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The erroneous notion of trading

January 31, 2012 By 2 Comments

While starting out as a trader, you have likely read most of the classic books on trading, technical analysis, money management, or psychology. You might have even executed a few trades with meager success. From a theoretical experience you are not a newbie but from a practical standpoint you still are.

Being a trader is commonly associated with an erroneous picture of freedom. You may be drawn to the flexibility of lifestyle, not having a boss, and having geographic independence. That’s like saying you want to become a racing driver because of the high salaries and traveling around the world. But to be a good racing driver you need to love racing. Not everyone loves racing. Similarly, to be a good trader you need to love markets. Showing “passion” may be overrated for this business, but strong interest coupled with the right approach does correlate with performance. Committing to doing something brings with it the duty to do what is required.

Someone who ponders about making $1 million per year with no boss, and getting out of a job which he hates, is definitely looking at trading for the wrong reasons. Trading doesn’t work like that as it is not a consistent income. Furthermore, it is not a steady progression like most careers. Success (if it comes) is rather unpredictable, comparable to the evolution of an entrepreneur. You can have great periods and you can have dead periods. A great method can suddenly stop working after years of success, and you may have disasters where you lose a lot of money.

If not pursued earnestly, trading can offer excitement for the time being and serve as a big dream of a glorious life in riches. In reality, chances of prosperity in this case are as likely as with playing the lottery.

Those who claim they wish to be traders but are secretly unwilling to do the work, will never get there. As a mentor, I am honest and blunt to aspiring traders, just as the professor is to an aspiring medical doctor. They won’t be told that due to the hard work in their profession of healing it would be better done in a country where there are less medical regulations with worse tools and technology than you find in the West. If you kill a few poor patients along the way, it would not matter because you are unlikely to be sued or prevented from working further. That is not the discipline you want to see in someone. Becoming an independent trader must not be taken lightheartedly either. Education is of utmost importance in this business, and working with a competent trader can be easier than being self-taught. Those who are relentless in figuring out a methodology are more likely to succeed. If you find investigation, research, problem solving, and frequent setbacks tedious, you would be well advised to do something else.

Regardless of assistance, you should be fairly comfortable with experimenting on your own because even a personal mentor can only go as far as showing you the path. A strategy still has to be based on your very own decisions to be able to trade with confidence. Start with a $10,000 account and trade part-time outside your normal working hours. Set maximum drawdown goals by losing not more than $3,000, for instance. The point of this is not to make money, but to learn trading with real money without taking excessive financial risks. If by the end of year one, you managed to make a profit without losing 30% of your starting capital at any point, then you have some potential. Take your time and put more emphasis on gradual growth with a sound strategy than sudden wealth.

What remains to be said about the brutal reality is that the vast majority of retail traders fail even to break even over their trading careers; let alone make a living from it. Those that do, tend to have an unusual aptitude and passion for markets and trading. Therefore you are generally better advised to keep your job until you have figured out a time-tested strategy. Not being able to watch the market during regular trading hours is not an excuse.

Filed Under: Trader Education Tagged With: , ,

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.

Filed Under: Mentoring Tagged With: ,

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!

Filed Under: Mentoring Tagged With: , ,

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.

Filed Under: Mentoring Tagged With: , , ,

Concept of a new trend following strategy

December 8, 2011 By 2 Comments

There is a trend following tactic which I believe has great potential for the average market participant. It involves a moving average and signals an entry as price bounces off it. I want to take the time to explain the concept to you here and experiment with it live in the coming months. The performance will be published regularly so that we will see if it’s a viable approach.

The strategy is simple to set up and you will only need a basic charting package to get started. By using an influential moving average in several time frames, we get a good read of the market. The way I have my charts configured for this experiment is as follows:

  • A monthly, weekly, daily chart with an 200 exponential moving average (EMA) in each. These three time frames will serve as orientation and show at which zones our attention is needed.
  • In addition, we need an intraday chart such as the 1H or 4H time frame which gives the necessary precision in trade entries.

Note how the price basically bounces from the EMA in one time frame to another. Without this, we would float in a sphere of tremendous lack of orientation. Some understanding of price action is required to take the actual trades, but is otherwise very straightforward.

Take the AUD/USD currency pair for example. See how price has approached and penetrated the 200 EMA from below in the daily chart (bottom left), and is now on the verge of a turnaround. We take this bounce as a potential short entry and switch to the intraday chart (bottom right) to find a confirmation therein. A break of this visible support level at 1.014 would confirm the bounce and we go short. A stop-loss order to limit our risk would be set to a visible high created in the daily or intraday time frame.

With the moving average bounce strategy, you are looking for the price to fall toward the EMA and then make a rapid move upward away from it for a long entry. For a short entry, you want price to move downward away from the EMA. It is common to see the price briefly penetrate the EMA, since there are many market participants involved. But what follows is often a noticeable bounce.

 

Filed Under: Experimental Tagged With: , ,

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.

Filed Under: Mentoring Tagged With: , ,

The two approaches to discretionary trading

December 2, 2011 By Leave a Comment

Trading is not just trading. If you are a discretionary trader, there are actually two approaches to this business which are not elucidated clearly when people talk about it:

  1. Planned approach: A trade is planned in advance and executed.
  2. Real-time approach: Market conditions are monitored in real-time and opportunities are identified and taken on the spot.

The equipment and strategies differ from one another. In the second case, trading has the objective to capitalize on short-term sentiment by using advantageous pricing. You need tools such as market data feeds, an advanced charting package, and low commissions. A scalper would be better advised, focusing on the real-time approach, as outdated information is of little use. To crystallize one’s method, literally thousands of hours need to be spent in front of the charts. Only then you have sufficient experience to adapt to changing market conditions promptly enough. Every trading day is a new day with its challenges. Your performance is impacted if you are unable to read price action accurately.

A planned approach is less sensitive to performance pressure, however, one is not able to make use of most recent information. If something surprising occurs the next day, your plan can be turned upside down.

The way I trade trends nowadays involves elements of both approaches: Plan the trade and execute real-time. On evenings (and sometimes throughout the trading session), I would review the market and consider what the next day must offer in order for me to enter or exit a position.

Being able to interpret price action in real-time is even beneficial for the planned approach. Let’s assume you have defined an important resistance area X which the market needs to cross to reverse its current downtrend. You could place a buy stop order above X, to open a long position automatically while you are absent. Or you can choose to observe price action closely as soon as the market does reach X the next day. It could be a false breakout anyway.

Obviously most of us are unable to have the charts up all-day long, unless our job deals directly with financial markets or trading. One solution I have came up with is to set a price alert at price X. I can then glance at the market and evaluate whether I see the real-time price action promising enough to justify an entry.

Filed Under: Trader Education Tagged With: ,

The risk of using multiple time frames

November 23, 2011 By 2 Comments

You may find it discouraging, or even boring, if a market has not been offering a good setup for a longer while. Some books actually talk about how using multiple time frames can improve your trading and help with spotting potential setups. Instead of encouraging it, I would rather take this advice with care.

If you look at more than one time frame just because you cannot find a potential entry, you are basically forcing yourself into trades. In this case, using multiple time frames will backfire. They should solely be used to get a better view of the overall market situation. The actual trades, however, need to be executed based on the time frame you have backtested your strategy with.

I backtested my current trend following strategy back to mid 2009 with a one hour chart and it has never failed fundamentally at yielding a consistent return. A trader’s objective is not about being involved in the market at whatever cost, but about preserving what has been captured and refraining from trades when there is no opportunity presented. In case the market has nothing to offer, so be it. I don’t have a particular goal with regards to trading but to make right decisions. Even a loss is only worth it, if it happened despite having made the right decisions. The rest will take care of itself. It basically boils down to pure statistics, or your “edge”.

You certainly can trade shorter time frames in the minutes or ticks. I am personally of the impression that the shorter the time frame, the more randomness is involved in price action. So I rather stick to my mantra of objectiveness and trade those trends that are really there to stay and not fade within a few minutes time. I wouldn’t be able to manage that. I would get severely frustrated. Therefore, I trade best with the one hour chart. Missing out on the smaller swings, and giving back portions of unrealized profits during counter-moves is the consequence of my approach. In trading, you sadly can’t have the cake and eat it too.

Filed Under: Psychology Tagged With: , ,
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