Weblog of Joe Ross, Trading Educator and Trader for over 5 Decades

I was watching the movie “Coach Carter,” starring Samuel L. Jackson. I couldn’t help thinking about the many similarities between what a coach must do to prepare his players and what a trader must do to prepare to trade.

Since trading is largely a self-directed business venture, embarking on a trading career requires that you are able to set clearly defined objectives and develop a specific plan for achieving them.

Clearly defined objectives and well-developed plans carry the stamp of success in any professional undertaking.

Imagine an ocean liner departing without a navigational plan, a repairman doing repairs on your refrigerator without full knowledge of the workings of the compressor, or a professional basketball team running onto the court without a game plan.

In each case, the lack of a clearly defined plan in which specific objectives are set and specific steps are outlined can produce disastrous results. Clearly defined plans are essential. The captain sails his ship with plans for the safe and on-time arrival to a destination city. The repairman examines the inner workings of your refrigerator and uses the correct parts and tools to fix the problem. The coach tells the basketball team to run specific plays to defeat the opponent.

Successful trading careers start with plans that specify objectives, which in turn lead to success. There are psychological benefits to establishing objectives and developing plans to reach them. First, you may find your stress levels are reduced. Making a specific plan allows you to detail any vague and seemingly unattainable objectives into clearly defined steps, which in turn make the larger goal seem more reachable. When you have a specific plan, you can more easily identify which steps to do first, and then figure out how you will achieve each one. In addition, you will find that following a plan ensures you stay positive, so you control each aspect of your trading day (instead of it’s controlling you). This leads to increased confidence and consistency, which leads to increased effectiveness, which in turn leads to advancement towards your ultimate goal.

You must then write down the way you envision your goal. Create a definitive statement detailing as much of it as you can. Be very specific. Then read your objectives aloud every day. They must become believable.

Accordingly, you adjust trade size and protective stops so that you never lose more than your planned amount on any trade.

Now, map out your plan. What is your budget for hardware, software, and education? How much time can you devote? How much money will you use? What trading time frame, or style, matches your personality? For example, if you have trouble making split-second decisions, then scalping is not for you. Perhaps position trading, with a 2-5 day hold, better suits your personality.

Maybe you want to target certain markets and become a “specialist” in those markets. Or maybe you prefer to trade spreads or options. What set-ups do you prefer? Become an expert at trading a particular set-up and have it deliver the main part of your gains. Detail your trade, risk and money management strategies. Finally, establish a list of trading rules that you keep close-by.

Once you establish convincing and realistic objectives, and map out a plan that leads to those goals, you will find your trading efforts to be easier, more exciting, and certainly more successful!

I suppose for that reason and a whole bunch of others, you might hold on to a losing position because, deep down inside, you are reluctant to win. Sound ridiculous? Then why keep a loser when every advisor and statistic tells you to get rid of it?

I have seen many traders who could not consistently win because they had a monkey on their back. Sometimes it was an overbearing parent, sometimes it was from living in an abusive situation. In many cases it was because they were told they were no good, and that they would never amount to anything. They were told they were losers by someone, somewhere, and they heard it often enough that they began to believe it, and still do to this day.

I’m going to step out on a limb with this, because I am aware that most traders do not consider having a relationship with God as an important ingredient in their trading. However, if you have a belief in God, then you are already well on your way to better trading. The Bible states that we are made in the image of God. I don’t know what that means to you, but to me it means that my potential is far greater than that which other people see in me – i.e., that my parents, family, friends, or other traders see in me. Regardless of past problems, bad experiences, or even negative things said to me, I know I am made in the image of the Almighty. In the general sense, I can do anything I imagine that I can do.

If the Wright brothers had believed that man cannot fly, where would be today? We have learned to exist in space, under the oceans, and to move about much faster than our human physical restrictions will allow. We are able to see the most incredibly small things, and hear sounds that are above and below the human spectrum of hearing. We can see inside material objects with X-Rays, CT scans, and MRI machines.

Why should any trader believe what other people tell him or her about their capabilities? If you know you are in the image of God, then stop behaving as if you are not. Begin behaving as though you are the unique and special person you truly are.

Absolutely YES! It has already happened in my own lifetime as a trader. The markets today are no longer as they were when I began trading. They are hardly recognizable today compared with what they were then. It is as though trading, as I knew it originally, has disappeared. But there’s more, as you will see.
As traders, we tend to build our lives around our trading without giving much thought to what we would do if trading and markets were not available to us.
Recently, the question was asked:

“Joe, do you think we could ever see a complete collapse of the derivative markets?”

The answer is most certainly yes! The world is awash with all sorts of derivatives. A futures contract is a derivative of the underlying cash market. An option on futures is a derivative of a derivative – the underlying futures contract. All stock warrants and options are derivatives. And think of all the SWAPS that exist out there.

At some unknown point, if a hedge fund, a bank, a government, or other entity were to fail to meet its obligations, it could bring down the whole house of cards. We are living in a gigantic global bubble. The stock market is a bubble within a bubble, as were the dot com bubble and the real estate bubble. There are few indeed who know the true worth of anything. All fiat currencies are nothing more than a bubble with nothing whatsoever to back them up other than the willingness of the populace to accept essentially worthless pieces of paper.

It seems to me that an awful lot of people assume that things will always go on as usual, and yet, everywhere I go I detect a certain uneasiness about the status of the world’s economies. Certainly any worldwide stock market “correction” gives a lot of people pause for thought. Only a fool would think that a boom such as we have seen in recent years would never end. Yet that is exactly what I’m seeing in ever increasing numbers of people.

Do you realize that there was a huge crisis in equity markets a few years ago, precipitated by a devastating shock to the Asian currency markets? Beginning with the Thai Baht, the Philippine, Malaysian, Korean, and Indonesian (I’ve probably missed a few) currencies all plunged. The reaction to this was an immediate call by many Asian nations for a cessation of currency trading. If they couldn’t get a complete halt to trading of their currencies, they wanted at the very least to stop all short selling.

This is the way governments react to crises. Do you think for one minute that the same thing would not happen in Europe, the U.S., or Canada?

In any crisis of that sort, the President of the U.S. has the power, without anyone’s prior approval, to shut down all markets, banks, borders, etc. He can freeze all assets, both domestic and foreign. He can declare a state of emergency, call out the National Guard, and declare Martial Law. So I ask you, what is your plan “B?” You really need to have one!!

Do you have a problem with not taking money out of the market when it is there for the taking? Do you seem to think that somehow it is not yours — that it doesn’t really belong to you? What should you do if you have that problem?

Losers think the open equity they take home on overnight trades belongs to the market, or to someone else. The winner views open equity as his money, temporarily loaned to the markets for a greater return. The initial trade Closing price is not the only reference point for open equity. The trader is also theoretically long from entry to the highest open equity tick since the trade began. Think about this.

What you have really made in an upward move is from where you entered to the highest point prices have moved. But how much of that did you actually get? And what have you really made in a downward move from where you entered to the lowest point prices have moved?

If you could catch the entire move it would be great, but to the extent that you did not get it all, you have come up against the Law of Diminishing Returns. There are two laws at work in the market:

1. the law of diminishing returns, and
2. the law of diminishing productivity.

There are a number of ways you can experience diminishing returns other than not getting every tick of a move. Bad fills yield diminishing returns. Commissions result in diminishing returns. Every trader should realize that it is a lot easier to double a $5,000 account than it is to double a $100,000 account.

Diminishing productivity is seen when you are given split fills. Split fills yield a management problem causing you to be less productive. Similarly, too many positions can result in diminishing productivity. Too large of a size can bring diminishing productivity. The more you have to scramble to manage your trades, the less productive you will be.

Humans have a tendency to forget the obvious. We often think that life is more complex than the issues right in front of us, and that obvious solutions offer little comfort when trying to find solutions to seemingly insurmountable problems.

The markets are complex at times, but the psychology of the market is not. And the psychology of winning isn’t all that complicated either. It is essential to accentuate the obvious. You may have heard it time and time again, but there are a few axioms of trading worth repeating: Trade with discipline, manage risk, and think of the big picture. Each of these seemingly obvious issues can powerfully influence your trading performance.

Trading with discipline means developing a detailed trading plan and following it. Obviously, if you don’t have a plan, you’ll trade by the seat of your pants and make errors. You’ll enter too late or exit too early. You’ll make impulsive moves that lose money.

The disciplined trader is the winning trader. It’s obvious, but many traders forget this simple fact of trading profitably. Similarly, many traders refuse to admit that there is an element of probability involved in trading success. Sometimes the odds work in your favor and sometimes they don’t. If you manage risk, you’ll be able to account for those times when the odds just are not working in your favor. If you don’t manage risk, though, you won’t be able to ride out the bad times. Again, it’s obvious, but many traders wipe out their account balance because they risked too much on a few bad trades. Similarly, no single, isolated trade should be more important than any other trade. Don’t elevate a single trade psychologically,

Don’t under-emphasize the obvious. Accentuate it. Get a whiteboard and write down your favorite axioms of trading. Put the list in a prominent place to remind yourself throughout the day of what’s important. It will keep you focused and make you a winner. I’ll give you one for a starter: “Trade what you see, not what you think.”

A lot of people wish they could trade more contracts or more shares. But I try to tell them that there is a point of diminishing returns and diminishing productivity – two laws of economics. People have an erroneous impression that, if they could only trade well with a couple of contracts or 100 shares, they could do even better with 100 contracts and thousands of shares.

However, that is not quite as attractive as it seems to be, because of the two laws. For one thing, you would be limited to the number of markets or shares in which you could find opportunity without moving prices against yourself. Secondly, your size would mark you as a target for the insiders who are looking to skin large traders when they can. You offer them a juicy target. Sufficiently more contracts or shares can cause you severe management problems with partial fills and split fills.

Determining how big you want to be as a trader is important. I’m not saying you shouldn’t go for large size. What I am saying is that you must consider your own level of comfort, and your managerial ability in choosing the kind of trader you will be. Just as there are successful large traders, there are also successful small traders.

Try this idea: take the three-day average daily range and find the absolute difference from the ten-day average range. Project tomorrow’s range equal to the three-day average range plus or minus the absolute value from the ten-day average range. Define the trend, assume the open to be within 20% of the daily high or low, then project the high and low for tomorrow as soon as the market opens.

Example: Say the three-day average range is 400 points, and the ten-day average range is 320 points. There is an 80 point absolute value difference, which is added and subtracted to the three-day average range. This means the next day should have a minimum range of 320 points to a maximum range of 480 points.

This range may be used for profit objectives. If the previous day was confirming of bullish price action and you have bought a lower opening, expect a minimum 320 points from the intraday low to be a profit objective. The three-day average range relationship to the ten-day average range, expresses the strength or weakness of the most recent price movement and its probability of continuation.

I have not tried this on intraday charts, but give it a whirl, see if the principles above hold true. In fact, I’d really like to hear from every/anyone who makes the effort.

Many times in the past I’ve written about the need to adapt, the need to be able to change your behavior relative to the market because the markets are ever-changing.

I’ve stated that mechanical systems may be workable, but for only a short time relative to the life of markets. You must learn to trade what you see, and to understand what you see on a chart.

When I first began trading there was no such thing as futures contracts for foreign currencies. Why didn’t they exist? Because there was no need for them! In the 1970s all that changed when the US dollar went off the gold standard and began to float against other currencies. Following that, the Chicago Mercantile Exchange began to create currency futures to provide a place where currency traders could hedge the risks associated with dealing in foreign currencies. Some of these risks are direct and some are indirect. Direct risk is involved for those who deal directly in foreign exchange. Indirect risk involves companies who export or import, and receive payments or make payments in the currency of another country.

Ever since currency futures were created, they have been in a state of flux. In the mid-1990s for purposes of futures trading, currency trading made a massive move away from currency futures to more direct trading in the forex markets. Currency futures, while maintaining their volume and open interest figures, became less liquid than they had been previously. Volume and open interest do not reveal the picture of what was happening in the currency futures pits. Volume and open interest levels were being maintained by fewer and fewer futures traders.

In the period from 1992 to the present, we’ve witnessed currency futures moving from “red-hot” to “cool” and now “red-hot again” insofar as speculators are concerned. Foreign exchange, which in 1992 was one of the hottest plays, first turned dull and then back again to exciting. However, retail forex as traded through a forex broker in the big four currencies is no match in volume to the volume in the futures. Yes, I know you have heard that $3 trillion/day change hands in forex, but most of that volume is done directly between banks.

That this has happened can be seen in areas of which most futures traders are ignorant. Eight years ago, foreign currency traders were being paid huge salaries and anyone with a track record could virtually name his price. Following that, currency traders were no longer in great demand. Now, again, there is a huge demand for successful currency traders.

Currency futures are but a small representation of the $3 trillion dollar foreign exchange market. Professional currency traders use forex, forwarding contracts, derivatives of all kinds, and the futures markets, to deploy their various trading and hedging strategies. Looking at only the futures, or for that matter retail forex, is like the blind man trying to tell what an elephant is like by feeling only the tusks.

In the 1990s, Midland Bank closed its foreign New York office, laying off dozens of people. Frankfurt Bank had pulled out of New York, and Tokyo closed down its foreign exchange desk. At that time, the world’s largest foreign exchange trader was Citicorp. In the D-Mark alone, they shrank from 39 traders working at 17 different locations around the world to 4 D-Mark traders all working in one room. Keep in mind that these were traders who had been to a greater or lesser extent using the currency futures. The result at that time was that there were fewer big fluctuations in the currency futures than there once were, and therefore much less profit.

However, today, just the opposite is happening. Central banks are presently making much greater interventions in the currency markets. They have stopped publishing targeted exchange rates. Such action by the central banks leaves currency speculators at a loss for what to do, and the result has been a huge surge in foreign exchange trading, with much of the volume going to the futures markets.

Today, forex brokers abound and are actively marketing the idea of currency speculation. This is having a profound effect on the foreign exchange planning of individuals, companies, and nations, especially because of the risk in using a forex broker. There are no guarantees that you will not lose all your money if the broker goes broke, or runs away with your money.

If some day the world’s currencies would be the US dollar, the J-Yen, and the euro, who would need thousands of traders to trade them? There would be far fewer currency misalignments to provide a basis for trading. But that is not the way the world is moving. The picture I just presented ignores the rise of China (and the rest of Asia) as a major economic force on the world scene. Almost certainly, the Chinese currency will become a major trading vehicle. The same is true for other emerging countries. Some of them will no doubt have important currencies from the point of view of world trade. But will these currencies be traded in the futures markets or in forex?

The changes in just this one area – currency trading – are an example of how things change rapidly, and point out the need for traders to adapt. There have, of course, been many other changes in recent years. The advent of all-electronic markets has produced markets of a completely different kind. Computers have brought about the ability to trade in various time frames. New exchanges have created new markets and new contracts – so many, in fact, that it is difficult to know exactly where to direct one’s trading efforts. It is now possible to trade virtually around the clock. It increasingly seems that somewhere, some market is trading.

Trading can be brutal to your self-confidence and your self-image. Self-monitoring and self-examination are the keys to success.

To monitor myself, I developed a tool called the Life Index (which you can read about in my book Trading Is a Business.) One of the greatest struggles beginning traders face is carefully keeping track of their progress. Aspiring traders have not yet developed the skills to trade profitably in a variety of market conditions.

As might be expected, it is hard to develop a real sense of self-confidence when you aren’t sure just how well you can actually trade. It’s natural to wonder if you are doing well simply because of a particular set of market conditions, or whether you are truly building up some legitimate trading skills.

The bottom line is that you have to sharpen your trading skills to the point that you have complete confidence, and really know that you can trade well under a variety of market conditions.

The key to building up the needed skills comes from monitoring your performance. In the final analysis, you must face the cold, hard facts regarding your ability to trade. You must objectively evaluate how well you are trading and make mid-course corrections if you are going to trade profitably.

Although this applies to many, I have in mind a particular kind of individual, an aspiring trader who thinks he can reduce trading to a specific formula so that by doing everything according to the rules, he will be guaranteed success.

It can be emotionally difficult to check how well we are doing. We are usually afraid that if we look at our performance too closely, we’ll discover that we are inadequate. Often we tend to think that matters are worse than they really are. Paradoxically, we may spend more time and energy trying to ignore how poorly we are doing than in looking at our actual performance to take active, decisive steps to change matters.

The Life Index is now available on our website in an easy-to-use form we call LIFT (Life Index for Traders). Because it is also very important to track your account equity in a graphic format, LIFT includes software that enables you to track your equity in chart format.

It is also useful to keep a trade diary, or trading log. Record the market conditions for the trade, your trading strategy, your mood, the rationale for the trade, and its outcome. Also record what you learned from the trade.

Looking at your performance can be brutal. It is useful to set up a time and place to study your performance objectively. Make sure you are rested and relaxed and free of stress. If you look at your performance when you are emotionally volatile or tired, you’ll tend to get easily upset and have difficulty studying your performance records objectively. Pick a quiet place to review your records, a place where you feel safe and secure. Also, set up some time after you study your performance to recover emotionally. You may need some time to regain your emotional composure should your performance record upset you.

Make sure that you have some time to digest the feedback and accept it. For example, you don’t want to trade if you are emotionally upset about your performance. If you try to trade while you are still a little upset, you may take low probability setups or make trading errors. There may be an unconscious need to recoup losses even though you don’t have a plan for doing so. It’s better to regain a sense of confidence, and develop a well-devised long-term plan for improving your performance.

There’s no need to avoid facing the cold, hard facts regarding your trading performance. As with any challenge, trading requires that you objectively look at your performance and make necessary adjustments. It can be difficult at times, but the more you can objectively analyze your trading performance, the more profitably you will trade.

Master Traders develop a style that is a reflection of their education and character. Most individual trading styles are either positional or combinational and, rarely, a synthesis of both. However, there are other styles.

Positional traders take x amount of positions within a specific price area where the market is thought to be favorable to their trading strategy. This may occur on short term weakness when the longer trends are bullish. A known risk is assumed for a specific profit taking area. Positions remain until the losses or profits are taken or the price action analysis negates the trading strategy.

Combinational traders do not have the patience of positional traders, and want immediate profitable results or will exit the market quickly. These traders add additional orders as the market moves their way, building up large positions for fast two- to six-day price moves, then take profits and exit the market.

A third type of trader is a system trader, who adheres to a trading system discipline.

A fourth type of trader is the method trader. Methods differ from systems in that a method can be traded either as a system with no discretion, or traded with discretionary intervention. A method allows for a trader to be able to change parameters. A method gives full-disclosure of all its parameters and the logic behind the method. It should be realized that both systems and methods are based not so much upon a rationale as they are upon pure statistics, i.e., when a certain setup or pattern occurs, and you behave in a certain way, the result is statistically in accordance with the probable outcome.

The complete trader is able to combine all or parts of the above approaches with his own style. Trading mastery combines observation, scientific knowledge, good judgment, intuition, and creative instincts with decisive action.