before jumping in. He might take a look to see where crude oil is
on a chart, considering: Is it overbought? How much risk is involved? How
much can he hope to make on the trade, and so on? After meeting any criteria
he may have, he will next look to time an entry if he has decided to
get in. One of the things that make this trader better is that after deciding
to buy, but before getting in, he will start to make an exit strategy for the
trade. After getting in he will evaluate the trade on a regular basis.
Basically, he would have a both a plan of attack and a defensive strategy
for the trade, or more precisely he would have a game plan for the trade
from start to finish.
FIGURE 1.1 Crude Oil
Source: © TradeStation Technologies 1999. All rights reserved.
If you look at Figure 1.1, you can see the situation where these scenarios
could have happened. Crude oil was in the news a lot these days as gas prices were at record highs, and it looked like the market was going
for another record high after being in a congestion stage for a short while
in the strong uptrend. Though a prudent trader wouldn’t jump into a trade
based on it being in the news, let’s just say Harry, from here on in,the good
trader, looked at the chart the day of the shaded circle A, drew a couple
of trend lines and said, “You know what, this looks like a good situation. It
meets all my criteria [his trading plan]: It’s in a major uptrend [not seen in
its entirety in this chart but shown with Trend Line A]. It is fairly close to
the trend line; it just broke out of a small congestion area at $70, retraced
a bit and now has broken out again; it is near all-time highs; and the risk
measured by Trend Line B is acceptable, given the potential for it to take
off. A good place to have a stop would be just below that trend line so the
risk is about two points. The stochastics are high, but not yet crossing over,
and the upward trend line in them is a bullish signal. Should the stochastics
turn below the overbought area I’ll get out, as if the market breaks the
trend line.”
Now Harry has made a trade that fits his trading style and the criteria
set out in his trading plan. Plus, he has made a game plan as to what to
do with it. He doesn’t get shaken out two days later at circle B like John
does, but instead holds for another week and sells at circle C when both
the trend line C is broken and the stochastics cross below the overbought territory. Harry likes to draw trend lines and since the market got pretty
steep, he adjusted the angle to come up with trend line C. The bottom line
is that Harry, having a game plan, makes close to $4,000 per contract while
John, the yo-yo, lost $4,000 on the same trade.
By the way, I’m editing the book now and wrote the above more
than a year ago. Crude oil has since hit $135 dollars a barrel. Good
thing I didn’t start shorting when I thought it was overpriced at $70.
And Pedro Martinez since has torn his calf muscle, spent most of last
year on the disabled list with a torn rotator cuff, and followed that up
at the beginning of this year with a strained hamstring; so much for that
staying-healthy theory I had earlier. It just goes to show how things can
change.
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