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Trading randomness

February 25, 2012 By Leave a Comment

With the permission of a student, I would like to share a trade of her’s which I criticize as trading randomness. This was the scenario on a particular morning:

The DAX was about to break above a previous day’s high and the MACD indicator, which she loves referring to, generated an obvious buy signal. As soon as “resistance” (in fact, a mere random high of the previous day) was penetrated, she opened a long position and put the stop at a subjectively defined area. Goal was to exit at a risk to reward ratio of 1:2, an altogether discretionary target level. In about half an hour, the index rose several points, so she pondered if she should adjust her stop to break-even. She decided to wait.

Her predetermined target was now within 4 points reach, but the DAX started to tumble before it hit that level. Even the MACD was now offering a sell signal upon which she finally put her stop to break-even. She held onto the position. The market dropped until 2 points above her stop and rebounded slightly thereafter, leaving her a feeling of being on the right side of the market again. Eventually, the DAX performed another drop and stopped her out. She insisted that she had followed her “rules”, but wished she had listened to the MACD sell signal!

When I heard about this trade, I immediately knew that she was trading randomness. First of all, she was day trading. You won’t succeed in day trading, so why bother trying? It is not just my opinion, but it is statistical evidence.

Traders who are new to trading, frequently resort to magical indicators that can give them an answer in hope that they can overshadow their own incompetence. This is an entirely wrong approach. Furthermore, there were several mistakes with this trade:

  • You don’t see a previous day’s high as resistance, but an obvious area determined by price action in which bulls and bears fought out a visible battle. Those are best seen in both the 4H and daily time frames and they are definitely not a random high or low from the previous day.
  • You don’t adjust your stop to break-even. This is a subjective area which the market is not aware of. Avoid walking into that trap deliberately. A stop is put to the nearest high/low of significance where bulls or bears entered the market in large numbers. Think of it this way: The stop is placed where the original reason for your trade is no longer valid.
  • You don’t listen to indicators. None provides consistent profits. They give false recommendations at best, and contradict each other at worst. They are what they are: indicating nothing. Learn to read price and interpret what is happening behind the price instead.
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Little hope for the little trader

January 21, 2012 By 2 Comments

Traders that are new to the industry are too easily scammed into dubious trading products or subscriptions. So-called trading gurus permeate our society to exploit the starry-eyed eagerness of a trader trying to learn. It is marketers and their never-ending sales pitches like, “You need this system. This one will make you the star trader you’ve always dreamed of. The new and improved version is guaranteed to double your money instantly or you get your money back.”

Gossip tabloids exploit readers that crave sensational news. Did you hear the latest on Brad Pitt? The National Enquirer tells me so. What will your car salesman, who needs to achieve his quota for the month in order to pay for his new house, tell you? “You look successful. This car will represent you perfectly in your next business meeting.” You try on clothes in a fashion boutique and ask the salesgirl whether it suits you, “Fits perfectly.” Whatever you try on, it always fits perfectly. These people just want to sell you stuff! The sooner you understand it, the better. What will a politician tell his supporters? “If you want change, then vote for me. I will deliver change for you, my friend.”

We live in a capitalistic world where people will always inevitably seek to exploit the ignorance of others. The original intentions may be good, but trading products are often marketed in a way as to guarantee positive performance. A guru is under no obligation to disclose his profit and loss column to you or anyone.

It is pathetic to hear traders complain how gurus are out to extract money from them. It is up to them to separate the wheat from the chaff and some unfortunately are horrible at separating fact from fiction until it is too late. Usually money is lost as a penalty for not being properly informed. There is a learning curve involved in this business of trading and struggling traders are repeatedly seeking a quick solution to their problem that typically requires months or mostly years to reach proficiency.

Just because a trader can show proof that he can make money does not insinuate that he is also a good teacher, and vice versa. The very best thing to do is apply common sense while learning as much as you can (ideally with the help of a trusted mentor). Every trader is individual in his personality, so you need to find out what strategy, time frame, market, or position size suits you best. A mentor can only provide advice. You have to continuously test and improve while risking the least amount of money. This will increase your chances of emerging financially unscathed and start a profitable trading journey.

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Word of advice to an aspiring trader

January 9, 2012 By Leave a Comment

Message boards offer a great pool of information as well as opportunities to socialize with like-minded traders. Sometimes I post my advice on threads in which aspiring traders seek advice. Upon one post of mine, a trader messaged me this:

There will come a time where I will need to try to figure out my personal plan to be a trader and taking things into my own hands. Could you lend any advice to someone who has the ambition but has yet to even paper trade a “system” or “edge”?

Here was my reply to him. I would like to share it as I find it relevant for many traders:

Before you learn trading through painful mistakes, I suggest that you make printouts of charts and study them vigorously before testing your theory (either in paper trading, or with minimal amounts of real money). I personally printed out the continuous 1H chart of the ES from the last few years.

Know that experienced traders tend to be passive and ride out trends for as long as possible. Be objective in whichever approach you pursue. This is easily said, but what I mean is that you only enter a position when the market tells you to, not sooner and not later. Don’t trade what you expect, but merely according to what you see. You need to be able to clearly pinpoint the reason why you did something the way you did one month or a year from now. Only then will you have an objectively executed trade.

Last but not least, know when a trade is a failure before entering it in the first place. It means that you need a stop, or a risk limit. Decide based on what you see in the chart, not some 1% or 5 point distance rule relative to your entry. That is subjective. I hope this can help you with finding a smooth entry to becoming a good trader!

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Getting ahead in trading

December 14, 2011 By Leave a Comment

I recently received an email from an individual who already gained extensive hands-on experience in trading, but seems unable to get ahead. Whenever a large gain was made, it is slowly drained away by little losses here and there. At the end of the day, he is muddling around break even:

After all this, I feel I should be further in the game. Instead of being a consistent breakeven trader, I want to be a consistent profit maker. Perhaps you can open my eyes to trading.

Upon analyzing his transactions, I believe to have figured out the root of his problem. The most striking misbehavior is that he scalps the market up and down and takes way too many opportunities. Taking that many opportunities will result in many errors because a trader is not proficient enough to maneuver every move. He took 13 trades on a single day, very typical for beginners.

Trading off the 2 minute chart as he does is a false belief of having control over the market. You do not get more details from shorter time frames, but more confusion.

To design and execute a winning system, you must design yourself to becoming a winner, too. It implies that you refrain from trading out of gut feel, but according to rules of your strategy. I believe it’s a fallacy to assume that being break-even is a significant step toward consistent profitibality. You will think that one final touch to the strategy will make you profitable. Actually, it just proves that you cannot hold onto gains and will lose a lot of money very soon. A winner is someone who can hold onto gains and continue to build up the equity curve. So take less trades out of gut feel, and more based on objective observation of trends.

In case you do not have a firm trend following strategy yet, I advice you to take a step back and look at what is really happening in the market. Try to interpret the battle of bulls and bears behind. It’s all common sense. Concentrate on pure price action, not on candlestick formations, head and shoulders, topping patterns, you name it. They are all a consequence of this dynamic battle anyway. Close the small time frames and look at nothing below the 1H chart.

I know that you are seeking an indicator that will give you the answer each time, but a reliable indicator or a combination thereof does not exist. Do not fall into this trap that so many traders before you have, and still do. The only indicator which I find helpful is the exponential moving average (EMA) for general orientation. But beyond that I use none, not even volume. Only price pays.

Trading is about using common sense and objective analysis. I can tell you that the successful trend trader always looks at the big picture, not the small one. And it is quite obvious why. His experience has taught him that being active is not beneficial.

It is infinitely easier to understand the underlying forces and flow with them instead of taking a beating up and down. What was the reason he took those 13 trades? Was the market changing direction that often? In fact, it was exploding higher and never changed direction on that particular day. It was not hard to figure out that buying and staying long was the only sensible thing to do.

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Finding the ideal trading mentor

December 6, 2011 By Leave a Comment

If you adopt other people’s trading strategies, you are likely having a tougher time than figuring out a strategy on your own. Why couldn’t I simply signal my entries and exits for you to follow along? The strategy works for me after all, so why not share it? It seems to be the easier path, but you are mistaken.

According to discussions with fellow traders, many who have shared their methodology complain that the partner frequently messes up when mirroring their trades. This is not because their strategy did not work, but due to something entirely different. Emotions overwhelm a trader’s decisions all too often. The beginner makes many foolish mistakes behind the scenes which impacts his sensitive performance. An easily attained profit with the help of an experienced trader is jeopardized with several losses produced by the beginner.

Another obvious problem is of statistical nature: two traders with the same tactics might not be watching the market at the very same moment. While a trader takes an opportunity, the other one misses out on it. The next opportunity is then taken by both traders, which happens to end in a loss for the two of them. The first trader is still ahead, while the second is licking his wounds and questioning the strategy. The more often this happens, the more likely it is that one of them will call it quits.

Trading someone else’s strategy makes you fully dependent on the person who taught you, even though its signals have been explained to you numerous times. Yet, you need to ask for advice repeatedly because the market conditions appear unfamiliar and make it a challenge for you to handle.

Instead of asking for signals, a beginner is much better advised listening to the thinking of an experienced mentor. The actual trades taken can then serve as samples.

Let me give you a word of advice. Find a mentor who understands your needs and is already proficient in teaching traders, not a guru who sends signals. Based on the theories and mindset of a mentor, you will then find yourself developing a trading strategy on your own which serves you many years to come. This is the whole purpose of being mentored. Finding such an individual is not an easy task, however, the group of potential candidates can be narrowed down once you know what approach is most suitable to you.

  • Pick an instrument that you feel comfortable trading with. Be it equities, derivatives, currencies, or something else.
  • What is your budget? Are we talking about a few hundred dollars or several ten thousands that you want to deposit in your trading account? Is it really money that you can afford to lose? Be aware that you are risking money and can actually lose some or most of it.
  • What amount of time are you willing to dedicate for trading? Are you a student who can observe the market in real-time day after day, or do you have a full-time job?
  • Think about the leverage and maximum risk per trade you are willing to work with. For example, if the ES with its ~$60,000 market value per futures contract is too colossal for you, think of trading the highly scalable SPY.
  • How do you handle failure? You will encounter difficult times. Are these moments in which you feel like giving up or do you sit down and recapitulate your mistakes?

If you have a give-up mentality, then you are wasting your own and your mentor’s precious time. Mentoring a trader and learning trading goes in tandem alongside each other. The beginner needs to be able to communicate his difficulties openly, while the mentor should be experienced enough to detect false trading behavior and present solutions to such dilemma.

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How to trade trends in a profitable way

November 14, 2011 By Leave a Comment

During my trading journey I regularly encounter very interesting people from various fields. Their unprofitability in trading is what often unites them, however, which is why they are seeking advice. Aspiring traders are unable to reap consistent profits off the financial market despite having been involved for many years and having tried various approaches. I assert that this is due to the lack of a fundamental understanding of trends, which is why my attempt is to demonstrate how price action is interpreted correctly.

I personally had the luck to be taught by a mentor myself, and forged a trend trading strategy on top of this precious teaching. The nature of trends is the first thing an aspiring trader needs to fully comprehend. Trends do not stop from one moment to the other but last for a significant amount of time. A trend evolves in a sequence of support and resistance levels along its way, and reversals always take place after breaking an aforementioned level. Hence, there will be enough time to recognize a reversal and to adjust your position accordingly.

If you look at the 1 hour chart of the ES for example. You will notice a repeated pattern of uptrends (higher highs and higher lows), downtrends (lower highs and lower lows), as well as support and resistance levels along the way. A break of such a level is taken as an entry opportunity to catch a reversal and follow a newly established trend. You never do anything prematurely and always wait for the market to tell you what to do. By doing so, you will avoid entering and exiting positions based on gut feel.

That is all you need to boost your chances of becoming profitable. Let us think back to our childhood when we got our first bike. Our parents might not be particularly good cyclers but they knew one thing: to ride the bike we must be able to balance. Consequently, they do not bother teaching us which gear to use, or how to do dirt jumping. They leave it at the basics. But this is precisely what aspiring traders venture into. They start off with the most challenging stunts like scalping and picking tops without knowing anything about chart reading. Seeking answers in indicators is one of the major mistakes they succumb to.

Whenever an aspiring trader comes to me, I will ask him to turn off all indicators, then give him the basic understanding he needs to start trading profitably. This includes price action, understanding the battle between bulls and bears, and trends. After that we go into more details such as risk management by using stop loss orders properly.

To my surprise, many are able to find entries and manage positions with a bit of assistance within a few weeks, or have developed a totally new strategy with the help of the basics I provided. Most importantly, they do this without looking at any indicators that they used to love so much.

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