Category — Trading Advice

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.

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.

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.

I recently received this letter, and thought you might like to see how another currency trader approaches the markets.

“I approach the markets as a game of probabilities. As far as I’m concerned, that’s the only way to navigate the currency markets.

“What I mean by a game of probabilities is this: I do as much as I can when figuring my fundamental and technical analysis. I read and study all I can. And I do this with discipline, focus, and consistency. I do this to try to gain an edge.

“But I know there is never such thing as 100% certainty. You can never have enough brain power or computing power to harness the mind of the market. It’s not because the computing power isn’t available – it is. It’s because the players in the market do not make “rational” decisions all the time.

“When push comes to shove, the big moves in the market are driven by good old fear and greed, the base human emotions. The fear and greed and irrationality of millions of players can’t be modeled with much degree of certainty. That’s a problem for economists and experts who believe they can create some type of Holy Grail model to forecast price action. They simply don’t have the mathematics available yet to get their arms around irrationality in a modeling scenario. And there is no reason to think they’ll be able to factor in human emotions anytime soon.

“‘If you are going to use probability to model a financial market, you had better use the right kind of probability. Real markets are wild. Their price fluctuations can be hair-raising – far greater and more damaging than the mild variations of orthodox finance,’” writes Benoit Mandelbrot, The Misbehavior of Markets.
Note: Benoit Mandelbrot is the person who created fractal mathematics. He is a brilliant man, to say the least. And he has been shunned to a degree because he has never bought into financial orthodoxy that starts out with ‘the rational man.’

“Bingo! ‘Real markets are wild.’ The massive volatility we’ve already witnessed in the currency market, after only the days of trading this year, prove Mandelbrot right once again.

“So, does this mean we should be defeatist and believe we can never win? Absolutely not! But it does mean you need to develop a reliable system to help you recognize when it makes sense to trade. Or in other words, you need a system that pushes the probability of success in your favor. Here’s what I do to help make currency trading decisions.

“My methodology is a three-step approach:

“1) I watch the key macro themes around the world. I continually ask: where is the money flowing around the globe? What countries or regions are hot? What assets are investments flowing into? Is it stocks or bonds or commodities, or some combination of these? Why are assets flowing in those particular investments? Is it interest rates or economic growth, or geopolitics? These are the type of questions you need to ask in order to develop an understanding of the macro themes.

“2) I look at the technical pictures-charts! First I look at the weekly trends, then daily, then intraday (if it is a very short-term trade). Keep in mind, the tighter the timeframe you analyze on a chart, the more random the movements may be. In other words, these short-term movements you see could be just noise, so you can’t always try to match your broad macro themes to the daily charts. Use your weekly charts to confirm your macro view. Charts are especially helpful when you’re looking at intermarket relationships. For example, you can see if there’s a clear relationship between gold and the U.S. dollar. Often those two move almost as a mirror image of one another. When gold goes up, the dollar goes down, and visa versa. I continuously compare commodities, bonds, and equities against the move of the dollar to see if there is a relationship. Noticing these relationships can definitely give you an edge in the markets.

“3) I try to judge what the sentiment is in the markets. I ask myself, are too many players doing the same thing? This is extremely important, because you don’t want to be late to the party when investing. When everyone has bought, there is no one left to support prices, and they can fall of their own weight. I also look at surveys, open interest, and volume to gauge sentiment.

“Yes, it’s a lot of work. But this is my system that has evolved over the years and suits me well. I’m confident that if I do my homework and apply my system consistently, I’ll win over time. And the same system can work for you too.”

Some people like facts and figures; others prefer trusting their intuition and looking for artistic expression in the realm of trading. The trading profession is big enough for all kinds of traders, though. There isn’t one right way to trade, but the trick is to figure out what you are like and to match your trading style to your personality. Take the data-driven trader, for example. At an extreme, the data driven trader looks for consistency and attempts to find “rules” and conventional wisdom to guide trading decisions. For some data-driven traders, a major preoccupation is to study historical data and back-test ideas until a good fit is discovered. Other data-driven traders enjoy spending their nights scouring reports for a valuable tidbit of information that will give them an edge. If you are the kind of trader that enjoys getting caught up in the details, using this affinity to your advantage is the best way to profit from the markets.

Is trading easy or hard? To the outside observer, trading seems easy enough. You merely pick what you want to trade, bet it will go up or down, execute a trade and see what happens. What’s the big deal? If it were that easy, however, everyone would be doing it and making millions. Unfortunately, it is not that easy, especially in a sideways market or one that fluctuates wildly. In a strong bull market like we saw during the dot-com boom, amateur traders merely opened an online account and watched their account balances balloon. It all changed in 2000, though. We’ve seen a taste of “the good old days” in the past month, but even when the masses are interested and prices go up, trading is not easy. You have to work at it, and hard, to make profits across a series of trades.

Successful trading is part financial resources, part trading strategy, and part psychology. Suppose that you had a simple trading strategy. You might decide to find markets that temporarily went down on general weak economic news, but by all indications, the markets should increase when clearer heads prevail. You look at all the information, and decide to develop a trading method based on “seller’s remorse.” That is, you anticipate that there will be those investors who sold in a panic on weak economic news and will buy back when they realize that the markets were still good buys. But there’s more to it than good trading strategy. You must also decide how much capital you will devote to the strategy. On any one trade, you might risk 2-3%, but not all of your picks will go up in the way you had planned. Trading is also part mathematics. Some of your trades will come through, but others will not. You have to decide how many trades you will make and how much you will risk. And if you have the stomach to risk that much.

If you have relatively low financial resources, taking a 20% risk may be hard to handle. You may feel it would be a disaster if your approach did not realize a substantial profit. Psychologically, taking the risk can be anxiety provoking to say the least. A jumble of thoughts may race through your mind as you execute the trades, and monitor them. As you anxiously await the outcome, you may barely be able to think clearly as your emotions overpower you.

What do you do if you can’t tolerate risk? An obvious solution is to simply take less of a risk. You may not want to make all 10 trades, for example. Instead, look for two or three of the 10 that are the most likely to produce a profit. You do not stand to make as much, but you are not likely to lose as much either. And if you have trouble tolerating risk, the piece of mind you get instead will probably be worth more than the profits you could have made, considering the financial and psychological risks it would require. What are the long-term consequences? On the one hand, it may seem that you will never make huge profits in the markets if you are not willing to take risks. After all, seasoned, professional traders put on big trades and it doesn’t bother them. But you must decide if taking such big risks would be in your best interests. And until you are confident that you can make profits in market to market, you might want to hone your trading skills before taking big risks.

Don’t downplay the importance of risk management. There are financial and psychological benefits for limiting risks. A hard reality of trading is that there are few foolproof trading strategies. Even the most reliable strategy is bound to fail eventually. Market conditions frequently change, and when they do, your strategies must be changed also. The trouble is that you don’t know when a strategy will fail or when it will not beforehand. Your best defense against the sporadic changes in market conditions is to limit your risk. If you limit your risk, you’ll be able to survive the learning curve, and eventually, become one of the select few who profits big from trading the markets.