Advantages of Systems Trading:
There are many reasons why futures traders are turning to mechanical trading systems as their primary trading style. One of the biggest mistakes traders make is allowing emotions, excitement or fear, to overpower their logic and control over their trading. With systems trading, the trader relies on the system to select the trades; thus, freeing the trader from the burden of emotional fear and greed decisions.
Why there is NO Perfect System:
Selecting a trading system can be a difficult task. All system results are hypothetical, because they are based on past results and have the huge benefit of hindsight. The disclaimer for hypothetical results typically reads: “Past Performance does not guarantee future results.” Many trading systems seem too good to be true. Smart consumers know that when something looks too good to be true, it usually is.
Although trading systems are designed to select the most statistically desirable trades, they cannot completely or accurately predict market trends and cannot guarantee success. Countless factors contribute to market changes: price, volatility, news, shortages, wars, interest rates, increasing or decreasing money supply, etc. While some systems work in a bull market, some in a bear market, others do best during a choppy market.
What Goes Up Must Come Down:
While there is no system that can consistently assures success, that does not imply that systems trading is never profitable. Trading systems may deliver large profits during certain phases and then provide large losses later. Newton’s law of Gravity tells us that: “What goes up must come down.” Financial markets mimic this by having Bull markets and Bear Markets. Market prices will never continuously move in an upward trend. In the same way, the equity curve of any trading system will never continuously move positively. The equity curve for any high risk investment will fluctuate up and down; there will be winning and losing periods for any system.
While every trader will find himself in a losing period at times, there are strategic moves to attempt to minimize losses. A common strategy is diversification. By utilizing multiple trading systems, the trader is acknowledging that there is no trading system that can consistently make a profit. Many traders choose to use multiple automated systems, so that when one begins to lose during a certain market period, another may profit. The overall performance is not tied to only one set of rules.
Basic Techniques for Multiple Systems Trading: Portfolio vs. Selective
With portfolio systems trading, the “portfolio trader” runs multiple trading systems at the same time. The idea behind this style of multiple systems trading is that if one system suffers a loss then another system will hopefully receive a gain, thus minimizing or eliminating the loss. However, this style not only minimizes losses, but also minimizes profits: if one system is trending upward and profiting while another system is losing, then the losing system will reduce or eliminate the profit. The minimum account size for an individual trader using “portfolio trading” tends to be relatively high, because each system is trading a separate set of contracts each with margin requirements, thus portfolio system trading tends to be used primarily by high volume or high net worth traders.
The selective style falls into the category of multiple systems trading, because the trader utilizes several different systems, one at a time. Selective systems trading is designed to improve the trading performance of the systems based on modifications to the “working time” of any given system in the Market. The basic idea is to switch (turn one system off; turn a different system on) a trading system when the equity curve is expected to stop rising. While the strategy of the “portfolio trader” is to avoid taking major losses by balancing losing trades on one system with winning trades on another, the “selective trader” replaces a system that is losing or predicted to stop winning with a different system. There is no perfect method for predicting downward trends and ensuring consistent profit; profit cannot exist without loss. The process of predicting a downward trend in selective system trading is very complicated and will never be perfect; the goal is to minimize extended losing periods. A hypothetical example is detailed below.
Example: Hypothetical Selective Systems Trading Strategy for Determining when to Change Systems
Basic guidelines:
Switch system when the account has an overall daily loss at the close of the trading day.
Switch system after the account has a 5 consecutive days of overall daily profit.
Conclusion
While there are many advantages to systems trading, it must be acknowledged that there is no perfect system. While we would all like to hope that technology will advance to the point where a perfect system can be created, we must accept that the day may never come. Until that day, we feel the that the best approach is through the simultaneous use of multiple systems with a selective timing approach, so that if one system is not performing the other systems in the portfolio have an opportunity to potentially compensate and make for a smoother equity curve.
Risk Disclosure: Futures, and options trading contains substantial risk, is not for every trader, and only risk capital should be used. Any form of trading, including forex, options, hedging and spreads contains risk. Past performance is not indicative of future results. No representation is being made that any account will or is likely to achieve profits or losses. There have been no promises, assurances or warranties suggesting that any trading will result in a profit or will not result in a loss. Because there are no actual trading results to compare to the hypothetical performance results customers should be particularly wary of placing undue reliance on these hypothetical performance results.
Showing posts with label Trading Psychology. Show all posts
Showing posts with label Trading Psychology. Show all posts
Thursday, November 19, 2009
Thoughts on Trading
1. A trade is neither right nor wrong. A trade can only be pofitable or not profitable. a) Profitable is good. b) Unprofitable is bad. Do something!
2. Therapy for traders on a losing streak:
a) Brag about your losses. Tell everybody. Get on the phone!
b) You’ll soon discover that for a losing trade the only thing to brag about is how small you kept the loss, how quickly you stopped the bleeding.
3. The market is uncaring. If you hang on to losing trades, telling
yourself “I’m right, I know I’m right”, the market will reduce your
trading capital down to zero.
4. As an individual trader, you’re competing against guys with PhD.s in math and physics, against giant super-computers.
a) The PhD.s are probably smarter than you.
b) Your computer is no match for the competing computers.
c) Always know where the escape hatch is for each and every trade. How fast can you get through it? Practice!
5. If you start believing that you have some special insight into the market, that you’ve “cracked the code”, discovered “the natural order of the market”, that the market will go where you say, then put your money in Bank Fixed Deposits and take a long vacation. Motorcycle drivers who stay afraid of their machines die of old age. Those who think they are “daredevil charlie” land up in hospitals.
6. The market is a mechanism for transferring wealth. It does so by causing pain. Great wealth transfers in times of great pain. Losses are a way of causing pain. Trading is a business. You go to work in the morning, go home at night, and earn a paycheck at the end of the week. Keep the size of your trades reasonable.
7. Once in a while a sure thing comes along. It’s a good day to skip trading and take a walk on the beach.
8. Getting market direction right is only the first step of a trade.
Selecting the best trade (trading strategy) is the next step. For
example, is it better to go long a put (it will decay against you)?… or to enter a call spread for a credit (it will decay for you)? The answer depends on market conditions. Money management is the 3rd step. Your goal is to make a profit, not show the world. Your profit/loss statement will accurately reflect your trading at the end of every day. Read it carefully. Understand its message.
2. Therapy for traders on a losing streak:
a) Brag about your losses. Tell everybody. Get on the phone!
b) You’ll soon discover that for a losing trade the only thing to brag about is how small you kept the loss, how quickly you stopped the bleeding.
3. The market is uncaring. If you hang on to losing trades, telling
yourself “I’m right, I know I’m right”, the market will reduce your
trading capital down to zero.
4. As an individual trader, you’re competing against guys with PhD.s in math and physics, against giant super-computers.
a) The PhD.s are probably smarter than you.
b) Your computer is no match for the competing computers.
c) Always know where the escape hatch is for each and every trade. How fast can you get through it? Practice!
5. If you start believing that you have some special insight into the market, that you’ve “cracked the code”, discovered “the natural order of the market”, that the market will go where you say, then put your money in Bank Fixed Deposits and take a long vacation. Motorcycle drivers who stay afraid of their machines die of old age. Those who think they are “daredevil charlie” land up in hospitals.
6. The market is a mechanism for transferring wealth. It does so by causing pain. Great wealth transfers in times of great pain. Losses are a way of causing pain. Trading is a business. You go to work in the morning, go home at night, and earn a paycheck at the end of the week. Keep the size of your trades reasonable.
7. Once in a while a sure thing comes along. It’s a good day to skip trading and take a walk on the beach.
8. Getting market direction right is only the first step of a trade.
Selecting the best trade (trading strategy) is the next step. For
example, is it better to go long a put (it will decay against you)?… or to enter a call spread for a credit (it will decay for you)? The answer depends on market conditions. Money management is the 3rd step. Your goal is to make a profit, not show the world. Your profit/loss statement will accurately reflect your trading at the end of every day. Read it carefully. Understand its message.
Overtrading: Are you Guilty ?
The first rule to understand is this: Futures trading may not be suitable for everyone. The risk of loss can be substantial.
One of the most common mistakes made by FNO traders is overtrading.
When you create a trading position which is much larger than justified by your capital, this is overtrading.
What is too large? A simple rule is to ensure that any single loss should not exceed 2% of your trading capital. If your trading positions require you to take a loss which is larger then your volume is too large – you are overtrading.
Here are some psychological signals that you are taking more risk than proper:
Sweating during trading hours while sitting in an AC room
Watching Television but switiching channels hoping that some channel will provide you with “suitable” news
Closing your position at a loss which actually brings you relief, only to see that the market moves in your favor after you exit
Shouting at your spouse, children, office people for no apaprent reason (the real reason is that you are losing money on a large position)
Calling your broker every five minutes seeking assurance that your positions are correctly placed.
This is not the life of your dreams, is it ? The solution is to reduce your volume and trade small. But, you will ask, how can I trade small and make a living ? I will answer this question here.
On trading small volumes:
My thinking is that if you’re a good trader with good ideas, each trade you make isn’t significant. It’s the sum total of a lot of good ideas over a lot of years that will make you wealthy. Everyone is wrong sometimes and what happens If you risk it all (or most of it) on a single trade, and you’re wrong? If what I’m saying makes sense, then trading small makes sense. Good opportunities come along fairly often.
Trading with a small capital
Use the Mini Nifty contract
Trade only in stock futures which have a small value
Learn how to hedge with options
One of the most common mistakes made by FNO traders is overtrading.
When you create a trading position which is much larger than justified by your capital, this is overtrading.
What is too large? A simple rule is to ensure that any single loss should not exceed 2% of your trading capital. If your trading positions require you to take a loss which is larger then your volume is too large – you are overtrading.
Here are some psychological signals that you are taking more risk than proper:
Sweating during trading hours while sitting in an AC room
Watching Television but switiching channels hoping that some channel will provide you with “suitable” news
Closing your position at a loss which actually brings you relief, only to see that the market moves in your favor after you exit
Shouting at your spouse, children, office people for no apaprent reason (the real reason is that you are losing money on a large position)
Calling your broker every five minutes seeking assurance that your positions are correctly placed.
This is not the life of your dreams, is it ? The solution is to reduce your volume and trade small. But, you will ask, how can I trade small and make a living ? I will answer this question here.
On trading small volumes:
My thinking is that if you’re a good trader with good ideas, each trade you make isn’t significant. It’s the sum total of a lot of good ideas over a lot of years that will make you wealthy. Everyone is wrong sometimes and what happens If you risk it all (or most of it) on a single trade, and you’re wrong? If what I’m saying makes sense, then trading small makes sense. Good opportunities come along fairly often.
Trading with a small capital
Use the Mini Nifty contract
Trade only in stock futures which have a small value
Learn how to hedge with options
Trading with Market Flow
Learning to trade with the market is a key part of improving trading results. There are many trading systems that work well in some market conditions and not at all in others. There are few, if any, systems that work in all market conditions. Trading results are improved when the trader has a variety of techniques available, and selects the one most appropriate for the current market conditions.
Trading success does not come from finding the Holy Grail; it is the mastery of several different aspects of trading that leads to success. It takes time, effort and money to learn this. Mastering trading, like many other professions is well worth the investment you make.
Consider a two-year period in the Nifty. Buy and hold investors who bought in May of 2001 ended up in pretty much the same place in May of 2003. Strategies with long holding periods showed draw downs during the first half of the period, and gains during the second half. The net result of holding during the 2001-2003 period was essentially breakeven.
Short-term traders could make profits during the first half of the period by using effective shorting strategies, and profits during the second half of the period by using effective long strategies. Trading with the Market requires one to have a variety of strategies that are known to work in different Market environments, and a method for determining which strategy to use.
We have developed a number of different scans that find setups suitable for a variety of different market conditions. There are scans that look for long and short pullbacks, volume accumulation, volume distribution, and various patterns. We have tested these scans in bullish, bearish, and trading range market periods; so we know which ones work best in any given market environment. We make a careful analysis of the current market conditions each evening then select the right tool for the job.
The key to selecting the best trading system to use for current market conditions is determine whether the current market is in a narrow trading range, a wide basing area, or a trend. Once we determine what the current market environment it is we know which of the trading tools to use because we have tested each tool in these different market conditions.
We use trend lines on the NIFTY to determine whether to focus on long or short scans. If the NIFTY is above an ascending trend line, we select tools that perform well in an up trending market. If the NIFTY is below a descending trend line, we select tools that perform well in a down trending market. We have also found moving averages to be effective tools for determining which trading tools to use. Backtesting results indicate that several of our systems respond well to limiting Long Entries to periods when the 30-day zero lag moving average for the NIFTY is moving up.
When the NIFTY broke above the descending trend line in April 2003 it implied that it was time to stop focusing on tools that perform well in down trending markets and select another tool. A trend line break does not imply the immediate start of a new trend. It indicates that something has changed; the market may base awhile then resume the original trend or start a new one. In either case the indication that something has changed in the market indicates that the trader must change with it. The way traders change is to change the tools they are using and their position sizing.
After a trend line break we reduce position size. The reason for this is that swing trading in bases carries more risk than trading in trends, so reducing position size is one way to compensate for this. After the April break of the descending trend line the market bases for four weeks. During this basing period we focus on tools and techniques that have tested well in this type of environment and also continue to trade half size positions. At some point the market will either break above or below the base, and attempt to start another trend. When it does we will trade with the break using the appropriate set of tools.
When the Market is in a clear trend, either up or down, we focus on tools and techniques for Swing or Intermediate term trades. When the Market is range bound , we generally focus on Short Term or Swing trades. The Market conditions tell us which type of trading patterns and techniques to focus on, and the type of trading determines the exit strategies.
Short Term Trading involves taking quick profits on the breakout. We typically exit after 1-2 days, or after a quick pop. This approach can be profitable in range bound markets when the market is only moving up or down a few days at a time. Holding periods of more than a few days in this type of market usually just churn the account.
Swing Trading requires the market to be moving in a large basing range or trending. We place a stop under the low of the setup pattern and close positions as the stock approaches support or resistance. This tends to be more profitable than Short Term trading when the Market is trending or trading in bases that take at least five days to move between the top and bottom of the range.
Intermediate Term trading generally is preferred when the market is strongly trending. We will place an initial stop under the low of the set up pattern and hold while market conditions remain favorable. We will sell when the Stock or the market breaks a key Trend Line or shows signs of topping.
Range bound markets are generally poor places for intermediate term trading. Short term or Swing trading techniques can provide better results. In Narrow bases, where the market moves between the top and bottom in less than four days we limit ourself to short term trading techniques when the market is bouncing off support or resistance, or stand aside. Narrow ranges require quick, decisive action. We just focus on taking a quick profit on the initial move after a trigger.
When the market is in a wide base where it takes at least five days to move between the top and bottom of the range swing trading can be effective. We focus on entering trades when the market is bouncing off support or resistance and avoid taking trades in the middle of the range. The reason for this is trades taken in the middle of the basing area have less time to work out than ones taken on either end. We refer to the middle third of a basing area as the ‘no zone’, and avoid taking new trades in this area.
Intermediate term trading works best when the Market is in a clear up or down trend. We watch for the break of an intermediate or long-term trend line, or a successful retest of a base breakout as possible beginnings of a new trend. We focus on Swing Trading until the market makes a higher low. After a higher low is established we can draw a trend line and consider Intermediate term trading techniques until the trend line is broken.
In order to use Intermediate term trading techniques, the market must be in a clear trend. An up trend usually is not clear until the market has formed a higher low. Until a higher low is formed it is often safer to focus on short term or swing trading rather than intermediate term trading.
Sometimes the market conditions will allow you to use more than one trading style. When the market channels up active traders may use both Intermediate and Short Term Trading techniques. To use short term trading in a channel focus on entering longs as the market bounces off the bottom of the channel, and taking profits as the Market approaches the upper channel boundary.
Successful traders analyze the market to determine the trading system and techniques most suitable to the current conditions. Ignoring market conditions can lead to significant draw down’s for most systems. It is important to have multiple techniques in the traders toolbox that have been tested in bull, bear, and trading range markets, then select the right tool for the current market environment.
Summary
The Market is a strong force that influences the outcome of most trades. Taking all trades generated by a system regardless of Market conditions will likely give you lots of practice at taking draw downs and stop losses. Having different systems that test well for Bull, Bear, and sideways Markets and selecting the right tool for the current Market conditions can improve your results.
Rather than focusing on Short, Intermediate, or Long Term trading consider developing expertise in all three and letting Market conditions determine which set of rules to use.
Trading success does not come from finding the Holy Grail; it is the mastery of several different aspects of trading that leads to success. It takes time, effort and money to learn this. Mastering trading, like many other professions is well worth the investment you make.
Consider a two-year period in the Nifty. Buy and hold investors who bought in May of 2001 ended up in pretty much the same place in May of 2003. Strategies with long holding periods showed draw downs during the first half of the period, and gains during the second half. The net result of holding during the 2001-2003 period was essentially breakeven.
Short-term traders could make profits during the first half of the period by using effective shorting strategies, and profits during the second half of the period by using effective long strategies. Trading with the Market requires one to have a variety of strategies that are known to work in different Market environments, and a method for determining which strategy to use.
We have developed a number of different scans that find setups suitable for a variety of different market conditions. There are scans that look for long and short pullbacks, volume accumulation, volume distribution, and various patterns. We have tested these scans in bullish, bearish, and trading range market periods; so we know which ones work best in any given market environment. We make a careful analysis of the current market conditions each evening then select the right tool for the job.
The key to selecting the best trading system to use for current market conditions is determine whether the current market is in a narrow trading range, a wide basing area, or a trend. Once we determine what the current market environment it is we know which of the trading tools to use because we have tested each tool in these different market conditions.
We use trend lines on the NIFTY to determine whether to focus on long or short scans. If the NIFTY is above an ascending trend line, we select tools that perform well in an up trending market. If the NIFTY is below a descending trend line, we select tools that perform well in a down trending market. We have also found moving averages to be effective tools for determining which trading tools to use. Backtesting results indicate that several of our systems respond well to limiting Long Entries to periods when the 30-day zero lag moving average for the NIFTY is moving up.
When the NIFTY broke above the descending trend line in April 2003 it implied that it was time to stop focusing on tools that perform well in down trending markets and select another tool. A trend line break does not imply the immediate start of a new trend. It indicates that something has changed; the market may base awhile then resume the original trend or start a new one. In either case the indication that something has changed in the market indicates that the trader must change with it. The way traders change is to change the tools they are using and their position sizing.
After a trend line break we reduce position size. The reason for this is that swing trading in bases carries more risk than trading in trends, so reducing position size is one way to compensate for this. After the April break of the descending trend line the market bases for four weeks. During this basing period we focus on tools and techniques that have tested well in this type of environment and also continue to trade half size positions. At some point the market will either break above or below the base, and attempt to start another trend. When it does we will trade with the break using the appropriate set of tools.
When the Market is in a clear trend, either up or down, we focus on tools and techniques for Swing or Intermediate term trades. When the Market is range bound , we generally focus on Short Term or Swing trades. The Market conditions tell us which type of trading patterns and techniques to focus on, and the type of trading determines the exit strategies.
Short Term Trading involves taking quick profits on the breakout. We typically exit after 1-2 days, or after a quick pop. This approach can be profitable in range bound markets when the market is only moving up or down a few days at a time. Holding periods of more than a few days in this type of market usually just churn the account.
Swing Trading requires the market to be moving in a large basing range or trending. We place a stop under the low of the setup pattern and close positions as the stock approaches support or resistance. This tends to be more profitable than Short Term trading when the Market is trending or trading in bases that take at least five days to move between the top and bottom of the range.
Intermediate Term trading generally is preferred when the market is strongly trending. We will place an initial stop under the low of the set up pattern and hold while market conditions remain favorable. We will sell when the Stock or the market breaks a key Trend Line or shows signs of topping.
Range bound markets are generally poor places for intermediate term trading. Short term or Swing trading techniques can provide better results. In Narrow bases, where the market moves between the top and bottom in less than four days we limit ourself to short term trading techniques when the market is bouncing off support or resistance, or stand aside. Narrow ranges require quick, decisive action. We just focus on taking a quick profit on the initial move after a trigger.
When the market is in a wide base where it takes at least five days to move between the top and bottom of the range swing trading can be effective. We focus on entering trades when the market is bouncing off support or resistance and avoid taking trades in the middle of the range. The reason for this is trades taken in the middle of the basing area have less time to work out than ones taken on either end. We refer to the middle third of a basing area as the ‘no zone’, and avoid taking new trades in this area.
Intermediate term trading works best when the Market is in a clear up or down trend. We watch for the break of an intermediate or long-term trend line, or a successful retest of a base breakout as possible beginnings of a new trend. We focus on Swing Trading until the market makes a higher low. After a higher low is established we can draw a trend line and consider Intermediate term trading techniques until the trend line is broken.
In order to use Intermediate term trading techniques, the market must be in a clear trend. An up trend usually is not clear until the market has formed a higher low. Until a higher low is formed it is often safer to focus on short term or swing trading rather than intermediate term trading.
Sometimes the market conditions will allow you to use more than one trading style. When the market channels up active traders may use both Intermediate and Short Term Trading techniques. To use short term trading in a channel focus on entering longs as the market bounces off the bottom of the channel, and taking profits as the Market approaches the upper channel boundary.
Successful traders analyze the market to determine the trading system and techniques most suitable to the current conditions. Ignoring market conditions can lead to significant draw down’s for most systems. It is important to have multiple techniques in the traders toolbox that have been tested in bull, bear, and trading range markets, then select the right tool for the current market environment.
Summary
The Market is a strong force that influences the outcome of most trades. Taking all trades generated by a system regardless of Market conditions will likely give you lots of practice at taking draw downs and stop losses. Having different systems that test well for Bull, Bear, and sideways Markets and selecting the right tool for the current Market conditions can improve your results.
Rather than focusing on Short, Intermediate, or Long Term trading consider developing expertise in all three and letting Market conditions determine which set of rules to use.
Why buying on dips is generally a good idea
What The Professionals do, and Don’t Want You To Know
Judging from my email, it is apparent that I have not explained a very important concept very well – one that professional traders DO NOT want you to know about.
Here it is:
You want to be buying stocks on down days in the market – not selling!
You want to be selling stocks on up days in the market – not buying!
I get emails that go something like this:
“Sudarshan, I just bought XYZ stock. Is this a good trade?”
First of all, I can’t predict the future, so I have no idea if it will be a good trade. Second, the stock was bought on a major up day in the market. So, when the market pulls back, it will likely pull the stock with it and this person will get stopped out!
Now, I realize that buying on down days can be psychologically hard to do. After all, those in the media are saying things like this:
“The market sold off hard today as investors are worried about ‘X’.”
“The Nifty is down 100 points today on ‘X’ concerns.”
With all this negativity, it is no wonder why you could be worried! But, you have to learn to ignore the media.
“But what if I buy a stock on a down day and the market continues to sell off?”. Good question, but you could also say the following: “What if I buy on an up day and then the market sells off”!
At least in the first scenario, you got in after a wave a selling has already taken place. That is certainly a lot better than getting in before a wave of selling has taken place!
So…
Wait for a down day in the market. Now run your scans. Look for stocks that are up. Or, if the market is trading at the bottom of it’s intraday range, look for stocks that are trading at the top of it’s intraday range.
You are looking for stocks that have relative strength – stocks that are stronger than the market. Many times, these stocks will just trade sideways until the overall market reverses.
Then you will be sitting pretty. You will have already established a position. Now you can just watch all the novice traders move the stock in your direction.
You NEED these traders to buy after you buy. You NEED these traders to sell after you short.
That is a sensible way to make money trading stocks.
Judging from my email, it is apparent that I have not explained a very important concept very well – one that professional traders DO NOT want you to know about.
Here it is:
You want to be buying stocks on down days in the market – not selling!
You want to be selling stocks on up days in the market – not buying!
I get emails that go something like this:
“Sudarshan, I just bought XYZ stock. Is this a good trade?”
First of all, I can’t predict the future, so I have no idea if it will be a good trade. Second, the stock was bought on a major up day in the market. So, when the market pulls back, it will likely pull the stock with it and this person will get stopped out!
Now, I realize that buying on down days can be psychologically hard to do. After all, those in the media are saying things like this:
“The market sold off hard today as investors are worried about ‘X’.”
“The Nifty is down 100 points today on ‘X’ concerns.”
With all this negativity, it is no wonder why you could be worried! But, you have to learn to ignore the media.
“But what if I buy a stock on a down day and the market continues to sell off?”. Good question, but you could also say the following: “What if I buy on an up day and then the market sells off”!
At least in the first scenario, you got in after a wave a selling has already taken place. That is certainly a lot better than getting in before a wave of selling has taken place!
So…
Wait for a down day in the market. Now run your scans. Look for stocks that are up. Or, if the market is trading at the bottom of it’s intraday range, look for stocks that are trading at the top of it’s intraday range.
You are looking for stocks that have relative strength – stocks that are stronger than the market. Many times, these stocks will just trade sideways until the overall market reverses.
Then you will be sitting pretty. You will have already established a position. Now you can just watch all the novice traders move the stock in your direction.
You NEED these traders to buy after you buy. You NEED these traders to sell after you short.
That is a sensible way to make money trading stocks.
Requirements of Successful Trading
This is not a list of “trading rules”; it’s a list of requirements for successful trading. Most worthwhile truths are simple, and this list contains only five items. Like most rewards life offers, market profits are not as easy to come by as the novice believes. Making money in the market requires a good deal of education, like any craft or business. If you’ve got the time, the drive, and the right psychological makeup, you can enter that elite realm of the truly professional, or at least successful, trader or investor. Here’s what you need:
1. A method.
I mean an objectively definable method. One that is thought out in its entirety to the extent that if someone asks you how you take your decisions, you can explain it to him, and if he asks you again in six months, he will receive the same answer. This is not to say that a method cannot be altered or improved; it must, however, be developed as a totality before it is implemented. A prerequisite for obtaining a method is acceptance of the fact that perfection is not achievable. People who demand it are wasting their time searching for the Holy Grail, and they will never get beyond this first step of obtaining a method.
2. The discipline to follow your method.
This requirement is so widely understood by the true professionals that among them, it almost sounds like a cliche´ . Neverthless, it is such an important cliche´ that it cannot be sidestepped, ignored, or excepted. Without discipline, you really have no method in the first place.
3. Experience.
Paper trading is useful for the testing of methodology, but it is of no value in learning about trading. Why? Because the markets are not merely an intellectual exercise. They are an emotional (and in extreme cases, even physical) one as well. To put it mildly, you will find it impossible to approach your task with the same cool detachment you displayed in your living room. This new situation is real, it matters, it is physical, it is dangerous, other people are watching, and you are being bombarded with stimuli. This is what your life is like when you are actually trading. You know it is real, you know it matters, you must physically pick up the phone and speak to place orders, you perform under the scrutiny of your broker or clients, your spouse and business acquaintances, and you must operate while thousands of conflicting messages are thrown at you from the financial media, the brokerage industry, analysts, and the market itself. In short, you must conquer a host of problems, most of them related to your own inner strength in battling powerful human emotions, in order to trade real money successfully.
There is only one shortcut to obtaining experience, and that is to find a mentor. Locate someone who has proved himself over the years to be a successful trader or investor, and go visit him. Observe not only what he does, but far more important, what he does not allow himself to do.
4. Accept the Fact that Losses Are Part of the Game.
The perfect trading system does not exist. Expecting, or even hoping for, perfection is a guarantee of failure. Speculation is akin to batting in cricket. A player scoring 60 runs in a one day match is good. A player scoring 100 is great. But even the great player fails to hit 60% of the time! He even gets out for low scores often. But he still deserves to be called a good player, because although not perfect, he has approached the best that can be achieved. You don’t have to be perfect to win in the markets, either; you “merely” have to be better than almost everybody else, and that’s hard enough.
Practically speaking, you must include an objective money management system when formulating your trading method in the first place.
How about the last requirement for successful tradiing ?
5. The Mental Fortitude to Accept Huge Gains.
This comment usually gets a hearty laugh, which merely goes to show how little most people have determined it actually to be a problem. But consider. How many times has the following sequence of events occurred? For a full year, you trade futures contracts, making 1000 here, losing 1500 there, making 3000 here and losing 2000 there. Once again, you enter a trade because your method told you to do so. Within a week, you’re up 4000. Your friend/partner/acquaintance/broker/advisor calls you and, looking out only for your welfare, tells you to take your profit. You have guts, though, and you wait. The following week, your position is up 8000, the best gain you have ever experienced. “Get out!”, says your friend. You sweat, still hoping for further gains. The next Monday, your contract opens limit against you. Your friend calls and says, “I told you so. You got greedy. But hey, you’re still way up on the trade. Get out tomorrow.” The next day, on the opening, you exit the trade, taking a 5000 profit. It’s your biggest profit of the year, and you click your heels, smiling gratefully, proud of yourself. Then, day after day for the next six months, you watch the market continue to go in the direction of your original trade. You try to find another entry point and continue to miss. At the end of six months, your method finally, quietly, calmly says, “Get out.” You check the figures and realize that your initial entry, if held, would have made a profit of 450,000.
So what was your problem? Simply that you had allowed yourself unconsciously to define your “normal” range of profit and loss. When the big trade finally came along, you lacked the self esteem to take all it promised. Who were you to shoot for such huge gains? Why should you deserve more than your best trade of the year? You then abandoned both method and discipline. To win the game, make sure that you understand why you’re in it. The big moves in markets only come once or twice a year. Those are the ones which will pay you for all the work, fear, sweat and aggravation of the previous eleven months or even eleven years. Don’t miss them for reasons other than those required by your objectively defined method.
[Excerpts from an article by Robert Prechter]
1. A method.
I mean an objectively definable method. One that is thought out in its entirety to the extent that if someone asks you how you take your decisions, you can explain it to him, and if he asks you again in six months, he will receive the same answer. This is not to say that a method cannot be altered or improved; it must, however, be developed as a totality before it is implemented. A prerequisite for obtaining a method is acceptance of the fact that perfection is not achievable. People who demand it are wasting their time searching for the Holy Grail, and they will never get beyond this first step of obtaining a method.
2. The discipline to follow your method.
This requirement is so widely understood by the true professionals that among them, it almost sounds like a cliche´ . Neverthless, it is such an important cliche´ that it cannot be sidestepped, ignored, or excepted. Without discipline, you really have no method in the first place.
3. Experience.
Paper trading is useful for the testing of methodology, but it is of no value in learning about trading. Why? Because the markets are not merely an intellectual exercise. They are an emotional (and in extreme cases, even physical) one as well. To put it mildly, you will find it impossible to approach your task with the same cool detachment you displayed in your living room. This new situation is real, it matters, it is physical, it is dangerous, other people are watching, and you are being bombarded with stimuli. This is what your life is like when you are actually trading. You know it is real, you know it matters, you must physically pick up the phone and speak to place orders, you perform under the scrutiny of your broker or clients, your spouse and business acquaintances, and you must operate while thousands of conflicting messages are thrown at you from the financial media, the brokerage industry, analysts, and the market itself. In short, you must conquer a host of problems, most of them related to your own inner strength in battling powerful human emotions, in order to trade real money successfully.
There is only one shortcut to obtaining experience, and that is to find a mentor. Locate someone who has proved himself over the years to be a successful trader or investor, and go visit him. Observe not only what he does, but far more important, what he does not allow himself to do.
4. Accept the Fact that Losses Are Part of the Game.
The perfect trading system does not exist. Expecting, or even hoping for, perfection is a guarantee of failure. Speculation is akin to batting in cricket. A player scoring 60 runs in a one day match is good. A player scoring 100 is great. But even the great player fails to hit 60% of the time! He even gets out for low scores often. But he still deserves to be called a good player, because although not perfect, he has approached the best that can be achieved. You don’t have to be perfect to win in the markets, either; you “merely” have to be better than almost everybody else, and that’s hard enough.
Practically speaking, you must include an objective money management system when formulating your trading method in the first place.
How about the last requirement for successful tradiing ?
5. The Mental Fortitude to Accept Huge Gains.
This comment usually gets a hearty laugh, which merely goes to show how little most people have determined it actually to be a problem. But consider. How many times has the following sequence of events occurred? For a full year, you trade futures contracts, making 1000 here, losing 1500 there, making 3000 here and losing 2000 there. Once again, you enter a trade because your method told you to do so. Within a week, you’re up 4000. Your friend/partner/acquaintance/broker/advisor calls you and, looking out only for your welfare, tells you to take your profit. You have guts, though, and you wait. The following week, your position is up 8000, the best gain you have ever experienced. “Get out!”, says your friend. You sweat, still hoping for further gains. The next Monday, your contract opens limit against you. Your friend calls and says, “I told you so. You got greedy. But hey, you’re still way up on the trade. Get out tomorrow.” The next day, on the opening, you exit the trade, taking a 5000 profit. It’s your biggest profit of the year, and you click your heels, smiling gratefully, proud of yourself. Then, day after day for the next six months, you watch the market continue to go in the direction of your original trade. You try to find another entry point and continue to miss. At the end of six months, your method finally, quietly, calmly says, “Get out.” You check the figures and realize that your initial entry, if held, would have made a profit of 450,000.
So what was your problem? Simply that you had allowed yourself unconsciously to define your “normal” range of profit and loss. When the big trade finally came along, you lacked the self esteem to take all it promised. Who were you to shoot for such huge gains? Why should you deserve more than your best trade of the year? You then abandoned both method and discipline. To win the game, make sure that you understand why you’re in it. The big moves in markets only come once or twice a year. Those are the ones which will pay you for all the work, fear, sweat and aggravation of the previous eleven months or even eleven years. Don’t miss them for reasons other than those required by your objectively defined method.
[Excerpts from an article by Robert Prechter]
Be prepared for the trading day!
The process of maneuvering around the financial markets and trading profitably has become an even more difficult task. We must be prepared and equipped with the appropriate tools in order to trade successfully.
The first and most important weapon to obtain is knowledge. As the saying goes, “knowledge is power,” and this is what will initially separate you from the majority of people who try their hand trading the markets. Secondly, proper money management is extremely important and should be taken very seriously in order to survive and play the game for many years. Lastly, preparation before the trading day is something that is mandatory in order to give yourself an edge against those you are competing against. This last tool, preparation, refers to having a trading game plan and knowing what you are going to do given certain movements in the market.
At first glance, preparation may not seem pertinent to succeeding as a trader, but have you ever placed a trade and then come to realize that you did the wrong thing? Or how about this one? The
market makes a huge move in one direction or the other and you are stuck wondering how you should adjust your trade. Instead of reacting immediately, you stop to think and before you know it, the opportunity has passed you by. These are things that should not happen to you and the proper preparation will keep you out of these costly and frustrating situations.
The first and most important weapon to obtain is knowledge. As the saying goes, “knowledge is power,” and this is what will initially separate you from the majority of people who try their hand trading the markets. Secondly, proper money management is extremely important and should be taken very seriously in order to survive and play the game for many years. Lastly, preparation before the trading day is something that is mandatory in order to give yourself an edge against those you are competing against. This last tool, preparation, refers to having a trading game plan and knowing what you are going to do given certain movements in the market.
At first glance, preparation may not seem pertinent to succeeding as a trader, but have you ever placed a trade and then come to realize that you did the wrong thing? Or how about this one? The
market makes a huge move in one direction or the other and you are stuck wondering how you should adjust your trade. Instead of reacting immediately, you stop to think and before you know it, the opportunity has passed you by. These are things that should not happen to you and the proper preparation will keep you out of these costly and frustrating situations.
Be prepared for the trading day!
The process of maneuvering around the financial markets and trading profitably has become an even more difficult task. We must be prepared and equipped with the appropriate tools in order to trade successfully.
The first and most important weapon to obtain is knowledge. As the saying goes, “knowledge is power,” and this is what will initially separate you from the majority of people who try their hand trading the markets. Secondly, proper money management is extremely important and should be taken very seriously in order to survive and play the game for many years. Lastly, preparation before the trading day is something that is mandatory in order to give yourself an edge against those you are competing against. This last tool, preparation, refers to having a trading game plan and knowing what you are going to do given certain movements in the market.
At first glance, preparation may not seem pertinent to succeeding as a trader, but have you ever placed a trade and then come to realize that you did the wrong thing? Or how about this one? The
market makes a huge move in one direction or the other and you are stuck wondering how you should adjust your trade. Instead of reacting immediately, you stop to think and before you know it, the opportunity has passed you by. These are things that should not happen to you and the proper preparation will keep you out of these costly and frustrating situations.
The first and most important weapon to obtain is knowledge. As the saying goes, “knowledge is power,” and this is what will initially separate you from the majority of people who try their hand trading the markets. Secondly, proper money management is extremely important and should be taken very seriously in order to survive and play the game for many years. Lastly, preparation before the trading day is something that is mandatory in order to give yourself an edge against those you are competing against. This last tool, preparation, refers to having a trading game plan and knowing what you are going to do given certain movements in the market.
At first glance, preparation may not seem pertinent to succeeding as a trader, but have you ever placed a trade and then come to realize that you did the wrong thing? Or how about this one? The
market makes a huge move in one direction or the other and you are stuck wondering how you should adjust your trade. Instead of reacting immediately, you stop to think and before you know it, the opportunity has passed you by. These are things that should not happen to you and the proper preparation will keep you out of these costly and frustrating situations.
Donchian's guide to trading
Richard D Donchian first published his ideas in 1934 to help stock market traders. Donchiian is one of the most respected technicians on wall street, specially in commodities.
General Guides
1. Beware of acting immediately on public opinion. Even if correct, it will usually delay the move.
2. From a period of dullness and inactivity, watch for and prepare to follow a move in the direction in which volume increases.
3. LIMIT LOSSES, ride profits – irrespective of all other rules.
4. Light positions are advisable when a market position is not certain. Clearly defined moves are made frequently enough to make life interesting, and concentration on these moves to the virtual exclusion of others will prevent unprofitable “whipsawing”.
5. Seldom take a position of an immediately preceding three day move. Wait for a one day reversal.
6. Judicious use of stop orders is a valuable aid to profitable trading. Stops may be sued to protect profits, limit losses and to take positions from certain formations such as triangles. Stop orders are apt to be less treacherous and more valuable if used in proper relation to the chart formation.
General Guides
1. Beware of acting immediately on public opinion. Even if correct, it will usually delay the move.
2. From a period of dullness and inactivity, watch for and prepare to follow a move in the direction in which volume increases.
3. LIMIT LOSSES, ride profits – irrespective of all other rules.
4. Light positions are advisable when a market position is not certain. Clearly defined moves are made frequently enough to make life interesting, and concentration on these moves to the virtual exclusion of others will prevent unprofitable “whipsawing”.
5. Seldom take a position of an immediately preceding three day move. Wait for a one day reversal.
6. Judicious use of stop orders is a valuable aid to profitable trading. Stops may be sued to protect profits, limit losses and to take positions from certain formations such as triangles. Stop orders are apt to be less treacherous and more valuable if used in proper relation to the chart formation.
Wednesday, November 4, 2009
Buying Option: A time to buy them and a time to avoid them Part 1.
Since trading in index and stock options began in June/July 2001, many traders have been attracted to trading in options.
The two aspects of trading in options are: Buying options and selling or writing options.
When we buy options, we are paying for time premium and in return we obtain limited risk and unlimited reward on the options purchased. When we sell options we are receiving time premium but in return we accept unlimited risk on the options sold accompanied by limited reward.
For the risk-averse investor, buying options provides a low risk method of participating in the options market.
But when we buy options, we are paying for time premium. Time premiums suffer from time decay. This means, as time goes by, the premium on the option comes down even if the underlying prices remain the same.
Hypothetical Example:
Date: May 2, 2002
Satyam is trading at 260
The 260 call expiring on May 30 is priced at 15.00
Date: May 16, 2002
Satyam is trading at 260
The 260 call expiring on May 30 is priced at 10.00
We see that the price of the option has come down from 15 to 10 even though the price of Satyam has remained the same.
This happens due to the concept of time decay. As the date of expiration comes closer, the probability of making a profit from the option comes down.
Most of the time, the buyer of options ends up as a loser even when he makes a correct call on the direction of the option. This happens because the value of this option falls due to the effect of time decay. Even if the underlying stock makes a move in her favor, the detrimental effect of time decay may more than offset the positive benefits of the move by the stock.
Buying Time Premium
As a buyer of options, we want to identify periods or situations when the premium paid on our options should be subjected to the minimum of time decay. We want to buy premium (we actually buy premium when we buy options) only if we find a low risk buy zone. This applies to both calls and puts.
Buy Premium Strategies.
The "Buy Premium" strategies are essentially "hit and run" techniques. The "hit and run" nature of these strategies is due primarily to the detrimental effect of time decay on option premiums. The longer an option position is held, the more time premium will decrease. In other words, the longer you hold a position, the greater the eventual market movement must be in order to overcome the negative effects of time decay. As a result, the intent is generally to catch short-term swings in the market, rather than waiting (and hoping) for an extended movement in the Underlying price.
We will discuss strategies that will try to:
01. Identify short-term movements in the market;
02. Get in just before a significant market movement;
03. Take profits quickly (within 2 to 10 trading days).
04. Maintain a stop loss if the trade goes wrong.
These strategies will be discussed in subsequent issues.
The two aspects of trading in options are: Buying options and selling or writing options.
When we buy options, we are paying for time premium and in return we obtain limited risk and unlimited reward on the options purchased. When we sell options we are receiving time premium but in return we accept unlimited risk on the options sold accompanied by limited reward.
For the risk-averse investor, buying options provides a low risk method of participating in the options market.
But when we buy options, we are paying for time premium. Time premiums suffer from time decay. This means, as time goes by, the premium on the option comes down even if the underlying prices remain the same.
Hypothetical Example:
Date: May 2, 2002
Satyam is trading at 260
The 260 call expiring on May 30 is priced at 15.00
Date: May 16, 2002
Satyam is trading at 260
The 260 call expiring on May 30 is priced at 10.00
We see that the price of the option has come down from 15 to 10 even though the price of Satyam has remained the same.
This happens due to the concept of time decay. As the date of expiration comes closer, the probability of making a profit from the option comes down.
Most of the time, the buyer of options ends up as a loser even when he makes a correct call on the direction of the option. This happens because the value of this option falls due to the effect of time decay. Even if the underlying stock makes a move in her favor, the detrimental effect of time decay may more than offset the positive benefits of the move by the stock.
Buying Time Premium
As a buyer of options, we want to identify periods or situations when the premium paid on our options should be subjected to the minimum of time decay. We want to buy premium (we actually buy premium when we buy options) only if we find a low risk buy zone. This applies to both calls and puts.
Buy Premium Strategies.
The "Buy Premium" strategies are essentially "hit and run" techniques. The "hit and run" nature of these strategies is due primarily to the detrimental effect of time decay on option premiums. The longer an option position is held, the more time premium will decrease. In other words, the longer you hold a position, the greater the eventual market movement must be in order to overcome the negative effects of time decay. As a result, the intent is generally to catch short-term swings in the market, rather than waiting (and hoping) for an extended movement in the Underlying price.
We will discuss strategies that will try to:
01. Identify short-term movements in the market;
02. Get in just before a significant market movement;
03. Take profits quickly (within 2 to 10 trading days).
04. Maintain a stop loss if the trade goes wrong.
These strategies will be discussed in subsequent issues.
Options Strategies - Safety in Collars
Collars are a way of protecting stocks that an investor would like to hold. In the uncertainty of the current market, investors who feel the market is bottoming and might want to buy stock but still hedge their positions can utilize a collar to protect their investment.
A collar uses a long at-the-money put and short out-of-the-money call to protect a long position in a stock holding. The goal of the protection is to allow the investor to continue to take advantage of any (further) upside movement for the stock while protecting against loss in the event of unexpected downside. The way this works is as follows:
Example: An investor feels that Satyam is consolidating and may go up. He enters into a Collar:
(Note: RS stands for Rupees)
(ATM stands for At The Money, and OTM for Out Of Money).
Buy 1200 shares SATYAM at RS 264
Buy 1 ATM put at 260 strike for RS 6 (LONG PUT)
Sell 1 OTM call at 280 strike for RS 4 (SHORT CALL)
Risk is RS 6 to make RS 14.
Risk is calculated by subtracting the cost of the put from the premium of the call—in this case, a net debit of RS 2. (We pay to buy the PUT and we receive money when we sell the Call.) Since the put will provide protection from RS 260 downwards, we will also lose RS 4 in the shares purchased before we get protection.
The maximum upside this trade now has is RS 16. We buy at 264 and a call is sold at 280. The maximum profit is 280 minus 264 = RS 16.
The cost of the Collar is RS 6 and this cost should be deducted from the maximum gain of RS 16. The Net gain is RS 16 minus RS 6 = RS 10.
I repeat, the maximum loss is = RS 6.
For one contract of Satyam, the loss is 1200 shares multiplied by RS 2 = RS 7200. Commissions will have to be considered separately.
Spreads: The actual bid and offer prices for the two options we are considering are given below. Rates as on close on Friday, May 3, 2002.
Satyam PUT 260: Bid 5.85 and Ask 6.20
Satyam CALL 280: Bid 4.25 and Ask 4.50
The Bid is the price that a buyer is prepared to pay. If you are selling then you will receive the bid price. The Ask is the price at which a seller is prepared to sell. If you are buying then you will have to pay this price.
Since a collar is usually a debit spread, you should not have to put up margin money. However you should check with your broker to find out if they require margin.
What is the benefit of looking at collars in the current market?
The Nifty has retraced from its highs and has reached a support level. Therefore there may be a possibility that the market may rally from here.
An investor who feels that the market is bottoming out and wants to buy stocks may use collars to protect his risk.
A trader who is not sure about market direction may set up a collar to benefit if the market rises. He has limited losses if the market falls.
Investment. This trade requires investments. You have to buy 1200 shares of Satyam. Most brokers and banks will give you 50% financing on the cost. Instead of buying 1200 shares you can buy ONE Satyam futures. Margin on futures will be less. But you also have to pay a premium and your potential profits are reduced by this amount. If your broker requires margin on the Call sold, then you also have to deposit this amount. The margin is usually 20% of the cost.
There is no such thing as a free lunch. Traders must now be prepared to put in money to make gains.
As usual, be careful.
A collar uses a long at-the-money put and short out-of-the-money call to protect a long position in a stock holding. The goal of the protection is to allow the investor to continue to take advantage of any (further) upside movement for the stock while protecting against loss in the event of unexpected downside. The way this works is as follows:
Example: An investor feels that Satyam is consolidating and may go up. He enters into a Collar:
(Note: RS stands for Rupees)
(ATM stands for At The Money, and OTM for Out Of Money).
Buy 1200 shares SATYAM at RS 264
Buy 1 ATM put at 260 strike for RS 6 (LONG PUT)
Sell 1 OTM call at 280 strike for RS 4 (SHORT CALL)
Risk is RS 6 to make RS 14.
Risk is calculated by subtracting the cost of the put from the premium of the call—in this case, a net debit of RS 2. (We pay to buy the PUT and we receive money when we sell the Call.) Since the put will provide protection from RS 260 downwards, we will also lose RS 4 in the shares purchased before we get protection.
The maximum upside this trade now has is RS 16. We buy at 264 and a call is sold at 280. The maximum profit is 280 minus 264 = RS 16.
The cost of the Collar is RS 6 and this cost should be deducted from the maximum gain of RS 16. The Net gain is RS 16 minus RS 6 = RS 10.
I repeat, the maximum loss is = RS 6.
For one contract of Satyam, the loss is 1200 shares multiplied by RS 2 = RS 7200. Commissions will have to be considered separately.
Spreads: The actual bid and offer prices for the two options we are considering are given below. Rates as on close on Friday, May 3, 2002.
Satyam PUT 260: Bid 5.85 and Ask 6.20
Satyam CALL 280: Bid 4.25 and Ask 4.50
The Bid is the price that a buyer is prepared to pay. If you are selling then you will receive the bid price. The Ask is the price at which a seller is prepared to sell. If you are buying then you will have to pay this price.
Since a collar is usually a debit spread, you should not have to put up margin money. However you should check with your broker to find out if they require margin.
What is the benefit of looking at collars in the current market?
The Nifty has retraced from its highs and has reached a support level. Therefore there may be a possibility that the market may rally from here.
An investor who feels that the market is bottoming out and wants to buy stocks may use collars to protect his risk.
A trader who is not sure about market direction may set up a collar to benefit if the market rises. He has limited losses if the market falls.
Investment. This trade requires investments. You have to buy 1200 shares of Satyam. Most brokers and banks will give you 50% financing on the cost. Instead of buying 1200 shares you can buy ONE Satyam futures. Margin on futures will be less. But you also have to pay a premium and your potential profits are reduced by this amount. If your broker requires margin on the Call sold, then you also have to deposit this amount. The margin is usually 20% of the cost.
There is no such thing as a free lunch. Traders must now be prepared to put in money to make gains.
As usual, be careful.
Sunday, October 4, 2009
5 SIMPLE RULES TO MAKING and KEEPING PROFITS
I recently received a call from a very prominent Wall Street "guru" who wanted to know why I was so intent on revealing my secrets of success in the stock market. He was of the opinion that not only were my efforts a waste of my valuable time, but that if I truly succeeded in teaching these inner workings, it would result in many of my techniques becoming obsolete due to their overuse.
While I simply don't have the space to fully address this gentleman's question, I would like to establish one thing before we go any further. These methods and techniques are not my secrets or anyone else's for that matter. And whenever you even hear the words, "I am going to reveal my secrets on how . . . .," you should make a 180 degree turn and run as fast, and as far away, as you possibly can. Why? Because that is an old sales pitch which has been used by every bullshit artist since the beginning of time. And if you stay around long enough you'll end up losing your shirt.
The fact is, the public's belief that "secrets" exist helps to support a multi-billion dollar book industry, as there are no less than 3 financial books published every single week (all of which contain the "ultimate" secret to riches, of course). And this is not to mention the multi-millions of dollars spent on the latest computer software programs which will triple your money every 3 months, "guaranteed".
No, my friends! As disappointing as this may be, there are no secrets. . . . . . .just plain, old-fashioned common sense. And I am about to go over a few common sense sell guidelines which should help you to better ascertain when to exit your trades. In addition to individual sell pointers, I will reveal to you what I like to refer to as the Pristine Profit Plan (PPP). I strongly encourage that you make every effort to understand it, as it is a simple (common sense) approach which makes it IMPOSSIBLE to lose money in the stock market over time.
Now I know that sounds like a sales pitch, but I'm not selling anything remember. You are already subscribers.
Once again, I am presenting something which I feel is worth several times the annual subscription rate to The Pristine Day Trader. Read it, study it, keep it, and above all employ it. There is no doubt that knowing how to sell and when to sell will help you obtain more consistent profitability in your everyday trading. So, let's get right to it.
THE PRISTINE PROFIT PLAN (PPP)
(A simple approach which will render it mathematically impossible to lose money)
RULE NUMBER 1: NEVER LOSE MORE THAN 8% ON ANY STOCK
What is the trader/investor's most valuable commodity? His/her initial capital, of course. What should be of paramount importance is the preservation of your starting capital. This is your life. This is what will keep you in the game, and it is foolish to do anything that will jeopardize it. That is why you should never be willing to let a position go against you by more than 8%. If you have entered the trade properly, and your timing was precise (our suggested entry points take care of this concern), the issue SHOULD NOT decline by more than 8%. Otherwise, something has gone amiss and the trade should be eliminated with no questions asked. But what if it's a blue chip company? What if the earnings are still positive? Frankly, these are the rationalizations of an amateur. The earnings of a company don't put money in your pocket. Neither does the color of the company's chip. There is only one thing that can put money in the bank and that's a RISING STOCK, not a declining one. Remember, all stock are bad, unless they go up. Cut your losses at 8% and move on.
RULE NUMBER 2: ALWAYS TAKE PROFITS (AT LEAST SOME) AT 20% - 25%
Once a stock you own rises by 20% or more, it is foolish not to pull at least some off the table. This really boils down to common sense. Stocks have a tendency to advance 20% to 25%, then decline before they take off again (if they are going to take off again at all). I am in the habit of comparing my daily and weekly profits to the CD purchaser. I constantly ask myself, "How long will it take for the average 1 year CD to produce the gains that I have in this stock right now?" This question is an excellent way to keep your feet firmly fixed on the ground of financial reality. It also does a good job of tempering greed, one of the biggest enemies of every trader. It would take the purchaser of a 1 year CD paying 6% more than 8 years to match a 20% stock gain. Nearly all of you have witnessed many of our stock selections rise 20% or more over several days. But more important than all of this is the mathematical magic that the combination of Rule 1 and Rule 2 brings into being. If your are disciplined enough to cut losses at 8% while taking profits at 20% - 25%, you can't possibly lose money over time as this law of mathematics cannot be broken. with these two simple rules, you can lose three times and win only once and still not get into financial trouble. Now, if you can't produce 1 winning trade out of every 3, you don't belong in the market. Of course as subscribers this shouldn't be your problem. I know two traders who sell only on the basis of Rule 1 and 2. The stocks that they buy will either be sold at an 8% loss, or they will be sold at 20% or above. That's it. That's their only sell rules, and they are both rich, I might add. But I will show you how to do even better.
RULE NUMBER 3: ONCE A STOCK RISES BY 6% TO 8%, MOVE YOUR SELL POINT TO BREAK EVEN
This additional sell rule is not employed by my friends mentioned above, as they operate on a do or die approach. Either their stock produces a 20% gain, or it produces an 8% loss. I don't believe you should be so fatalistic. Allowing a winner to fall back into losing territory is just not smart, no matter what the reason. It is hard enough being right in the stock market without allowing the winner to turn into losers. So after a stock has demonstrated it's ability to move in the desired direction, you should take further action by raising your sell point to break even. This will have the effect of taking ALL of the risk out of the trade. At that point you can literally put your feet up on the coffee table, lean back and watch, as there is no initial capital at risk. I can not begin to tell you how psychologically important this rule is. Once a trader realizes that money can no longer be lost, a tremendous calm and clarity begins to pervade his mind. A sense of power and control evolves as he adopts the frame of mind of an employer who has now hired an employee (the stock) to do all the work. Once you're up 6% or more, decide never to be down in that position again.
RULE NUMBER 4: ONCE A STOCK RISES BY 10%, PROTECT 3% OF YOUR PROFITS
This rule should be self explanatory after Rule 3. There are some who might ask, "Why just 3%?" And it's a good question. So let me explain. At Pristine, we have one very simple goal for our personal and managed accounts. We strive to produce a 3% gain every month. Now it should be obvious to you that we supersede this goal by leaps and bounds as we are already up over 100% year to date. So why so small a goal? Well, in reality this goal is not as small as one might think, despite the ease with which we appear to top it. If you can produce a monthly gain of 3%, your annual return will be in excess of 45%. Now, if you can produce gains in excess of 45% annually on a consistent basis, Wall Street would be sleeping outside your door (we step over them every day, smile). Let's take the scenario a bit further by asking, "What if you produced an average 3% gain on all of your stock trades?" We certainly wouldn't have to worry about your financial condition. That's for sure. So are you starting to understand why we will not let that 3% get away from us when we have at least a 10% gain? Go do likewise my friends. I promise you won't be sorry. Nickels and dimes do add up.
RULE NUMBER 5: ONCE A STOCK RISES 15%, PROTECT 10% AND TARGET YOUR 20% PROFIT POINT
You now know the rationale. The higher a stock continues to rise, the greater the probability of a decline. So with this in mind, we tighten our stops and only give the stock a 5% margin of movement. It is at this point that we experience a lot of sells as many of the stock selections fall back a bit. But in most cases, the 10% gain is produced over several days. The average mutual fund produces gains in the area of 7% yearly. So why should we be disappointed? Besides, there is no rule that says we can't repurchase a stock after selling it. We do this all the time. Now a good portion of your selections will not stop you out at 10%. These are the stocks which tend to be the future leaders in the market. Once you have a 15% gain and you have moved your stop to protect 10% of your profits, determine the exact price at which you will sell at least 1/2 of your position. This step that I am mentioning now is one of the hallmarks of a professional. At this point he comes to the market every day knowing precisely where he will exit. When the price reaches his sell spot, he leaps into action unfettered by indecision and confusion. There are no rationalizations, no waiting for another 1/4 point, no delaying, just action. We favor the approach of selling only half of your position, especially with those stocks which have run to this level in less than 2 weeks. Rapid movement of this nature indicates very strong demand and the likelihood that it will carry is very great. The remaining half can stay in as long as the stock stays above it's 50 period simple moving average (sum of last 50 closing prices divided by 50).
COMMENTS
That's all there is to our Pristine Profit Plan, just 5 relatively simple rules. However, let me be very real for a moment. There is no question, that if you are disciplined enough to follow a plan such as the one just outlined, it will dramatically improve your results many times over. But the fact is that most individuals will not comply. Why? Where will they fail in their attempt to stick to a proven money making approach? Nearly all will fail at the very beginning, Rule Number 1. If I had to choose the biggest difference between winners and losers it would by rule number 1. Winners cut their losses short and move on to the next winning trade. Losers hold on to falling stocks 1/4 point by 1/4 point until the very ability to make a rational decision has been zapped from their bodies. This costly fault is also an ego problem as selling at a loss forces the trader to admit that he was wrong. As long as he holds on to his dud, he does not have to really admit he has made a mistake. This attitude and frame of mind is the hallmark of a loser. And finding someone who thinks like this and suffers from this paralysis can actually be a gem in and of itself. Once you have pinpointed a true loser, reverse his every decision and I guarantee that you'll make a fortune. Because when he should be selling a losing position, he'll buy more rationalizing that it's now cheaper that his original purchase. When he should by buying, it will look too high for his taste, or the spread will be too big, or the P/E will be too high. He will find any excuse not to take a winning trade. Why? Because a loser can't help it; the simple truth is winning is against his nature.
A FINAL NOTE
When I first started out in this business, I lost money consistently. The day I bought a stock was the last up day that issue would see in a great while. When I sold, it was sure to be the bottom just before a major multi-month advance. I was a kid without any direction, without any experience and no one willing to help me get it. I spent many years and a lot of lost money to get to the point at which I am now. Where is that, you ask? Well, I'll answer that by telling you what I demand from the people who work for me. My traders must be able to take $50,000 and a margin account and produce $1,000 in profits a day (and I mean every single day if they like working for me. I accept no excuses.) But let me tell you this. A very talented trader would not even be impressed with that. I had the privilege of spending a period of time with an individual who effortlessly pulled $40,000 a day out of the markets. And guys, that is no typo. The time I spent with this "master" was worth more money than most people will ever see in a lifetime. If you are ever fortunate enough to find a successful market player like this, do everything in your power to procure his guidance. Pay him $100,000 for several weeks instruction if you can. Believe me, that sum will prove to be a mere pittance compared to the future rewards. The time and money saved alone will be well worth the cost.
The Pristine Day Trader was formed to partly provide this guidance which I so desperately needed in my early years. And while it can never replace the benefit of personalized instruction, I do believe it is the next best thing. Good luck my friends, and happy trading.
While I simply don't have the space to fully address this gentleman's question, I would like to establish one thing before we go any further. These methods and techniques are not my secrets or anyone else's for that matter. And whenever you even hear the words, "I am going to reveal my secrets on how . . . .," you should make a 180 degree turn and run as fast, and as far away, as you possibly can. Why? Because that is an old sales pitch which has been used by every bullshit artist since the beginning of time. And if you stay around long enough you'll end up losing your shirt.
The fact is, the public's belief that "secrets" exist helps to support a multi-billion dollar book industry, as there are no less than 3 financial books published every single week (all of which contain the "ultimate" secret to riches, of course). And this is not to mention the multi-millions of dollars spent on the latest computer software programs which will triple your money every 3 months, "guaranteed".
No, my friends! As disappointing as this may be, there are no secrets. . . . . . .just plain, old-fashioned common sense. And I am about to go over a few common sense sell guidelines which should help you to better ascertain when to exit your trades. In addition to individual sell pointers, I will reveal to you what I like to refer to as the Pristine Profit Plan (PPP). I strongly encourage that you make every effort to understand it, as it is a simple (common sense) approach which makes it IMPOSSIBLE to lose money in the stock market over time.
Now I know that sounds like a sales pitch, but I'm not selling anything remember. You are already subscribers.
Once again, I am presenting something which I feel is worth several times the annual subscription rate to The Pristine Day Trader. Read it, study it, keep it, and above all employ it. There is no doubt that knowing how to sell and when to sell will help you obtain more consistent profitability in your everyday trading. So, let's get right to it.
THE PRISTINE PROFIT PLAN (PPP)
(A simple approach which will render it mathematically impossible to lose money)
RULE NUMBER 1: NEVER LOSE MORE THAN 8% ON ANY STOCK
What is the trader/investor's most valuable commodity? His/her initial capital, of course. What should be of paramount importance is the preservation of your starting capital. This is your life. This is what will keep you in the game, and it is foolish to do anything that will jeopardize it. That is why you should never be willing to let a position go against you by more than 8%. If you have entered the trade properly, and your timing was precise (our suggested entry points take care of this concern), the issue SHOULD NOT decline by more than 8%. Otherwise, something has gone amiss and the trade should be eliminated with no questions asked. But what if it's a blue chip company? What if the earnings are still positive? Frankly, these are the rationalizations of an amateur. The earnings of a company don't put money in your pocket. Neither does the color of the company's chip. There is only one thing that can put money in the bank and that's a RISING STOCK, not a declining one. Remember, all stock are bad, unless they go up. Cut your losses at 8% and move on.
RULE NUMBER 2: ALWAYS TAKE PROFITS (AT LEAST SOME) AT 20% - 25%
Once a stock you own rises by 20% or more, it is foolish not to pull at least some off the table. This really boils down to common sense. Stocks have a tendency to advance 20% to 25%, then decline before they take off again (if they are going to take off again at all). I am in the habit of comparing my daily and weekly profits to the CD purchaser. I constantly ask myself, "How long will it take for the average 1 year CD to produce the gains that I have in this stock right now?" This question is an excellent way to keep your feet firmly fixed on the ground of financial reality. It also does a good job of tempering greed, one of the biggest enemies of every trader. It would take the purchaser of a 1 year CD paying 6% more than 8 years to match a 20% stock gain. Nearly all of you have witnessed many of our stock selections rise 20% or more over several days. But more important than all of this is the mathematical magic that the combination of Rule 1 and Rule 2 brings into being. If your are disciplined enough to cut losses at 8% while taking profits at 20% - 25%, you can't possibly lose money over time as this law of mathematics cannot be broken. with these two simple rules, you can lose three times and win only once and still not get into financial trouble. Now, if you can't produce 1 winning trade out of every 3, you don't belong in the market. Of course as subscribers this shouldn't be your problem. I know two traders who sell only on the basis of Rule 1 and 2. The stocks that they buy will either be sold at an 8% loss, or they will be sold at 20% or above. That's it. That's their only sell rules, and they are both rich, I might add. But I will show you how to do even better.
RULE NUMBER 3: ONCE A STOCK RISES BY 6% TO 8%, MOVE YOUR SELL POINT TO BREAK EVEN
This additional sell rule is not employed by my friends mentioned above, as they operate on a do or die approach. Either their stock produces a 20% gain, or it produces an 8% loss. I don't believe you should be so fatalistic. Allowing a winner to fall back into losing territory is just not smart, no matter what the reason. It is hard enough being right in the stock market without allowing the winner to turn into losers. So after a stock has demonstrated it's ability to move in the desired direction, you should take further action by raising your sell point to break even. This will have the effect of taking ALL of the risk out of the trade. At that point you can literally put your feet up on the coffee table, lean back and watch, as there is no initial capital at risk. I can not begin to tell you how psychologically important this rule is. Once a trader realizes that money can no longer be lost, a tremendous calm and clarity begins to pervade his mind. A sense of power and control evolves as he adopts the frame of mind of an employer who has now hired an employee (the stock) to do all the work. Once you're up 6% or more, decide never to be down in that position again.
RULE NUMBER 4: ONCE A STOCK RISES BY 10%, PROTECT 3% OF YOUR PROFITS
This rule should be self explanatory after Rule 3. There are some who might ask, "Why just 3%?" And it's a good question. So let me explain. At Pristine, we have one very simple goal for our personal and managed accounts. We strive to produce a 3% gain every month. Now it should be obvious to you that we supersede this goal by leaps and bounds as we are already up over 100% year to date. So why so small a goal? Well, in reality this goal is not as small as one might think, despite the ease with which we appear to top it. If you can produce a monthly gain of 3%, your annual return will be in excess of 45%. Now, if you can produce gains in excess of 45% annually on a consistent basis, Wall Street would be sleeping outside your door (we step over them every day, smile). Let's take the scenario a bit further by asking, "What if you produced an average 3% gain on all of your stock trades?" We certainly wouldn't have to worry about your financial condition. That's for sure. So are you starting to understand why we will not let that 3% get away from us when we have at least a 10% gain? Go do likewise my friends. I promise you won't be sorry. Nickels and dimes do add up.
RULE NUMBER 5: ONCE A STOCK RISES 15%, PROTECT 10% AND TARGET YOUR 20% PROFIT POINT
You now know the rationale. The higher a stock continues to rise, the greater the probability of a decline. So with this in mind, we tighten our stops and only give the stock a 5% margin of movement. It is at this point that we experience a lot of sells as many of the stock selections fall back a bit. But in most cases, the 10% gain is produced over several days. The average mutual fund produces gains in the area of 7% yearly. So why should we be disappointed? Besides, there is no rule that says we can't repurchase a stock after selling it. We do this all the time. Now a good portion of your selections will not stop you out at 10%. These are the stocks which tend to be the future leaders in the market. Once you have a 15% gain and you have moved your stop to protect 10% of your profits, determine the exact price at which you will sell at least 1/2 of your position. This step that I am mentioning now is one of the hallmarks of a professional. At this point he comes to the market every day knowing precisely where he will exit. When the price reaches his sell spot, he leaps into action unfettered by indecision and confusion. There are no rationalizations, no waiting for another 1/4 point, no delaying, just action. We favor the approach of selling only half of your position, especially with those stocks which have run to this level in less than 2 weeks. Rapid movement of this nature indicates very strong demand and the likelihood that it will carry is very great. The remaining half can stay in as long as the stock stays above it's 50 period simple moving average (sum of last 50 closing prices divided by 50).
COMMENTS
That's all there is to our Pristine Profit Plan, just 5 relatively simple rules. However, let me be very real for a moment. There is no question, that if you are disciplined enough to follow a plan such as the one just outlined, it will dramatically improve your results many times over. But the fact is that most individuals will not comply. Why? Where will they fail in their attempt to stick to a proven money making approach? Nearly all will fail at the very beginning, Rule Number 1. If I had to choose the biggest difference between winners and losers it would by rule number 1. Winners cut their losses short and move on to the next winning trade. Losers hold on to falling stocks 1/4 point by 1/4 point until the very ability to make a rational decision has been zapped from their bodies. This costly fault is also an ego problem as selling at a loss forces the trader to admit that he was wrong. As long as he holds on to his dud, he does not have to really admit he has made a mistake. This attitude and frame of mind is the hallmark of a loser. And finding someone who thinks like this and suffers from this paralysis can actually be a gem in and of itself. Once you have pinpointed a true loser, reverse his every decision and I guarantee that you'll make a fortune. Because when he should be selling a losing position, he'll buy more rationalizing that it's now cheaper that his original purchase. When he should by buying, it will look too high for his taste, or the spread will be too big, or the P/E will be too high. He will find any excuse not to take a winning trade. Why? Because a loser can't help it; the simple truth is winning is against his nature.
A FINAL NOTE
When I first started out in this business, I lost money consistently. The day I bought a stock was the last up day that issue would see in a great while. When I sold, it was sure to be the bottom just before a major multi-month advance. I was a kid without any direction, without any experience and no one willing to help me get it. I spent many years and a lot of lost money to get to the point at which I am now. Where is that, you ask? Well, I'll answer that by telling you what I demand from the people who work for me. My traders must be able to take $50,000 and a margin account and produce $1,000 in profits a day (and I mean every single day if they like working for me. I accept no excuses.) But let me tell you this. A very talented trader would not even be impressed with that. I had the privilege of spending a period of time with an individual who effortlessly pulled $40,000 a day out of the markets. And guys, that is no typo. The time I spent with this "master" was worth more money than most people will ever see in a lifetime. If you are ever fortunate enough to find a successful market player like this, do everything in your power to procure his guidance. Pay him $100,000 for several weeks instruction if you can. Believe me, that sum will prove to be a mere pittance compared to the future rewards. The time and money saved alone will be well worth the cost.
The Pristine Day Trader was formed to partly provide this guidance which I so desperately needed in my early years. And while it can never replace the benefit of personalized instruction, I do believe it is the next best thing. Good luck my friends, and happy trading.
Friday, September 4, 2009
How to Become a Trader: 11-Step Plan for Success.
The fact is that the overwhelming majority of new traders lose their trading capital when they start. Markets have a way of seductively looking predictable and tradeable, but that's only until you take a position. At that point, they go nuts and you lose your money.
But now, I'm going to turn around and tell you that yes, it is possible to make money in trading . There are some basic ground rules you need to know, and you have to have or develop a lot of patience. Advice (even mine) must be taken and viewed with a critical eye. The trick is to learn a lot, watch what other people are doing, and then you will have the foundation to pick out what is right and wrong for you. Trading is an intensely individual effort.
The 11-Step Plan to Trading Success
1. Get some books that give a basic overview of the stocks, options and futures markets.
2. Get a book on technical analysis of stocks and futures.You're welcome to do fundamental analysis if you want (growth prospects, industry profile, interest rates, etc.), but I'm a technical trader, so you get my point of view here.
3. Read the books. If you feel impatient, well, then this is good training. Sit and read. Yes, the markets are in motion now, but they will still be in motion when you are ready to trade. There is no single grand missed opportunity here. The markets will give us opportunities every day.
4. Now get a book on trading discipline, money management, etc., if you haven't already read some things about those topics. Don't overdose on psychology; everyone will pretty much say the same things. One iteration of, "Control risk, stay capitalized, use stops" is about all you need, though you may need to read it a few times
5. Figure out how you're going to get your data. A good idea is to subscribe to a data service like Technical Trends. (http://www.technicaltrends.com). They give you data including intra day data during market hours) and a free software and a daily newsletter
6. Start watching markets. You may notice that you have not started trading yet. Good. Yes, you probably just missed that huge move in Rolta. So what? Be patient. Say it with me again: Markets are in motion now, but they will still be in motion when you are ready to trade. Do not be led astray by the feeling of missing the train. So, start watching markets. Find your favorite technical formations and indicators. Watch the markets go up and down, or not.
7. At some point, you should start looking at a market and saying, "It's going to go up. It's right there in front of me. When this starts to happen, it is a sign that you are ready to paper trade. Set up a simple way for yourself to track the following things:
* The date you took the trade
* The date you exited the trade
* Your entry price
* Your exit price
* Net result after subtracting commissions and fees
* The reason you took the trade
* The reason why you exited
* Anything about why it did or didn't work.
And then write down your entry price. Be realistic to the point of pessimism; you're not trying to convince yourself to trade, here, you're trying to demonstrate that your reasoning is sound. You already know that you want to trade, and that you want to win. The easiest thing to do is to take the closing price for the day. Whatever you do, do not use the high or low for the day as an entry or exit price. It's just not realistic.
8. Now that you're here, paper trade like crazy. Do as many markets as you want, because it's free. This will give you a great idea of how much work you can handle. Never pull tricks like letting things drift for a few days, and then going back to discover that if you'd exited on Wednesday, you would have had a nice profit, so you make your paper exit occur on that Wednesday. If you didn't make that decision on Wednesday, it's lost forever. This is a dry run for what you will do when you are trading. Never, ever, give yourself slack by being generous with entries and exits, omitting bad trades, changing your mind after entry, none of that. You are lying to yourself, and you are trying to hurry and convince yourself to trade, not to prove that your method works.
9. Paper trade until you have had at least half a dozen trades in strongly trending markets, in whipsaw (violent ups and downs without actually going anywhere) markets, in gradual trend markets, and in doldrums markets. This will take many weeks to the better part of a year. Impatient? So what? One more time: Markets are in motion now, but they will still be in motion when it's time for you to take real trades. Work on your system
10. When, and only when, you have adequately tested your system on paper and found that it worked pretty well in many circumstances, and it's something you have time to do, and you have the money to risk, then go find a broker (with low commissions) you like and open an account.
11. Get going! You tested your system, right? Then look for signals and take them just as aggressively as you did on paper. Change nothing about your approach in the real market. If you are being timid, then you lack confidence in something; stop trading and figure out what's wrong. Are you taking losses? Are they unexpected? Really? Then stop trading and figure out why your paper trading didn't take account of what is happening now. If there is a fatal flaw (a couple of ticks here or there is making a big difference in the real world, for example), stop and get back to work on your system. Don't tinker with the system in the actual market; this is what I did for a while, and it's just a frustrating way to lose money. If you are taking expected losses but decide that real money going down the drain is too painful, then stop trading and start looking for a new way to approach your trading.
But now, I'm going to turn around and tell you that yes, it is possible to make money in trading . There are some basic ground rules you need to know, and you have to have or develop a lot of patience. Advice (even mine) must be taken and viewed with a critical eye. The trick is to learn a lot, watch what other people are doing, and then you will have the foundation to pick out what is right and wrong for you. Trading is an intensely individual effort.
The 11-Step Plan to Trading Success
1. Get some books that give a basic overview of the stocks, options and futures markets.
2. Get a book on technical analysis of stocks and futures.You're welcome to do fundamental analysis if you want (growth prospects, industry profile, interest rates, etc.), but I'm a technical trader, so you get my point of view here.
3. Read the books. If you feel impatient, well, then this is good training. Sit and read. Yes, the markets are in motion now, but they will still be in motion when you are ready to trade. There is no single grand missed opportunity here. The markets will give us opportunities every day.
4. Now get a book on trading discipline, money management, etc., if you haven't already read some things about those topics. Don't overdose on psychology; everyone will pretty much say the same things. One iteration of, "Control risk, stay capitalized, use stops" is about all you need, though you may need to read it a few times
5. Figure out how you're going to get your data. A good idea is to subscribe to a data service like Technical Trends. (http://www.technicaltrends.com). They give you data including intra day data during market hours) and a free software and a daily newsletter
6. Start watching markets. You may notice that you have not started trading yet. Good. Yes, you probably just missed that huge move in Rolta. So what? Be patient. Say it with me again: Markets are in motion now, but they will still be in motion when you are ready to trade. Do not be led astray by the feeling of missing the train. So, start watching markets. Find your favorite technical formations and indicators. Watch the markets go up and down, or not.
7. At some point, you should start looking at a market and saying, "It's going to go up. It's right there in front of me. When this starts to happen, it is a sign that you are ready to paper trade. Set up a simple way for yourself to track the following things:
* The date you took the trade
* The date you exited the trade
* Your entry price
* Your exit price
* Net result after subtracting commissions and fees
* The reason you took the trade
* The reason why you exited
* Anything about why it did or didn't work.
And then write down your entry price. Be realistic to the point of pessimism; you're not trying to convince yourself to trade, here, you're trying to demonstrate that your reasoning is sound. You already know that you want to trade, and that you want to win. The easiest thing to do is to take the closing price for the day. Whatever you do, do not use the high or low for the day as an entry or exit price. It's just not realistic.
8. Now that you're here, paper trade like crazy. Do as many markets as you want, because it's free. This will give you a great idea of how much work you can handle. Never pull tricks like letting things drift for a few days, and then going back to discover that if you'd exited on Wednesday, you would have had a nice profit, so you make your paper exit occur on that Wednesday. If you didn't make that decision on Wednesday, it's lost forever. This is a dry run for what you will do when you are trading. Never, ever, give yourself slack by being generous with entries and exits, omitting bad trades, changing your mind after entry, none of that. You are lying to yourself, and you are trying to hurry and convince yourself to trade, not to prove that your method works.
9. Paper trade until you have had at least half a dozen trades in strongly trending markets, in whipsaw (violent ups and downs without actually going anywhere) markets, in gradual trend markets, and in doldrums markets. This will take many weeks to the better part of a year. Impatient? So what? One more time: Markets are in motion now, but they will still be in motion when it's time for you to take real trades. Work on your system
10. When, and only when, you have adequately tested your system on paper and found that it worked pretty well in many circumstances, and it's something you have time to do, and you have the money to risk, then go find a broker (with low commissions) you like and open an account.
11. Get going! You tested your system, right? Then look for signals and take them just as aggressively as you did on paper. Change nothing about your approach in the real market. If you are being timid, then you lack confidence in something; stop trading and figure out what's wrong. Are you taking losses? Are they unexpected? Really? Then stop trading and figure out why your paper trading didn't take account of what is happening now. If there is a fatal flaw (a couple of ticks here or there is making a big difference in the real world, for example), stop and get back to work on your system. Don't tinker with the system in the actual market; this is what I did for a while, and it's just a frustrating way to lose money. If you are taking expected losses but decide that real money going down the drain is too painful, then stop trading and start looking for a new way to approach your trading.
Put Call Ratio
The Put/Call Ratio is the total number of traded put options divided by the total number of traded call options on the National Stock Exchange of India (NSE) on a given day.
Since there are generally more call options traded than put options, the ratio is usually below 1.
Example:
On February 15, 2001: the total number of Calls and Puts traded were:
Number of Calls (contracts): 7723
Number of Puts (contracts): 1693
Put-Call Ratio = Puts / Calls
= 7723 / 1693
= .22 (Rounded off to 2 decimals)
This is an important CONTRARIAN indicator of investor sentiment.
Put/Call ratios are commonly used as a measurement of market sentiment. It is widely believed that the “PUBLIC” is typically wrong on the market and thus should be used as contra-market indicators. In other words, when “PUBLIC” are overwhelmingly buying calls, it is bearish as they are probably wrong in their bet. Conversely, when put volume is at extreme levels, you should turn bullish as the put buyers are probably wrong.
The Ratio is drawn as a line chart.
When the ratio gets too low, it indicates that call volume is high relative to put volume and the market may be overly bullish or complacent. When the ratio gets too high, it indicates that put volume is high relative to call volume and the market may be overly bearish or in panic. Traders look to sell when the ratio gets too low and the market is extremely bullish. They look to buy when the ratio is too high and the market is extremely bearish.
In short term trading, bullish conditions often become more bullish, and bearish conditions lead to more bearishness. Therefore, use of this indicator is more difficult for short-term traders.
Given below are the S&P Nifty and the Put-Call ratio charts. Note that high ratios indicate market bottoms, while a low ratio indicated the beginning of a reaction.
Like most other overbought / oversold indicators, the Put-Call ratio should be used with care.
Since there are generally more call options traded than put options, the ratio is usually below 1.
Example:
On February 15, 2001: the total number of Calls and Puts traded were:
Number of Calls (contracts): 7723
Number of Puts (contracts): 1693
Put-Call Ratio = Puts / Calls
= 7723 / 1693
= .22 (Rounded off to 2 decimals)
This is an important CONTRARIAN indicator of investor sentiment.
Put/Call ratios are commonly used as a measurement of market sentiment. It is widely believed that the “PUBLIC” is typically wrong on the market and thus should be used as contra-market indicators. In other words, when “PUBLIC” are overwhelmingly buying calls, it is bearish as they are probably wrong in their bet. Conversely, when put volume is at extreme levels, you should turn bullish as the put buyers are probably wrong.
The Ratio is drawn as a line chart.
When the ratio gets too low, it indicates that call volume is high relative to put volume and the market may be overly bullish or complacent. When the ratio gets too high, it indicates that put volume is high relative to call volume and the market may be overly bearish or in panic. Traders look to sell when the ratio gets too low and the market is extremely bullish. They look to buy when the ratio is too high and the market is extremely bearish.
In short term trading, bullish conditions often become more bullish, and bearish conditions lead to more bearishness. Therefore, use of this indicator is more difficult for short-term traders.
Given below are the S&P Nifty and the Put-Call ratio charts. Note that high ratios indicate market bottoms, while a low ratio indicated the beginning of a reaction.
Like most other overbought / oversold indicators, the Put-Call ratio should be used with care.
Why Turtles made a splash ?
Imagine a technically-driven futures trading system with a big reputation where traders are told to expect up to 70 per cent of their decisions to be wrong. At the same time, an extremely basic system where the principal consideration is changes in price and the main aim and challenge is to identify a clear price trend - up or down - and then stick with it in a disciplined way.
The system is the quaintly named Turtle method, a technique that attracted a better than fair share of US media attention during the late 1980s and early 1990s as a whiz bang way of training successful commodity traders. Turtle trading and its founders get three chapters in the best-selling Market Wizards financial books.
The Turtle system, claims Russell Sands - one of the original Turtles, is a very straightforward way of trading futures and currencies. While it can be used to trade shares, it works better on securities that are more likely to exhibit trend-like behavior.
One of the important features of Turtle is it makes no attempt to anticipate markets. "When we go with a trend, we have absolutely no idea how long it will last or how far it will go," says Sands, a protégé of the system's creators, countrymen Richard Dennis and William Eckhardt. Turtle traders start with the basic assumption that markets follow trends. The principal requirement before there is any trading action is that the trend must be firmly in place.
If prices go up for 20 days in a row, for instance, that signals the start of an up trend. The end of the up trend comes when prices reverse for 10 days in a row.
The big thing about the method, says Sands, is that Turtle traders - if they play the game properly - never enter a market too early and never pick the bottom. Prices have to rise for a reasonable period and build up some momentum before any action is justified. Equally, they must clearly show they are on the way down before a position is closed out.
But once a position is taken, it stays in place until the criteria are met for a trend reversal. It therefore takes a certain amount of opposite price movement before a trader quits a position.
The same rules apply for short positions. Sands says he took a sold position in August gold futures about three weeks ago after the price had retreated for the requisite number of days. The gold price when he acted was $US395 an ounce and he expects to stay with the downtrend until the market rallies for, say, 10 days in a row or he is stopped out by sharp movements.
Turtle trading also incorporates price-related stop losses as part of the overall money management strategy.
These rules relate activity to a trader's resources and strive to discourage overtrading. There are other guides that suggest how profitable positions can be enhanced by expanding a position using unrealized profits.
The biggest trap for futures traders, says Sands, is overtrading. An important part of the Turtle method is putting this into context in terms of market psychology and trading behavior and defining the probabilities of overall ruin due to over-exposure.
The Turtle system argues that if traders wish to stay in the game for the long haul they should try to risk no more than 2 per cent of their total funds at any one time. This means having enough in the way of financial resources to make worthwhile trades but also stay in the game. "Running a $20,000 trading account and then trading five or 10 gold contracts on this is suicidal behavior," says Sands. His personal method is to trade one contract for every $30,000 of capital. Although markets can be traded with less capital, it increases the risk of being wiped out.
An extreme example is a gold trader with a $5,000 account. With such a small amount, setting a stop loss at 2 per cent of account size is obviously uneconomical as it represents scope for just a $1 price move.
If the gold price is given $5 to move, the money at risk in a 100-ounce contract is $500, or 10 per cent of total funds. But someone with $30,000 will be risking less than 2 per cent of their total funds. The same small trader will, of course, make a more impressive profit if he wins. But then, however, trading becomes more of a function of courage rather than a discipline.
"Obviously the bigger risk you take when you trade, the bigger the reward if you're right. But equally, the smaller you trade, the less chance you will go bust," says Sands. The Turtle philosophy is to trade many times as small as possible in order to stay trading forever. This is important, says Sands, because 60 to 70 per cent of the time the identified trends fizzle out and traders wind up losing a small amount of money. The compensation comes when a solid trend is identified which rewards the trader handsomely. "Maybe 30 per cent of the time you are right and when I win with Turtle I can make between five to 10 times what I've previously lost," claims Sands.
The system is the quaintly named Turtle method, a technique that attracted a better than fair share of US media attention during the late 1980s and early 1990s as a whiz bang way of training successful commodity traders. Turtle trading and its founders get three chapters in the best-selling Market Wizards financial books.
The Turtle system, claims Russell Sands - one of the original Turtles, is a very straightforward way of trading futures and currencies. While it can be used to trade shares, it works better on securities that are more likely to exhibit trend-like behavior.
One of the important features of Turtle is it makes no attempt to anticipate markets. "When we go with a trend, we have absolutely no idea how long it will last or how far it will go," says Sands, a protégé of the system's creators, countrymen Richard Dennis and William Eckhardt. Turtle traders start with the basic assumption that markets follow trends. The principal requirement before there is any trading action is that the trend must be firmly in place.
If prices go up for 20 days in a row, for instance, that signals the start of an up trend. The end of the up trend comes when prices reverse for 10 days in a row.
The big thing about the method, says Sands, is that Turtle traders - if they play the game properly - never enter a market too early and never pick the bottom. Prices have to rise for a reasonable period and build up some momentum before any action is justified. Equally, they must clearly show they are on the way down before a position is closed out.
But once a position is taken, it stays in place until the criteria are met for a trend reversal. It therefore takes a certain amount of opposite price movement before a trader quits a position.
The same rules apply for short positions. Sands says he took a sold position in August gold futures about three weeks ago after the price had retreated for the requisite number of days. The gold price when he acted was $US395 an ounce and he expects to stay with the downtrend until the market rallies for, say, 10 days in a row or he is stopped out by sharp movements.
Turtle trading also incorporates price-related stop losses as part of the overall money management strategy.
These rules relate activity to a trader's resources and strive to discourage overtrading. There are other guides that suggest how profitable positions can be enhanced by expanding a position using unrealized profits.
The biggest trap for futures traders, says Sands, is overtrading. An important part of the Turtle method is putting this into context in terms of market psychology and trading behavior and defining the probabilities of overall ruin due to over-exposure.
The Turtle system argues that if traders wish to stay in the game for the long haul they should try to risk no more than 2 per cent of their total funds at any one time. This means having enough in the way of financial resources to make worthwhile trades but also stay in the game. "Running a $20,000 trading account and then trading five or 10 gold contracts on this is suicidal behavior," says Sands. His personal method is to trade one contract for every $30,000 of capital. Although markets can be traded with less capital, it increases the risk of being wiped out.
An extreme example is a gold trader with a $5,000 account. With such a small amount, setting a stop loss at 2 per cent of account size is obviously uneconomical as it represents scope for just a $1 price move.
If the gold price is given $5 to move, the money at risk in a 100-ounce contract is $500, or 10 per cent of total funds. But someone with $30,000 will be risking less than 2 per cent of their total funds. The same small trader will, of course, make a more impressive profit if he wins. But then, however, trading becomes more of a function of courage rather than a discipline.
"Obviously the bigger risk you take when you trade, the bigger the reward if you're right. But equally, the smaller you trade, the less chance you will go bust," says Sands. The Turtle philosophy is to trade many times as small as possible in order to stay trading forever. This is important, says Sands, because 60 to 70 per cent of the time the identified trends fizzle out and traders wind up losing a small amount of money. The compensation comes when a solid trend is identified which rewards the trader handsomely. "Maybe 30 per cent of the time you are right and when I win with Turtle I can make between five to 10 times what I've previously lost," claims Sands.
The 12 Commandments Of Technical Analysis
There are no hard and fast rules about technical analysis, But Here Are 12 Guidelines that will help you succeed.
1. Always assume the current trend is in force until the majority of evidence indicates otherwise.
The biggest mistake most traders make is selling too soon. The second biggest mistake is buying too early. You want confirmation from multiple sources before you take action. Stocks always move in funny lines and unless you have the discipline to ride out the smaller jiggles, you will be furiously trading without ever capturing longer, sustainable trends. Trends are persistent so give yourself the opportunity to ride those trends for all they are worth.
2. The more frequently a trendline is touched, the more valid that trendline becomes.
Trend-lines are fickle but can also be very faithful. The best trend-lines will regularly tell you they love you by repeatedly touching the prices, over and over again. The more a trend-line is touched, the more dependable that trend-line is.
3. The longer a trendline is in force, the more valid that trendline becomes.
This is a corollary to the above principle. Trend-lines that have been in-tact for an extended period of time are usually very reliable. Some traders mistakenly think that something that has gone up for a long period of time cannot continue much longer. Not true. Long trend-lines are very dependable and very worthy of your consideration. Of course, nothing last forever but jump on board and enjoy the ride until it reverses. One thing about long trend-lines -- once they are broken, it is usually time to get very worried.
4. Uptrends live above 50 and downtrends live below 50.
Stocks that wiggle back and forth between positive and negative RSI readings are bad news. Persistency is the quality you should admire most in a stock so concentrate on those that have a recent track record of staying in positive territory and avoid those stocks that cannot generate enough buying pressure to stay above 50.
5. Generally, you should avoid making new purchases when RSI is in overbought territory and avoid selling existing positions when RSI is in oversold territory.
Like a rubber band that is stretched too far, stocks that rise into overbought territory are usually ripe for a near-term pullback. Conversely, stocks in oversold territory should experience a bounce. In both cases, the best time to take action is as soon as they move out of these extreme readings. One caveat is that the more volatile the stock, the longer they can survive in overbought/oversold territory. Volatile stocks can move fast and continue moving fast so change your guidelines to extremely overbought or extremely oversold for these types of stocks.
6. Trendlines get broken all the time. RSI will tell you if you should re-draw your trendline or if a trend reversal is developing.
One thing you need to get used to is that trend-lines are never as straight as you want them to be. Every time a trend-line is broken, you need to make a decision whether a trend reversal is developing or whether you should re-draw your trend-line to incorporate the new low. Do not take a guess - ask your RSI friend what to do. A trend-line break accompanied by a positive RSI reading tells you that things are still okay and that it is time to draw a new trend-line. A trend-line break accompanied by a negative RSI reading tells you that a trend reversal is possible (not absolute) and that you need to be wary of a potential sell.
7. Breakouts above resistance are usually good times to buy.
Breakouts below support are usually good times to sell. Breakouts are to technical analysis what voters are to politicians - they are supposed to get your attention. Whenever you see a breakout, you should assume that there has been a powerful shift in investor perception. Either a lot of new buyers have jumped on board or a bunch of sellers are running for the exits. In either case, a significant change has occurred and you should take action. The Stock Market is pretty smart. Things go up or down for good reasons. Breakouts deserve your attention.
8. Always look at three factors before buying or selling - trendline analysis, support/resistance lines, and momentum indicators.
The point of all this technical analysis stuff to play the odds. Nothing is guaranteed but a lot of things are probable. You want to find those circumstances when the odds are most in your favor. The way you improve your odds is when you have confirmation from several sources. You want to find stocks with clear trends, favorable support/resistance characteristics, and positive momentum indicators.
9. Your best buys will usually occur after a stock recovers from a deeply oversold reading.
Your buys will usually comes from two sources - stocks that are already moving up (buying high and hoping it goes higher) or finding trend reversals (buying low, hoping to sell higher). If you are looking for bottoms, your most profitable buys will come from stocks that are recovering from deeply oversold readings. This does not mean that you should automatically buy stocks that are deeply oversold. It does mean that when a deeply oversold stock does turn positive, it usually produces big gains.
10. Resistance, once broken, becomes your new support level.
Conversely, support, once broken, become your new resistance level. Pretty straightforward stuff but often overlooked. This principle is important because it helps you identify your mistakes. Buying on breakouts is usually a very good idea. However, if a stock does a quick turnaround and drops below that old resistance (now support) you may have been pushed into a bad trade. Making mistake is not fun, but not admitting them when they happen is very expensive.
11. Let your winners run and cost your losses.
During the course of your trading career, you will have many opportunities to capture a quick buck. While it may be tempting to grab a quick 10% gain, you should not sell until there is compelling reasons to do so. You will probably have a lot of small, profitable trades but there will always be that one or two trades each year that makes you a bunch of money. The success of your year will depend upon that one or two monster trades. On the other extreme, holding on to your losers will probably result in deeper losses. You will screw up - guaranteed. We all do, but the important thing is to cut your losses and look for the next monster trade. Stocks go up and down for good reasons. Do not try to figure out why. Just go find a new, more friendly sandbox to go play in.
12. Expect 1 out of every 3 trades you make to be losers.
Technical analysis will constantly test your faith. Not only should you expect to lose money on about 1 out of every 3 trades, you find that your losers usually come in bunches. You might have 10 good trades in a row and then 5 dogs. It is easy to lose your faith when everything you touch seems to turn into dust. However, if you minimize the impact of your mistakes by quickly cutting your losses, you will be able to prosper as a technician.
These are time-tested principles that will help you sway the odds into your favor. Apply discipline, logic, and probabilities to your stock picks and you should do very well. Re-read these principles frequently. I do and I find it helps me avoid the big mistakes. I hope it help you too.
WARNING:
The above information is provided for general information only, and is not intended for trading purposes. You should carefully consider whether any trading in which you expect to engage will be suitable for you given your financial objectives and financial condition.
1. Always assume the current trend is in force until the majority of evidence indicates otherwise.
The biggest mistake most traders make is selling too soon. The second biggest mistake is buying too early. You want confirmation from multiple sources before you take action. Stocks always move in funny lines and unless you have the discipline to ride out the smaller jiggles, you will be furiously trading without ever capturing longer, sustainable trends. Trends are persistent so give yourself the opportunity to ride those trends for all they are worth.
2. The more frequently a trendline is touched, the more valid that trendline becomes.
Trend-lines are fickle but can also be very faithful. The best trend-lines will regularly tell you they love you by repeatedly touching the prices, over and over again. The more a trend-line is touched, the more dependable that trend-line is.
3. The longer a trendline is in force, the more valid that trendline becomes.
This is a corollary to the above principle. Trend-lines that have been in-tact for an extended period of time are usually very reliable. Some traders mistakenly think that something that has gone up for a long period of time cannot continue much longer. Not true. Long trend-lines are very dependable and very worthy of your consideration. Of course, nothing last forever but jump on board and enjoy the ride until it reverses. One thing about long trend-lines -- once they are broken, it is usually time to get very worried.
4. Uptrends live above 50 and downtrends live below 50.
Stocks that wiggle back and forth between positive and negative RSI readings are bad news. Persistency is the quality you should admire most in a stock so concentrate on those that have a recent track record of staying in positive territory and avoid those stocks that cannot generate enough buying pressure to stay above 50.
5. Generally, you should avoid making new purchases when RSI is in overbought territory and avoid selling existing positions when RSI is in oversold territory.
Like a rubber band that is stretched too far, stocks that rise into overbought territory are usually ripe for a near-term pullback. Conversely, stocks in oversold territory should experience a bounce. In both cases, the best time to take action is as soon as they move out of these extreme readings. One caveat is that the more volatile the stock, the longer they can survive in overbought/oversold territory. Volatile stocks can move fast and continue moving fast so change your guidelines to extremely overbought or extremely oversold for these types of stocks.
6. Trendlines get broken all the time. RSI will tell you if you should re-draw your trendline or if a trend reversal is developing.
One thing you need to get used to is that trend-lines are never as straight as you want them to be. Every time a trend-line is broken, you need to make a decision whether a trend reversal is developing or whether you should re-draw your trend-line to incorporate the new low. Do not take a guess - ask your RSI friend what to do. A trend-line break accompanied by a positive RSI reading tells you that things are still okay and that it is time to draw a new trend-line. A trend-line break accompanied by a negative RSI reading tells you that a trend reversal is possible (not absolute) and that you need to be wary of a potential sell.
7. Breakouts above resistance are usually good times to buy.
Breakouts below support are usually good times to sell. Breakouts are to technical analysis what voters are to politicians - they are supposed to get your attention. Whenever you see a breakout, you should assume that there has been a powerful shift in investor perception. Either a lot of new buyers have jumped on board or a bunch of sellers are running for the exits. In either case, a significant change has occurred and you should take action. The Stock Market is pretty smart. Things go up or down for good reasons. Breakouts deserve your attention.
8. Always look at three factors before buying or selling - trendline analysis, support/resistance lines, and momentum indicators.
The point of all this technical analysis stuff to play the odds. Nothing is guaranteed but a lot of things are probable. You want to find those circumstances when the odds are most in your favor. The way you improve your odds is when you have confirmation from several sources. You want to find stocks with clear trends, favorable support/resistance characteristics, and positive momentum indicators.
9. Your best buys will usually occur after a stock recovers from a deeply oversold reading.
Your buys will usually comes from two sources - stocks that are already moving up (buying high and hoping it goes higher) or finding trend reversals (buying low, hoping to sell higher). If you are looking for bottoms, your most profitable buys will come from stocks that are recovering from deeply oversold readings. This does not mean that you should automatically buy stocks that are deeply oversold. It does mean that when a deeply oversold stock does turn positive, it usually produces big gains.
10. Resistance, once broken, becomes your new support level.
Conversely, support, once broken, become your new resistance level. Pretty straightforward stuff but often overlooked. This principle is important because it helps you identify your mistakes. Buying on breakouts is usually a very good idea. However, if a stock does a quick turnaround and drops below that old resistance (now support) you may have been pushed into a bad trade. Making mistake is not fun, but not admitting them when they happen is very expensive.
11. Let your winners run and cost your losses.
During the course of your trading career, you will have many opportunities to capture a quick buck. While it may be tempting to grab a quick 10% gain, you should not sell until there is compelling reasons to do so. You will probably have a lot of small, profitable trades but there will always be that one or two trades each year that makes you a bunch of money. The success of your year will depend upon that one or two monster trades. On the other extreme, holding on to your losers will probably result in deeper losses. You will screw up - guaranteed. We all do, but the important thing is to cut your losses and look for the next monster trade. Stocks go up and down for good reasons. Do not try to figure out why. Just go find a new, more friendly sandbox to go play in.
12. Expect 1 out of every 3 trades you make to be losers.
Technical analysis will constantly test your faith. Not only should you expect to lose money on about 1 out of every 3 trades, you find that your losers usually come in bunches. You might have 10 good trades in a row and then 5 dogs. It is easy to lose your faith when everything you touch seems to turn into dust. However, if you minimize the impact of your mistakes by quickly cutting your losses, you will be able to prosper as a technician.
These are time-tested principles that will help you sway the odds into your favor. Apply discipline, logic, and probabilities to your stock picks and you should do very well. Re-read these principles frequently. I do and I find it helps me avoid the big mistakes. I hope it help you too.
WARNING:
The above information is provided for general information only, and is not intended for trading purposes. You should carefully consider whether any trading in which you expect to engage will be suitable for you given your financial objectives and financial condition.
TECHNICAL ANALYSIS : QUESTIONS AND ANSWERS
This Article is actually a reply sent by Bob Fulks, a respected technical trader, to questions raised on technical analysis.
Question 1) I realize no method is perfect, but can technical analysis be as effective a method for equity (or other market) selection and timing as compared to analyzing fundamentals or some other method?
Answer 1)
The two methods are quite different. The reasons equities change price is due to both longer term fundamental factors, such as revenue and profit growth, and short-term psychological factors, such as people thinking it will be worth more tomorrow. The problem with fundamental analysis is that if no except you understands that an equity is undervalued, the price may not move up for years. Fundamental analysis tends to work if there are industry analysts following a stock and promoting it to their clients. Technical analysis just looks at what is happening now and doesn't much care why it is happening. Most people on these lists care primarily about
technical analysis.
Question 2) If the answer to #1 was positive, is automating the process to a trading system the next logical step? Do real/full-time traders use trading systems to make real income?
Answer 2)
Many people look at charts and make decisions on chart patterns. The human brain is very good at recognizing patterns that are almost impossible for a
computer to interpret. But it is hard for a person to be objective. There are hundreds of indicators and it is easy to look at enough indicators and
see what you want to see. Trading systems are objective but can only handle situations that they are programmed to handle. Lots of traders make real
income using trading systems, (even though many academics will tell you that technical analysis doesn't work.)
Question 3) If the answer to #2 was positive, would you recommend the TradeStation software to a close friend? Is the product a necessity for a serious ta/system trader? If you had it to do again, would you plunk down another $2400+ dollars for it? If not TS then what?
Answer 3)
If your trading system is more than a few lines in length, (and it better be), there is really no other choice. There are other products but they tend to be limited in what kind of systems you can create. SuperCharts has many similar features but the lack of the PowerEditor makes it nearly impossible to write other than very simple indicators and systems.
In addition, there are a large number of programs for TradeStation that are available from many sources. This makes it easy to build upon the work of
others and helps you learn the many quirks of programming the product. People hate Omega Research because Omega tends to do dumb things that
alienate their customers. I could never figure out why. I was an executive of a software company before I started trading and we would never think of
treating our customers the way Omega treats theirs. TradeStation is the only choice now but there are companies trying to end that dominance. Many
users would quickly move to another product if they had a real choice. It certainly is not perfect but as of now, it is about the only game in town.
Lots of people can make it do marvelous things. To put the cost in perspective, the cost of the software will be insignificant when you consider the cost of the time you spend learning to use it and the cost of all the money you will lose learning to trade.
Question 4) If the answer to #3 was positive, were you successful and what were your experiences developing your own profitable system? Did you find it necessary to obtain one from another source? If so, how does one evaluate these sources?
Answer 4)
Don't plan on making money with the canned systems and indicators that come with the product. These are really just examples to learn from. To create a
profitable system, you will need to write your own system in their EasyLanguage. The language is pretty easy to learn if you have any computer
programming experience but can be pretty difficult if you don't. Most of the power is in the library of functions which take a lot of time to learn
to use effectively.
There are also several newsletters, such as TSExpress, that explain many of the idiosyncrasies of using the product. I suggest you buy several of these
and get all the back issues. It will save you a lot of effort. Developing a trading system that really works seems to be hard for a lot of
people. Recent threads on this list have been discussing this topic in detail. I think the main problem is that people try to use the popular
indicator functions. There are many popular indicators such as MACD, RSI, ADX, etc., that have been developed over the years to help people try to
see changes in trends on charts. These always look good on charts. They were developed as stand-alone indicators to show some feature and work
pretty well for this.
But many people try to combine a bunch of them together to generate buy/sell signals. In my opinion this cannot work well. After all, most of
these indicators start by using the price as the input. The indicator functions then manipulate the price lots of ways to derive a new value for
the indicators. People then manipulate these indicator values lots of ways to create a trading signal. But, by the time the original price data has
gone through all of these transformations, it is impossible to understand what is really happening. They then tune lots of parameters until
TradeStation tells them that combination of parameters would have made money if they had that code with those values to start trading a few years
ago. And then they get discouraged when they lose money trading the system. I feel that it is better work directly with the raw price data and
manipulate it in ways that make logical sense to you.
The other option is to purchase a trading system from someone. In my experience, this rarely works because there are so many variables in every
style of trading. It is very unlikely that you will find a good system that actually works and that fits your style of trading. Besides, most of the
ones that you can buy for any reasonable price are worthless. Why would anyone sell you, for a few thousand dollars, a printing press to print
money? Most of the ones you can buy are locked so that you cannot see the code (called "Black Boxes"). If you don't know how something works, it is
hard to really have enough confidence in it to trade it.
There are many vendors selling professionally developed components that you can use to help develop your systems. (Jurik Research, SirTrade, etc.)
There are also consultants that will help you develop systems for a fee. Many are very experienced.
Question 5) I don't mind putting in hours and hours of reading and research and adding this to my share of hard-knocks, but I want to feel that my initial learning efforts are headed in the right direction. Any comments or opinions from individuals who are truely "walking-the-walk" would be very much appreciated.
P.S. My apologies to those who've heard these questions for the 10,000th time. Maybe a FAQ for new comers is available?
Answer 5)
I thought your questions were well thought out and worth the effort to answer. These are obviously my personal opinions. Others will probably disagree.
Bob Fulks
Question 1) I realize no method is perfect, but can technical analysis be as effective a method for equity (or other market) selection and timing as compared to analyzing fundamentals or some other method?
Answer 1)
The two methods are quite different. The reasons equities change price is due to both longer term fundamental factors, such as revenue and profit growth, and short-term psychological factors, such as people thinking it will be worth more tomorrow. The problem with fundamental analysis is that if no except you understands that an equity is undervalued, the price may not move up for years. Fundamental analysis tends to work if there are industry analysts following a stock and promoting it to their clients. Technical analysis just looks at what is happening now and doesn't much care why it is happening. Most people on these lists care primarily about
technical analysis.
Question 2) If the answer to #1 was positive, is automating the process to a trading system the next logical step? Do real/full-time traders use trading systems to make real income?
Answer 2)
Many people look at charts and make decisions on chart patterns. The human brain is very good at recognizing patterns that are almost impossible for a
computer to interpret. But it is hard for a person to be objective. There are hundreds of indicators and it is easy to look at enough indicators and
see what you want to see. Trading systems are objective but can only handle situations that they are programmed to handle. Lots of traders make real
income using trading systems, (even though many academics will tell you that technical analysis doesn't work.)
Question 3) If the answer to #2 was positive, would you recommend the TradeStation software to a close friend? Is the product a necessity for a serious ta/system trader? If you had it to do again, would you plunk down another $2400+ dollars for it? If not TS then what?
Answer 3)
If your trading system is more than a few lines in length, (and it better be), there is really no other choice. There are other products but they tend to be limited in what kind of systems you can create. SuperCharts has many similar features but the lack of the PowerEditor makes it nearly impossible to write other than very simple indicators and systems.
In addition, there are a large number of programs for TradeStation that are available from many sources. This makes it easy to build upon the work of
others and helps you learn the many quirks of programming the product. People hate Omega Research because Omega tends to do dumb things that
alienate their customers. I could never figure out why. I was an executive of a software company before I started trading and we would never think of
treating our customers the way Omega treats theirs. TradeStation is the only choice now but there are companies trying to end that dominance. Many
users would quickly move to another product if they had a real choice. It certainly is not perfect but as of now, it is about the only game in town.
Lots of people can make it do marvelous things. To put the cost in perspective, the cost of the software will be insignificant when you consider the cost of the time you spend learning to use it and the cost of all the money you will lose learning to trade.
Question 4) If the answer to #3 was positive, were you successful and what were your experiences developing your own profitable system? Did you find it necessary to obtain one from another source? If so, how does one evaluate these sources?
Answer 4)
Don't plan on making money with the canned systems and indicators that come with the product. These are really just examples to learn from. To create a
profitable system, you will need to write your own system in their EasyLanguage. The language is pretty easy to learn if you have any computer
programming experience but can be pretty difficult if you don't. Most of the power is in the library of functions which take a lot of time to learn
to use effectively.
There are also several newsletters, such as TSExpress, that explain many of the idiosyncrasies of using the product. I suggest you buy several of these
and get all the back issues. It will save you a lot of effort. Developing a trading system that really works seems to be hard for a lot of
people. Recent threads on this list have been discussing this topic in detail. I think the main problem is that people try to use the popular
indicator functions. There are many popular indicators such as MACD, RSI, ADX, etc., that have been developed over the years to help people try to
see changes in trends on charts. These always look good on charts. They were developed as stand-alone indicators to show some feature and work
pretty well for this.
But many people try to combine a bunch of them together to generate buy/sell signals. In my opinion this cannot work well. After all, most of
these indicators start by using the price as the input. The indicator functions then manipulate the price lots of ways to derive a new value for
the indicators. People then manipulate these indicator values lots of ways to create a trading signal. But, by the time the original price data has
gone through all of these transformations, it is impossible to understand what is really happening. They then tune lots of parameters until
TradeStation tells them that combination of parameters would have made money if they had that code with those values to start trading a few years
ago. And then they get discouraged when they lose money trading the system. I feel that it is better work directly with the raw price data and
manipulate it in ways that make logical sense to you.
The other option is to purchase a trading system from someone. In my experience, this rarely works because there are so many variables in every
style of trading. It is very unlikely that you will find a good system that actually works and that fits your style of trading. Besides, most of the
ones that you can buy for any reasonable price are worthless. Why would anyone sell you, for a few thousand dollars, a printing press to print
money? Most of the ones you can buy are locked so that you cannot see the code (called "Black Boxes"). If you don't know how something works, it is
hard to really have enough confidence in it to trade it.
There are many vendors selling professionally developed components that you can use to help develop your systems. (Jurik Research, SirTrade, etc.)
There are also consultants that will help you develop systems for a fee. Many are very experienced.
Question 5) I don't mind putting in hours and hours of reading and research and adding this to my share of hard-knocks, but I want to feel that my initial learning efforts are headed in the right direction. Any comments or opinions from individuals who are truely "walking-the-walk" would be very much appreciated.
P.S. My apologies to those who've heard these questions for the 10,000th time. Maybe a FAQ for new comers is available?
Answer 5)
I thought your questions were well thought out and worth the effort to answer. These are obviously my personal opinions. Others will probably disagree.
Bob Fulks
Friday, August 14, 2009
Advice for Beginning Traders
The things I wish I'd known at the beginning were:
A: The "classic texts" (Murphy, Edwards & Magee etc.)
B: Capitalization
C: Risk Management
D: "Don't quit your day job"
E: Psychology
I was lucky enough to find an honest and supportive broker. I found it an important fact that large funds, big traders and small traders all use different methodologies. They can all be successful.
I think a set of End Of Day charts and some good books that you study in the evening after work are probably the most cost effective and sensible tools to use until you become profitable. Trend-lines, 1-2-3 bottoms and patience...
The most daunting aspect of day trading, is that it's a full time endeavor. You cannot work another job. Any beginner who tries to go full time, runs the risk of becoming another casualty of the Market.
As with all walks of business the only way to learn is to:
(1) Do it with a make or break attitude,
(2) Go work with someone or a group of people for an extended period of time, watching, learning and doing before going out on your own.
You cannot pay Rupees, spend one week looking over the shoulder of a "master trader", read some material and then go out on your own - it does not work that way!! Its not that easy!!
What makes you think that you can let someone else endure the years or hard work, perspiration and sickly feeling at the bottom of their stomach. The sleepless nights. The loss of appetite. The feeling of having failed.... pay them a few Rupees and expect to buy the end result of their hard work and think you can make it work for you. It doesn't work that way.
If you want the results you must pay the price and the cost is not just measured in RUPEE terms.
There are people who can take short cuts and succeed, but they are exceptions and are far and few between.
As long as your are disciplined and know when to admit you are wrong and have the guts to jump right back on top of the horse then you'll do just fine.
Don't get so worked up about learning the new fad or secret approach to markets. Relax. Prices can either go up or go down or maybe stay the same.
Trading is as difficult as you want it to be.
A: The "classic texts" (Murphy, Edwards & Magee etc.)
B: Capitalization
C: Risk Management
D: "Don't quit your day job"
E: Psychology
I was lucky enough to find an honest and supportive broker. I found it an important fact that large funds, big traders and small traders all use different methodologies. They can all be successful.
I think a set of End Of Day charts and some good books that you study in the evening after work are probably the most cost effective and sensible tools to use until you become profitable. Trend-lines, 1-2-3 bottoms and patience...
The most daunting aspect of day trading, is that it's a full time endeavor. You cannot work another job. Any beginner who tries to go full time, runs the risk of becoming another casualty of the Market.
As with all walks of business the only way to learn is to:
(1) Do it with a make or break attitude,
(2) Go work with someone or a group of people for an extended period of time, watching, learning and doing before going out on your own.
You cannot pay Rupees, spend one week looking over the shoulder of a "master trader", read some material and then go out on your own - it does not work that way!! Its not that easy!!
What makes you think that you can let someone else endure the years or hard work, perspiration and sickly feeling at the bottom of their stomach. The sleepless nights. The loss of appetite. The feeling of having failed.... pay them a few Rupees and expect to buy the end result of their hard work and think you can make it work for you. It doesn't work that way.
If you want the results you must pay the price and the cost is not just measured in RUPEE terms.
There are people who can take short cuts and succeed, but they are exceptions and are far and few between.
As long as your are disciplined and know when to admit you are wrong and have the guts to jump right back on top of the horse then you'll do just fine.
Don't get so worked up about learning the new fad or secret approach to markets. Relax. Prices can either go up or go down or maybe stay the same.
Trading is as difficult as you want it to be.
Tuesday, August 4, 2009
Be prepared Whipsaws happen
WHIPSAW: A change of trading signals within a relatively short period of time.
Trading aims to reduce risk and to compound gains. The better trading systems reduce the number of whipsaws, but they all have them.
Two types of whipsaws
BUY signal SOON after a SELL signal. In this type of whipsaw, traders usually BUY BACK AT HIGHER PRICES.
SELL signal SOON after a BUY signal: In this type of whipsaw, traders often LOSE MONEY.
Worst case scenario: Even in the best of trading systems, you can have type 1 whipsaw followed by type 2.
Problem #1: No-one can be emotionally prepared for whipsaws.
Problem #2: Whipsaws can come in consecutive trades.
Problem #3: After being whipsawed a few times, there's a tendency to ignore signals -- which can be VERY costly.
Are they worth it?
WHIPSAW frustrations are the PRICE traders pay for:
Lowering risks (by being out of the market part of the time) and,
Significantly increasing profit potential (by finding the "better mousetrap").
Protections
Use more than one trading system.
Select a time frame (short, intermediate, long) which suits your personality.
Prefer trading systems back tested for long periods of time.
Corollaries: The shorter the time frame of a trading system -- the more whipsaws it is likely to have. With a longer time frame, you have fewer profits over a ten year period -- and fewer whipsaws -- everything else being equal.
Systems which attempt to eliminate ALL whipsaws miss many good profit opportunities.
Traders have no alternative except to learn to live with whipsaws. It's part of the discipline. Those who don't have the courage and patience to endure trading losses are very likely to pay a much larger price for holding on to bad trades.
Trading aims to reduce risk and to compound gains. The better trading systems reduce the number of whipsaws, but they all have them.
Two types of whipsaws
BUY signal SOON after a SELL signal. In this type of whipsaw, traders usually BUY BACK AT HIGHER PRICES.
SELL signal SOON after a BUY signal: In this type of whipsaw, traders often LOSE MONEY.
Worst case scenario: Even in the best of trading systems, you can have type 1 whipsaw followed by type 2.
Problem #1: No-one can be emotionally prepared for whipsaws.
Problem #2: Whipsaws can come in consecutive trades.
Problem #3: After being whipsawed a few times, there's a tendency to ignore signals -- which can be VERY costly.
Are they worth it?
WHIPSAW frustrations are the PRICE traders pay for:
Lowering risks (by being out of the market part of the time) and,
Significantly increasing profit potential (by finding the "better mousetrap").
Protections
Use more than one trading system.
Select a time frame (short, intermediate, long) which suits your personality.
Prefer trading systems back tested for long periods of time.
Corollaries: The shorter the time frame of a trading system -- the more whipsaws it is likely to have. With a longer time frame, you have fewer profits over a ten year period -- and fewer whipsaws -- everything else being equal.
Systems which attempt to eliminate ALL whipsaws miss many good profit opportunities.
Traders have no alternative except to learn to live with whipsaws. It's part of the discipline. Those who don't have the courage and patience to endure trading losses are very likely to pay a much larger price for holding on to bad trades.
Trading Is Not Investing
The problem with day trading, an expert on financial markets says, is that few people bother to learn the rules first. college roommate, half a century ago, was a lean, athletic young man who cared about sports in mind as well as in body. He could tell you the batting averages of the 20 leading hitters for the last 20 years, or cite such arcane facts as the name (and the time) of the man who came in third in the Wanamaker Mile at the Millrose Games in 1935.
When he finished college, he went to work at a Wall Street firm that knew how to use his talents: He became a tape reader. If you gave him the symbol for any of some hundreds of stocks, he could tell you how often two upticks in its price produced a third uptick or a downtick the next time the stock traded at a different price. He sat in a cell of a room on Wall Street, the physical ticker tape scrolling through his hands. Ideally, he had no position when he came to work and none when he went home. But every day he made millions of dollars of purchases and sales and over the year a noticeable contribution to the profits of his firm.
Ordinary people couldn't hope to compete with my friend, quite apart from his extraordinary personal storage and retrieval capacities. Those were days when fixed commissions cost outsiders 1 to 1.5 percent of every trade, with no volume discounts. And the spread between bid and asked was normally half a point; the outsider bought at the top of the spread and sold at the bottom. Fees, spreads, and commissions would eat traders alive even if they got their markets right.
But my friend's trading imposed virtually no costs on his firm. All he had to do was get it right more often than not. And there's no question that different stocks, because they draw different sorts of people as followers, have different short-term activity patterns.
There was also another kind of trading, which tried to find price movements that might last for several days or even weeks. This, too, was best done by members on the floor of an exchange-indeed, the Securities and Exchange commission had occasional fits about "floor traders." Only a handful of these traders were left in the 1950s. I asked one of them what he did for a living: "I listen for the streetcar," he said. "When I hear it coming, I get on; when it seems to be slowing down, I get off." Outsiders had the handicap that they weren't on the streetcar's route.
The chance ordinary people had to play these games profitably opened up first in Chicago in the 1960s, when the commodities markets began to clean up what had been a pretty dubious act. People could buy their way in for a few tens of thousands of dollars, and stand in a trading pit, "spreading" the price of corn against the price of hogs, or June contracts against September contracts, "scalping" the short-term movements in the prices of contracts-first for the prices of agricultural commodities and then, with a whoosh, for currencies and interest-rate futures and all sorts of financial commodities. Because relatively small sums of money could control relatively large purchases and sales in the low-margin world of the commodities markets, outsiders were not so severely handicapped as the visitors to brokerage offices.
Very recently, trading as a business has been democratized. Today, anybody with a computer and a modem can buy a service that delivers up-to-the-minute detailed information about trades and prices in markets all over the world. One such service, MarketWatch.com, went public in January with a prospectus claiming 2.2 million hits per month on its Website-and the price of the stock more than quintupled in the first day of trading. The cable networks run commercials all day from brokers offering to execute transactions at commission rates measured in tenths of a percent of the value of the trade.
Much Internet "trading" is performed by people who have a barber who's plugged in to technology or a brother-in-law who lives near San Jose and keeps a keen ear open at cocktail parties. Buying stocks on the basis of tips or comments in chat rooms is like betting on the advice of touts at the racetracks: It's not a business, and over time it's not going to be profitable. Even for people who know what they're doing, cyberstreets are not paved with gold. The vigorish is still with the house, and the electronic customer, like his ancestor who hung around at the broker's office, still buys at the asked and sells at the bid. But in actively traded stocks the spread may be as little as a sixteenth of a point, or six and one quarter cents a share, a manageable handicap.
The first rule for success in the trading world is to take the work seriously, to concentrate as hard as my roommate concentrated on his tape. Leo Melamed, who invented the first financial futures contracts, remembered that as long as he continued to practice law on the side, he lost money as a trader. This was and is a business of numbers and psychology, not economics: You have to live the numbers and practice the psychology. The trader's be-all and end-all is the most recent movement of prices in the markets-not just his one market, but many others: The walls of the rooms that hold the giant trading floors are covered with lights telling traders what's happening in the world's major markets for all the big commodities and financial instruments. If you're trading, say, interest-rate futures, you'd better keep abreast of what's happening in oil and gold.
The second rule, then, offered to novice commodity traders in a lecture by Charles DiFrancesca, is to know why you take positions, why you hold them, and why you sell them. DiFrancesca, whose advice is transcribed in William Falloon's book Charlie D.: The Story of the Legendary Bond Trader (Wiley), was the most admired independent bond trader in the busiest pit in the world. He thought the best discipline for young traders was "spreading"-taking long positions in one contract against short positions in another, to exploit changes in relative prices that would disappear as normal patterns reasserted themselves.
Once a trader was fairly consistently profitable in this low-margin business, he was more likely to succeed at the trickier business of "scalping," taking positions in one contract to catch brief waves of motion. The legacy of spreading was that traders should always have a reason for what they did. "If you're standing in the pit like a nail," he told the novices, "you don't have a reason for everything you do. Rely on your outside crutches as a scalper who spreads price relationships and imbalances that you see developing inside and outside the pit."
But those outside crutches, those reasons, are there only to prevent aimless activity. Like every trader, DiFrancesca agreed with the notion that good traders have to take their losses, quickly, and cannot ask Divine Providence to bail them out: "The people who survive at the Board of Trade have a low puke point....God doesn't trade bonds....He doesn't care what kind of trouble you're in; He doesn't trade bonds. You want to throw those future contracts up all over your shoes....There has to be a feeling inside of you that won't let you stay with something too long."
Human nature leads people to deny their mistakes. Even traders may acquire a crazy kind of loyalty to the positions they have taken, especially if they've talked to friends and neighbors about them. Television's Adam Smith likes to remind people that "the stock doesn't know you own it." If you scratch a money-losing trader, you are all but certain to find that he tries to cut his losses by hanging on until the stock or the commodity "comes back."
By the same token, traders find it hard to resist taking profits too fast. One of the most successful big traders in the currency and interest-rate markets says that he expects that 70 percent of his trades will be losers. But when he loses he loses small, and when he wins he wins big. Others who work in his trading room will say that they are profitable on 70 percent of their trades-but most of them lose money, because they grab for small winnings.
In the current lingo of the business, the two different species of trader are those that "sell volatility" and those that "buy volatility." My college friend sold volatility-that is, his essential bet was that market prices wouldn't move much, which meant he could always reverse his trades when he wanted to do so. All the hedge funds that claim to be market neutral-they can make money whichever way the market goes because they are betting on anomalies-are sellers of volatility and rely on a lot of liquidity in the market. This includes the infamous Long-Term Capital Management, which last fall had to be rescued from destruction. And, at the extreme, Nick Leeson of Barings, who sold out-of-the-money puts and calls on Japanese stocks, leaving him a little cash to put in his pockets if the markets didn't move much and a big hole in Barings's capital if they did.
These are the descendants of the classic Wall Street stock trader, the "contrarian" who assumed that the public was usually wrong, that most of the price movement in the market was noise, and that one could make money by selling on small rises and buying on small dips. Even more than other traders, the seller of volatility needs a talent for smelling when to head for the hills. George Soros said recently that he thought the LTCM "convergence" strategy would work 99.9 percent of the time, which was very generous of him, but even on those terms it's easy to be a loser. If you make a few bucks every day for 999 days and lose millions on the thousandth day, you will leave your children memories rather than estates.
Those who expect to overwhelm frequent small losses with less frequent large winnings come from a different school. They "buy volatility." Far from adopting a contrarian position, they take as their motto the old line from the Chicago pits, that "the trend is your friend." This is still trading, not investing. Buyers of volatility couldn't care less about the future earnings stream or purchasing power associated with what they buy: Such factors, presumably, are already in the price. The best of them are often ready for crises, because they limit their downside with something in the nature of "stop loss" orders, which in the modern world may mean fancy schemes for dynamic hedging.
These days, one can buy computer programs that purport to flag opportunities for short-term trading profits. They are useful for practice, like the programs that teach you card games, but following a strategy that's for sale to everybody is not likely to tap into an income-producing spread. There is no aptitude test for trading-the successful traders I know come from all sorts of backgrounds, from the most rarefied academic specialties to the jock worlds.
It's not socially responsible to encourage people to try their hand at trading. Just as the worst thing that can happen to an adolescent is to win big on that first visit to the racetrack or the casino, a profitable first month as a trader is a real danger. It's only after you've had a few bloody noses and moved on that you begin to understand what you're doing. Still, traders love what they do, though only a minority of them prosper; and technology has made it possible for almost anyone to try.
When he finished college, he went to work at a Wall Street firm that knew how to use his talents: He became a tape reader. If you gave him the symbol for any of some hundreds of stocks, he could tell you how often two upticks in its price produced a third uptick or a downtick the next time the stock traded at a different price. He sat in a cell of a room on Wall Street, the physical ticker tape scrolling through his hands. Ideally, he had no position when he came to work and none when he went home. But every day he made millions of dollars of purchases and sales and over the year a noticeable contribution to the profits of his firm.
Ordinary people couldn't hope to compete with my friend, quite apart from his extraordinary personal storage and retrieval capacities. Those were days when fixed commissions cost outsiders 1 to 1.5 percent of every trade, with no volume discounts. And the spread between bid and asked was normally half a point; the outsider bought at the top of the spread and sold at the bottom. Fees, spreads, and commissions would eat traders alive even if they got their markets right.
But my friend's trading imposed virtually no costs on his firm. All he had to do was get it right more often than not. And there's no question that different stocks, because they draw different sorts of people as followers, have different short-term activity patterns.
There was also another kind of trading, which tried to find price movements that might last for several days or even weeks. This, too, was best done by members on the floor of an exchange-indeed, the Securities and Exchange commission had occasional fits about "floor traders." Only a handful of these traders were left in the 1950s. I asked one of them what he did for a living: "I listen for the streetcar," he said. "When I hear it coming, I get on; when it seems to be slowing down, I get off." Outsiders had the handicap that they weren't on the streetcar's route.
The chance ordinary people had to play these games profitably opened up first in Chicago in the 1960s, when the commodities markets began to clean up what had been a pretty dubious act. People could buy their way in for a few tens of thousands of dollars, and stand in a trading pit, "spreading" the price of corn against the price of hogs, or June contracts against September contracts, "scalping" the short-term movements in the prices of contracts-first for the prices of agricultural commodities and then, with a whoosh, for currencies and interest-rate futures and all sorts of financial commodities. Because relatively small sums of money could control relatively large purchases and sales in the low-margin world of the commodities markets, outsiders were not so severely handicapped as the visitors to brokerage offices.
Very recently, trading as a business has been democratized. Today, anybody with a computer and a modem can buy a service that delivers up-to-the-minute detailed information about trades and prices in markets all over the world. One such service, MarketWatch.com, went public in January with a prospectus claiming 2.2 million hits per month on its Website-and the price of the stock more than quintupled in the first day of trading. The cable networks run commercials all day from brokers offering to execute transactions at commission rates measured in tenths of a percent of the value of the trade.
Much Internet "trading" is performed by people who have a barber who's plugged in to technology or a brother-in-law who lives near San Jose and keeps a keen ear open at cocktail parties. Buying stocks on the basis of tips or comments in chat rooms is like betting on the advice of touts at the racetracks: It's not a business, and over time it's not going to be profitable. Even for people who know what they're doing, cyberstreets are not paved with gold. The vigorish is still with the house, and the electronic customer, like his ancestor who hung around at the broker's office, still buys at the asked and sells at the bid. But in actively traded stocks the spread may be as little as a sixteenth of a point, or six and one quarter cents a share, a manageable handicap.
The first rule for success in the trading world is to take the work seriously, to concentrate as hard as my roommate concentrated on his tape. Leo Melamed, who invented the first financial futures contracts, remembered that as long as he continued to practice law on the side, he lost money as a trader. This was and is a business of numbers and psychology, not economics: You have to live the numbers and practice the psychology. The trader's be-all and end-all is the most recent movement of prices in the markets-not just his one market, but many others: The walls of the rooms that hold the giant trading floors are covered with lights telling traders what's happening in the world's major markets for all the big commodities and financial instruments. If you're trading, say, interest-rate futures, you'd better keep abreast of what's happening in oil and gold.
The second rule, then, offered to novice commodity traders in a lecture by Charles DiFrancesca, is to know why you take positions, why you hold them, and why you sell them. DiFrancesca, whose advice is transcribed in William Falloon's book Charlie D.: The Story of the Legendary Bond Trader (Wiley), was the most admired independent bond trader in the busiest pit in the world. He thought the best discipline for young traders was "spreading"-taking long positions in one contract against short positions in another, to exploit changes in relative prices that would disappear as normal patterns reasserted themselves.
Once a trader was fairly consistently profitable in this low-margin business, he was more likely to succeed at the trickier business of "scalping," taking positions in one contract to catch brief waves of motion. The legacy of spreading was that traders should always have a reason for what they did. "If you're standing in the pit like a nail," he told the novices, "you don't have a reason for everything you do. Rely on your outside crutches as a scalper who spreads price relationships and imbalances that you see developing inside and outside the pit."
But those outside crutches, those reasons, are there only to prevent aimless activity. Like every trader, DiFrancesca agreed with the notion that good traders have to take their losses, quickly, and cannot ask Divine Providence to bail them out: "The people who survive at the Board of Trade have a low puke point....God doesn't trade bonds....He doesn't care what kind of trouble you're in; He doesn't trade bonds. You want to throw those future contracts up all over your shoes....There has to be a feeling inside of you that won't let you stay with something too long."
Human nature leads people to deny their mistakes. Even traders may acquire a crazy kind of loyalty to the positions they have taken, especially if they've talked to friends and neighbors about them. Television's Adam Smith likes to remind people that "the stock doesn't know you own it." If you scratch a money-losing trader, you are all but certain to find that he tries to cut his losses by hanging on until the stock or the commodity "comes back."
By the same token, traders find it hard to resist taking profits too fast. One of the most successful big traders in the currency and interest-rate markets says that he expects that 70 percent of his trades will be losers. But when he loses he loses small, and when he wins he wins big. Others who work in his trading room will say that they are profitable on 70 percent of their trades-but most of them lose money, because they grab for small winnings.
In the current lingo of the business, the two different species of trader are those that "sell volatility" and those that "buy volatility." My college friend sold volatility-that is, his essential bet was that market prices wouldn't move much, which meant he could always reverse his trades when he wanted to do so. All the hedge funds that claim to be market neutral-they can make money whichever way the market goes because they are betting on anomalies-are sellers of volatility and rely on a lot of liquidity in the market. This includes the infamous Long-Term Capital Management, which last fall had to be rescued from destruction. And, at the extreme, Nick Leeson of Barings, who sold out-of-the-money puts and calls on Japanese stocks, leaving him a little cash to put in his pockets if the markets didn't move much and a big hole in Barings's capital if they did.
These are the descendants of the classic Wall Street stock trader, the "contrarian" who assumed that the public was usually wrong, that most of the price movement in the market was noise, and that one could make money by selling on small rises and buying on small dips. Even more than other traders, the seller of volatility needs a talent for smelling when to head for the hills. George Soros said recently that he thought the LTCM "convergence" strategy would work 99.9 percent of the time, which was very generous of him, but even on those terms it's easy to be a loser. If you make a few bucks every day for 999 days and lose millions on the thousandth day, you will leave your children memories rather than estates.
Those who expect to overwhelm frequent small losses with less frequent large winnings come from a different school. They "buy volatility." Far from adopting a contrarian position, they take as their motto the old line from the Chicago pits, that "the trend is your friend." This is still trading, not investing. Buyers of volatility couldn't care less about the future earnings stream or purchasing power associated with what they buy: Such factors, presumably, are already in the price. The best of them are often ready for crises, because they limit their downside with something in the nature of "stop loss" orders, which in the modern world may mean fancy schemes for dynamic hedging.
These days, one can buy computer programs that purport to flag opportunities for short-term trading profits. They are useful for practice, like the programs that teach you card games, but following a strategy that's for sale to everybody is not likely to tap into an income-producing spread. There is no aptitude test for trading-the successful traders I know come from all sorts of backgrounds, from the most rarefied academic specialties to the jock worlds.
It's not socially responsible to encourage people to try their hand at trading. Just as the worst thing that can happen to an adolescent is to win big on that first visit to the racetrack or the casino, a profitable first month as a trader is a real danger. It's only after you've had a few bloody noses and moved on that you begin to understand what you're doing. Still, traders love what they do, though only a minority of them prosper; and technology has made it possible for almost anyone to try.
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