range for a stock selling at a price of Rs 25, and is simply an arbitrary selection to serve as a fixed point of reference in determining rations)

I have given above what I thought would be of interest to other beginners. Hope this is the lull before the storm and from here the relay factor comes in. Hope traderji tells us how to practically implement this. Creditviolet has the same input in his excellent presentationWhat is money management elsewhere in this forum. But the process and output seem significantly different.
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