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May 6, 2013 by Leave a Comment

Beyond the “Spotlight”

For the Week of May 06, 2013

The GBE Trade Spotlight advisory service applies the GBE trading methodology (buying or selling commodity contracts based on breakouts of chart formations and technical indicators) to identify one to two trade setups per week.

Highlighting This Week’s Potential Breakouts:

June 2013 Live Cattle

The June 2013 Live Cattle contract closed below a lower trend line on Friday. There are touches on the trend line at 119.425 (4/16/13), 120.400 (4/22/13), and 121.675 (5/01/13). The Trend Seeker (a US Chart Company tool to help identify market trend) is Neutral, with a Bearish ranking. The MACD, a trend indicator, is bearish, but below the baseline and rising. Until the Trend Seeker changes to a Downtrend, there is no entry trigger. Perhaps it will take the contract to trade through a recent low of 121.675 (5/01/13). A potential sell entry could be on a retracement to the upward sloping trend line. Potential stop losses can go above recent resistance, the high of 124.550 (4/01/13). A potential downside target is the twelve month contract low of 119.375 (4/15/13).

dd-bts1

July 2013 Coffee

Coffee futures continues its sideways trading action since mid-March. The July 2013 contract’s Channel Formation is defined by the high of 144.50 (4/22/13) and the low of 132.70 (4/29/13). The Trend Seeker (a US Chart Company tool to help identify market trend) is Bearish, with a Weak ranking. The MACD indicator is bullish, below the baseline. Perhaps the market has finally made its low after selling off the past year. A 20-day Exponential and 50-day Simple Moving Average are converging. The same is happening with the Stochastic indicator. A close above the top of the Channel, with Trend Seeker changing to an Uptrend and other technical indicators agreeing, will trigger an entry to the upside. If the market continues selling-off, than a close below the bottom of the channel, with the technical indicators agreeing, will trigger an entry to the downside.

dd-bts2

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The “GBE Trade Spotlight” is a complimentary service based on the GBE trading methodology designed for you to leverage the knowledge, skills, and experience of Daniels Trading. Receive trade setups, trade recommendations, and trade management emails when you sign up for the GBE Trade Spotlight Advisory newsletter!

Additional Disclosures
STOP ORDERS DO NOT NECESSARILY LIMIT YOUR LOSS TO THE STOP PRICE BECAUSE STOP ORDERS, IF THE PRICE IS HIT, BECOME MARKET ORDERS AND, DEPENDING ON MARKET CONDITIONS, THE ACTUAL FILL PRICE CAN BE DIFFERENT FROM THE STOP PRICE. IF A MARKET REACHED ITS DAILY PRICE FLUCTUATION LIMIT, A "LIMIT MOVE", IT MAY BE IMPOSSIBLE TO EXECUTE A STOP LOSS ORDER.
Filed Under: Beyond the "Spotlight", Market Analysis, Trading Tips Tagged With: , , , , , , , ,
April 22, 2013 by Leave a Comment

Beyond the “Spotlight”

For the Week of April 22, 2013

The GBE Trade Spotlight advisory service applies the GBE trading methodology (buying or selling commodity contracts based on breakouts of chart formations and technical indicators) to identify one to two trade setups per week.

Highlighting This Week’s Potential Breakouts:

June 2013 Japanese Yen

Since September 2012, the Japanese Yen market has been selling-off with only short-term retracements. Establishing a new twelve month low at 1.0008 on April 11th, the market retraced to 1.0383 (4/15/13), only to roll over once again. The Trend Seeker (a US Chart Company tool to help identify market trend) is in a Downtrend; a close below the twelve month contract low will trigger a Hi-Lo breakout entry. The Hi-Lo Breakout is entering a market after a close above (or below) a twelve month contract high (or low). The MACD indicator agrees with the Trend Seeker. The contract is also trading below both a 20-day Exponential Moving Average and 50-day Moving Average. The Stochastic indicator is bearish, just below the “Over Sold” line. There is favorable Momentum with an ADX reading of 22.04. A stop loss above the recent retracement (1.0383) may be too steep of risk, but that would be the natural level of resistance. A potential target could be 0.9657, using a Wave Projection.

July 2013 Kansas City Wheat

The July 2013 Kansas City Wheat contract has found support along a lower trend line, There are touches at 711’4 (4/01/13), 735’2 (4/15/13), 735’4 (4/16/13), and 742’0 (4/19/13). The Trend Seeker (a US Chart Company tool to help identify market trend) is Down but the ranking is Weak. If the market takes out a recent high of 763’0 (4/12/13), this would trigger an Momentum Entry Technique. Although, the Trend Seeker must change to an Uptrend before working an open order. It may take the contract to take out the high of 783’4 (3/28/13) for the Trend Seeker to change. The MACD indicator is already bullish, below the baseline. The Stochastic indicator is also bullish, below the “Over Bought” territory. A 50-day Moving Average is converging on a 20-day Exponential Moving Average. This is evident by a current sideways trading market. The Momentum is currently down. The ADX indicator reads 16.56. Perhaps on the breakout, Momentum will increase, setting up good follow through.

August 2013 Feeder Cattle

The August 2013 Feeder Cattle futures contract is setting up for a Hi-Lo Breakout trigger. A close below the twelve month contract low of 145.25 (3/20/13) will trigger an entry to the downside. An aggressive trade opportunity is using the Momentum Entry Technique to place an open order taking out the contract low, instead of waiting for the close below. The MACD indicator is bearish, below the baseline. The Stochastic indicator is also bearish, in the “Over Sold” territory. Momentum is high, with an ADX reading of 29.64. A stop loss can go above the recent retracement at 148.025 (4/17/13). A potential target could be 138.850, using a Wave Projection.

Subscribe to the GBE Trade Spotlight!

The “GBE Trade Spotlight” is a complimentary service based on the GBE trading methodology designed for you to leverage the knowledge, skills, and experience of Daniels Trading. Receive trade setups, trade recommendations, and trade management emails when you sign up for the GBE Trade Spotlight Advisory newsletter!

Additional Disclosures
STOP ORDERS DO NOT NECESSARILY LIMIT YOUR LOSS TO THE STOP PRICE BECAUSE STOP ORDERS, IF THE PRICE IS HIT, BECOME MARKET ORDERS AND, DEPENDING ON MARKET CONDITIONS, THE ACTUAL FILL PRICE CAN BE DIFFERENT FROM THE STOP PRICE. IF A MARKET REACHED ITS DAILY PRICE FLUCTUATION LIMIT, A "LIMIT MOVE", IT MAY BE IMPOSSIBLE TO EXECUTE A STOP LOSS ORDER.
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April 12, 2013 by Leave a Comment

Technically Speaking: Markets you should be watching RIGHT NOW!

June mini-SP

I am looking to take a shot at the downside of the stock market via a put spread. I think traders would very much like to see 15,000 print in the DOW (1600 in SP) and then their attention will move elsewhere. There is no question we have been on a unbelievable run here as of late. But in my opinion, we are due for a correction. I am willing to step in here while we are trading at 1590-ish. We will need to get a bit closer to 1600 to get the price I am looking for. Not a bad idea if you are looking to protect recent gains in your stock portfolio during the next 72 days.

June mini-SP 1580 / 1540 put spread:

Buying the June 1580 put
Selling the June 1540 put

Premium of 10 points to the BUY side     (GTC)

Risk will be the cost of the spread …($500.00 plus trading costs)

OBJ will be a close below 1540.00 on expiration on June 21st … $2,000.00 (minus trading costs)

Have a look:

june-sp

Follow the Moves of a Technical Trading Pro

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Additional Disclosures
WHEN INVESTING IN THE PURCHASING OF OPTIONS, YOU MAY LOSE ALL OF THE MONEY YOU INVESTED.
STRATEGIES USING COMBINATIONS OF POSITIONS, SUCH AS SPREAD AND STRADDLE POSITIONS MAY BE AS RISKY AS TAKING A SIMPLE LONG OR SHORT POSITION.
Filed Under: Cullen Outlook, Trading Tips Tagged With: , , , , , ,
April 11, 2013 by Leave a Comment

What Does the Miami Heat Win Streak Have to Do with Spread Trading?

As many basketball fans may know, the Miami Heat recently had a 27 game winning streak, which was the 2nd longest winning streak in NBA history. It ended on Wednesday, March 27, 2013 when they visited my Chicago Bulls in a game that a lot of folks thought the Heat should have won easily.

The Chicago Bulls were set to play the game without their superstar Derrick Rose, All-Star center and arguably the heart of the team, Joakim Noah, shooting guard Rip Hamilton and shooting guard Marco Belinelli.

The Heat, lead by LeBron James, Dwayne Wade and Chris Bosh, was at full strength and playing like a well-oiled machine.

So why am I mentioning this on a futures trading blog?

Good question. The point spread on this Heat vs. Bulls game was -5, meaning that the Heat were favored by 5 points. Because the Bulls were missing key players and Miami appeared untouchable throughout their win streak, many in the sports gambling world thought the Heat would win by much more than 5 points. Indeed, they viewed this 5 point spread to be inaccurate and believed that it should be much larger.

To be clear, I’m not comparing gambling on a basketball game to futures trading. Rather, I intend to use the point spread for the Bull vs. Heat game for educational purposes, because the concept of a point spread in this basketball scenario is similar to spread trades in futures. Unquestionably, futures trading is more sophisticated, and when investing in futures and options you can lose more money than you initially invested. Further, you should carefully consider whether such trading is suitable for you in light of your circumstances and financial resources.

So let’s look at the spread between two contracts (teams) in Heating Oil, December (the Heat) versus July (the Bulls). On March 12, 2013, the price of a December Heating Oil futures contract was 3.0631, the price of July was 3.0181. As such, the spread, or difference in price between the two contracts, was .0450.

This is a summer vs. winter spread. In Heating Oil, quite naturally, the consumption is greatest in the winter month, and as a result the market often builds a premium into the December and nearby contracts relative to other months. So in this spread a trader would buy December.

As for the short contract, July, this one tends to stay under pressure, relatively speaking, given reasonable supply. Strong demand for gasoline in the summer means that heating oil, essentially the by-product of gasoline is plentiful. More supply means that there will be lower prices, so a trader would sell July.

On March 12, the spread between December and July is at .0450. Based on our understanding of fundamental knowledge in Heating Oil, we recognize that the spread is too big and should be smaller. This is a lot like how many folks thought the Heat would beat the Bulls by more than 5 points leading them to place their money on the Heat.

Thanks to some tough defense, great shooting and superior coaching, the Bulls bullied, outworked and beat the Heat 101 to 97. So the Bulls wound up covering the spread by winning outright by 4 points.

As of March 31, the July Heating Oil contract did the same thing and outpaced the December to the downside in price, since we put our spread on.

Initially trading at 3.0631, the price of July Heating Oil dropped to 3.0280, and since we shorted July, this was a positive $1474.20 move for the spread. Conversely, we went long December, which initially traded at 3.0181 and dropped only to 3.0124 during this time period, which resulted in a $239.40 move against the spread. The spread between the two contracts narrowed to .0156 (3.0280 – 3.0124) and resulted in a successful trade to the tune of $1234.80 ($1474.20 – $239.40).

Hopefully the concept of a point spread in this basketball scenario has shed some light on how trading a futures spread can be similar. Don’t forget though that there is substantial risk of loss in trading futures and options. December did not outpace July to the downside making our trade a winner. The Heat did not outgain the Bulls on March 27, 2013, resulting in a loss for folks putting their money on the Heat and a win for the Bulls.

Go Bulls!

Additional Disclosures
STRATEGIES USING COMBINATIONS OF POSITIONS, SUCH AS SPREAD AND STRADDLE POSITIONS MAY BE AS RISKY AS TAKING A SIMPLE LONG OR SHORT POSITION.
Filed Under: Trading Tips Tagged With: , , ,
March 27, 2013 by Leave a Comment

Tax Advantages of Futures Trading

As we are all aware, tax season is now upon us and I am sure everybody could use some relief from the tax man, so what better time to learn about the tax advantages of futures trading!

Most experienced traders may understand the differences between trading stocks versus futures and the benefits each offers depending on the trader’s goals, but very few traders understand the tax differences between the two trading avenues. For short-term traders, you may be interested to know that the tax benefits of futures trading are outstanding!

What are the tax differences of futures over stocks, you ask? While stocks are taxed at the 35% short-term capital gains rate for positions held less than a year, futures are taxed 60/40. This means that while 40% of your gains in futures trading is taxed at the same 35% rate as short-term stock trading, 60% of your gains are taxed at the long-term capital gains rate of 15%! That is a total of 23% (60% x 15% + 40% x 35%) difference in tax rate! Something that is very important to consider when deciding which markets to allocate your capital to!

To better visualize the tax advantages of futures trading over stock trading consider the following simplified example of Trader Joe. Trader Joe enjoys day trading silver futures contracts and Apple stock. Trader Joe ends the year with profits equaling $10,000 from his silver trading. In addition to Joe’s silver trading, let’s consider that Joe coincidentally captures profits of $10,000 on his Apple trading. Come tax season, while Joe will be paying $3,500 (35% x $10,000) in taxes on his profits resulting from Apple stock, he will only pay $2,300 [$1,400 = ($4,000 x 35%) + $900 ($6,000 x 15%)] on his profits resulting from silver futures trading. It gives Joe comfort that he has retained more of his profits trading silver futures!

It may also be comforting to know that you are not limited to simply trading commodities in the futures markets, such as gold, oil, and grains, but have access to the stock market as well. The futures markets offer access to all of the major stock index markets including the S&P 500, Nasdaq, and Dow Jones Industrial Average. The futures markets also allow you to choose your leverage using large contracts for the trader with a higher risk tolerance to the beginner interested in minimizing his/her risk with mini contracts. Ultimately, the futures markets offer many avenues and benefits that may fit into your financial goals that you are not even aware of.

To learn more about the tax advantages and the many benefits futures trading offers I encourage you to contact Daniels Trading toll-free at 1-800-800-3840 and speak to a broker.

To learn more about the tax benefits of futures over stocks please speak with your tax consultant.

Additional Disclosures
THE RISK OF LOSS IN TRADING COMMODITY FUTURES AND OPTIONS CONTRACTS CAN BE SUBSTANTIAL. THERE IS A HIGH DEGREE OF LEVERAGE IN FUTURES TRADING BECAUSE OF SMALL MARGIN REQUIREMENTS. THIS LEVERAGE CAN WORK AGAINST YOU AS WELL AS FOR YOU AND CAN LEAD TO LARGE LOSSES AS WELL AS LARGE GAINS.
Filed Under: Trading Tips Tagged With:
June 8, 2011 by Leave a Comment

Occam’s Razor and Futures Trading

Over the weekend I got an email from a trader who follows the Taylor Trading Technique as he learned from Linda Raschke.  Linda’s version of the Taylor Trading Technique is the basis of my Swing Trader’s Insight futures advisory service.

The trader asked me whether I use indicators for trading with the TTT and whether I recommended their use (Linda has shown using a moving average oscillator, ADX and ROC among others).  As I was writing a response to him I saw a blog post about applying Occam’s razor to trading.  I am a big proponent of the “simpler is better” school of trading so I thought I’d explain my take on simplifying your trading strategy.

William of Ockham

The theory of “Occam’s Razor” is attributed the English monk and logician William of Ockham.  He lived in the late 13th through mid-14th Century.  Although there’s no specific writing of Occam’s razor attributed to him it is commonly accepted that he developed it.

Occam’s razor is said to be the maxim that assumptions introduced to explain a thing must not be multiplied beyond necessity.  Another way of putting it is to choose the hypothesis that makes the smallest number of assumptions when hypotheses are equal in other respects.

How does this apply to trading?  In myriad ways it argues to simplify your trading.  This means fewer inputs to your trading decisions.  It could be a smaller number of indicators, less tweaking (curve fitting) of the ones you use, or paying less attention to fundamental factors.

How can you use the Occam’s razor principle?  For some it may be the trading process itself – cleaning your trading space, reducing your inputs while trading (news wires, TV, trade rooms) or trading fewer setups.

For me that’s where the Taylor Trading Technique comes in.  The TTT has a limited use for indicators and I find they can almost always be secondary to the price chart itself.  You may use an indicator to determine where a market appears to be in the TTT cycle but you can stay with price action itself to make trading decisions.  Doing this can allow you to trade off price itself, not more complicated derivations of price.  Understanding the physics of riding a bicycle doesn’t help you get out and ride a bike.

Letting go of complex solutions can be tough for a trader.  Trading is a difficult endeavor, and I think it’s human nature to assume that a difficult problem has to have a complex answer.  There’s also a belief that a trading system can be tweaked or fine-tuned to “solve” the puzzle of trading.  In reality, complicated systems tend to obscure the essence of trading, that trading isn’t “You against the markets, it’s you against you” (to borrow a saying from Ed Seykota).  Occam’s razor may allow you to employ a more robust system that will stand the test of time and give you better market and self mastery.

© 2011 Scott Hoffman

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March 9, 2011 by 2 Comments

Effective Habits of Successful Traders: Keeping a Trade Log

Do you keep a trade log recording your risk/reward parameters, results, expectancy, and other important statistics for each trade you make?  If you answered no, do you experience inconsistent results and regular draw downs in your account?  For most, this is not a coincidence.  Trading without a trade log is analogous to finding your way out of a desert with no map or compass.  At best, it is a struggle.  At worst, you never make it out alive.  Your trade log is your map guiding your trading by effectively evaluating your strengths and weaknesses to help you reach your goals.  Your compass is your “trading framework”, something that will be covered at another time.

How Do You Evaluate Your Trading Performance?

Your trade log supplies you with the cold, hard numbers of your trading.  It is a very important tool in trading yet few traders actually “keep their stats”.  On the surface, it does not seem like such a big deal.  However, a trade log does more than just list your numbers.  It gives you the capability to honestly evaluate your trading performance so you can understand your strengths and weaknesses.  Do you even keep a list of your strengths and weaknesses as a trader?  If not, how do you know what you need to improve?  The trade log is the beginning of this process.  In my opinion, it is equally important that you understand what you do well (so you can keep doing it) and recognize your flaws (so you can improve).  All traders make mistakes, but the good ones are able to contain them so they do not incur serious damage to their accounts.  Poor traders tend to compound their mistakes, which result in heavy drawdowns and uneven or inconsistent results.

Some examples of poor trading include:

  • Incorrect position sizing (the size traded e.g., 1 contract vs.  10 contracts)
  • Poorly or undefined risk (the amount you decide to risk before the trade is on)
  • No real plan to exit the trade (what are your objectives with the trade?)
  • Trading in a market without understanding the market type (up, trending market vs.  down, volatile market)
  • Averaging-down (adding to losing positions hoping they will “come back”)
  • Mental errors (e.g., changing the plan once in a trade)

Unless you are able to identify your errors and begin minimizing and eliminating them, there is no way to improve as a trader.

The most important trait for a trader to possess is the ability to take responsibility for his or her actions and their subsequent results in the trading account.  As a trader, you are solely responsible for what happens when you trade.  If you cannot take responsibility for your actions, you cannot accept that you need to change your trading.  Keeping a trade log will help you to take responsibly and make appropriate changes to improve your trading.

Benefits of Keeping a Trade Log

Keeping a Trade Log Establishes Discipline
Winning traders have excellent discipline.  They have a reason for getting in and more importantly, they have a reason for getting out.  Poor traders typically trade indiscriminately and “overtrade” or make too many bets.  This is a major mistake that leads to losses and can leave traders emotionally off-balance.  Once you start logging trades, you’ll be thinking about why you’re taking trades and how to construct them versus trading indiscriminately.

A Trade Log Allows You to Objectively Evaluate the Numbers
You’ll figure out quickly whether you are doing things right or not.  Winning traders enjoy reviewing their “stats” because it’s rewarding to follow your style and make trades you feel good about.  Poor traders have a tough time keeping their stats, let alone reviewing them.  It isn’t psychologically pleasing to review losses and think about lost money but you can’t effectively evaluate your trading without keeping the numbers.

Below are some critical trading statistics you should be tracking in your trade log:

  • # of Trades
  • Win Ratio
  • Loss Ratio
  • Unit Risk
  • Unit Reward
  • Expectancy
  • Trade Map
  • Distribution Chart

A Trade Log Helps You Determine Your Weaknesses as a Trader

Are you too risk-averse?
These traders keep stops too close and get stopped too often.  This means you are keeping stops within normal ranges of volatility.  This is frequently seen in day-traders who keep stops far too close and are regularly stopped out.  Many traders like this are under the guise they are managing their risk effectively when they are bleeding to death by a 1,000 cuts.  Worse, these types typically take profits too early because they are unused to them and “want to lock in profit”.  Their win/loss ratio doesn’t match the magnitude of their winners and losers.  Lots of small losers with even smaller winners equal consistent drawdowns.

Do you wing it?
These traders have no plan and simply throw around trade ideas with no real idea or understanding of why they’re doing it.  They will occasionally hit winning trades, even big winning trades, but they are capable of giving it right back to the market.

Do you use poor position sizing strategies?
Are you betting too much and taking on too much leverage in losing trades?  Are you too conservative with winning trades?

Do you ride losers?
These kinds of trades start out normal but turn against you at some point.  These traders typically do not have specific exit stops and limits.  When the trade starts going sour, the losses multiply and the trader’s psychology changes.  The idea of a winning trade turns into a position that one can only “hope” to come back to even.  The losses multiply and the trader digs his or her heels in.  Margin calls are met and then met again.  A once annoying trade has now snowballed into heavy losses.  Eventually, a large and unnecessary loss is taken.

A Trade Log Also Helps You Determine Your Strengths

Do you take contained losses and understand why you lost?
Paradoxical to conventional thought, successful traders take losses, but they are defined and manageable losses.  More importantly, when you take a loss, you should strive to understand why you lost.  Was it a poor entry or exit because you were emotionally compromised?  Was it poor risk management while the trade was on?  Was a significant technical level broken?  Did the market unexpectedly get volatile and your trading strategy simply didn’t fit the environment anymore?  The point is, if you identify why you lost, you can improve your trading.

Do you utilize appropriate position sizing strategies?
Successful traders fully understand the concept of leverage in futures so they know when to use it and when not to use it.

Have you developed a framework for your trading?
Successful traders use a methodology or a way to perceive or give context to what is they believe is happening in a market.  Are you a systematic trader using certain technical rules to govern your trading (e.g., a simple moving average(s) crossover)?  Are you a rules-based discretionary trader using specific rules for order entry and exit?  Are you a discretionary trader who has no real rules over the long haul?  Successful traders tend to be systematic or rules-based discretionary traders.  Most average traders are discretionary traders, thus, they are losing traders.

There are many trading concepts we have just covered and all of them relate back to keeping a trade log.  Let us examine the trade log to see how we set it up and use it.

How to Setup and Utilize a Trade Log

To start, download my sample trade log so you can follow along.

Trade Log Format
The table formatting is as follows:  contract traded, buy/sell, entry price, exit price, risk (in $), per unit risk, reward (in $), and per unit reward.  You will notice that this trader begins trading with $25,000 in her account and decides her per unit risk is $500, or 2% of the account opening balance.  Per unit risk and reward is a very important concept in trading.  You’ll notice with this trader, the most she is willing to risk going into a trade is 2 units of risk (2R or $1,000).  This trader did an excellent job of containing losses as she stuck to their plan of never taking losses bigger than 2R.  On the other side, the trader is able to put herself in a position for a reward greater than 2R.

The statistics of the trade log give you very important data

  • Number of Trades:  How many do you make?  Do you have a pre-defined plan for each trade or are you winging it?
  • Win/Loss Ratio:  Winning 30% of your trades versus 50% will impact your risk/reward ratio is needed to successful over the long-haul.
  • Winning %:  What is it?  If you are able to have winning trades 60% of the time, you can have smaller average winning trades versus someone with a 30% win rate.
  • Losing %:  What is it?  This is the flipside of the winning percentage as seen above
  • Scratch Trades %:  Do you even take scratch trades (trades that net you nominal gains/losses)?
  • Average Winning Trade:  What is the magnitude of your average winning trades?
  • Average Losing Trade:  What is the magnitude of your average losing trades?
  • Distribution Chart:  I recommend viewing each trade on a “distribution chart” to look beyond the “averages”.  This is composed of R-multiples on the x-axis and the number of each winning/losing trade on the y-axis.  This gives you a visual representation of your trading results.
  • Trade Map:  Lists each trade with defined buy/stop loss and stop before trade is even entered.  This helps you learn to define your risk and think about objectives for the trade.  This is where you will outline your risk management plan for the trade, when and where you move stops and why.  See an example of a “Trade Map”
  • Expectancy of your trading:  For every 1R ($500 in this example) of initial risk you take, how much do you get back?  In example provided, it would be +.86R or $430.  If your “R-number” is negative, you will lose money over the long-haul.  If your “R-number” is OR, you are a break-even trader.  And if you have a positive R, you are a winning trader.  Keeping this our example of 1R equals $500, an expectancy of -.25R means you will lose $125 for every $500 of initial risk taken.  If the expectancy is 0R, it means you’ll return $0 for every $500 you risk.  A positive expectancy is what every trader strives for.  A positive expectancy of .4R means the trader will return $200 for every $500 risked.

As you can see, a trade log is a valuable tool needed for successful trading.  It will begin to shine light into your trading habits and the forces you to evaluate your trading decisions.  Over time, you will learn the “expectancy” and distribution of your trading.  If you find that you do not like your results, you must be willing to evaluate your trading in an honest light and begin making the necessary steps to improvement.  The trade log can immediately impact your trading and your bottom line, so I encourage you to make it an integral part of your trading.

I invite all feedback and questions below or directly at 312-706-7649 (toll-free 877-224-1953) or via email at Tim Chilleri.

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February 10, 2011 by 5 Comments

Effective Habits of Successful Traders:  Why Do I Trade?

Why do I trade?  It’s a simple question, yet the vast majority of traders have not outlined why they trade.  How much time have you spent thinking about it?  Have you ever written down why you trade?  If you haven’t, how do you know what your true motivations are?  Have you sorted out what your objectives are?  These are critically important questions you must answer to begin employing effective trading habits.

The journey begins by examining the reasons why you trade and what your objectives are.  Do you trade make money?  Do you trade for the challenge?  Are you bored and want to pass time?  Do you seek the adrenaline rush of the unknown?  Do you want to spend time by yourself?  There are many reasons that people take on the challenge of trading, and your motivations will help determine how you will trade.  They will form your habits and dictate what kind of trader you must become to fulfill the objectives you have.

Why Trading Programs Fail

The vast majority of “trading programs” try to teach you a method or system as if it suits every trader’s personality and objectives.  This canned approach has it backwards.  You must determine who you are and your objectives to have a style that fits you – not a style that is taught as “the golden system”.  Because programs and methodologies are often not matched to the individual trader, the trader opens an account, loses money and then blames the system or program he or she learned.

As a broker, I have countless conversations with traders who are “searching for a new strategy” or “seeing what else is out there”.  Yet, I rarely hear traders discuss that they are working on understanding themselves as a trader.  Trading is an extension of who you are and how you view markets.  If you are very risk adverse, you’re going to need to develop a style where you can risk small amounts of equity while still fulfilling your profit objectives.  If you want to take on risk because you like to gamble, you’re going to have strategies with higher leverage ratios and open risk during trades.  If you prefer taking long-term bets and building large positions, your risk management is going to be significantly different than a day-trader looking to pick up several points on each trade.  Recognizing who you are as a trader helps you determine how you will develop your strategy and risk management techniques.

Understand Your Motivations and How They Affect Your Trading

By understanding your motivations, you will immediately identify why you make many of the trading decisions you do.  For example, if you need to have positions on, it means you’re trading for the thrill of it, the adrenaline.  The root of this motivation to trade has nothing to do with the markets – the markets simply offer an outlet for you to achieve the adrenaline rush.  Here is another example, if you trade fairly well but get impatient and lapse into phases where you take on more contracts than you normally would, this could mean you’re trying to make money quickly, which is never a good trading strategy.

If you are unable to recognize your true objectives for trading, it is extremely difficult to fulfill them!  It means you are likely capable of making decisions that, in retrospect, are very foolish.  I sometimes hear traders say, “I just don’t know what got into me” or “I just wasn’t thinking”.  I believe what they are really trying to say is, “how did I let that happen?  I didn’t even know I was capable of that.” They didn’t know they were capable of it because they don’t know what’s truly motivating them.

Trading will challenge you to make high pressured decisions while under stress.  Your body will instinctually react by letting blood flow from your brain to your body as it thinks it is a “fight or flight” response.  This cuts blood flow to your brain making it more difficult to process information and think clearly.  As such, you need to understand yourself well so you will not let the stress of a situation affect your ability to think clearly – you know why you trade and you have a plan in place.  This is the level successful traders achieve.

The Difference between Successful Traders and Unsuccessful Traders

Let’s contrast reasons for trading from unsuccessful and successful traders.  When I ask the average trader why they do this, I almost immediately and overwhelming hear “for the money of course!” I typically hear an air of dismissal as they are almost shocked I asked.  They believe this is not only the most important reason for trading, they believe it’s the only reason!

What you’re about to read may shock some of you but here it is:  if you solely trade to make money, you are ensuring your demise.  How can this be true?  I believe this because most people who try to only “make money” have a skewed sense of reality in the markets.  It is so utterly important to make money and never have losses to them, that they develop terrible habits that lead them into many losers.  The most common example (and something way too many average traders do) is enter a position and see what happens.  Many times, the trade will begin losing money.  So what do they do?  They sit and wait for the position to “come back”.  Their initial trade idea transforms from a money-making venture into a place where they hope it comes back enough for them to at least break even.  They are so overwhelmed by seeing a negative (red) number that they surrender control to it.  Sometimes the trade does come back and their “hold on and hope” process is validated.  This only makes the situation worse as this becomes a habit.  That is, until the trade doesn’t come back.  When the trade doesn’t come back, losses mount and margin calls are met.  A once average trade is now terrorizing your account.  You’re paralyzed as the trade is overwhelming you.  Finally, the position is liquidated for a massive loss.

Successful traders understand that there are times where it makes sense to exit a position for a loss in order to preserve capital.  They are not attached to their position because they understand they are simply using a financial instrument to achieve their objectives.

There are several variations to the scenario above.  For example, traders add to their position “averaging down”.  Again, they look brilliant when the trade comes back.  But the one time it doesn’t (and the day always comes sooner or later), massive losses are taken.  Legendary trader Paul Tudor Jones said it best, “Losers Average Losers”.  Another example is day-traders indiscriminately trading for no reason other than “trying to make money”.  I hear it frequently, “I just want to make $X a day doing this”.  If this is your reason for trading, I highly recommend you stop, close your account, and never look back.

At the core, most average traders associate successful trading with never taking losing trades.  By having specific risk parameters before putting on a trade and acknowledging that you need to take losing trades in order to achieve your objectives (whatever they are), you manage your risk more effectively.

Are you beginning to see how trading “to make money” doesn’t necessarily make the most sense?  This process leads you into making poor decisions and forming habits that will create misery in the markets.  Thus, you need to start thinking, why do I trade?  Is it just about the money?  If so, what kinds of decisions am I capable of making?  Why else am I doing this?  Do I like learning and gaining experience in the markets?  Would I do this activity if there wasn’t potential profit from it?

How does this compare with successful traders?  Typically, most successful traders possess “self-awareness” and have a thorough understanding of themselves and why they trade.  I typically hear successful traders discuss their trading in terms of:

  1. The Challenge:  Trading is hard and requires significant attention to detail.  This detail is both inner (my psychology) and outer (the markets).  While I understand that the market is a designed to fool and frustrate me, it gives me a landscape to construct and bet on price changes.
  2. The Fun:  I just cannot think of a better way than spend time following and thinking about markets.  It is an ever-changing and evolving landscape that forces me to be adapting all the time.
  3. The Game:  Trading is a three-dimensional, real-life game that results in real-life financial consequences.
  4. The Freedom:  Trading gives me a venue to exercise a limitless set of ideas.  I love the freedom I am given with in my trading world.  I trade when I want and how I want.  If it isn’t fun, I simply walk away from the markets because I know they will be there when I decide to come back.
  5. The Self-Responsibility:  Trading gives me a place where I and I alone are responsible for my trading results.  I take pride in how I act and do not blame others for my financial misfortunes.
  6. The Competition:  Trading is me versus the market, an amalgam of all characters from every corner on earth.  I compete against hedge fund managers, professional proprietary traders, farmers and amateurs like architects, doctors, MBAs, athletes, and students.
  7. The Money:  If I’m playing the game like I should, my reward is money. While I may have started trading “purely for the money”, it has evolved into something more.  I can trade full-time or supplement my income with trading.

There are many reasons for trading – some of them constructive, some of them not.  At the end of the day, it is about understanding yourself and your motivations.  I highly recommend taking time to actually write down your reasons for trading and review them often.  When you do, you’ll find yourself making clearer and smarter decisions since you have developed an “awareness” of yourself and why you participate in the markets.  As time goes on, your reasons may change, so it’s important to keep it up to date.  Taking time to complete this exercise is the beginning to better understanding yourself as a trader.  I believe you’ll find trading more enjoyable as you have outlined why you do it and what you want out of it.

Filed Under: Getting Started, Trading Tips Tagged With: , , ,
November 18, 2010 by 1 Comment

Dollar Cost Averaging: Jim Cramer vs. Dennis Gartman

This post is part of Craig Turner’s Innovative Trading Concepts series.

Jim Cramer vs. Dennis Gartman

Two of my favorite financial commentators are Dennis Gartman and Jim Cramer.  Say what you will about them (and I’ve read criticism about both), but they are well respected, successful traders that everyone can learn from.  One issue I have seen in blogs and message boards is there positions on “averaging down” or “adding to losing positions.”  While their approach to this issue differs, I think in the end they are doing the same thing, but just going about with different styles of trading.

“Never Add to a Losing Position” – Dennis Gartman

Dennis Gartman is a big believer in “never add to a losing position”.  Dennis Gartman comes from a commodity futures trading background, and this makes perfect sense.  If he wants to get long gold at $1400, then he will be long a $140,000 Gold futures contract ($1400/oz X 100oz = $140,000 Gold).  When he gets into a position, either that contract is going to hold those support levels and start going up, or he wants out.  He might get in due to technical or fundamental analysis, and if he is correct, he wants the market to tell him so.  If he is wrong, he is happy to get out with a small loss, which could be a break below the nearest support lines.

It makes sense to trade this way in commodity futures because of the leverage being used.  When you are trading on margin and leverage, the gains (and losses) can pile up fast.  Plus you can’t buy gold $25K at a time; you have to commit to the full value of the commodity futures contract.  For Gartman, $140,000 of Gold is the minimum amount to play and that is where he will start.

The Jim Cramer Method

Jim Cramer is primarily an equities trader and tends to buy his positions in 4 or 5 trades.  It is easier to do this in stocks because one share is typically under $100.  Let’s say Jim Cramer wanted to have an initial position of $140,000 in Ford when it is trading at $14.00/share.  That is 10,000 shares of Ford.  For that kind of size, you most likely have to split it up into 4 orders of 2,500 shares.  Plus, Jim Cramer is a fundamental expert and he might have a price range for Ford between 13.50 and 14.50.  He might buy his first 2,500 shares at $14.00 and wait to see what happens.  If it goes down to 13.75, he will buy 5,000 shares, and then pick up the last 2,500 on the next break or if it rallies back to 14.00.

Now, if the stock breaks below $12.50, he might be ready to get out and just take a loss if he thinks it is a bad trade.  One thing I don’t think Jim Cramer is doing is “averaging down” a loser.  I think he has a very strong opinion on where the market should be fundamentally, and he knows the market can go up and down based on news and events unrelated to the stock he is buying.  That reason, combined with the size of his purchases, probably makes it more efficient for him to buy his positions in multiple trades.

The most important thing to note is that Cramer is not getting into a full position and then buying a dollar lower and doubling up.  He commits to the size he wants in terms of shares and works the order for a few days.  If it loses too much value, he gets out.  He will also buy more as the price goes in his favor, a technique that Dennis Gartman also employs.

The confusion I see on the blogs and message boards is that Jim Cramer is averaging down losers.  However, what Cramer is really doing is defining a full position and then buying that position in 4 or 5 equal parts.  The dollar cost average exists because he breaks up his buys for the initial position, not because he is doubling up due to the market is going against him.

Cramer & Gartman Risk Management

Dennis Gartman and Jim Cramer may have different trading styles, but their risk management is the same.  They take small losses.  If something is not working out, they get rid of it.  They don’t throw good money after bad.  Dennis Gartman, being so involved in futures, is probably the more risk adverse of the two, and that is mostly likely due to the leverage used in futures when compared to stocks.

In the end, it doesn’t matter which method you use, as long as you have a risk management plan to limit the size of your losing trades.  Both Jim Cramer and Dennis Gartman recognize the importance of this trading practice and do their best to follow their own rules.  Traders need to find a style of risk management that fits their trading and investing styles, just like Cramer and Gartman have.  If you want to be a successful trader, make sure you always know the size of the position you want and the risk you are willing to take before you initiate the trade.

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Filed Under: Getting Started, Risk, Strategies, Trading Tips Tagged With: , , , , , , ,