Kenny Rogers’s song The Gambler held, in my opinion, some of the most succinct trading advice ever penned. This was his advice:
“If you’re gonna play the game, boy, ya gotta learn to play it right.
You got to know when to hold ‘em, know when to fold ‘em,
Know when to walk away and know when to run.
You never count your money when you’re sittin’ at the table.
There’ll be time enough for countin’ when the dealin’s done.
Ev’ry gambler knows that the secret to survivin’
Is knowin’ what to throw away and knowing what to keep.
‘Cause ev’ry hand’s a winner and ev’ry hand’s a loser,
And the best that you can hope for is to die in your sleep.”
Many years ago, I had a friend who was a professional card player. One day, I went to a card room to watch him play. Before entering the building, he said, “The most important thing to remember is that you never bet any real money unless you have “The Nuts””, and “Never bet the house”. I proceeded to watch him throw a hand or two here and there, but would clean the table when the cards came. We walked out a couple hours later, he being much richer and me being much wiser.
In the book Market Wizards by Jack Schwager, I was not surprised to find that several of the “Wizards” were once professional gamblers. Over the years, I have found that successful trading is based upon gaming theory and management principles.
Over time, I adapted Poker Logic for my Hotlines and trading. The Poker Logic gave me some basic framework to work from, and it worked well for me.
Here are some of the rules and how we apply them:
- The trend is your first card. Is the long term trend up or down? If you are not sure, look at the chart and see where the market was six months ago, where it was three months ago and where it is today. Or, simply look at the 10 and 40 day moving average. If the 10 day average is above the 40 day average, then the trend is up. If the 10 day average is below the 40 day average then the trend is down.
- You now are looking for a consolidation breakout for your second card. The longer the consolidation, the higher the value. An example would be if a market had an uptrend that stalled for the past four to five weeks creating a Bull Triangle Pattern or a Head and Shoulders Pattern. A breakout of the Trend-line in favor of the longer term trend would be considered your Second Ace. Two Aces in your hand is a great time to start betting.
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.
- A breakout of the last pivot high would be considered your Third Ace. A pivot high is where the market has tried to rally, failed and then retreated. On a price chart, you will see the market rise above the past several days’ highs then is pushed back below those highs forming a high pivot. The sellers will be emboldened, believing the market is in a process of reversing. However, once a new rally eclipses those highs, many sellers will be forced to buy back their short positions, driving the market even higher. Thus, Three Aces are really hard to beat.
- A breakout to new contract highs or lows should be your Fourth Ace, and moving your stop appropriately should be your main concern. Your stop should be kept a few ticks below the most accelerated trend-line you can draw from the most recent pivots.
- Never count positive Open Trade Equity (OTE) as profit. Open Trade Equity is the amount you are ahead while the trade is open. Looking at OTE too closely can temp you to exit early, and may cost you a lot of money in the end. Profits should only be counted when the trade is exited.
- Stops should start below the last pivot. In an up market, you would use the most recent low pivot, and in a down market, you would use the most recent high pivot. Once the market has created a new Trend-line from the new pivots it is creating, move your stop up underneath the new Trend-line until stopped out.
- Never bet the farm. Use good money management. Never risk more than 5% of your account on any one trade and 10% of your account on any sector or related markets. I believe 1% to 2% Trade Risk with 6% to 8% Sector Risk is ideal. Also, one should consider sector correlations. Bonds and currencies are highly correlated as interest rates are a primary driver of currency values. Grain costs affect meat costs and so on.
- Know when to walk away. Never exit a trade unless the market tells you the party is over – for example, your stop has been hit or it is now going parabolic. A market usually goes parabolic after a trend has been in place for a considerable period of time. It will contain several days of significant gains or losses in the direction of the trend. It is the last of the participants who are on the wrong side of the market desperately trying to exit their positions at all cost. If a market goes parabolic, it is a great time to take your money and go home.
- Know when to run. When a shock hits the system like 9/11 or the Japanese Earthquakes, close your trades ASAP. You have no idea how the markets will react. When you do, it will be too late to do anything.
- Doing nothing is doing something. Waiting for a great hand is a good part of being successful. It is always better being out of a market wishing you were in, than in a market wishing you were out.
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