It doesn’t take that long to do all these things; you can knock it out in 30
minutes to 2 hours depending on how much you trade. But regardless of
how long it takes, it’s worth much more than the effort you’ll put into it.
By going over all your trades, you will gain insight into your trading and
you’ll learn what’s working and what isn’t. Those who never review their
trades will never learn what they do right and wrong. Instead, they will
keep making the same mistakes over and over again. By preparing for the
next day, you will get a tremendous head start on the day. Think how much
better you’ll trade if you come in with a game plan and scenarios for all your
trades. No matter what curveball the market throws at you, you’ll be ready.
Hell, they will all look like hanging curves if you are prepared.
Now go and have that beer with John.
Tuesday, November 9, 2010
REVIEW YOUR PLANS AND STRATEGY
Don’t just review the trades but constantly check the plan itself for validity.
You may be losing money and the reason may be that your plan is faulty so keep checking to make sure that it is sound. This is something you will
definitely do during off market hours. It is not something you will do every
night, but every now and then go over all your strategies and make sure
they are doing what you thought they should. If they are, are you following
them? Or maybe you just have strategies that were no good to start
with. Doing this will help keep you on top of your game and ensure you are
trading with a solid strategy.
You may be losing money and the reason may be that your plan is faulty so keep checking to make sure that it is sound. This is something you will
definitely do during off market hours. It is not something you will do every
night, but every now and then go over all your strategies and make sure
they are doing what you thought they should. If they are, are you following
them? Or maybe you just have strategies that were no good to start
with. Doing this will help keep you on top of your game and ensure you are
trading with a solid strategy.
GETTING READY FOR TOMORROW
Now that you have gone over all your previous trades, it’s time to start
focusing on the next day. As you reviewed your open trades you should
have been adjusting your plan for them as you went along. But what about
new trades you may want to put on? You can start looking at charts to see if there are any good setups you may want to trade. You can start creating
entry and exit points for these trades. You can look to see if there are any
schedule reports due. If so, figure out how you will react depending on
what the market does. Say you are trading oil and the American Petroleum
Institute (API) numbers are due tomorrow. If they are indicating a bigger
buildup in reserves than expected, you would expect the market to drop.
But after 20 minutes if it hasn’t dropped then you will go long, otherwise
you will short. If the numbers are weak, you will buy right away and give it
a two-point stop.
Look at your charts and know where all the indicators, trend lines,
and average true ranges are. See how the market closed today and figure
out what you want to do the next day based on different openings. In the
morning, you will follow up on this once you know where the opening is
going to be, but it is better to get a head start the night before.
As you scan charts, have a note of what you are looking for. Are you
looking for a breakout, a reversal, a bounce off of a channel? If you do
find something you like, then be prepared by knowing where you will be
exiting so you can estimate a risk and reward. Do your homework, look at
different time frames, be realistic about what you can expect and what you
can lose. Try to figure out how many contracts you will be trading based
on the risk of the trade. This doesn’t mean you will enter the trade in the
morning, but you are giving yourself a potential trading opportunity that
you have preestablished.
All this is a lot easier if you only trade one market; however, if you
are one of those day traders who has 120 stocks on his screen and trades
almost anything, this reviewing process is a little tougher. What I used to
do when I traded equities was I had a scenario I liked to trade (I looked for
trending stocks that have had a little pullback to a trend line) and I had my
favorite stocks to trade. I would quickly go through them all and see which
fit my setup. I made a list of the stocks that did and these are the ones I
would look to trade the next day if they met further requirements.
By doing the things outlined in this chapter you will be well on the
way to starting the trading day with a solid game plan. You will still have to
make some adjustments to it in the morning, but you should now know how
you will react to different situations in the market. You will have your stops
and exit levels for existing trades. You’ll have entry levels for new trades.
And you’ll even have targets and stops as well as risk and reward ratios.
focusing on the next day. As you reviewed your open trades you should
have been adjusting your plan for them as you went along. But what about
new trades you may want to put on? You can start looking at charts to see if there are any good setups you may want to trade. You can start creating
entry and exit points for these trades. You can look to see if there are any
schedule reports due. If so, figure out how you will react depending on
what the market does. Say you are trading oil and the American Petroleum
Institute (API) numbers are due tomorrow. If they are indicating a bigger
buildup in reserves than expected, you would expect the market to drop.
But after 20 minutes if it hasn’t dropped then you will go long, otherwise
you will short. If the numbers are weak, you will buy right away and give it
a two-point stop.
Look at your charts and know where all the indicators, trend lines,
and average true ranges are. See how the market closed today and figure
out what you want to do the next day based on different openings. In the
morning, you will follow up on this once you know where the opening is
going to be, but it is better to get a head start the night before.
As you scan charts, have a note of what you are looking for. Are you
looking for a breakout, a reversal, a bounce off of a channel? If you do
find something you like, then be prepared by knowing where you will be
exiting so you can estimate a risk and reward. Do your homework, look at
different time frames, be realistic about what you can expect and what you
can lose. Try to figure out how many contracts you will be trading based
on the risk of the trade. This doesn’t mean you will enter the trade in the
morning, but you are giving yourself a potential trading opportunity that
you have preestablished.
All this is a lot easier if you only trade one market; however, if you
are one of those day traders who has 120 stocks on his screen and trades
almost anything, this reviewing process is a little tougher. What I used to
do when I traded equities was I had a scenario I liked to trade (I looked for
trending stocks that have had a little pullback to a trend line) and I had my
favorite stocks to trade. I would quickly go through them all and see which
fit my setup. I made a list of the stocks that did and these are the ones I
would look to trade the next day if they met further requirements.
By doing the things outlined in this chapter you will be well on the
way to starting the trading day with a solid game plan. You will still have to
make some adjustments to it in the morning, but you should now know how
you will react to different situations in the market. You will have your stops
and exit levels for existing trades. You’ll have entry levels for new trades.
And you’ll even have targets and stops as well as risk and reward ratios.
THE CLOSED TRADES
Did You Follow Your Plan?
After you finish reviewing the open trades, you then should go over the
trades you closed out during the day. This is where the real learning begins.
Again, you can do this in any order you like, but I like to go over all my
losers first. I want to learn what I did wrong or right and reviewing is the
best way to do this. The first thing you want to do is to make sure you had
and stuck to a plan for the trades you made.
As you go over every trade ask yourself:
Having and following a plan is so important in being a winning trader.
It is one thing you really need to keep on top of all the time. If you have
a plan and have exit strategies in that plan and you consistently ignored
them, then it’s useless having a plan. You may need someone slapping you
in the back of the head every now and then saying, “Hey stupid, what are you doing? Follow your plan.” If you’ve ever watched the old Pink Panther
movies, you’ll remember Cato, Inspector Clouseau’s martial arts expert
manservant. Cato would constantly jump out of closets and sneakattack
Clouseau to keep his defensive skills and awareness sharp. Well,
maybe we all need to hire a Cato to keep us on our toes and in line every
time we deviate from our plan. It may hurt a little at first, but soon you’ll be
able to stick to your plan much better.
If you didn’t follow your plan, ask yourself why not and what you
should do differently next time to help you follow it. Find out why you
put on every trade, and why you got out of them. If you are diligent about
sticking to a plan, then you don’t have much work to do here, but always
review to make sure you stick to your guns.
The Good Losers
Some losing trades are good trading decisions that didn’t work out and if
you got out with a small loss when you were supposed to, I don’t consider
it a bad trade. A bad trade is when you let it get away or make a stupid, unplanned
trade. Being able to take a good losing trade is the most important
trade of all and this is a behavior I want to reinforce. The reason I think
they are the most important trades of all is that your money is made as a
total of all your trades—winners and losers. You will have losing trades,
and you cannot get around that no matter how good you think you are. But
if you are able to limit losses to a manageable amount and avoid the huge
losses, your net profits will soar and you will be a better trader. I am more
proud of getting out of something with a small loss that would have turned
out to be worse, than I am about having a winning trade. Everyone can get
lucky and make a great winning trade here and there, but only good traders
know how to get out at the right time on the losing side. Even though I may
have lost money on a trade it is a good trade if I did the right thing. When
I review these trades I look to remember what I did to make me get out
quickly so that if I see that situation again I hope to act correctly the next
time as well.
Ones That Got Away
Next you can go over the ones that you just let go. These trades usually fall
into two categories, either you overstayed your welcome and gave back
too much on a winner, or you let a loser go and froze up as you watched it
disintegrate. Either way they are going to really affect your P&L statement.
It only takes one bad trade to wipe you out, even after 10 winners in a row,
so try as hard as possible to not let it happen. You have got to learn to stick
to your exit plans and constantly reviewing this will definitely help.
Don’t be satisfied that you made money on a trade. If you had a 50-
point winner that you turned into a 3-point winner, you screwed up that
trade and gave back your money. At the end of the day, week, month, or
year it’s a total of all your trades that determines how you did, so don’t take
it too lightly if you take a small winner that was once a big one. You lost
that 47 points, that was your money to be had. Find out why.
If I let a trade get really bad, I try to see why I did so, so I don’t do it
again in the future. As you look over the trade, look for the spot you should
have gotten out and try to figure out why you didn’t. It could be because
you had no exit strategy or because you failed to follow one if you did, or
because you got greedy and tried to get more than you could out of a trade.
Or did you freeze up and hope a loser would come back? There are many
reasons you could let a trade get beyond the point where you were suppose
to get out. Figure out why you did so and work on not doing it again. These
are the trades you need to work on the most on because they will draw
down your account faster than the good trades will add to it.
The Good Winners
The last thing I review is my good winning trades and again I’ll try to learn
from them. Good winners are the trades you did everything right on and
made some decent money with. Don’t just look at it and say “good trade”
and move on. Really delve into it. Ask yourself, “Why was it a good trade
and what did I do right?” Did you just get lucky or did you really do something
right. If you did something right, then make sure you keep doing it.
By studying trades you may find that every time you make a trade with a
certain setup it works great, but if a certain variable was changed a little it
doesn’t work as well. Only thorough reviewing will tell you things like this.
If you are a person who has trouble following a game plan, and odds
are you are or you wouldn’t have bought this book, keep track of how you
did on trades where you followed a plan, had an entry point, and came up
with a predetermined exit level. And then keep track of those trades you
put on with little preparation. Next, compare them to see how they do.
Hopefully you will see a big discrepancy and realize that you need to have
and follow a strategy/plan when you trade if you really want to succeed.
After you finish reviewing the open trades, you then should go over the
trades you closed out during the day. This is where the real learning begins.
Again, you can do this in any order you like, but I like to go over all my
losers first. I want to learn what I did wrong or right and reviewing is the
best way to do this. The first thing you want to do is to make sure you had
and stuck to a plan for the trades you made.
As you go over every trade ask yourself:
- Why did I make this trade?
- Did I have an entry plan when I got in?
- Did I have an exit plan for the trade?
- Did I followmy plan?
- What did I do differently and why didn’t I follow that plan?
Having and following a plan is so important in being a winning trader.
It is one thing you really need to keep on top of all the time. If you have
a plan and have exit strategies in that plan and you consistently ignored
them, then it’s useless having a plan. You may need someone slapping you
in the back of the head every now and then saying, “Hey stupid, what are you doing? Follow your plan.” If you’ve ever watched the old Pink Panther
movies, you’ll remember Cato, Inspector Clouseau’s martial arts expert
manservant. Cato would constantly jump out of closets and sneakattack
Clouseau to keep his defensive skills and awareness sharp. Well,
maybe we all need to hire a Cato to keep us on our toes and in line every
time we deviate from our plan. It may hurt a little at first, but soon you’ll be
able to stick to your plan much better.
If you didn’t follow your plan, ask yourself why not and what you
should do differently next time to help you follow it. Find out why you
put on every trade, and why you got out of them. If you are diligent about
sticking to a plan, then you don’t have much work to do here, but always
review to make sure you stick to your guns.
The Good Losers
Some losing trades are good trading decisions that didn’t work out and if
you got out with a small loss when you were supposed to, I don’t consider
it a bad trade. A bad trade is when you let it get away or make a stupid, unplanned
trade. Being able to take a good losing trade is the most important
trade of all and this is a behavior I want to reinforce. The reason I think
they are the most important trades of all is that your money is made as a
total of all your trades—winners and losers. You will have losing trades,
and you cannot get around that no matter how good you think you are. But
if you are able to limit losses to a manageable amount and avoid the huge
losses, your net profits will soar and you will be a better trader. I am more
proud of getting out of something with a small loss that would have turned
out to be worse, than I am about having a winning trade. Everyone can get
lucky and make a great winning trade here and there, but only good traders
know how to get out at the right time on the losing side. Even though I may
have lost money on a trade it is a good trade if I did the right thing. When
I review these trades I look to remember what I did to make me get out
quickly so that if I see that situation again I hope to act correctly the next
time as well.
Ones That Got Away
Next you can go over the ones that you just let go. These trades usually fall
into two categories, either you overstayed your welcome and gave back
too much on a winner, or you let a loser go and froze up as you watched it
disintegrate. Either way they are going to really affect your P&L statement.
It only takes one bad trade to wipe you out, even after 10 winners in a row,
so try as hard as possible to not let it happen. You have got to learn to stick
to your exit plans and constantly reviewing this will definitely help.
Don’t be satisfied that you made money on a trade. If you had a 50-
point winner that you turned into a 3-point winner, you screwed up that
trade and gave back your money. At the end of the day, week, month, or
year it’s a total of all your trades that determines how you did, so don’t take
it too lightly if you take a small winner that was once a big one. You lost
that 47 points, that was your money to be had. Find out why.
If I let a trade get really bad, I try to see why I did so, so I don’t do it
again in the future. As you look over the trade, look for the spot you should
have gotten out and try to figure out why you didn’t. It could be because
you had no exit strategy or because you failed to follow one if you did, or
because you got greedy and tried to get more than you could out of a trade.
Or did you freeze up and hope a loser would come back? There are many
reasons you could let a trade get beyond the point where you were suppose
to get out. Figure out why you did so and work on not doing it again. These
are the trades you need to work on the most on because they will draw
down your account faster than the good trades will add to it.
The Good Winners
The last thing I review is my good winning trades and again I’ll try to learn
from them. Good winners are the trades you did everything right on and
made some decent money with. Don’t just look at it and say “good trade”
and move on. Really delve into it. Ask yourself, “Why was it a good trade
and what did I do right?” Did you just get lucky or did you really do something
right. If you did something right, then make sure you keep doing it.
By studying trades you may find that every time you make a trade with a
certain setup it works great, but if a certain variable was changed a little it
doesn’t work as well. Only thorough reviewing will tell you things like this.
If you are a person who has trouble following a game plan, and odds
are you are or you wouldn’t have bought this book, keep track of how you
did on trades where you followed a plan, had an entry point, and came up
with a predetermined exit level. And then keep track of those trades you
put on with little preparation. Next, compare them to see how they do.
Hopefully you will see a big discrepancy and realize that you need to have
and follow a strategy/plan when you trade if you really want to succeed.
THINKING ABOUT TOMORROW
As you go over all your open trades, you need to keep thinking about them
in the future. You will want to draw up different scenarios for each trade
and make notes as to how you will react if that situation arises. I like to
think up different possibilities of what the market can do and draw up targets
and exit points for them. I’ll anticipate if I will add to or subtract from
a position. Doing this keeps me from getting surprised when something
does happen. Maybe there is an earnings report coming out, and there is
a chance it can cause your stock to move. As a good trader you will be
prepared for anything that stock could do the next day.
For example, if you were long in Figure 7.5 you could start preparing
for anything that could happen the next day and in the near future. You
may say, “If the market breaks above the double top line I will add five
contracts to my position, with a target of 14,300, and I’ll raise my stop to
under yesterday’s low to the Stop 2 level. However, if it drops below the
double bottom, I’ll exit all my longs and reverse and use the double top
area as a stop. If the market stays within the range it is in now, I’ll keep my
current stop (Stop 1) and do nothing.”
Planning out current trades will start to take the gamble out of your
trading as it’s much better to have all your scenarios planned out before
they happen and surprise you. You can get more elaborate and consider
what you will do if the market opens up 50 points and rallies or reverses
after the up open or what you’ll do if it opens below the support line. The
possibilities are endless and the better you have them considered in your
game plan the better you will do.
This isn’t an end-all list of things to look for when going over your
open trades. You may have special criteria you want to keep track of on
your own, or you may have things that are specific to the way you trade or
the markets you trade. I can’t come up with every little thing, but part of
trading is that you should always be learning and finding ways to improve,
so work a little on figuring out other things to look for when going over
your trades.
in the future. You will want to draw up different scenarios for each trade
and make notes as to how you will react if that situation arises. I like to
think up different possibilities of what the market can do and draw up targets
and exit points for them. I’ll anticipate if I will add to or subtract from
a position. Doing this keeps me from getting surprised when something
does happen. Maybe there is an earnings report coming out, and there is
a chance it can cause your stock to move. As a good trader you will be
prepared for anything that stock could do the next day.
For example, if you were long in Figure 7.5 you could start preparing
for anything that could happen the next day and in the near future. You
may say, “If the market breaks above the double top line I will add five
contracts to my position, with a target of 14,300, and I’ll raise my stop to
under yesterday’s low to the Stop 2 level. However, if it drops below the
double bottom, I’ll exit all my longs and reverse and use the double top
area as a stop. If the market stays within the range it is in now, I’ll keep my
current stop (Stop 1) and do nothing.”
Planning out current trades will start to take the gamble out of your
trading as it’s much better to have all your scenarios planned out before
they happen and surprise you. You can get more elaborate and consider
what you will do if the market opens up 50 points and rallies or reverses
after the up open or what you’ll do if it opens below the support line. The
possibilities are endless and the better you have them considered in your
game plan the better you will do.
This isn’t an end-all list of things to look for when going over your
open trades. You may have special criteria you want to keep track of on
your own, or you may have things that are specific to the way you trade or
the markets you trade. I can’t come up with every little thing, but part of
trading is that you should always be learning and finding ways to improve,
so work a little on figuring out other things to look for when going over
your trades.
THE OPEN TRADES
Many of the situations below can apply to winning and losing trades, so
I’m not going to separate them into two sections. Just figure out which
applies to your situations as you read them. A winning and losing trade
can be looked at the same way depending on how long you have held a
position. A winning trade that gives back too much profit is no worse than
a losing trade. You don’t want to give back too much on a winning position
by overstaying your welcome. Even if you close it out as a winner, if you
gave back too much, in my eyes it’s a bad trade at least for the last part of
the trade. Though I prefer to review my winners first, it doesn’t matter if
you do them or your losers first or if you just go down your list of trades
in the order that you put them on. Whatever way you do it, just be sure to
give them all their fair due. If you are a day trader who closes everything
out at the end of the day then the next few pages may not be necessary, but
you paid for the book, so the read them anyway. If you trade one market
or stock, the reviewing part will go faster and then you could meet John at
Moran’s quicker. As you do go over every trade keep in mind that the main
purpose for doing so is to prepare for the next day’s game plan.
Why Did I Make the Trade?
The first thing I do when I look at my open trades is to start with ones I put
on most recently. I ask myself, “Why did I make this trade?” Throughout a
trade’s history you need to keep making sure that it is within your plan’s scope. I want to make sure that the trade is part of my trading strategy and
not some randomly put on trade. I want validation that I made the trade
for a proper reason. If I did, great, I can move on; if not, I want to make
sure it fits into one of my strategies. If it doesn’t, I’ll look to get out as
soon as possible, as I do not want to hold a trade that contradicts my basic
principles. Sometimes during the heat of battle of the trading day, you may
make some random trade and then not get out of it because you had no
plan for it. Hopefully this doesn’t happen often to you, but when it does, be
aware you are doing something wrong and remedy it as soon as you can.
Do the Reasons You Got in Still Hold?
If you shorted the Dow Jones because the 3-period moving average crossed
below the 10-period one as in point A in Figure 7.1, make sure it’s still the
case. If it’s not, it’s time to reevaluate the trade. Don’t wait until you are
stopped out to get out of a trade that isn’t working, if things have changed,
it’s okay to get out. In Figure 7.1 if you got out after the 3-period moving
average crossed back over the 10-period one, instead of waiting for the stop
to be elected you would have saved yourself about 200 points.
If it’s still within the parameters that got you in, look to see if they may
be changing, so you can anticipate an exit. Maybe the trade is still good but
FIGURE 7.1 Daily Dow
Source: © TradeStation Technologies 1999. All rights reserved.
it’s getting close to not being so, so you may have to watch it more carefully
tomorrow. Make a note of this and keep it on your radar screen (I’m not
referring to TradeStation’s radar screen but to your personal one). Make
sure if a trade is getting close to being one you have to exit that you are
on top of it. In the example in Figure 7.1 you can see the 3-period moving
average turning up and the highs of each bar getting higher prior to the
crossover at point B. This could be a sign your trade may not be within
the reasons you sold it for much longer, so you can start getting ready
for action.
Is It Simply Not Working as Planned?
Another thing you should monitor is whether the trade is working like you
planned. Yes, it could still be within your parameters, but maybe you were
looking to get a quick move on the trade and after three days it’s been stagnant,
not doing a thing. You need to consider whether you still want to hold
and monitor this dud? Your time and money could maybe be better spent
elsewhere. So why not get out? The trade is not doing what you wanted it
to, so you can consider moving on, though before you do make sure you
gave it an opportunity to work. If you look at Figure 7.1 again you’ll see this
as well. Assuming you got filled on the short at the first circle, the market
did nothing for the next few days. You expected it to go down right away
and it hasn’t. Even though the moving averages are still confirming a short,
you may consider getting out as it’s simply not performing as you’d like it
to, especially on the fourth day. At this point, you gave it time to work and
it didn’t and now it looks like it may pop back up.
Is It Close to the Target Area?
Once your trade starts getting close to the target area that you should have
established when you put the trade on, you should begin to monitor it more
closely. The target area can be a number, like when the market hits 13,541
or it can be a technical target as in when the market reaches the top of a
channel. It can be a time target as in exit after seven periods. Whichever the
case, you want to be aware that it’s getting close so that you can get ready
to act on it the next day if the target is reached. You may, after reevaluating,
consider moving the target, which is always an option, but make sure you
have a reason for it if you do. In Figure 7.2 I used Fibonacci projections
based on the up trend that started in July, to pick a target for a long using
a breakout of a previous high. As soon as the market gets within about two
normal days range from this target area (13,531), I would monitor it much
more closely to determine when I need to get out. One thing you need to
be on the lookout for is that it may fail to reach the target, in which case
you need a backup plan as to what to do. I do this by constantly moving my
stop up in a big move like this.
Has It Reached the Target Area?
Not only do you have to look to see if a trade is near its target area, you
should also keep an eye out for trades that have already hit your target
area. Let’s say the market traded through a channel you had set as a target.
You didn’t exit because maybe the move was strong and you wanted to let
your profits ride, which is a valid excuse. You now need to reevaluate the
exit points. Should you come up with a new target and stop areas or should
you get out, because your original level was hit? You could maybe keep the
trade and use your old target as your new stop. You really want to be on
top of a trade like this because there is no worse feeling then having a trade
reach its target and then some, then getting a little greedy and before you
know it goes against you and it turns into a loser. These losers are hard to
exit because you keep thinking it will come back to the best levels of the
trade and you end up just watching it fade away. Let’s say in Figure 7.2 you
did not exit at the target level and now the market is trading in the second
circle. You need to now reevaluate the trade as a new trade and determine
if you’d like to keep it as well as make a new target (target 2) and create a
new stop level (stop 2). You may introduce new technical indicators to help
you decide. I personally would have gotten out the second time it dipped
below the 13,531 level. I would have given it one time to test the level and
if it dipped below a second time I would exit. The reason being that I gave
it a shot to work and it didn’t right away, and it has already reached the
target so why not get out?
Is It Approaching a Stop Level?
Just as when the trade is getting close to its target level, you also should
be aware of any trades getting close to their stop levels. The closer it is to
the stop point, the more you should pay attention, or maybe paying less attention
is the better way to say it. Thinking too much about stops is a great
way to cancel or move them, as the market gets closer to them. Sometimes
your stops are mental and now is the time to either place them in or really
watch the market so you can exit it if it does hit the level. If you are
near a stop level, I recommend putting the stop in and forgetting about it.
Do not try to second-guess it. If your original stop was well thought out,
there is little reason to move it as the market gets closer. Most of the time
you will end up losing more money by moving or ignoring a stop. You do,
however, need to go over, review, and adjust stop levels on a regular basis.
But I would not be moving them further away as they get closer for fear of getting stopped out. Look at Figure 7.3 and you’ll see two different scenarios,
the first is the long from the first shaded circle, which is the same from
the previous example. As the market started getting better I would move
the stops S2, S3, S4, and so forth, up along the with moving average until
eventually the market catches up to it at S7 and you get stopped out; this
is the proper way to move a stop. The wrong way is the other example.
Say you shorted at the arrow marked Short and you placed a stop (Stop1)
above previous highs. But a couple of days later the market rallies strong
(oops). Now instead of leaving your stop in and taking it like a man, you
move it up to Stop 2 to give the market room to breathe. All you are doing
here is costing yourself 200 more points for no reason. As the market
reaches the stop level you have reasoned to be good, leave it alone. I’ll get
into this in more detail later in the book.
Did You Ignore Stop Levels?
This section assumes you are a moron and let the market go through the
level where you should have placed your stop. I’ll discuss it later in the
book, but you should not make a trade unless you know where you are
getting out on both the winning and losing side. Maybe you had a mental
stop, but froze and never put it on, or worse, you never even thought about
one and just hoped for the best. Maybe you’ve been in the trade for a while
and are making money and got a little lackadaisical moving a stop along to
lock in a profit. Regardless of the reason, if you ignored a stop you need
to put this trade on your “I must get the hell out of it soon” list and make
sure you are on top of it first thing in the morning. If you go back to Figure
7.3 and for some reason you let the short keep going and did not enter
the stop at Stop 2 and now it’s trading above that, you really need to force
yourself out of the trade the next day. Cutting your losses is something you
need to learn and emphasize as you are making your game plan every day.
Ignoring stops will definitely lead you down the wrong path, so should you
find yourself in a position where you did ignore one and are now in danger,
do not sit there and hope for the best; instead, get out and take the loss.
Should You Add to It or Cut Back?
Position size is another decision you should be thinking about as you go
over every trade. If, as in the example in Figure 7.2, the market reached
your target area and the trade is still working, why not take off some of
the trade and lock in a little profit, but keep a little if you think it still has
room. Maybe, on the other hand, it’s earlier in the trade and the market
just broke above the Break Out X line. Here you can have another strategy
that kicks in when you break out of this resistance level. You are already in
the trade with a nice profit and now you get confirmation of a strong trade
with a new signal. In this situation you may want to consider adding to the
position as the trade just got better in your eyes.
What, however, if the trade isn’t really working as well as you had intended
it to, but you don’t want to get out in case it does take off? A good
strategy here is to reduce the size of the position while still holding onto
some of it, just in case it does end up working. Cutting back and scaling is
one of the hardest things to do in trading, as you can probably make a case
for both sides in every instance. No matter what you do never ever forget
the cardinal rule of never adding to a loser.
Is Your Money Better Spent Elsewhere?
A part of the thinking process in the above scenarios when deciding on adjusting
position size is that if you take off a portion of your trade, it will
free up money to be used elsewhere. As you go over every trade keep that
in mind and ask yourself, “Is my money better spent elsewhere?” If the
answer is yes you may be better off getting out and putting on a different
trade. Or at least keeping money on the sidelines for when a better
setup does come along. You should not be in the habit of being maxed
out, but many new traders have limited funds and can quickly reach their margin levels. Freeing up some money then becomes part of their everyday
game plan.
Should a Trade Be Closed Now or Held Longer?
Which leads to the question, “Should I hold or get out?” If you have a purely
mechanical system then you shouldn’t override it and as such you should
only get out when a signal is given. However, this book deals mostly with
discretionary systems, which leaves a trader to make a lot of decisions.
Althoughmost everything mentioned above comes down to this basic question.
Ask it out loud. “Should I get out or stay in?” Keep singing the Clash’s
song “Should I stay or should I go?” until it becomes second nature. Ask
yourself, “If I didn’t have this position on would I get in now?” If the answer
is no, you should get out and move on. Don’t waste your time, money,
and energy on positions you do not feel like you would have on if you had a
fresh start. There have been many times where I’ve been married to a position
I knew was wrong, but I couldn’t make myself get out of it. I’d be long
losing money and I knew that if I had no trade on I’d want to be getting
short, because the market looked so bearish. Yet I couldn’t bring myself
to take a loss. Eventually I found that taking a loss is okay, and doing it
will save you lots of money over time. So learn to do it. Now this doesn’t
just apply to losing trades, you could have trades that are winners but are
no longer doing anything. You may want to reevaluate those as well every
night, and if you believe or your strategies tell you it’s done, get out and
move on.
Has Volatility Changed?
As I write this, the volatility in the stock market has recently exploded.
As you can see by looking at the Average True Range (ATR) in Figure 7.4,
the S&Ps range has more than doubled in the last couple of weeks of trading.
The average trading range went from under 12 points a day to well
over 20 for the month of August. You must be aware of this as you trade
because the dynamics of any trade made before this just got different. Targets
and stops may need to be moved further away to make them realistic.
The market may now be too dangerous for you to trade and you may have
to reconsider your strategy. If you had a stop that was to get out after two
consecutive days of negative closes and before you thought you were risking
$2,000 dollars, well that risk may now be $5,000 and you may not be able
to afford it. Likewise, you may have a fixed stop that is about $2,000 away,
but now that can easily be hit by a modest intraday swing, so you’ll get
stopped out when technically you shouldn’t have been. When the volatility
changes dramatically you must reconsider your positions. Even if the
volatility changes to be smaller, you should still reconsider your positions.
You may now want to add to your position or move your targets in to be
more reasonable. Volatility may not have drastic changes often but when it
does, be prepared to alter your strategy and game plan accordingly.
What Was in the News?
Another thing I think traders should look at is why the markets moved like
they did. If you were in a trade that acted out of the ordinary, find out why
it did so. It may not help you much on closed trades, but it’s good to know
if you still have a trade open. Though I don’t like trading off of the news, it
can sometimes change the nature of a trade, and you should be aware of it.
Many news events are blips that will give a market a nice swing, but in the
long run don’t make a difference. But there are some that can be the cause
of a market reversal, like when the Fed cuts rates more than expected, or
a central bank tightens its monetary policy, or a company reports really
bad financial news, or a CEO gets arrested out of the blue for accounting
fraud. If news made something move, even just for the day, it’s good to be
aware of it so you can make a more educated game plan the next day. I
always find trading how a market reacts to news to be a powerful tool, and you can take advantage of it if you incorporate that information into your
game plan.
I’m not going to separate them into two sections. Just figure out which
applies to your situations as you read them. A winning and losing trade
can be looked at the same way depending on how long you have held a
position. A winning trade that gives back too much profit is no worse than
a losing trade. You don’t want to give back too much on a winning position
by overstaying your welcome. Even if you close it out as a winner, if you
gave back too much, in my eyes it’s a bad trade at least for the last part of
the trade. Though I prefer to review my winners first, it doesn’t matter if
you do them or your losers first or if you just go down your list of trades
in the order that you put them on. Whatever way you do it, just be sure to
give them all their fair due. If you are a day trader who closes everything
out at the end of the day then the next few pages may not be necessary, but
you paid for the book, so the read them anyway. If you trade one market
or stock, the reviewing part will go faster and then you could meet John at
Moran’s quicker. As you do go over every trade keep in mind that the main
purpose for doing so is to prepare for the next day’s game plan.
Why Did I Make the Trade?
The first thing I do when I look at my open trades is to start with ones I put
on most recently. I ask myself, “Why did I make this trade?” Throughout a
trade’s history you need to keep making sure that it is within your plan’s scope. I want to make sure that the trade is part of my trading strategy and
not some randomly put on trade. I want validation that I made the trade
for a proper reason. If I did, great, I can move on; if not, I want to make
sure it fits into one of my strategies. If it doesn’t, I’ll look to get out as
soon as possible, as I do not want to hold a trade that contradicts my basic
principles. Sometimes during the heat of battle of the trading day, you may
make some random trade and then not get out of it because you had no
plan for it. Hopefully this doesn’t happen often to you, but when it does, be
aware you are doing something wrong and remedy it as soon as you can.
Do the Reasons You Got in Still Hold?
If you shorted the Dow Jones because the 3-period moving average crossed
below the 10-period one as in point A in Figure 7.1, make sure it’s still the
case. If it’s not, it’s time to reevaluate the trade. Don’t wait until you are
stopped out to get out of a trade that isn’t working, if things have changed,
it’s okay to get out. In Figure 7.1 if you got out after the 3-period moving
average crossed back over the 10-period one, instead of waiting for the stop
to be elected you would have saved yourself about 200 points.
If it’s still within the parameters that got you in, look to see if they may
be changing, so you can anticipate an exit. Maybe the trade is still good but
FIGURE 7.1 Daily Dow
Source: © TradeStation Technologies 1999. All rights reserved.
it’s getting close to not being so, so you may have to watch it more carefully
tomorrow. Make a note of this and keep it on your radar screen (I’m not
referring to TradeStation’s radar screen but to your personal one). Make
sure if a trade is getting close to being one you have to exit that you are
on top of it. In the example in Figure 7.1 you can see the 3-period moving
average turning up and the highs of each bar getting higher prior to the
crossover at point B. This could be a sign your trade may not be within
the reasons you sold it for much longer, so you can start getting ready
for action.
Is It Simply Not Working as Planned?
Another thing you should monitor is whether the trade is working like you
planned. Yes, it could still be within your parameters, but maybe you were
looking to get a quick move on the trade and after three days it’s been stagnant,
not doing a thing. You need to consider whether you still want to hold
and monitor this dud? Your time and money could maybe be better spent
elsewhere. So why not get out? The trade is not doing what you wanted it
to, so you can consider moving on, though before you do make sure you
gave it an opportunity to work. If you look at Figure 7.1 again you’ll see this
as well. Assuming you got filled on the short at the first circle, the market
did nothing for the next few days. You expected it to go down right away
and it hasn’t. Even though the moving averages are still confirming a short,
you may consider getting out as it’s simply not performing as you’d like it
to, especially on the fourth day. At this point, you gave it time to work and
it didn’t and now it looks like it may pop back up.
Is It Close to the Target Area?
Once your trade starts getting close to the target area that you should have
established when you put the trade on, you should begin to monitor it more
closely. The target area can be a number, like when the market hits 13,541
or it can be a technical target as in when the market reaches the top of a
channel. It can be a time target as in exit after seven periods. Whichever the
case, you want to be aware that it’s getting close so that you can get ready
to act on it the next day if the target is reached. You may, after reevaluating,
consider moving the target, which is always an option, but make sure you
have a reason for it if you do. In Figure 7.2 I used Fibonacci projections
based on the up trend that started in July, to pick a target for a long using
a breakout of a previous high. As soon as the market gets within about two
normal days range from this target area (13,531), I would monitor it much
more closely to determine when I need to get out. One thing you need to
be on the lookout for is that it may fail to reach the target, in which case
you need a backup plan as to what to do. I do this by constantly moving my
stop up in a big move like this.
Has It Reached the Target Area?
Not only do you have to look to see if a trade is near its target area, you
should also keep an eye out for trades that have already hit your target
area. Let’s say the market traded through a channel you had set as a target.
You didn’t exit because maybe the move was strong and you wanted to let
your profits ride, which is a valid excuse. You now need to reevaluate the
exit points. Should you come up with a new target and stop areas or should
you get out, because your original level was hit? You could maybe keep the
trade and use your old target as your new stop. You really want to be on
top of a trade like this because there is no worse feeling then having a trade
reach its target and then some, then getting a little greedy and before you
know it goes against you and it turns into a loser. These losers are hard to
exit because you keep thinking it will come back to the best levels of the
trade and you end up just watching it fade away. Let’s say in Figure 7.2 you
did not exit at the target level and now the market is trading in the second
circle. You need to now reevaluate the trade as a new trade and determine
if you’d like to keep it as well as make a new target (target 2) and create a
new stop level (stop 2). You may introduce new technical indicators to help
you decide. I personally would have gotten out the second time it dipped
below the 13,531 level. I would have given it one time to test the level and
if it dipped below a second time I would exit. The reason being that I gave
it a shot to work and it didn’t right away, and it has already reached the
target so why not get out?
Is It Approaching a Stop Level?
Just as when the trade is getting close to its target level, you also should
be aware of any trades getting close to their stop levels. The closer it is to
the stop point, the more you should pay attention, or maybe paying less attention
is the better way to say it. Thinking too much about stops is a great
way to cancel or move them, as the market gets closer to them. Sometimes
your stops are mental and now is the time to either place them in or really
watch the market so you can exit it if it does hit the level. If you are
near a stop level, I recommend putting the stop in and forgetting about it.
Do not try to second-guess it. If your original stop was well thought out,
there is little reason to move it as the market gets closer. Most of the time
you will end up losing more money by moving or ignoring a stop. You do,
however, need to go over, review, and adjust stop levels on a regular basis.
But I would not be moving them further away as they get closer for fear of getting stopped out. Look at Figure 7.3 and you’ll see two different scenarios,
the first is the long from the first shaded circle, which is the same from
the previous example. As the market started getting better I would move
the stops S2, S3, S4, and so forth, up along the with moving average until
eventually the market catches up to it at S7 and you get stopped out; this
is the proper way to move a stop. The wrong way is the other example.
Say you shorted at the arrow marked Short and you placed a stop (Stop1)
above previous highs. But a couple of days later the market rallies strong
(oops). Now instead of leaving your stop in and taking it like a man, you
move it up to Stop 2 to give the market room to breathe. All you are doing
here is costing yourself 200 more points for no reason. As the market
reaches the stop level you have reasoned to be good, leave it alone. I’ll get
into this in more detail later in the book.
Did You Ignore Stop Levels?
This section assumes you are a moron and let the market go through the
level where you should have placed your stop. I’ll discuss it later in the
book, but you should not make a trade unless you know where you are
getting out on both the winning and losing side. Maybe you had a mental
stop, but froze and never put it on, or worse, you never even thought about
one and just hoped for the best. Maybe you’ve been in the trade for a while
and are making money and got a little lackadaisical moving a stop along to
lock in a profit. Regardless of the reason, if you ignored a stop you need
to put this trade on your “I must get the hell out of it soon” list and make
sure you are on top of it first thing in the morning. If you go back to Figure
7.3 and for some reason you let the short keep going and did not enter
the stop at Stop 2 and now it’s trading above that, you really need to force
yourself out of the trade the next day. Cutting your losses is something you
need to learn and emphasize as you are making your game plan every day.
Ignoring stops will definitely lead you down the wrong path, so should you
find yourself in a position where you did ignore one and are now in danger,
do not sit there and hope for the best; instead, get out and take the loss.
Should You Add to It or Cut Back?
Position size is another decision you should be thinking about as you go
over every trade. If, as in the example in Figure 7.2, the market reached
your target area and the trade is still working, why not take off some of
the trade and lock in a little profit, but keep a little if you think it still has
room. Maybe, on the other hand, it’s earlier in the trade and the market
just broke above the Break Out X line. Here you can have another strategy
that kicks in when you break out of this resistance level. You are already in
the trade with a nice profit and now you get confirmation of a strong trade
with a new signal. In this situation you may want to consider adding to the
position as the trade just got better in your eyes.
What, however, if the trade isn’t really working as well as you had intended
it to, but you don’t want to get out in case it does take off? A good
strategy here is to reduce the size of the position while still holding onto
some of it, just in case it does end up working. Cutting back and scaling is
one of the hardest things to do in trading, as you can probably make a case
for both sides in every instance. No matter what you do never ever forget
the cardinal rule of never adding to a loser.
Is Your Money Better Spent Elsewhere?
A part of the thinking process in the above scenarios when deciding on adjusting
position size is that if you take off a portion of your trade, it will
free up money to be used elsewhere. As you go over every trade keep that
in mind and ask yourself, “Is my money better spent elsewhere?” If the
answer is yes you may be better off getting out and putting on a different
trade. Or at least keeping money on the sidelines for when a better
setup does come along. You should not be in the habit of being maxed
out, but many new traders have limited funds and can quickly reach their margin levels. Freeing up some money then becomes part of their everyday
game plan.
Should a Trade Be Closed Now or Held Longer?
Which leads to the question, “Should I hold or get out?” If you have a purely
mechanical system then you shouldn’t override it and as such you should
only get out when a signal is given. However, this book deals mostly with
discretionary systems, which leaves a trader to make a lot of decisions.
Althoughmost everything mentioned above comes down to this basic question.
Ask it out loud. “Should I get out or stay in?” Keep singing the Clash’s
song “Should I stay or should I go?” until it becomes second nature. Ask
yourself, “If I didn’t have this position on would I get in now?” If the answer
is no, you should get out and move on. Don’t waste your time, money,
and energy on positions you do not feel like you would have on if you had a
fresh start. There have been many times where I’ve been married to a position
I knew was wrong, but I couldn’t make myself get out of it. I’d be long
losing money and I knew that if I had no trade on I’d want to be getting
short, because the market looked so bearish. Yet I couldn’t bring myself
to take a loss. Eventually I found that taking a loss is okay, and doing it
will save you lots of money over time. So learn to do it. Now this doesn’t
just apply to losing trades, you could have trades that are winners but are
no longer doing anything. You may want to reevaluate those as well every
night, and if you believe or your strategies tell you it’s done, get out and
move on.
Has Volatility Changed?
As I write this, the volatility in the stock market has recently exploded.
As you can see by looking at the Average True Range (ATR) in Figure 7.4,
the S&Ps range has more than doubled in the last couple of weeks of trading.
The average trading range went from under 12 points a day to well
over 20 for the month of August. You must be aware of this as you trade
because the dynamics of any trade made before this just got different. Targets
and stops may need to be moved further away to make them realistic.
The market may now be too dangerous for you to trade and you may have
to reconsider your strategy. If you had a stop that was to get out after two
consecutive days of negative closes and before you thought you were risking
$2,000 dollars, well that risk may now be $5,000 and you may not be able
to afford it. Likewise, you may have a fixed stop that is about $2,000 away,
but now that can easily be hit by a modest intraday swing, so you’ll get
stopped out when technically you shouldn’t have been. When the volatility
changes dramatically you must reconsider your positions. Even if the
volatility changes to be smaller, you should still reconsider your positions.
You may now want to add to your position or move your targets in to be
more reasonable. Volatility may not have drastic changes often but when it
does, be prepared to alter your strategy and game plan accordingly.
What Was in the News?
Another thing I think traders should look at is why the markets moved like
they did. If you were in a trade that acted out of the ordinary, find out why
it did so. It may not help you much on closed trades, but it’s good to know
if you still have a trade open. Though I don’t like trading off of the news, it
can sometimes change the nature of a trade, and you should be aware of it.
Many news events are blips that will give a market a nice swing, but in the
long run don’t make a difference. But there are some that can be the cause
of a market reversal, like when the Fed cuts rates more than expected, or
a central bank tightens its monetary policy, or a company reports really
bad financial news, or a CEO gets arrested out of the blue for accounting
fraud. If news made something move, even just for the day, it’s good to be
aware of it so you can make a more educated game plan the next day. I
always find trading how a market reacts to news to be a powerful tool, and you can take advantage of it if you incorporate that information into your
game plan.
G O O D K I D , B A D K I D
A great example of this is parents with two kids, one who is near perfect, a
straight-A student, captain of the tennis team, doing community service, and
the other is cutting class, failing some classes, getting into fights, smoking
cigarettes, shaving half his head, and so on. The parents can spend so much
time talking about and dealing with the bad seed that the good kid starts to feel abandoned. He starts getting depressed thinking that they don’t love him as much as his brother and soon begins drinking heavily. Then he finds some of
his brother’s pot and because no one pays attention he quickly develops a $5 a
day pot habit. So the moral here is to cut your losses, send the troubled kid to
military school, and praise the good kid; odds are he’ll make more money in the
future than the troublemaker allowing you to retire earlier, as he supports you.
The bad kid on the other hand is going to cost you money for years, military
school, bail, lawyers, counseling, hair dye, and so on. So cut your losses and
concentrate on your winners.
Now back from my tangent, as you are reviewing don’t get complacent
with good trades. Analyze them in depth and always think about how you
will get out. As you review your trades there are several things you can look
at as I’ll describe in the rest of this chapter. I’ll start with the open trades.
straight-A student, captain of the tennis team, doing community service, and
the other is cutting class, failing some classes, getting into fights, smoking
cigarettes, shaving half his head, and so on. The parents can spend so much
time talking about and dealing with the bad seed that the good kid starts to feel abandoned. He starts getting depressed thinking that they don’t love him as much as his brother and soon begins drinking heavily. Then he finds some of
his brother’s pot and because no one pays attention he quickly develops a $5 a
day pot habit. So the moral here is to cut your losses, send the troubled kid to
military school, and praise the good kid; odds are he’ll make more money in the
future than the troublemaker allowing you to retire earlier, as he supports you.
The bad kid on the other hand is going to cost you money for years, military
school, bail, lawyers, counseling, hair dye, and so on. So cut your losses and
concentrate on your winners.
Now back from my tangent, as you are reviewing don’t get complacent
with good trades. Analyze them in depth and always think about how you
will get out. As you review your trades there are several things you can look
at as I’ll describe in the rest of this chapter. I’ll start with the open trades.
LET’S REVIEW
This chapter may seem out of order at times because it assumes you are
doing things that I’ll discuss throughout the book some of which will come
later. However, I put it here because the best way to start your trading day
is to get ready for it the night before. But before you start getting ready for
the next trading day, the first thing you should do is go over all the trades
you made or have on. You can do this in any order you like, but I prefer
to start by looking at any trades I have that are still open. These are the
ones I need to be the most focused on going into the next day, and I like to
confirm that they are still good trades.
By “good” I mean that the reasons I put the trade on are still valid.
I’ve been known to not get out of bad trades in hopes of them opening
up the next day in my favor. This is always a bad decision as bad trades
should always be gotten out of as soon as possible. Now this is different
from a trade that is not making money but is still in the parameters of your
strategy. I’m referring to trades that blow through your levels but that you
have decided not to get out of.
If I still have a bad trade on after the day, I make a big note to GET
OUT if it does not start reacting correctly as soon as the market opens. It’s
oh-so-common to look at a bad position and rationalize why it could work.
For example, if it gaps down against you the next day, you may say, okay
this is the worst it can get and it will close the gap. And you sit there and
hope all day it does. Doing this could easily throw off your whole game plan
for the next day as you will spend too much time babying a bad position
and ignoring the good ones you have, which may end up turning bad.
doing things that I’ll discuss throughout the book some of which will come
later. However, I put it here because the best way to start your trading day
is to get ready for it the night before. But before you start getting ready for
the next trading day, the first thing you should do is go over all the trades
you made or have on. You can do this in any order you like, but I prefer
to start by looking at any trades I have that are still open. These are the
ones I need to be the most focused on going into the next day, and I like to
confirm that they are still good trades.
By “good” I mean that the reasons I put the trade on are still valid.
I’ve been known to not get out of bad trades in hopes of them opening
up the next day in my favor. This is always a bad decision as bad trades
should always be gotten out of as soon as possible. Now this is different
from a trade that is not making money but is still in the parameters of your
strategy. I’m referring to trades that blow through your levels but that you
have decided not to get out of.
If I still have a bad trade on after the day, I make a big note to GET
OUT if it does not start reacting correctly as soon as the market opens. It’s
oh-so-common to look at a bad position and rationalize why it could work.
For example, if it gaps down against you the next day, you may say, okay
this is the worst it can get and it will close the gap. And you sit there and
hope all day it does. Doing this could easily throw off your whole game plan
for the next day as you will spend too much time babying a bad position
and ignoring the good ones you have, which may end up turning bad.
After the Close
A man rushes into his house and yells to his wife, “Martha, pack
up your things! I just made a fortune in the stock market!” Martha
replies, “Wow, should I pack for warm weather or cold?” The man
responds, “I don’t care. Just get out!”
So, it’s 4:15 P.M. and the S&P futures just closed and you had a bad
day trading, so what do you do? Go down to your local bar and get
soused? No, you start preparing for the next day. Actually, first you
should run to the bathroom as you probably have been sitting for four
hours straight glued to your monitor. Then go take a quick walk to stretch
out and clear your mind. If you work on a trading desk at a day trading firm
most likely everyone will be gone when you come back. But the next hour
or so could be the most valuable one of your trading day. You’re thinking
the markets are closed, I can’t trade anymore, the day is over, why should I
still be here? But it’s only the end of the day for John and his loser friends.
Great traders use this time to review their day and start planning for the
next one. As soon as the market closes is when your trades are freshest in
your mind, so why not spend some time after the close going over them?
You can gain a lot of insight into your trading by reviewing what you have
done and what’s more, you can start getting ready for tomorrow by doing
so. After you’ve gone over all your trades, you should take some time
preparing tomorrow’s game plan. This is a two-part process, which should
be done both the night before and the morning of, but by spending time
on it the night before you will get an incredible jump on it the following
morning and will be able to see things much clearer during the trading day.
Some things you will be concentrating on are what’s happening tomorrow,
what will you do if such and such happens, which of your trades just
aren’t working, and what are you doing wrong. You can also spend time
looking for places to adjust your stops to and review your money management
and risk levels. It doesn’t take a long time to do all this, and its worth
is invaluable.
up your things! I just made a fortune in the stock market!” Martha
replies, “Wow, should I pack for warm weather or cold?” The man
responds, “I don’t care. Just get out!”
So, it’s 4:15 P.M. and the S&P futures just closed and you had a bad
day trading, so what do you do? Go down to your local bar and get
soused? No, you start preparing for the next day. Actually, first you
should run to the bathroom as you probably have been sitting for four
hours straight glued to your monitor. Then go take a quick walk to stretch
out and clear your mind. If you work on a trading desk at a day trading firm
most likely everyone will be gone when you come back. But the next hour
or so could be the most valuable one of your trading day. You’re thinking
the markets are closed, I can’t trade anymore, the day is over, why should I
still be here? But it’s only the end of the day for John and his loser friends.
Great traders use this time to review their day and start planning for the
next one. As soon as the market closes is when your trades are freshest in
your mind, so why not spend some time after the close going over them?
You can gain a lot of insight into your trading by reviewing what you have
done and what’s more, you can start getting ready for tomorrow by doing
so. After you’ve gone over all your trades, you should take some time
preparing tomorrow’s game plan. This is a two-part process, which should
be done both the night before and the morning of, but by spending time
on it the night before you will get an incredible jump on it the following
morning and will be able to see things much clearer during the trading day.
Some things you will be concentrating on are what’s happening tomorrow,
what will you do if such and such happens, which of your trades just
aren’t working, and what are you doing wrong. You can also spend time
looking for places to adjust your stops to and review your money management
and risk levels. It doesn’t take a long time to do all this, and its worth
is invaluable.
CLOSING THOUGHTS
The better you know your stuff the better your chances of surviving are.
It does require extra work learning everything you can about the markets
you trade, but you will only be a better trader by doing so. Some of the
things I mentioned you will only gain knowledge of through time by watching
markets day in and day out. If you are lucky and have experienced
traders who you work with, you may be able to learn faster. Just don’t rush
things and expect to know how the markets will react to every piece of news disseminated out there. And don’t get stubborn about what you think
should happen. Remember the markets are always right, and they will tell
you where they should be—not the other way around.
When I was studying for my SATs I learned the word “parsimonious.”
Twenty-five years later, I don’t think I had ever used it, until this sentence.
Yes, it has nothing to do with trading but it was a thought I had while I was
rereading these closing thoughts so I figure I’d share it with you.
It does require extra work learning everything you can about the markets
you trade, but you will only be a better trader by doing so. Some of the
things I mentioned you will only gain knowledge of through time by watching
markets day in and day out. If you are lucky and have experienced
traders who you work with, you may be able to learn faster. Just don’t rush
things and expect to know how the markets will react to every piece of news disseminated out there. And don’t get stubborn about what you think
should happen. Remember the markets are always right, and they will tell
you where they should be—not the other way around.
When I was studying for my SATs I learned the word “parsimonious.”
Twenty-five years later, I don’t think I had ever used it, until this sentence.
Yes, it has nothing to do with trading but it was a thought I had while I was
rereading these closing thoughts so I figure I’d share it with you.
GETTING THE BIG PICTURE
Let’s forget about the peculiarities of individual stocks, but let’s look at
the big picture of where a stock is. When you trade, you need to know
where in time you are. Some traders have blinders on when trading and
forget to see where a market is in its long-term picture. Before you make
a trade you need to know what type of market it is because markets will
react differently in different conditions. You should be looking at charts in
multiple time frames to get both a short- and long-term picture of what the
market is doing to help determine if the market is trending, choppy, range
bound, and so on. You also need to know what the general direction of the
market is. You may also want to be using indicators to help you determine
where the current market is in relationship to the big picture. Once you
know all these things you can make smarter trading decisions.
For example, is the market in a long-term rally but has currently surged
and moved too far off its trend line and therefore due for a retracement before
going back up? Is it near the support of a range bound, choppy market
with clear support and resistance levels? Has it recently broken out of a
choppy market? Is it in a position where a possible reversal is looming?
Once you can pinpoint where a market is and know all of its levels you
can start planning trades with much less of a gambling factor than if you
were just looking at a small amount of data. Good traders will use different
technical indicators and systems depending on the market conditions.
Their game plan will vary according to where the market is versus its longterm
history. They will be able to make smarter decisions as to where to
get in and out as the picture gets clearer. All this in turn will make them
better traders.
the big picture of where a stock is. When you trade, you need to know
where in time you are. Some traders have blinders on when trading and
forget to see where a market is in its long-term picture. Before you make
a trade you need to know what type of market it is because markets will
react differently in different conditions. You should be looking at charts in
multiple time frames to get both a short- and long-term picture of what the
market is doing to help determine if the market is trending, choppy, range
bound, and so on. You also need to know what the general direction of the
market is. You may also want to be using indicators to help you determine
where the current market is in relationship to the big picture. Once you
know all these things you can make smarter trading decisions.
For example, is the market in a long-term rally but has currently surged
and moved too far off its trend line and therefore due for a retracement before
going back up? Is it near the support of a range bound, choppy market
with clear support and resistance levels? Has it recently broken out of a
choppy market? Is it in a position where a possible reversal is looming?
Once you can pinpoint where a market is and know all of its levels you
can start planning trades with much less of a gambling factor than if you
were just looking at a small amount of data. Good traders will use different
technical indicators and systems depending on the market conditions.
Their game plan will vary according to where the market is versus its longterm
history. They will be able to make smarter decisions as to where to
get in and out as the picture gets clearer. All this in turn will make them
better traders.
R O U N D-A B O U T-W A Y-W E A T H E R-C A N-A F F E C T-P R I C E S
I own a bar/restaurant and was just speaking to my produce vendor, who is a
large nationwide company. We were talking about how ridiculous prices have
gotten, and he said “you aint seen nuttin’ yet.” He was telling me how the recent
flooding in the Midwest is going to drive prices through the roof and not
just because the floods have made the grains hit record highs. It’s because his
cross-country truckers have to take alternate routes as the roads are impassable.
He said it normally costs $4,200 to send one truck cross-country, and last
week it was over $11,000 as they had to go through Canada. Between the extra
manhours and extra gasoline, coupled with all-time record-high oil prices, the
cost of a fajita at my place is going to go up.
large nationwide company. We were talking about how ridiculous prices have
gotten, and he said “you aint seen nuttin’ yet.” He was telling me how the recent
flooding in the Midwest is going to drive prices through the roof and not
just because the floods have made the grains hit record highs. It’s because his
cross-country truckers have to take alternate routes as the roads are impassable.
He said it normally costs $4,200 to send one truck cross-country, and last
week it was over $11,000 as they had to go through Canada. Between the extra
manhours and extra gasoline, coupled with all-time record-high oil prices, the
cost of a fajita at my place is going to go up.
KNOW ANY CORRELATIONS
If you are trading stocks you should know if they are part of the major
indices and how a move in the indices correlates to the stock. It need not
be exact but you should know that if the Dow drops 100 points your stock
would normally drop $1.50 or that a dollar move in your stock will move the
Dow 11 points. Sometimes it’s easier to look at the markets as a whole and
get a determination of what a stock may do, instead of trying to figure out
what a stock may do on its own. And if you knew the correlation between
the two, you could time your trades a little better or know if a stock is
stronger or weaker than the market.
You can look for correlations between stocks in a sector, or commodities
and the price of gold, or oil, or the dollar, or between commodity
groups like heating oil vs. crude oil. Many people trade the stock market
based on what the bond market is doing. Many things affect different markets
and there are correlations all over the place. The better you know
them, the better you become as you may pick something up just a little
faster if you are aware of them.
Are They Laggards or Leaders?
This leads me to another factor you should know when trading and that is
whether the stock or market is a leader or a laggard. Within every sector
there are the stocks that make the sector move first and there are others
that move once the sector becomes active. Some stocks move in sympathy
with other stocks, like if one bank has great earnings and rallies, the other
banks will follow as well. It’s good to know these things and which stocks
do what as it will help you find opportunities to trade.
This isn’t just true within sectors but in the market as a whole. There
are some stocks that can move the market by themselves. Well, not by
themselves, but so many other firms react with these stocks that it moves
the market, and the one stock was the catalyst that made it happen. These
are usually the big name stocks with huge volume. If a company like Bear
Stearns has a bad earnings report every other bank may drop, as well as
many other firms that depend on the banks, which can create a snowball
effect and start an avalanche. I’m not telling you not to trade these stocks
but be aware that sometimes the big safe stocks can be riskier to trade than
the stocks that are laggards.
I used to trade at a firm that never liked it when people traded the
leaders. They thought it was too difficult to compete with all the big players
in those big stocks. Instead they preferred to find small and mid cap
stocks with volume of 100,000 to 500,000 shares a day that would follow
the moves. They had less competition and more time to react and felt they
could trade better, and this is how they taught new traders. I never liked
doing it, which is why I left, but it worked for them.
What Moves It?
Though I’ve always been a technical trader and barely looked at the news
to trade, as I write this chapter I’m realizing how important being better educated
can be. I still believe that everything is reflected in the price and that
news may not help you react any quicker, but if you know why something
did something, then you can be better prepared to exit a position when
that condition is over. As a trader you should be aware of what moves the
markets you trade. There are many factors that can cause a commodity or
stock to move and you should be alert to them. Some of the things you
should know are:
Which Reports Can Do What and When Do They
Come Out?
There are so many reports that I’m not going to bother to list them, but an
example or two are crop reports that will move the grain markets and the Consumer Price Index report, which can move the whole stock market and
different stocks in several ways.
When Do Earnings Come Out and What to Do
with Them?
Not only should you know when earnings come out, but you should learn
how to read a stock’s reaction to them. Good or bad earnings is not important
to me, it’s how the stock reacts to that report that is key. Don’t
get caught with your pants down because you did not know the stock you
shorted last night has earnings due today before the open.
How Do Markets React to Changes in Interest
Rates and Foreign Exchange?
One of the most anticipated things in the market is the Federal Reserve’s
announcement on interest rates. A cut or hike greater or smaller than expected
can trigger a huge move in a stock, future, sector, and whole market.
But not all sectors and stocks react the same way, as some sectors react favorable
to higher interest rates while other do not. You should know what
a change in rates will do to the stuff you trade. And of course you should
know when these announcements are due. Changes in foreign exchange
can have more subtle effects on some markets, but nevertheless you should
know if the stocks or commodities you trade are sensitive to them. As the
U.S. dollar drops, gold will most likely go up. Cocoa is a market that can be
affected by the British pound because London cocoa futures trading, which
have a huge impact on worldwide prices, is conducted in British pounds.
So, big fluctuations in the pound will impact the price of U.S. cocoa futures,
due to the cross-currency fluctuations of the British pound vs. the
U.S. dollar. There is constant arbitrage taking place between the New York
and London cocoa markets so the rate between the pound and the dollar is
very important. This is something the average person may not be aware of
but it’s good to know.
Is the Market Weather Sensitive?
Orange juice, oil, grains, the softs (coffee, sugar, cocoa, and cotton), cattle,
and a few more, are very much weather-related products and a frost,
drought, flood, or heat wave can send prices soaring in some markets. Or a
slightly different weather pattern can send one market up while sending another
down. Keeping abreast of the weather can help you determine which
direction you want to be trading some markets. Hurricanes or threats of
them, for example, can cause large moves in the oil markets and soft markets, but may not have any effect on cocoa, which is not made in the
area affected by the hurricane.
indices and how a move in the indices correlates to the stock. It need not
be exact but you should know that if the Dow drops 100 points your stock
would normally drop $1.50 or that a dollar move in your stock will move the
Dow 11 points. Sometimes it’s easier to look at the markets as a whole and
get a determination of what a stock may do, instead of trying to figure out
what a stock may do on its own. And if you knew the correlation between
the two, you could time your trades a little better or know if a stock is
stronger or weaker than the market.
You can look for correlations between stocks in a sector, or commodities
and the price of gold, or oil, or the dollar, or between commodity
groups like heating oil vs. crude oil. Many people trade the stock market
based on what the bond market is doing. Many things affect different markets
and there are correlations all over the place. The better you know
them, the better you become as you may pick something up just a little
faster if you are aware of them.
Are They Laggards or Leaders?
This leads me to another factor you should know when trading and that is
whether the stock or market is a leader or a laggard. Within every sector
there are the stocks that make the sector move first and there are others
that move once the sector becomes active. Some stocks move in sympathy
with other stocks, like if one bank has great earnings and rallies, the other
banks will follow as well. It’s good to know these things and which stocks
do what as it will help you find opportunities to trade.
This isn’t just true within sectors but in the market as a whole. There
are some stocks that can move the market by themselves. Well, not by
themselves, but so many other firms react with these stocks that it moves
the market, and the one stock was the catalyst that made it happen. These
are usually the big name stocks with huge volume. If a company like Bear
Stearns has a bad earnings report every other bank may drop, as well as
many other firms that depend on the banks, which can create a snowball
effect and start an avalanche. I’m not telling you not to trade these stocks
but be aware that sometimes the big safe stocks can be riskier to trade than
the stocks that are laggards.
I used to trade at a firm that never liked it when people traded the
leaders. They thought it was too difficult to compete with all the big players
in those big stocks. Instead they preferred to find small and mid cap
stocks with volume of 100,000 to 500,000 shares a day that would follow
the moves. They had less competition and more time to react and felt they
could trade better, and this is how they taught new traders. I never liked
doing it, which is why I left, but it worked for them.
What Moves It?
Though I’ve always been a technical trader and barely looked at the news
to trade, as I write this chapter I’m realizing how important being better educated
can be. I still believe that everything is reflected in the price and that
news may not help you react any quicker, but if you know why something
did something, then you can be better prepared to exit a position when
that condition is over. As a trader you should be aware of what moves the
markets you trade. There are many factors that can cause a commodity or
stock to move and you should be alert to them. Some of the things you
should know are:
Which Reports Can Do What and When Do They
Come Out?
There are so many reports that I’m not going to bother to list them, but an
example or two are crop reports that will move the grain markets and the Consumer Price Index report, which can move the whole stock market and
different stocks in several ways.
When Do Earnings Come Out and What to Do
with Them?
Not only should you know when earnings come out, but you should learn
how to read a stock’s reaction to them. Good or bad earnings is not important
to me, it’s how the stock reacts to that report that is key. Don’t
get caught with your pants down because you did not know the stock you
shorted last night has earnings due today before the open.
How Do Markets React to Changes in Interest
Rates and Foreign Exchange?
One of the most anticipated things in the market is the Federal Reserve’s
announcement on interest rates. A cut or hike greater or smaller than expected
can trigger a huge move in a stock, future, sector, and whole market.
But not all sectors and stocks react the same way, as some sectors react favorable
to higher interest rates while other do not. You should know what
a change in rates will do to the stuff you trade. And of course you should
know when these announcements are due. Changes in foreign exchange
can have more subtle effects on some markets, but nevertheless you should
know if the stocks or commodities you trade are sensitive to them. As the
U.S. dollar drops, gold will most likely go up. Cocoa is a market that can be
affected by the British pound because London cocoa futures trading, which
have a huge impact on worldwide prices, is conducted in British pounds.
So, big fluctuations in the pound will impact the price of U.S. cocoa futures,
due to the cross-currency fluctuations of the British pound vs. the
U.S. dollar. There is constant arbitrage taking place between the New York
and London cocoa markets so the rate between the pound and the dollar is
very important. This is something the average person may not be aware of
but it’s good to know.
Is the Market Weather Sensitive?
Orange juice, oil, grains, the softs (coffee, sugar, cocoa, and cotton), cattle,
and a few more, are very much weather-related products and a frost,
drought, flood, or heat wave can send prices soaring in some markets. Or a
slightly different weather pattern can send one market up while sending another
down. Keeping abreast of the weather can help you determine which
direction you want to be trading some markets. Hurricanes or threats of
them, for example, can cause large moves in the oil markets and soft markets, but may not have any effect on cocoa, which is not made in the
area affected by the hurricane.
O P E N-I N T E R E S T
Open interest is the total number of active or open contracts for any given
commodity at the end of each day. It refers to the total number of contracts long
or short in a delivery month that have been entered into and not yet liquidated
by an offsetting trade or fulfilled by delivery. It measures the flow of money
into and out of the market. For each seller of a futures contract there must be a
buyer of that contract and they combine to create only one contract. Therefore,
to determine the total open interest you only need to know the totals from one
side or the other, buyers or sellers, not the sum of both. Open interest can
change in three ways:
1. If one new buyer buys from one new seller, open interest will go up as thereis a new contract being made.
2. If an old buyer sells to an old existing short. There will be one less opencontract and open interest will drop by one.
3. If an old buyer sells to new buyer, it results in no change, as it’s just thepassing of an existing contract to someone new.
By keeping track of the changes in the open interest at the end of each
trading day, you can get some information out of the market. Increasing open
interest means that new money is flowing in and that the present trend will
continue. Declining open interest means that the market is liquidating and implies
that the trend is coming to an end. Watching open interest and combining
it with volume and price direction can be a great method of preparing for the
end of a trend or confirming a move. Using price, volume, and open interest
together you can draw the following conclusions:
Price Volume Open Interest Indication
Rising Rising Rising Market is strong
Rising Falling Falling Market may weaken
Falling Rising Rising Market is weak
Falling Falling Falling Market may strengthen
commodity at the end of each day. It refers to the total number of contracts long
or short in a delivery month that have been entered into and not yet liquidated
by an offsetting trade or fulfilled by delivery. It measures the flow of money
into and out of the market. For each seller of a futures contract there must be a
buyer of that contract and they combine to create only one contract. Therefore,
to determine the total open interest you only need to know the totals from one
side or the other, buyers or sellers, not the sum of both. Open interest can
change in three ways:
1. If one new buyer buys from one new seller, open interest will go up as thereis a new contract being made.
2. If an old buyer sells to an old existing short. There will be one less opencontract and open interest will drop by one.
3. If an old buyer sells to new buyer, it results in no change, as it’s just thepassing of an existing contract to someone new.
By keeping track of the changes in the open interest at the end of each
trading day, you can get some information out of the market. Increasing open
interest means that new money is flowing in and that the present trend will
continue. Declining open interest means that the market is liquidating and implies
that the trend is coming to an end. Watching open interest and combining
it with volume and price direction can be a great method of preparing for the
end of a trend or confirming a move. Using price, volume, and open interest
together you can draw the following conclusions:
Price Volume Open Interest Indication
Rising Rising Rising Market is strong
Rising Falling Falling Market may weaken
Falling Rising Rising Market is weak
Falling Falling Falling Market may strengthen
WHO MOVES THE MARKETS?
Amongst the things you should know if you want to be a complete trader,
is who moves the market. If it’s a NASDAQ stock, you should know which
market makers are the most active in it, and you should try and find out
which position they are taking. Are they getting long or are they shorting?
This is something you can get the hang of if you trade the stock all
the time or you have a friend at Goldman Sachs you can call who knows
everything.
You should know if the market or stock is included in any hedge fund
and then know what the funds are doing. Are they buying or are they liquidating?
Are they accumulating or shorting? These things can help you
determine the possible direction of the market. If you know all the players
and know what they are doing then you have a heads up. If you know all
the hedge funds and major players are long then who is left to buy? No
one—which is an indicator that the market may be running out of steam.
You should also get to know the open interest in a futures market and understand
what it means. Open interest when combined with volume can
help you determine in which direction the market is most likely to go and
it is a great tool to have.
is who moves the market. If it’s a NASDAQ stock, you should know which
market makers are the most active in it, and you should try and find out
which position they are taking. Are they getting long or are they shorting?
This is something you can get the hang of if you trade the stock all
the time or you have a friend at Goldman Sachs you can call who knows
everything.
You should know if the market or stock is included in any hedge fund
and then know what the funds are doing. Are they buying or are they liquidating?
Are they accumulating or shorting? These things can help you
determine the possible direction of the market. If you know all the players
and know what they are doing then you have a heads up. If you know all
the hedge funds and major players are long then who is left to buy? No
one—which is an indicator that the market may be running out of steam.
You should also get to know the open interest in a futures market and understand
what it means. Open interest when combined with volume can
help you determine in which direction the market is most likely to go and
it is a great tool to have.
A-R A N D O M-R A N T
One thing I find funny about trading books is that they give you an idea and
then find the perfect scenario to show you a chart of. What the authors fail to
tell you is that they probably looked at another 20 different spots where the
strategy failed on the chart. But because they found one good one, it’s good
enough to be in a book. It’s like a sports handicapper sending 50 people a free
pick saying the New York Giants will beat the spread over the Dallas Cowboys
this Sunday and then sending a different free pick to 50 other people stating the
Dallas Cowboys will win. If the Giants win, he then e-mails 25 of the 50 people
whom he told the Giants would win and tells them the Miami Dolphins will beat
the spread over the Buffalo Bills the next weekend. Meanwhile, he tells the other
25 people that the Bills will win. After the Bills win, he tells 12 of those people
that the New York Jets will beat the spread over the Chicago Bears on week 3,
and 13 people get told that the Bears will win. He keeps doing this for another
week or two until he has given a few people 5 consecutive winning bets. He then sends them an e-mail and says if you would like to receive more great picks,
sign up for my service at $500 a week. These remaining people should be quite
impressed with his picks so they may sign up, even though in reality he was
wrong at least once to 97 other people. So just take what you see in books with
a grain of salt. You may see the perfect scenario in a chart to prove a point and
make it look great, when in reality it may have taken quite a bit of time looking
for the right chart to prove that point.
then find the perfect scenario to show you a chart of. What the authors fail to
tell you is that they probably looked at another 20 different spots where the
strategy failed on the chart. But because they found one good one, it’s good
enough to be in a book. It’s like a sports handicapper sending 50 people a free
pick saying the New York Giants will beat the spread over the Dallas Cowboys
this Sunday and then sending a different free pick to 50 other people stating the
Dallas Cowboys will win. If the Giants win, he then e-mails 25 of the 50 people
whom he told the Giants would win and tells them the Miami Dolphins will beat
the spread over the Buffalo Bills the next weekend. Meanwhile, he tells the other
25 people that the Bills will win. After the Bills win, he tells 12 of those people
that the New York Jets will beat the spread over the Chicago Bears on week 3,
and 13 people get told that the Bears will win. He keeps doing this for another
week or two until he has given a few people 5 consecutive winning bets. He then sends them an e-mail and says if you would like to receive more great picks,
sign up for my service at $500 a week. These remaining people should be quite
impressed with his picks so they may sign up, even though in reality he was
wrong at least once to 97 other people. So just take what you see in books with
a grain of salt. You may see the perfect scenario in a chart to prove a point and
make it look great, when in reality it may have taken quite a bit of time looking
for the right chart to prove that point.
TIME FRAMES AND CHARTING
Another factor associated with the liquidity and volatility of a market is
which time frame best suits that market. Some people like to look at different
time period charts depending on the market they trade. With a thin
stock, a one- or five-minute chart may look spotty, while in IBM you can
comfortably get good entry and exit spots using a one-minute chart. Compare
a one-minute chart (Figure 6.4) of AKF and IBM to see the difference.
There is no way you could make a reasonably smart trade based on a oneminute
chart of AKF but you could from the IBM chart.
If you are trading the thin AKF then you’ll need to up the time frame to
maybe 10 minutes or 30 minutes to get a decent picture that may actually
tell you something. That means you may have to have a longer hold period
for that stock than you would for one where you can more easily get in and
out of a trade. I’ve added a 30-minute chart of AKF in Figure 6.5 and even
here it is a little spotty, but at least you can see some resemblance to a real
chart in it and you could use it to get into and out of the stock. I would only
trade this kind of stock if I was planning on holding it for quite a while, like
weeks or years. I have bought a few of them over the years, and they were
always long-term plays.
which time frame best suits that market. Some people like to look at different
time period charts depending on the market they trade. With a thin
stock, a one- or five-minute chart may look spotty, while in IBM you can
comfortably get good entry and exit spots using a one-minute chart. Compare
a one-minute chart (Figure 6.4) of AKF and IBM to see the difference.
There is no way you could make a reasonably smart trade based on a oneminute
chart of AKF but you could from the IBM chart.
If you are trading the thin AKF then you’ll need to up the time frame to
maybe 10 minutes or 30 minutes to get a decent picture that may actually
tell you something. That means you may have to have a longer hold period
for that stock than you would for one where you can more easily get in and
out of a trade. I’ve added a 30-minute chart of AKF in Figure 6.5 and even
here it is a little spotty, but at least you can see some resemblance to a real
chart in it and you could use it to get into and out of the stock. I would only
trade this kind of stock if I was planning on holding it for quite a while, like
weeks or years. I have bought a few of them over the years, and they were
always long-term plays.
FIGURE 6.4 1-Minute AKF vs. IBM
Source: © TradeStation Technologies 1999. All rights reserved
FIGURE 6.5 30-Minute AKF
Source: © TradeStation Technologies 1999. All rights reserved.
While we are on the subject of charting, I want to bring up how I look
at charts when I’m trading the index futures, as it will apply throughout the
rest of the book.
As you know, I like to look at different time frames when I trade. The
problem when trading a futures contract like the Dow Jones or S&P is that
the longer term chart you look at, the smaller amount of good data you
get. As you can see in Figure 6.6, there are only a few months worth of data
that are reasonable to look at; the rest are just useless dots. This is because
the futures do not trade very much at all when they are back months and
are only shown as the settlement price. This limited charting makes it very
hard to plot indicators and get a full idea of what is going on. I’ve included
the 50- and 200-day moving averages in Figure 6.6, but you can see they
are only useful in the last couple of months because before December they
factor in 0 as data points. You can also see there is really nothing to grasp
at if you were trying to plot a long-term trend line.
Now if you look at the actual Dow Index (Figure 6.7) you will see
a much nicer, fuller chart on which you can draw your trend lines, have
proper long-term moving averages, and make your trading decisions from.
If I were to condense this chart you could even see five years of solid data
on the screen to give you a longer term picture, with the futures contract
FIGURE 6.6 Daily Dow Mini Futures
Source: © TradeStation Technologies 1999. All rights reserved.
FIGURE 6.7 Daily Dow Index
Source: © TradeStation Technologies 1999. All rights reserved.
what you saw above is all you get. You can, however, get a fuller picture
with futures using continuous charts. There are people who like to stay
true to the futures and will use a continuous futures chart to get their information.
Continuous charts are where the front month of the futures contract
gets charted and the contracts get rolled over as they expire to make one
smooth flowing long-term chart. There are two common ways to do this,
but both have problems associated with them. Usually there is some spread
in the price of contracts between the expiring and new front month. For
example, when the December Dow contract expires it can be trading at
13,526 and the March contract, which is the next month, will be trading a
little at 13,592, due to the time value, interest rates, and traders’ expectations.
When you try to combine two contracts on a chart, you can do so by
using the real prices, which will result in a gap appearing on the chart at the
time of rollover. But this will mess up your technical analysis, as old trend
lines, supports, resistance levels, and so forth will be not be helpful anymore,
and new ones will have to be redrawn with each new contract. Yet it
may not be easy to properly redraw them as data has just changed and levels
move as a result of when a new contract becomes the front month and
has a 70-point gap from the old one. The change in the data may lead you to
believe that a market has broken a support level when in reality it did not.
The other way you can chart continuous data is without gaps. You just
plot the new contract at the point where the other left off and then adjust
the price of back months to coincide with the current front month. The
December contract now looks like it was trading 13,590 when it rolled over
and not 13,526 as it actually did. The problem with this method is you can
sometimes get very strange pricing as you go back in time. It is not uncommon
to see markets with negative values if the data gaps are large enough
between front and back months.
The problem with both methods is that you lose some accuracy when
making the adjustments. If you compare the charts in Figure 6.7 (the actual
Dow index) with that of Figure 6.8, which is a back adjusted continuous
futures chart, you’ll see how some of the technical points have changed.
For example, point A in Figure 6.8 is only a few points lower than
the previous low made about two weeks prior. In Figure 6.7 it’s quite a
bit lower, which in this case may have given you a signal to short or a
stop that Figure 6.8 wouldn’t have, albeit a signal you probably wouldn’t
have wanted anyway. But in another example, the low made by point C in
Figure 6.8 is below the low made at point B, however in Figure 6.7 it is
above point B. Though it may not have indicated a trading signal on the
chart in Figure 6.7, it would have in Figure 6.8. Nevertheless, you can see
how the two charts are a little different and how at some time or other you
may make a trade based on one chart that you wouldn’t have made using
FIGURE 6.8 Continuous Dow Mini Chart
Source: © TradeStation Technologies 1999. All rights reserved.
another. Because the futures market can be a little more erratic, I prefer to
just base my decisions on the actual indices in order to get a truer picture.
Once I have that picture, then I make my trades with help of the smaller
time framed futures charts.
Monday, November 8, 2010
WHAT’S THE REAL RISK?
As part of their uniqueness markets have different risks involved, which
you should be aware of when trading them. You may think you can only
lose up to your stop levels, but this is not always true. How much you could
actually lose when trading a stock or commodity is not always controllable
and you should be aware of this. Some stops can easily be blown through
especially in thin markets, and you may get filled at levels much worse than
you thought. Commodity markets can also lock limit and then your stop
level is meaningless. This could cause you to get stopped out at a price
you were never even expecting to be possible. The wider the spread in a
stock is, the bigger the risk is, as you saw above. Markets or stocks that
are news sensitive are much riskier. For example, $50 biotech companies
that have a new cancer drug waiting to get approval by the Federal Drug
Administration can become penny stocks in less than a day if they do not
get that approval. A stop in this instance would do you no good.
In commodities you may want to be aware of how often the market
has a habit of locking its limit. If you don’t know what that means, some
commodity markets have a limit they are allowed to move in one day (say
two points), if they hit that limit they can’t trade in the direction of the limit
any more for the rest of the day. (So if a market is plummeting and hits its
down limit, it will not trade below that price, it can, however, trade above
it.) This can be quite costly, when you are on the wrong side of the trade
and can’t get out. Some markets, especially the thin ones, have a greater
tendency than others to lock their limits for the day or for several days.
Managing your risk when this happens is tough, so make sure you know
how likely a market is to lock its limit before you jump into a trade. There
are options to help you when you are in a locked position and one of those
options is options. Options will keep trading even when a market is locked.
So if you are stuck you can trade the options on a commodity to help you
protect yourself, but this is usually costly as they become quite overpriced.
Another factor determining how great the real risk can be, is what happens
overnight. Some markets can have wild moves overnight and open
past where your stop loss level may have been. You then get stopped out at
the open without a say, and this could be a few to a lot of points from where
you thought your worst-case scenario was. As you get to know stocks and
commodities better you will get a sense of which markets can hurt you the
most overnight, and you then can trade accordingly.
you should be aware of when trading them. You may think you can only
lose up to your stop levels, but this is not always true. How much you could
actually lose when trading a stock or commodity is not always controllable
and you should be aware of this. Some stops can easily be blown through
especially in thin markets, and you may get filled at levels much worse than
you thought. Commodity markets can also lock limit and then your stop
level is meaningless. This could cause you to get stopped out at a price
you were never even expecting to be possible. The wider the spread in a
stock is, the bigger the risk is, as you saw above. Markets or stocks that
are news sensitive are much riskier. For example, $50 biotech companies
that have a new cancer drug waiting to get approval by the Federal Drug
Administration can become penny stocks in less than a day if they do not
get that approval. A stop in this instance would do you no good.
In commodities you may want to be aware of how often the market
has a habit of locking its limit. If you don’t know what that means, some
commodity markets have a limit they are allowed to move in one day (say
two points), if they hit that limit they can’t trade in the direction of the limit
any more for the rest of the day. (So if a market is plummeting and hits its
down limit, it will not trade below that price, it can, however, trade above
it.) This can be quite costly, when you are on the wrong side of the trade
and can’t get out. Some markets, especially the thin ones, have a greater
tendency than others to lock their limits for the day or for several days.
Managing your risk when this happens is tough, so make sure you know
how likely a market is to lock its limit before you jump into a trade. There
are options to help you when you are in a locked position and one of those
options is options. Options will keep trading even when a market is locked.
So if you are stuck you can trade the options on a commodity to help you
protect yourself, but this is usually costly as they become quite overpriced.
Another factor determining how great the real risk can be, is what happens
overnight. Some markets can have wild moves overnight and open
past where your stop loss level may have been. You then get stopped out at
the open without a say, and this could be a few to a lot of points from where
you thought your worst-case scenario was. As you get to know stocks and
commodities better you will get a sense of which markets can hurt you the
most overnight, and you then can trade accordingly.
KNOW WHAT YOU ARE TRADING
If you are going to trade, you should take the time to learn the essence
of a market or stock. Some things can be learned quickly but others you
will only learn over time and by trading. The longer you have been trading
a particular market, the better you will know how it reacts. Trading is a
learning process and if you are attentive you will always be able to learn
something new.
Start by getting to know the basics. If you are trading a futures contract,
make sure you know its margin, the hours it trades, and when the
contract expires, rolls over, or goes into delivery. I remember once trading
the front month in crude and not realizing it was last day of trading,
and I got stuck with taking delivery of 5,000 barrels of oil. I panicked a bit
because I lived in Manhattan and space in a Manhattan studio apartment
is quite tight. I was concerned about what I was going to do with all that
oil. I figured maybe I could make an end table or two but that still left me
with a lot of barrels of oil and I didn’t even have a car back then. Luckily
my clearinghouse took care of it (at a cost, of course). These things are
not uncommon and I have had a customer do it once as well. It is also not
uncommon to not realize when a market closes. Because futures markets
all have different hours, people who trade a lot of them can get caught taking
positions home they don’t really want, simply because they are careless
and were so caught up trading crude oil that they forgot to get out of their
soybean position at 2:15 when it closed. Yes, they can get out after hours,
but they may not get as good a price and they may get a margin call if they
are undercapitalized. It’s not that difficult to know what opens and closes
at what times, and it is something you ought to know. Another simple thing
you should know (and again, I’ve been guilty of this) is what a tick is worth
in a commodity. The first time I traded coffee I had no idea that a penny
move was worth $37.50, (I actually thought it was worth $3.75), nor did I
take the time to notice that on average it moved about $1,500 a day. I made
a trade based on someone’s recommendation without really studying it.
This was a lot more action than I was used to getting in crude, which at the
time was trading at $18/barrel and had about a $300 swing on a good day.
It was both scary and exciting trading coffee. But I soon realized I wasn’t
capitalized properly for it.
The same holds for stocks, there are some stocks that move with a
one-penny spread and others have a dollar spread. You need to know this
before getting involved. The larger the spread is the more you are risking
if you are wrong. When you trade Microsoft at $28 a share you know that
if you change your mind and get out right away you will only lose maybe a
penny or two, but if you trade Google at $628 a share then you may be out
a dollar a share before it has even begun to move.
This leads to the importance of knowing the volatility and liquidity of
a market. The best indicator for knowing liquidity is to look at volume. A
stock that trades 24 million shares a day will take a convoy of Mack trucks
to make it budge. You can trade it all day long and get the bid and the ask
for it if you are patient instead of paying for it. On the other hand, if you
are trading a goofy stock like AKF (Ambac Financial Group), that has an
average trading volume of less than 80,000 shares a day, and you try to
buy 5,000 shares you could actually make the stock move a little, at least
temporarily until you are filled. Then it will most likely go back where it
was before you bought it. It’s harder to trade thin markets as you have to
pick your spots much better just to get a fair price. Look at Figure 6.3 and
you’ll see that it’s hard to find any support from a thinly traded stock. I have
never looked at this stock and just found it randomly searching for a thin
stock. Commodities can be quite dangerous when trading thin markets.
Unless you are on the floor yourself, you can get taken for a ride in a thin
market. Your stops may get filled even if the market is not in the area.
Mysteriously at lunchtime when there are three guys in the pit the market
could make a quick move to hit the stops and come right back. I’ve seen it
happen and I’ve been a part of it when I traded on the floor, so yes, it does
of a market or stock. Some things can be learned quickly but others you
will only learn over time and by trading. The longer you have been trading
a particular market, the better you will know how it reacts. Trading is a
learning process and if you are attentive you will always be able to learn
something new.
Start by getting to know the basics. If you are trading a futures contract,
make sure you know its margin, the hours it trades, and when the
contract expires, rolls over, or goes into delivery. I remember once trading
the front month in crude and not realizing it was last day of trading,
and I got stuck with taking delivery of 5,000 barrels of oil. I panicked a bit
because I lived in Manhattan and space in a Manhattan studio apartment
is quite tight. I was concerned about what I was going to do with all that
oil. I figured maybe I could make an end table or two but that still left me
with a lot of barrels of oil and I didn’t even have a car back then. Luckily
my clearinghouse took care of it (at a cost, of course). These things are
not uncommon and I have had a customer do it once as well. It is also not
uncommon to not realize when a market closes. Because futures markets
all have different hours, people who trade a lot of them can get caught taking
positions home they don’t really want, simply because they are careless
and were so caught up trading crude oil that they forgot to get out of their
soybean position at 2:15 when it closed. Yes, they can get out after hours,
but they may not get as good a price and they may get a margin call if they
are undercapitalized. It’s not that difficult to know what opens and closes
at what times, and it is something you ought to know. Another simple thing
you should know (and again, I’ve been guilty of this) is what a tick is worth
in a commodity. The first time I traded coffee I had no idea that a penny
move was worth $37.50, (I actually thought it was worth $3.75), nor did I
take the time to notice that on average it moved about $1,500 a day. I made
a trade based on someone’s recommendation without really studying it.
This was a lot more action than I was used to getting in crude, which at the
time was trading at $18/barrel and had about a $300 swing on a good day.
It was both scary and exciting trading coffee. But I soon realized I wasn’t
capitalized properly for it.
The same holds for stocks, there are some stocks that move with a
one-penny spread and others have a dollar spread. You need to know this
before getting involved. The larger the spread is the more you are risking
if you are wrong. When you trade Microsoft at $28 a share you know that
if you change your mind and get out right away you will only lose maybe a
penny or two, but if you trade Google at $628 a share then you may be out
a dollar a share before it has even begun to move.
This leads to the importance of knowing the volatility and liquidity of
a market. The best indicator for knowing liquidity is to look at volume. A
stock that trades 24 million shares a day will take a convoy of Mack trucks
to make it budge. You can trade it all day long and get the bid and the ask
for it if you are patient instead of paying for it. On the other hand, if you
are trading a goofy stock like AKF (Ambac Financial Group), that has an
average trading volume of less than 80,000 shares a day, and you try to
buy 5,000 shares you could actually make the stock move a little, at least
temporarily until you are filled. Then it will most likely go back where it
was before you bought it. It’s harder to trade thin markets as you have to
pick your spots much better just to get a fair price. Look at Figure 6.3 and
you’ll see that it’s hard to find any support from a thinly traded stock. I have
never looked at this stock and just found it randomly searching for a thin
stock. Commodities can be quite dangerous when trading thin markets.
Unless you are on the floor yourself, you can get taken for a ride in a thin
market. Your stops may get filled even if the market is not in the area.
Mysteriously at lunchtime when there are three guys in the pit the market
could make a quick move to hit the stops and come right back. I’ve seen it
happen and I’ve been a part of it when I traded on the floor, so yes, it does
FIGURE 6.3 1-Minute AKF
Source: © TradeStation Technologies 1999. All rights reserved.
happen. Just remember the thinner the market, the better you have to pick
your stop locations or the more likely they are to get filled.
T H E-M E G A-T R A D E R
One reason for the uniqueness of markets is that each market tends to have the
same group of players trading them day in and day out. It’s the summation of
all these traders’ uniqueness that moves a market the way it does. To make it
clearer, think of all the people who regularly trade cocoa as one mega person.
He will have a different uniqueness than the mega trader of cotton. It is this
style of the mega trader that gives each market its own feel. If all the traders
who trade cocoa started trading cotton instead, I bet cotton would soon start
having the same patterns as cocoa. It’s just a theory of mine.
same group of players trading them day in and day out. It’s the summation of
all these traders’ uniqueness that moves a market the way it does. To make it
clearer, think of all the people who regularly trade cocoa as one mega person.
He will have a different uniqueness than the mega trader of cotton. It is this
style of the mega trader that gives each market its own feel. If all the traders
who trade cocoa started trading cotton instead, I bet cotton would soon start
having the same patterns as cocoa. It’s just a theory of mine.
MARKETS DIFFER
In the same way that every trader is different, well, every market or
stock has its own uniqueness about itself. Markets have different liquidity, different spreads, different high to low intraday moves, even different
hours. The costs to trade them are different, the way they trend or how
they react intraday are different. Some stocks are market leaders, some
are followers. Some will move one way when interest rates drop and others
a different way. Some are in all the hedge funds and are prone to huge
swings if the funds get involved. Some markets react differently to news
than do others. Some are largely dependent on news and weather, while
others are more technical. Some are very active at night and others don’t
even trade after hours. I could keep going on and on but you get the picture.
stock has its own uniqueness about itself. Markets have different liquidity, different spreads, different high to low intraday moves, even different
hours. The costs to trade them are different, the way they trend or how
they react intraday are different. Some stocks are market leaders, some
are followers. Some will move one way when interest rates drop and others
a different way. Some are in all the hedge funds and are prone to huge
swings if the funds get involved. Some markets react differently to news
than do others. Some are largely dependent on news and weather, while
others are more technical. Some are very active at night and others don’t
even trade after hours. I could keep going on and on but you get the picture.
Know Your Markets
A guy new to trading has been paper trading for a year now and
is still afraid to make a real trade. He just watches the markets all
day long making mental trades. Last week, he lost his mind.
Just like you need to know yourself, you also need to know what you
are trading. This includes the individual stocks or commodities you
may trade, as well as the overall markets in general. It means knowing
everything you can learn about them to make you a more efficient trader in
those markets. You should get to know every little nuance of what makes
a stock tick, how much it could move, how liquid it is, the risks involved
trading it, and so on. These are just a few things that can affect a stock,
there are a lot more factors I’ll discuss later. These are things you should
know before entering into a position, so that you can control your risk. You
also should know the macro picture of what you are trading. You should
be aware of what type of market you’re in; is it choppy, trending, near a
reversal or support point, and so on? If a market is on a good run, find out
why, it can help you determine how to trade it and when to maybe ease up.
Just looking at a five-minute chart of a stock will not help you much, but if
you know the overall picture of the market you’ll fare much better.
is still afraid to make a real trade. He just watches the markets all
day long making mental trades. Last week, he lost his mind.
Just like you need to know yourself, you also need to know what you
are trading. This includes the individual stocks or commodities you
may trade, as well as the overall markets in general. It means knowing
everything you can learn about them to make you a more efficient trader in
those markets. You should get to know every little nuance of what makes
a stock tick, how much it could move, how liquid it is, the risks involved
trading it, and so on. These are just a few things that can affect a stock,
there are a lot more factors I’ll discuss later. These are things you should
know before entering into a position, so that you can control your risk. You
also should know the macro picture of what you are trading. You should
be aware of what type of market you’re in; is it choppy, trending, near a
reversal or support point, and so on? If a market is on a good run, find out
why, it can help you determine how to trade it and when to maybe ease up.
Just looking at a five-minute chart of a stock will not help you much, but if
you know the overall picture of the market you’ll fare much better.
CLOSING THOUGHTS
I know I’ve been a little contradictory about following a system and being
discretionary. I do believe you need a core system to point you in the right
direction, but you can actually make the trades using discretion as long as
you follow your rules, are consistent, and your trades are premeditated.
This may not apply to active day traders as they have to react quickly, but
even then, they should have recognizable patterns they see all the time that
they act upon. As I write this book, it will be geared more toward the trader
who uses discretion in his trades, as the purely systematic trader doesn’t
really need to follow a game plan as much because he is on autopilot. The
person who uses discretion in his trading really needs the guidance of a
game plan to keep him on track.
Once again, if you want to succeed, you will learn to make a game plan
everyday that employs your trading strategies and you will follow it.
discretionary. I do believe you need a core system to point you in the right
direction, but you can actually make the trades using discretion as long as
you follow your rules, are consistent, and your trades are premeditated.
This may not apply to active day traders as they have to react quickly, but
even then, they should have recognizable patterns they see all the time that
they act upon. As I write this book, it will be geared more toward the trader
who uses discretion in his trades, as the purely systematic trader doesn’t
really need to follow a game plan as much because he is on autopilot. The
person who uses discretion in his trading really needs the guidance of a
game plan to keep him on track.
Once again, if you want to succeed, you will learn to make a game plan
everyday that employs your trading strategies and you will follow it.
STICK TO YOUR TRADING STRATEGY
This shouldn’t need to be said, but once you have a strategy, use it. If you
have back tested it and it works, don’t deviate from it or second-guess it. If
you put on a trade, make sure it is part of your strategy. Don’t just randomly
put on trades because you feel like it. Make sure they are in your strategy
and in your game plan. Once you have your trading and game plan set,
you’d be wise to follow it.
have back tested it and it works, don’t deviate from it or second-guess it. If
you put on a trade, make sure it is part of your strategy. Don’t just randomly
put on trades because you feel like it. Make sure they are in your strategy
and in your game plan. Once you have your trading and game plan set,
you’d be wise to follow it.
TIMES FRAMES AND HOLDING TIMES
It’s not enough to just have buy and sell signals, you need to determine
the time frame you will be looking at and how long you will be holding
trades. Here is a time where knowing yourself comes into play. Some
people can hold forever and others need to get in and out all the time.
As you develop your strategies, you need to take this into consideration.
You need to know what time frame charts you will look at when you
make your trade. Are you going to be basing your trades off of a oneminute
chart or a weekly chart? I recommend looking at a range of time
frames to get a true market picture and to time your trades. However,
you should have a base time frame somewhere in between to actually
make your trading decisions. I also recommend that when you choose
your stops you look at a time frame above what you are trading to base
them on.
One of the things that worked for me was looking at an even smaller
time frame to actually pull the trigger. I have found that in the past I had
of habit of rushing into trades. My signals would get me into the market
at the highest point of a move. I was not very patient about getting
in and I would get in at horrible places. One of the most helpful things
I have implemented into my strategies are conditions that make me wait
for pullbacks before getting into a trade, the same held for exits. I’d panic
and get out at the worst levels possible. The way I do this is by overlapping
two strategies. One is the basic get in signal using a daily and/or
60-minute time frame and the other is a timing signal that is usually a 1- or
5-minute time frame. I also use a weekly or daily time frame to figure out
the long-term situation and give me more fodder for planning my exits.
However, when it comes to actually pulling the trigger, I’m usually looking
at a short time frame to time the exit if I’m not stopped out. I’ll get into more
detail later in the book on how to use different time frames to make trades.
the time frame you will be looking at and how long you will be holding
trades. Here is a time where knowing yourself comes into play. Some
people can hold forever and others need to get in and out all the time.
As you develop your strategies, you need to take this into consideration.
You need to know what time frame charts you will look at when you
make your trade. Are you going to be basing your trades off of a oneminute
chart or a weekly chart? I recommend looking at a range of time
frames to get a true market picture and to time your trades. However,
you should have a base time frame somewhere in between to actually
make your trading decisions. I also recommend that when you choose
your stops you look at a time frame above what you are trading to base
them on.
One of the things that worked for me was looking at an even smaller
time frame to actually pull the trigger. I have found that in the past I had
of habit of rushing into trades. My signals would get me into the market
at the highest point of a move. I was not very patient about getting
in and I would get in at horrible places. One of the most helpful things
I have implemented into my strategies are conditions that make me wait
for pullbacks before getting into a trade, the same held for exits. I’d panic
and get out at the worst levels possible. The way I do this is by overlapping
two strategies. One is the basic get in signal using a daily and/or
60-minute time frame and the other is a timing signal that is usually a 1- or
5-minute time frame. I also use a weekly or daily time frame to figure out
the long-term situation and give me more fodder for planning my exits.
However, when it comes to actually pulling the trigger, I’m usually looking
at a short time frame to time the exit if I’m not stopped out. I’ll get into more
detail later in the book on how to use different time frames to make trades.
EXITS
Anyone can get into a trade, it’s pretty easy. You just buy or sell anything at
any time for any reason and you are in a trade. However, in order to make
money you need to know when to get out. I could give the same trade to two traders, John and Harry, and Harry will be most likely to make money
on that trade because he knows how to plan an exit. Even if he loses on it,
he will probably get out with a smaller loss and restrict his damage. This,
in my eyes, is long-term winning.
I’m not going to spend too much time writing about exiting now as I’ll
delve into it later in the book, but I’ll go over the basics of it to give you an
idea of what goes into the trading plan. First of all, you will want a signal
that will get you out with a profit. This signal can also get you out with a
loss even though it isn’t meant to act as a stop. You can see how this may
happen in Figure 5.3. Here, I’m using a simple moving average crossover
system that only takes trades in the direction of the major trend. It buys
at the close of the day when the faster moving average line crosses over
the slower one. I got a buy signal at the circle E1 and sold it at circle X1
for a great trade. The next trade happened at circle E2 when the averages
crossed again. I would have placed a stop just below the lows of the previous
move indicated by stop line S1. Now, even though the market had not
reached the stop line at the time, the trade was liquated because I got an
exit signal telling me the reason I entered the trade has changed.
After the exit signal you will need a stop signal to give you a safety net.
Stops are complicated, because of the many ways you can use them; again,
FIGURE 5.3 Daily Dow Jones
Source: © TradeStation Technologies 1999. All rights reserved.
more on them later in the book. But overall they are just there to protect
you. One thing to keep in mind is that your loss target should always be
less than your profit target. If you are risking three points to make two
points then you are making a poor trade. When I trade, I look at my exit
before my entry and determine the risk involved and the potential earnings
I can make. If the ratio is good then I start looking for an entry. If you are
writing a system, look for this in your back testing. Is the proper place to
put a stop versus the amount you can make reasonable? If not your system
won’t work. Knowing where to place stops will make you a winning trader
on its own, so don’t ignore them like many traders do. Even in the previous
example where I do not have a set profit target, I know that in an uptrend
the market has potential to move up 5 to 10 times what I was risking with
my stop on a good trade. This is the start of a winning formula, you just
need to be right enough times to make it tradable.
One other note, some systems will always keep you in the market.
These don’t use stops but use the exit signals to not only get you out of
the market but to get you in the other way. The theory behind these is if I
don’t want to be long I should be short. These strategies are normally used
by overtraders, who always have to be in something and need the action.
Even if you have this type of system, I recommend using an emergency stop
to protect you should the system fail to give you a signal quickly enough if
you are losing big on a trade. If you go back to the chart in Figure 5.3 and
remove the rule of only taking trades in the direction of the major trend,
you have a system that is always in the market. Instead of getting out at
point X1, you would be exiting and getting short at the same time.
any time for any reason and you are in a trade. However, in order to make
money you need to know when to get out. I could give the same trade to two traders, John and Harry, and Harry will be most likely to make money
on that trade because he knows how to plan an exit. Even if he loses on it,
he will probably get out with a smaller loss and restrict his damage. This,
in my eyes, is long-term winning.
I’m not going to spend too much time writing about exiting now as I’ll
delve into it later in the book, but I’ll go over the basics of it to give you an
idea of what goes into the trading plan. First of all, you will want a signal
that will get you out with a profit. This signal can also get you out with a
loss even though it isn’t meant to act as a stop. You can see how this may
happen in Figure 5.3. Here, I’m using a simple moving average crossover
system that only takes trades in the direction of the major trend. It buys
at the close of the day when the faster moving average line crosses over
the slower one. I got a buy signal at the circle E1 and sold it at circle X1
for a great trade. The next trade happened at circle E2 when the averages
crossed again. I would have placed a stop just below the lows of the previous
move indicated by stop line S1. Now, even though the market had not
reached the stop line at the time, the trade was liquated because I got an
exit signal telling me the reason I entered the trade has changed.
After the exit signal you will need a stop signal to give you a safety net.
Stops are complicated, because of the many ways you can use them; again,
FIGURE 5.3 Daily Dow Jones
Source: © TradeStation Technologies 1999. All rights reserved.
more on them later in the book. But overall they are just there to protect
you. One thing to keep in mind is that your loss target should always be
less than your profit target. If you are risking three points to make two
points then you are making a poor trade. When I trade, I look at my exit
before my entry and determine the risk involved and the potential earnings
I can make. If the ratio is good then I start looking for an entry. If you are
writing a system, look for this in your back testing. Is the proper place to
put a stop versus the amount you can make reasonable? If not your system
won’t work. Knowing where to place stops will make you a winning trader
on its own, so don’t ignore them like many traders do. Even in the previous
example where I do not have a set profit target, I know that in an uptrend
the market has potential to move up 5 to 10 times what I was risking with
my stop on a good trade. This is the start of a winning formula, you just
need to be right enough times to make it tradable.
One other note, some systems will always keep you in the market.
These don’t use stops but use the exit signals to not only get you out of
the market but to get you in the other way. The theory behind these is if I
don’t want to be long I should be short. These strategies are normally used
by overtraders, who always have to be in something and need the action.
Even if you have this type of system, I recommend using an emergency stop
to protect you should the system fail to give you a signal quickly enough if
you are losing big on a trade. If you go back to the chart in Figure 5.3 and
remove the rule of only taking trades in the direction of the major trend,
you have a system that is always in the market. Instead of getting out at
point X1, you would be exiting and getting short at the same time.
THE ENTRY
The first part of your system will be a signal to get you into the market. For
example:
Short if the market dips below the trend line for two periods.
Though not as important as exiting a trade, you cannot trade if you
never enter the market. The goal of the trading plan is to have a strategy
that gives you trades that will have a good chance of making money.
By having a system that gives you entry signals you will be making better
trades than if you just winged it, which, in turn, starts you off on the right
foot. If you want to succeed you need to have a valid reason for every trade
you enter. Having a strategy that gives you a reason for getting in will make
your trading so much easier. However, as you’ll see in a second, getting
into a trade is the easy part. It’s the getting out where you’ll determine if
you make or lose money.
example:
Short if the market dips below the trend line for two periods.
Though not as important as exiting a trade, you cannot trade if you
never enter the market. The goal of the trading plan is to have a strategy
that gives you trades that will have a good chance of making money.
By having a system that gives you entry signals you will be making better
trades than if you just winged it, which, in turn, starts you off on the right
foot. If you want to succeed you need to have a valid reason for every trade
you enter. Having a strategy that gives you a reason for getting in will make
your trading so much easier. However, as you’ll see in a second, getting
into a trade is the easy part. It’s the getting out where you’ll determine if
you make or lose money.
WHAT GOES INTO A STRATEGY?
Regardless of how you get your signals, a trading strategy is made up of
a few things. I am going to separate money management from this part of a strategy and deal with it on its own in a later chapter. But keep in
mind that the best trading strategies and a great system will not help you
one bit without a proper money management strategy. So ignoring money
management for now, the first thing that you will need is an entry signal,
which is then followed by an exit signal. The exit is composed of two parts.
One tells you when to get out with a profit and the other tells you when to
get out with a loss. The exit signals are partially derived from your money
management strategy, but we’ll discuss that later. Other things that you
may have in your system are the time frames you will trade and the holding
period of your trades. You may have different systems for different markets
or types of markets. You may have different systems to trade long-term
and short-term. This may call for you to look at different time frames and
holding periods when making your trading decisions. Regardless of these
things you still need the basics: a buy, a sell, and a protective signal to have
a proper strategy.
a few things. I am going to separate money management from this part of a strategy and deal with it on its own in a later chapter. But keep in
mind that the best trading strategies and a great system will not help you
one bit without a proper money management strategy. So ignoring money
management for now, the first thing that you will need is an entry signal,
which is then followed by an exit signal. The exit is composed of two parts.
One tells you when to get out with a profit and the other tells you when to
get out with a loss. The exit signals are partially derived from your money
management strategy, but we’ll discuss that later. Other things that you
may have in your system are the time frames you will trade and the holding
period of your trades. You may have different systems for different markets
or types of markets. You may have different systems to trade long-term
and short-term. This may call for you to look at different time frames and
holding periods when making your trading decisions. Regardless of these
things you still need the basics: a buy, a sell, and a protective signal to have
a proper strategy.
WHY SHOULD YOU HAVE A STRATEGY?
This is simple: to give you an edge. The main purpose of the strategy is
to make you trade with rules that you have determined will work. It will
keep you from trading foolishly and from overtrading—at least from the
part of overtrading that comes from putting on too many trades. Though
some strategies call for a lot of trades, a strategy will at least keep your
trades focused on what you think are the best trades. When you do not
have a strategy each trade you make has no rhyme or reason behind it and
could be totally the opposite from one similar situation to the next. With
a strategy you should trade the same way, time after time after time, and
hopefully you will be right more often then not, or else it’s time to toss out
or tweak the strategy.
Having trading strategies will help you focus on the good trades. Think
of it like having on blinders that keep you from seeing all the garbage out
there. These blinders will only let you see situations which you know have
a good chance of working out and will keep you from acting on impulse
on others you haven’t prepared for. In my opinion trading is all about making
the highest probability trades and ignoring all the others, and without
proven strategies you cannot get that edge.
to make you trade with rules that you have determined will work. It will
keep you from trading foolishly and from overtrading—at least from the
part of overtrading that comes from putting on too many trades. Though
some strategies call for a lot of trades, a strategy will at least keep your
trades focused on what you think are the best trades. When you do not
have a strategy each trade you make has no rhyme or reason behind it and
could be totally the opposite from one similar situation to the next. With
a strategy you should trade the same way, time after time after time, and
hopefully you will be right more often then not, or else it’s time to toss out
or tweak the strategy.
Having trading strategies will help you focus on the good trades. Think
of it like having on blinders that keep you from seeing all the garbage out
there. These blinders will only let you see situations which you know have
a good chance of working out and will keep you from acting on impulse
on others you haven’t prepared for. In my opinion trading is all about making
the highest probability trades and ignoring all the others, and without
proven strategies you cannot get that edge.
DON’T BE STUBBORN
One thing to keep in mind when using trading strategies is that they may
be bad, even though you think you are trading a winning system. In reality,
maybe you tested it wrong using insufficient data, or maybe you didn’t test
it at all. Regardless of why, don’t fall in love with a strategy because you
think it’s great. If it is not working, reevaluate it and don’t be afraid to throw
it out and start again. Try retesting over a longer period with more data or
over different market conditions. Maybe you only tested it in a trending
market and now you are in a choppy market, and the system just will not
work well under these conditions.
One good reason you want to know the biggest drawback and longest
losing streak is that it will help you evaluate if and when to toss out a strategy. Maybe you think it’s time to toss out the system because of four
losing trades in row, but in reality this may be normal for this system, as
may be an $8,000 losing streak at any given time. If this is the case and the
positive streaks outweigh the losing ones and you have the risk adversity to
handle these types of streaks, then you do not have to throw out the system.
You need to examine your strategies on a regular basis, so you can
determine if they are still valid. If you are losing money trading a system
and you test it over and over again and it seems like it should be positive,
then maybe you are doing something wrong in following it. You can find
this out by testing it over the period in which you traded and comparing
the results. A system is only as good as the person following it. Once you
start using discretion and ignoring signals, you will alter the results of the
system. Maybe the system is just fine, and it’s just you that needs tweaking
and discipline.
be bad, even though you think you are trading a winning system. In reality,
maybe you tested it wrong using insufficient data, or maybe you didn’t test
it at all. Regardless of why, don’t fall in love with a strategy because you
think it’s great. If it is not working, reevaluate it and don’t be afraid to throw
it out and start again. Try retesting over a longer period with more data or
over different market conditions. Maybe you only tested it in a trending
market and now you are in a choppy market, and the system just will not
work well under these conditions.
One good reason you want to know the biggest drawback and longest
losing streak is that it will help you evaluate if and when to toss out a strategy. Maybe you think it’s time to toss out the system because of four
losing trades in row, but in reality this may be normal for this system, as
may be an $8,000 losing streak at any given time. If this is the case and the
positive streaks outweigh the losing ones and you have the risk adversity to
handle these types of streaks, then you do not have to throw out the system.
You need to examine your strategies on a regular basis, so you can
determine if they are still valid. If you are losing money trading a system
and you test it over and over again and it seems like it should be positive,
then maybe you are doing something wrong in following it. You can find
this out by testing it over the period in which you traded and comparing
the results. A system is only as good as the person following it. Once you
start using discretion and ignoring signals, you will alter the results of the
system. Maybe the system is just fine, and it’s just you that needs tweaking
and discipline.
T R A D E S T A T I O N-C H A N G E S
One quick note, many people have e-mailed me saying they cannot get some of
the systems I wrote about in High Probability Trading to work for them. There
is a reason for this. I wrote them using TradeStation 4.0, currently they are on
Version 8.3, and somewhere along the line they changed the way you enter
systems. Before, you would write one long system with all the signals in it. Now
it’s broken up into different segments for entries and exits, making it a little
different.
the systems I wrote about in High Probability Trading to work for them. There
is a reason for this. I wrote them using TradeStation 4.0, currently they are on
Version 8.3, and somewhere along the line they changed the way you enter
systems. Before, you would write one long system with all the signals in it. Now
it’s broken up into different segments for entries and exits, making it a little
different.
M Y-B E G I N N I N G S-W I T H-S Y S T E M S
I remember one of the first systems I used to trade. It was a system that a friend
told me he got from a friend in Chicago, whose friend traded with Ed Seykota. Ed
Seykota was one of the traders mentioned In Jack Schwager’s Market Wizards,
which was one of the most popular trading books back when I started trading.
Anyway, this system was just hearsay handed down through a chain of people.
It now reminds me of playing a game of telephone as a kid where one person
starts by saying, “My mother has very nice hair,” and by the 50th person it comes
out as, “Your father’s feet smell like a chair.”
Maybe at one point it was a valid system if it actually did come from Ed
Seykota, but I have no idea if it did. And even if it did, how many alterations
did it go through before it got to me? Maybe I only got part of the system and
something was left out. The system was a reversal system that did have merits,
but I never really bothered to test it over an extended period of time. I thought
if it came from a market wizard it must be good. I didn’t make money trading
this system, but at least I had something to work with when I started making
my own systems. I was still a novice trader and had few tools, but this system
helped me a lot—not in my actual trading, but it helped me learn what a system
should be. It took over a year for me to adapt it with tools I learned to use and
to make it my own and back test it over a decent period of time. There is no way
I could have done it during my first year of trading; I just didn’t know enough
to have done so. But once I learned how markets react and how to manage
my money and how to use trend lines and moving averages and stochastics
and read hundreds of different trading strategies, I was able to put some solid
rules together to make this and a few other systems work for me. I’m sure that
if Ed Seykota had gotten hold of my system he probably couldn’t have made money with it-–unless of course he dissected it and made some changes to it
and reverted it back to his system.
told me he got from a friend in Chicago, whose friend traded with Ed Seykota. Ed
Seykota was one of the traders mentioned In Jack Schwager’s Market Wizards,
which was one of the most popular trading books back when I started trading.
Anyway, this system was just hearsay handed down through a chain of people.
It now reminds me of playing a game of telephone as a kid where one person
starts by saying, “My mother has very nice hair,” and by the 50th person it comes
out as, “Your father’s feet smell like a chair.”
Maybe at one point it was a valid system if it actually did come from Ed
Seykota, but I have no idea if it did. And even if it did, how many alterations
did it go through before it got to me? Maybe I only got part of the system and
something was left out. The system was a reversal system that did have merits,
but I never really bothered to test it over an extended period of time. I thought
if it came from a market wizard it must be good. I didn’t make money trading
this system, but at least I had something to work with when I started making
my own systems. I was still a novice trader and had few tools, but this system
helped me a lot—not in my actual trading, but it helped me learn what a system
should be. It took over a year for me to adapt it with tools I learned to use and
to make it my own and back test it over a decent period of time. There is no way
I could have done it during my first year of trading; I just didn’t know enough
to have done so. But once I learned how markets react and how to manage
my money and how to use trend lines and moving averages and stochastics
and read hundreds of different trading strategies, I was able to put some solid
rules together to make this and a few other systems work for me. I’m sure that
if Ed Seykota had gotten hold of my system he probably couldn’t have made money with it-–unless of course he dissected it and made some changes to it
and reverted it back to his system.
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