Archive for the ‘Trading System’ Category
What trips up the vast majority of traders so they never quite make the transition from new trader to good trader?
Not being able to deal with the stress of trading: this is caused primarily from a lack of faith in themselves and or their method.
They lack the ability to pull the trigger when it is time to enter a trade or cut a loss.
Some people just can’t overcome the fear of losing money both in the entry and exit.
Many traders just do not have the discipline or work ethic to create a trading plan through proper homework.
Most traders have no trouble over analyzing the markets to death with enough indicators to make someone go cross-eyed. Many traders read enough books to know how to trade, many follow enough different people online that they get so confused they do not know what to do. Most traders spend far to much time in front of the computer all day watching the prices tick. The majority of traders would really quit trading if they added up the amount of time they spent for the privilege of losing money.
What is the key to over coming the barriers to success in trading. A GOOD TRADING PLAN, not a few rules I mean a complete plan. A plan that you 100% believe in based on your own studies and back testing. Your own personal plan that YOU created, not someone’s opinions.
What needs to be in there?
The Trading Plan comes first and should account for the following parameters:
1. Entering a trade. Quantified approved entries.
2. Exiting a trade. Predetermined Exit point BEFORE you enter a trade.
3. Stop Placement. How will you know you were wrong about a trade? A stop loss, trailing stop, chart signal, volatility stop, time stop, or target price.
4. Money Management. How much capital will you risk on any one trade? This is the key to position sizing.
5. Position Sizing. How much capital will you put on any one trade? Do you have rules that tell you to trade bigger or smaller based on the odds?
6. What to Trade. What qualifies stocks to be on your watch list?
7. Trading Time Frames. Are you going to day trade or position trade and hold for a week or more? or will you be a short term or long term trend follower?
8. Back Testing. You need back testing either with a computer, by reviewing charts, or others research to show that your system is a winner.
9. Performance Review. You must keep a detailed log of your trades and watch your performance to understand the wins and losses and their causes.
10. Risk vs. Reward. Each trade must begin with the potential of winning more money than you are risking.
This is a very basic outline, I suggest expanding this to include 30 rules minimum; 10 each covering the areas of risk management, psychology, and method. If you can write this, believe it, and follow it, you will win in trading the only question that remains is when?
The biggest question I have received today from everyone, new traders, friends, family, even my wife is “What will happen to the stock market if Obama wins?’ or “If Romney wins will the market rally?”
How should we trade the election results? …..Don’t.
Do not let the results color your trading, trade price action, trade the chart, trade your system. Continue to manage risk and stay disciplined. Take your entries and exits just like you have always done inside a winning methodology.
If Obama wins and the market gaps under support tomorrow and begins a downtrend for multiple days then it may be time to go short. If Romney wins and we gap up tomorrow and the market starts to trend upwards then it may be time to go long. If the election is too close to call then…trade the chart, trade what is actually happening not your own opinion of what should happen. The answers to how to trade the price action should be based on your methodology and the time frame you trade on not who wins the election.
Everybody wants a prediction but no one has a crystal ball, the best traders I know trade the price action not their own predictions.
In trading, activity alone does not make money, the right activity at the right time is what makes money. Many times the right thing is to do nothing. Over trading is one thing that causes traders to lose money. You can not make money every day in every trade. Every trade is an exposure to losses, your capital should only be exposed to risk when you have an edge. Sometimes their are set ups and sometimes there are none. Trend Followers should only be trading trends. CAN SLIM investors should only be taking break outs from cup with handle patterns or bounces off the 50 day moving averages. Chart Pattern traders should only take entries off pattern set ups. Traders have to follow the entries that are in their trading plan. Even discretionary traders should only be entering based on their rules when their experience tells them the odds are in their favor. Your entry should be putting 1% of your capital at risk with the odds being you will return $3 for every $1 you have risked.
In your trading you have to do four things very well to make money.
You have to know when to get in.
Only enter trades that have the highest probability of success and the best risk/reward ratio. Buy the best monster stocks during up trends. Short the fallen leaders when the game changes and they are under the 50 day. Buy the monster stocks at the gift of the 200 day moving average at the first few tests. Short down trending junk stocks. Go where the trends are. Only take your best entry signals. Trading is not like baseball you do not get strikes, you can wait for the pitch you want.
You have to know when to get out.
When your trade reverses through a key support get out. When the market up trend reverses get out of your long positions. When your stop loss is hit, get out. When the stock reverses and hits your trailing stop, get out. When you have lost 1% of your trading capital, get out. Money is made on exits not entries and trading accounts are ruined by not taking stop losses when they are hit.
You have to know when to stay in.
If you enter a trade with the potential to trend let it run as far as it will go. Set a soft target, trail your winning trade with a stop. Let the trend tell you when it is done running. Do not cut your winners short, the only way to win in trading is if your winning trades are more than your losing trades.
And most importantly you have to know when to stay out.
If you do not know what to do, do nothing. If the charts confuse you, stay out. If the volatility is escalating and you are losing in every trade, stay out. If you are a trend trader and you see no potential trends, stay out. If you want to go long but all the stocks you want are going down, stay out. Wait until you see patterns, trends, and good entries emerge from the randomness and chaos, until then, do nothing. The one entry that has saved me the most money is going into cash and waiting for a storm to pass.
Where is the Apple that we use to know? It is crucial that we stay mentally flexible and trade what the chart is saying. Anything could happen next week. Apple could reverse and make a run for the 50 day as institutions start loading up at bargain prices or if we lose the 200 day we could roll over and start testing the $575 area. Don’t trade your opinions trade the chart and follow the momentum and what happens around key support and resistance areas. If you are wrong get out quickly if you are right let it go until it gets into a key area and look to bank profits. Stay quick on your feet or stay in cash. Currently this is a trader’s market.
Apple stock is in a downtrend, earnings did not reverse this situation.
Nine out of ten times that Apple has tested the 200 day sma in the past 4 years it has bounced back above immediately.
Apple has closed beneath the 5 day ema six out of the past seven days. Above the 5 day ema is a high probability area to initiate shorts.
the 150 day was support for 4 days but has now turned into the first layer of resistance.
Apple bounced almost to the penny off the 200 day in the post market after earnings and at $591 on Friday, long positions in the $585-$591 area are high probability spots to enter long for a trade or for investors to add to long term positions.
For me to consider going long we need to close above the 150 day and 5 day ema and follow through the next day.
The chart historically is saying we are oversold and due for a bounce.
There are seven skills you will need to survive in trading without discipline no system will work because it will not be followed. With out risk management it is a 100% probability that the trader will blow up their account. Without passion trader’s will not have enough energy and drive to get from new trader to rich trader. Without perseverance new traders become quitters after meeting with resistance, failure, and monetary losses. No work ethic = no edge over other traders. Without flexibility a rigid trader will be broken by the markets. Without a focus a new trader becomes the jack of all trades and the master of none.
DISCIPLINE: The trader must have the ability to control themselves and follow a plan. Discipline is a required skill in trading without it there is no edge, you are either a gambler or simply trading off fear and greed. You will not be successful, instead you will be gamed by those in control of their emotions.
RISK MANAGEMENT: Risk management must be a top skill for a trader to even survive in the markets. You must structure your risk per trade to be no more than risking 1% or 2% of your trading capital. You have to be able to survive 10 losses in a row. These strings of losses come around more often than a new trader would suspect. If you lose just 5% of your trading capital in each of ten trades you will be down almost 50% and need a 100% return just to get back to even. At this point you are ruined.
PASSION: A trader must love to trade, without a passion for the markets and trading the new trader will not survive the learning process because anyone with common sense would believe that it was not worth the struggle. Passion will be needed to bring a trader through the learning curve and later the losing streak.
PERSEVERANCE: A top skill of a trader is not quitting. A trader will have many bad days, bad weeks, bad months, and in the beginning, even bad years. The ability to keep going anyway because you have a goal in mind can not be underestimated.
WORK ETHIC: There is no easy money in trading it is work. Even the ‘easy’ money in bull markets is usually taken back from newbies in the next bear market cycle as they continue to fish for support and just know their stock will ‘come back to even and let them out’. Being a trader is probably equivalent to getting a bachelor degree in a college and in some ways it is like getting a law or medical degree. New traders should expect to pay tuition costs as they start out not just in books, tapes, videos, seminars, and newsletters but also trading losses. There is no professional field where you can just start it and make money from day one. Expecting to start making money trading from day one is like some one going up to a doctor and saying “Hey, how can I make some quick bucks in the medical field, just tell me how you do it.”
FLEXIBILITY:A trader must have the skill to both quickly realize they are wrong and act on that by taking a small loss before it becomes big. There are no crystal balls good traders play probabilities and try to go with the flow. Most new traders will never accept that trading is not about being right every time it is losing small when wrong and winning big when right. Expect a 50%-60% win rate and understand that your wins have to pay for your losses so make them as small as possible.
FOCUS:In trading being an expert on your specific markets: currencies, commodities, futures, options, or stocks will lead to more success than dividing your attention into too many parts. A small watch list allows you to not miss anything and understand your own trading vehicles better than the majority of others you are trading against. Also being an expert on your own systems, methods, or styles will give you an edge over others that drift between methodology.
Surprisingly I have found that these seven skills are primary and the winning trading system itself is secondary. There are many, many, robust systems, methods, and styles but none of those work if you are missing one of these.
Since the whole world is waiting on Apple earnings I felt I had no choice but to tell my blog readers how I see it. I have good news and I have bad news, which would you like first? Okay I will give them both to you straight.
The bad news is that no one can give you the right ‘advice’ on what to do, the good news is that you can have a plan before hand. If you are a long term investor with a rock solid $800 price target in 2013 you should hold, if you are a day trader you should not be involved at all, if you are a position trader it would be wise to start new positions after earnings and go in flat, if you are an option trader you can structure a trade that fits your beliefs, long, short, bet on volatility or against volatility, etc. My position will be NONE I will be IN CASH because one of my rules is not to trade through earnings due to the risk. My #1 priority is risk management not profits.
The bad news for bulls is that earnings may not meet expectations due to the older product line for that quarter the good news is that it is already priced in both in projections and the price hence the sell off.
The bad news is that Apple is already very over owned by institutions and investors, the good news is that it will be whether they hold or sell that will drive the price higher or lower.
The bad news for bulls is that Apple is perceived as too big to continue growing the good news is that it is already priced in with a decreasing P/E multiple.
The bad news is that if the earnings are the least bit disappointing the stock could fall quickly to the 200 day or even lose it, the good news is that it will be a buying opportunity at a bounce off the 200 day or a retaking of it later if it does roll over.
The bad news for bulls is that the many think Apple is done and can not continue to grow and compete, the good news is that is not how monster stocks generally go out, they go out on a euphoric blaze of glory where everyone loves them as they go lower.
The good news for bears is that Apple is under distribution an in danger of losing its key 200 day level, the bad news for Apple bears is that at a 14 P/E, $100 billion in cash, and the hottest products and infrastructure cloud in the world it will have great difficulty truly ‘crashing’. True parabolic crashes come off P/Es of 40-100 during euphoric bull markets not during market corrections. And I am not a value investor I am a chart reader, but common sense dictates how to define reasonable price levels from historical data.
The bad news is that Apple has trouble making and distributing products fast enough, the good news is that every company wants that ‘problem’.
The bad news is that many have tons of gloomy reasons why Apple is in trouble and doomed to fall from here, the good news is that it is nothing I have not heard since 2007 and before. Apple continues to break all the rules about what is possible. SO FAR….
My trading plan is to wait until after earnings and play the trend that emerges tomorrow with weekly options to limit my downside but capture the trend in either direction. If we fall to the 200 day and rebound I will be long with a bounce off of it (IDEAL) if we lose the 200 day I will be short while we are under it, if we gap up and break to the upside and hold I will go long tomorrow morning.
Trading is a process of learning and relearning key lessons in psychology, risk management, and using a proper method. Trading is like building a wall with the right bricks and when you leave a brick out, the whole wall eventually collapses. Or if you use the wrong quality of bricks even though the wall may stand for a while it also eventually collapses as that weakness is exposed in the wrong environment. Below is a trader’s 7 steps to building a wall that can withstand the strong winds and storms of the markets.
LET THE MARKET BE YOUR BOSS. Hold your opinions loosely and your discipline tightly. Trade in the direction of the trend for your time frame. Be quick to admit when you are wrong but hold your winners for as long as they keep going in your favor.
TRADE ONLY IF IT IS WORTH IT. Do not take any trade where your expected possible profits are not at least three times as much as your risk of loss. Risk $1 to Make $3, risking $3 to make $1 is a formula for losing.
STAY DISCIPLINED AND ONLY TRADE YOUR METHOD. If you do not have a robust system, method, or strategy do not trade again until you have one.
ONLY TAKE TRADES WITH IN THE PARAMETERS OF YOUR TRADING PLAN. Trade your plan not your emotions. If you do not have a plan that defines entries, exits, and position sizing do not trade again until you have one.
YOUR FIRST LOSS IS YOUR BEST LOSS. When your planned stop is first hit just get out. In trading hoping is a very expensive emotion
UNDERSTAND THE MARKET ENVIRONMENT. There are times to be short, times to be long, and times to be out. Volatility is many traders kryptonite. If the market itself is not conducive to your strategy wait until it is.
CHOOSE YOUR SPOTS CAREFULLY. Do not rush trades, wait until you get the right set up, trend, or break out you are waiting for, the market isn’t going anywhere, wait for the fat pitch.
MAKE YOUR NEXT TRADE ONLY ONE OF THE NEXT 100. How do you take much of the emotional sting and emotions out of your next trade? Risking only 1% of your trading capital on each trade with the use of stops and position sizing will make no one trade that big of a deal. Ten losing trades in a row will leave you down just 10%. What would your account look like if you had 10 losing trades in row with your current risk management? Would ten losses in a row knock your wall down?
1. Managing the risk of ruin.
Do not risk so much on any one trade that 10 losing trades in a row will destroy your account. risking 1% to 2% of your trading capital per trade is a great baseline for eliminating the risk of ruin.
2. Only trade with a positive risk/reward ratio.
Only take trades where your possible reward is at least two or three times the amount of capital you are risking in the trade.
3. Always trade in the direction of the prevailing trend.
Always trade in the direction of the flow of capital for your specific time frame. Shorting rockets and catching falling knives is not profitable in the long run.
4. Trade a robust system.
Back test and study your trading method, system, or style to ensure it is a winning system historically. The key is that it had bigger winners than losers over the long run in the past.
5. You must have the discipline to take your entries and exits as they are triggered.
You must take your entries when they trigger, your losses when they are hit, and your profits when a run is over to be a successful trader.
6. You must persevere through losing periods.
All successful traders were able to overcome their losing periods to come back and make the big money. If you quit you will not be around for the opportunity to win big.
7. If you want to be a winning trader you must follow your trading plan not your fear and greed.
Emotions will undo a trader more than anything else. Trading too big is due to greed, missing a winning trade due to no entry is a sign of fear, traders must trade the math and probabilities not their own opinions or emotions.
“It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.” -George Soros
One element of trading that is over looked as traders chase hot stocks, trends, and chart patterns is the importance of taking trades that have the potential to be big wins OR small losses. Big losses will kill your account quickly and small wins will do little to pay for those losses. Our trades have to be asymmetric where our downside is carefully planned and managed but our upside is open ended. This is a crucial element for trading success and has to be understood and planned for.
The risk/reward ratio is used by more experienced traders to compare the expected profits of a trade to the amount of money risked to capture the profits. This ratio is calculated mathematically by dividing the amount of profit the trader expects to have made when the position is closed (the reward) by the amount the trader could lose if price moves in the unprofitable direction and the trader is stopped out.
A big secret that many rich traders know that new traders do not is that the winning percentage for even the best traders is only about 50%-60% one type of trading edge comes in having bigger winners than losers. A great formula to use is a 3:1 risk/reward ratio, with this ratio a trader is risking $100 to make $300. If 100 shares of stock are bought for $100 a share and the stop is at $99 then the stock should only be purchased if it is probable that the stock could run to $103. At a $103 share price profits could be taken or ideally if it runs to $104 a trailing stop could be set at $103 to give the stock an opportunity to be an even bigger winner. After ten trades your account could look like this:
Profit $1,000 with only a 50% win rate!
However if you allow losers to run hoping they will come back and take profits quickly while they are there you can get into trouble fast.
Lost $500 even with an 80% win rate!
Other ways to measure the ratio:
In trades you can also plan to cut your losses if the stock drops 5% while taking entries on stocks that can run 15% of more.
Another way to measure a 3:1 ratio is that you can risk 1% of your trading capital for the possibility of making 3% of your trading capital in profits.
Remember that you can cut losses even shorter if you are proven wrong before your stop is hit, but at the same time you have to allow enough room for normal fluctuations and volatility in your stop and use position sizing that you are comfortable with for your trading account size. I also recommend you to allow winners to run as far as possible, you never know when you could have a huge win with the right entry and trend.
First know how much you will risk on any one trade then do not enter a trade where the upside is not at least two or three times your risk of loss.
There are two different types of traders, one that wins and one that whines. Whiners never win and winners never whine. Trading is a tough business and your have to be able to keep the right mind set to get you through the rough spots when the markets starts try to buck you off your game plan and system. Mental strength more than any other one thing will determine your success. You can come back from losing your whole account but you can’t come back from completely losing your faith and confidence. Your mind must be one of a winning trader do not entertain internal or external whining. Keep the faith, stay focused on your long term destination and what it will take to get there.
Winning traders take responsibility. Whining traders play the victim.
Winning traders take the right entries. Whining traders get in too early or too late and miss the opportunity.
Winning traders find a way to make money. Whining traders find an excuse why they did not.
Winning traders add value by entering a trading discussion. Whining traders add value by leaving a trading discussion.
Winning traders study ten times as much as they trade. Whining traders trade ten times more than they study.
Winning traders enjoy the game and the profits. Whining traders enjoy their delusions of the big score.
Winning traders build a mentor relationship. Whining traders think they are a mentor.
Winning traders are realistic about their possible returns. Whining traders are delusional about what returns are probable for them.
Winning traders are focused on their trading expertise. Whining traders are scatter brained and their style drifts to what they think will work.
Winning traders approach their trading as a business. Whining traders approach their trading as a hobby or gambling.