TRADING BUSINESS NOTES: REFERENCES; RULES; PLANS; STRATEGIES

FLEXIBILITY AND PATIENCE

(1) Flexibility in not being married to a particular view of the market, but being able to flow with the trend of the market. Listen to what the market is telling you by the actual price action.

(2) Flexibility in your choice of 'futures' strategies by not using ONE or TWO strategies that you like just because they were successful in the past. These strategies may be inappropriate for today's market.
 

What we are doing, therefore, is using 'flexibility' in working with what the market gives us, not 'forcing' a trade that we may like, but does not fit the current technical pattern in the futures pricing levels.
 

Patience can be summarized by not OVERTRADING, and waiting for the best opportunities. Overtrading tends to put too much pressure on us both emotionally and financially, forcing us to difficult situations if a market temporarily moves against us. Waiting for the best opportunities means that we will not buy a 'bull' just because the market is moving up.
 

TRADING IS A ZERO SUM GAME
 

This often maligned statement is quoted over and over again telling you for every loser there is a winner. The truth of the matter is that there are many more losers than winners. This is because all the costs for trading must be borne by the trader. The brokers, exchanges, all of their employees, regulatory agencies, and are all paid for by you (trader). Add to this the cost of a computer, publications, and software, and what finally happens is that for each trading dollar available at the end of the year an average of 15 to 20 cents is gone for expenses. This means that every year you must profit by this amount before you break even. This is not an easy task, and is another reason you should look for only the best positions that can give you a 'trading edge' over the markets.

MY PHILOSOPHY OF TRADING

My objective is to initiate trades that have either favorable risk/reward ratios or high probabilities of profit. I avoid initiating trades just because it is my opinion that the market is going up or down; I try to initiate positions that give me some kind of 'edge over' the markets through the characteristics available in 'futures'. This means that in buying 'futures' I prefer positions that have the potential for large rewards, while still keeping risk at manageable levels. When selling 'futures', I seek 'futures' that have high volatility ('overvalued' premium).

WHAT IS A 'TRADING EDGE'?

A 'trading edge' is using 'futures' only when you can obtain some 'advantage' form them. These advantages can take the form of positions that improve probability of profit, risk/reward, or loss control. This also includes strategies that allow for better money management, lessen the need to constantly predict the market or have precise market timing, and allow you to be wrong in your predictions of market direction and sometimes still profit.

This 'trading edge' through the use of 'futures' has the same objective as other systems or methods that have designed to give a trader an advantage such as trendline, stochastic, %R, Gann, etc. All are designed to improve your trading and give you a 'lead' over others.

THE ART AND SCIENCE OF TRADING
 

Trading 'futures' is both an art and science. The 'science' is becoming familiar with how a 'futures' work, time decay, expiration period, and volatility. The 'art' is having an insight on trading 'futures' that can only be gained by experience. This includes how to get the best prices for 'futures' orders in different markets, how to best use disparity in 'futures' pricing, and which 'futures' strategies work the best under various market conditions.

It is my goal to give you as many rules and concepts as possible to improve your knowledge in the area of 'science'. Unfortunately you must gain your 'art' experience on your own in actual trading. For this reason, it will always be best to trade as small as possible, for as long as possible. There will always be new opportunities in the market to take advantage of...unless you've lost your trading capital. 

THE 'FUTURES' TRADING PLAN

 

Before any trade is initiated several questions must be answered.
 

1. Where is the underlying market going (or not going)?
 

2. Is 'future' premium relatively high (signifying 'future' selling opportunities); relatively low ('future' buying opportunities); or is there a disparity in 'future' premium between different months or 'strike' prices presenting potential for initiation of 'future' strategies by purchasing undervalued and selling overvalued 'futures'?
 

Once these questions are answered we must then determined the most important question of all: is there a 'special circumstance' that provides us with a 'trading edge'?
 

We initiate trading positions only if a combination of these factors indicate that we can get a 'trading edge' over the markets.

What we do if only one elements is present? However, there was no option strategy available that would provide us with a 'trading edge' over these markets. Therefore, we recommend no trading position until a 'pullback' occurred. We prefer to wait until 'special circumstances' occur that provide us with our best trading opportunities. This might mean that we are not always in the market or might miss some opportunities, but we still prefer to be very choosy and pick only the best opportunities.

Just as in any other successful business, there is no easy way to do this work. No computer program yet has been programmed to be able to analyze all of these factors and determine the best strategy to use. To be a successful trader, you must not only find time to do all of this work on a regular basis; but also must be knowledgeable on all types of 'future' strategies and keep up to date with new material and research. There is no question that this is demanding work, but for hardworking trader, the potential rewards are well worth it.
 

The amount of work necessary to be successful in trading is no less than that which is necessary to be successful in any business or venture. Any successful business requires years of work, experience, and modification before successful results can be shown. (I would recommend that a trader spend at least 6 months in reading and research before any trade is initiated). During that time you should begin to keep a record of your trades. Any time you initiate a trade, mark down the position taken, the reason for it, and the stop loss points and profit objectives. At the end of each month, evaluate the results and only if you can do this profitably two out of three months should actual trading begin.
 

For some reason, actual trading is always much tougher. While you should not hesitate to pull the trigger, you should also be very cautious in the number of positions you do. For example, if your account could afford 2 to 3 gold positions, when you begin, trade only 1 initially and wait for profits to accrue before adding an additional one on a pullback. The worst that can happen by trading smaller quantities at first is that your profits will be slightly smaller. However, where this can really save you is if a losing streak occurs before you can modify your trading plan, so you will still be able to 'stay in the game'.
 

Several other points are also very important to any trader. Every trader must have a trading plan. Without a trading plan even the most talented trader is doomed for failure. This has been proven over and over again and should be followed by all traders. Your trading plan should be specific, however, flexible enough to be modified if conditions change.
 

Trade with a long term perspective only. It is much more difficult to determine short-term market movements, than the general long-term trend of the market. It is also much easier on a trader mentally not to thrashed around by the short-term market gyrations, but to maintain a long-term perspective.
 

GETTING A TRADING EDGE OVER THE MARKET
 

Without a plan and the discipline to follow it, even the best trader or system is destined to lose. This is the case in 'future' trading, the same as it is in everyday business.

There have been many instances of successful companies failing because of their inability to make long-term plans. This is magnified to an even greater degree when trading the markets. This is because of both the leverage factor and the short time periods in which large moves may occur. This is, of course, one of the attractions of the market - that large profits and huge returns can be made quickly; but these same factors can work against the trader who does not have a plan.

My plan encompasses what I feel are the strongest points of mathematical probability, money management, system trading, and discipline. It includes the following:

1. Determination of the trend by simple trendline analysis.

2. Using technical formations that in the past have had a high degree of reliability.

3. Using strict principles of money management requiring 'future' purchases only on pullbacks within a trend, and then to sell or hedge part of the position on significant rallies.

4. Trading on a long-term basis most of the time (when prices are more predictable).

5. Trading only in the direction of the trend.

6. Using disparities in 'future' pricing to our advantage, as well as positions that are profitable over a wide range of prices.

7. Using 'neutral' positions to trade flat or choppy markets.

Studies have shown that 90% of traders do not have complete trading plans while almost 99% of traders do not have their trading plans in writing. (It's interesting fact to find that most floor traders and professional traders do have trading plans, and these are the traders that are often successful).

WRITE IT DOWN

This is the first and most important step. A solid, concrete plan must be written down. If is not, we find that it is easily modifiable to meet your current feelings during the day. You will find that any news article, or tip from a broker or friend can spur you to take emotional action without sufficient basis.

By writing your plan, you can actually determine whether you really do have a plan or merely fire out trades when you 'feel like it'. Once you have finalized your plans we recommend that you have at least two copies, one that is always on your desk, and another blown up in your wall.

Other important items to look for at are whether your trading plan has provisions for taking profits as well as losses; and adding positions when the market moves in our favor.

COMBINING TRENDLINE AND VOLATILITY IN YOUR PLAN

Probably the first item most traders have learned is use of the trendline. The trendline is a technical indicator that determines for the trader the long, intermediate, and short-term direction of the market. Simply stated, a trendline is a line drawn connecting the significant high or low points on a chart. A 'long' position is taken as long as the prices are above the trendline and a 'neutral' position on the break to the outside of the line and a short position when anew downtrend line forms. Drawing trendlines is more of an art than a science.

USING TRADING SYSTEMS PROFITABLY

Most of us are familiar with the adage: 'put an infinite number of monkeys at an infinite number of typewriters, with an infinite amount of time, and you can guarantee soon that all the great works of the world will be reproduced'.

Unfortunately, from the traders' standpoint, this adage also applies to advisors, newsletter writers, and system development in the markets. We have an infinite number of them, making every imaginable prediction. The traders' question is whether he is following the right monkey. Time and time again, we have all heard claims that the "Holy Grail" (perfect system) has been developed. The basis of these systems ranges from main-frame computer based systems to the positioning of the moon and the planets.

The following rules are designed for the better trading systems:

1. Follow the trends.

2. Use 'futures' strategies that give you 'trading edge'.

3. Trade on a long-term basis.

Research, statistics, and mathematical probability prove that long-term, well capitalized traders often make money, while short-term, under capitalized traders consistently lose money.

USING FAVORABLE SITUATIONS TO TURN THE ODDS IN YOUR FAVOR
 

One additional item of importance is that OF PATIENCE. Be willing to wait for the best opportunities, and when they occur be ready to move quickly and take advantage of them. When they are not available, sit on the sidelines and use your time for the three R's - rest, recreation, and research.

'YOU GOT TO KNOW WHEN TO HOLD THEM; YOU GOT TO KNOW WHEN TO FOLD THEM.'

The professional knows that there is no odds in playing (trading) at the wrong time, and is content to be patient, sit back, and wait for when the cards (markets) turn favorable. The pro ends up playing only 10 to 20% of the time, but never loses sight of his goal, which is MAKING MONEY, and does whatever necessary to accomplish it. He is not there to make friends or get a thrill from the 'action'. He is waiting for the right time when the probabilities turn in his favor, and then is ready to pour it on and ply his trade.

How different is this principle in trading? The US markets are open 200 days a year ('our poker game') to allow us almost limitless action and opportunities. We have not just one poker hand to chose from, but over 40 as we can pick from any one of the markets that have the best opportunities, such as the Swiss franc, gold, sugar, etc.

The proper use of special circumstances and favorable situations, and only trading at the time when the best opportunities occur, can not only significantly increase your odds of success, but probably are the single most important item of any trading plan.

To summarize:
TRADE ONLY DURING THE MOST OPPORTUNE TIMES AND USE ONLY THE MARKETS THAT CAN PROVIDE YOU WITH A SPECIAL CIRCUMSTANCE OR OPPORTUNITY.
 

FLEXIBILITY AND MONEY MANAGEMENT - THE TWO MOST IMPORTANT, BUT OVERLOOKED RULES FOR SUCCESSFUL TRADING.

We have a few basis money management rules that we follow in initiating positions. Enter markets at the early stages of significant trend changes and on pullbacks; risk can more often be controlled by use of support and resistance levels.

THE HIDDEN EMOTIONAL FACTORS IN TRADING

Although fear, greed, and the lack of discipline are frequently discussed, two overlooked, often ignored subjects are 'overtrading' (including failing to take breaks from trading for the necessary 'rest and recreation' to recharge one's batteries), and only trading when situations present you with trades that have the highest probability of profit (either because of the market's technical pattern or disparity in 'future' pricing).

Violation of this concepts is responsible for losses as much as any of the so-called important items such as trade timing, failure to pick market direction, and money management.

Traders are always very reluctant to be away form the markets; they do not want to miss any trading opportunities. However, with more than 30 markets that have options, each containing at least three months of 'option' expirations and 10 or more 'strike prices, all in various configurations from bullish to bearish to neutral-choppy, flat, volatile, etc., enough opportunities for profitable trading will continue to occur, keeping even the most nimble trader very busy.

Traders are in a battle every day with these markets, which can be very tiring and draining. After long stretches of trading, especially ones that have not been particularly rewarding, traders begin to act like 'brainwashed' prisoners of war. They are ready to follow any system or pronouncement that promises profit and abandon all their old trading methods. Instead abandoning past work, it would be much more beneficial to take time out to examine previous errors and learn form them.

WHAT IT REALLY TAKES TO MAKE MONEY TRADING IS:
 

1. Making correct calls on the market (Market Prediction).

2. Having an appropriate plan that incorporates principles of money management (Trading Plan).

3. Preservation of capital during those times when trading becomes difficult and your calls become faulty (Money Management). 

Increase volatility and change brings opportunity to the knowledgeable trader. However, you must always remain alert to be able to both recognize what has changed and then use it to your advantage to get your 'trading edge'.

WHAT IS NECESSARY TO SUCCEED IN TRADING
 

There is nothing that can guarantee your success in trading; but, if you don't follow the rules 'these' successful traders have used in the past, your chances will drop to well under 5%.

IF YOU DO NOT FOLLOW THE RULES, YOU'RE DESTINED TO LOSE!
IT IS ABSOLUTELY NECESSARY TO HAVE AN 'EDGE'.

'You can't win without an edge, even with the world's greatest discipline and money management skills...if you don't have an edge, all that money management and discipline will do for you is guarantee that you will gradually bleed to death. Incidentally, if you don't know what your edge is, you don't have one.'

'Make sure you have the edge. Know what your edge is. Have risk controls...When you get down to it, to make money you need to have an edge and employ good money management. Good money management alone is not going to increase your edge at all.'

Traders lose because they don't have a winning strategy. Second, even among those traders who do, many don't follow the strategy. Trading puts pressure on weaker human traits and seems to seek out each individual's Achilles heels. A good trader has a maverick mind. It is also important to have a blend between the artistic and scientific side. You need the artistic side to imagine, discover and create trading strategies. You need a scientific side to translate those ideas into firm trading rules and to execute those rules. Novice traders should follow the following rules.

First, focus on trading vehicle strategies and time horizons that seek your personality. Second, identify nonrandom price behavior while recognizing that markets are random most of the time. Third, absolutely convince yourself that what you have found is statistically valid. Fourth, set up trading rules. Fifth, follow the rules. In a nutshell it all comes down to do your own thing (independence); and do the right thing (discipline).

1. Develop a competent analytical method. 2. Extract a reasonable trading plan from these methods. 3. Formulate rules for this plan that incorporate money management techniques. 4. Back test the plan over a long period. 5. Exercise self management so that you adhere to the plan. The best plan in the world won't work if you don't act on it...No trading plan is the biggest cause of losses. It causes lack of confidence, fear of loss, and poor execution.

USE A TRADING METHOD THAT YOU ARE CONFORTABLE WITH

The approach you use must be right for you; it must be comfortable. The importance of this can not be overemphasized - virtually every successful trader ultimately ended up with a trading style suited to his personality.

TRADE SMALL

'Once you have a method you still need money management to prevent an adverse streak from taking you out of the game. It is critical to take in mind that even if you have the edge, you can still lose all of your money. Therefore, the bet or trade side must be small enough to keep the probability of such an event very low.'

LISTEN TO THE MARKETS

'It is my firm belief that the markets wisdom is far greater than mine. In my opinion the markets price of an item is the best measure of its value. The general principle is that if you give up your ego and listen to what the markets are telling you, you can have a huge source of information.'

Fortunately, these ideas are very easy to understand; unfortunately, they are harder to put into practice. And as stated succinctly, 'The market is a stern master: You need to do almost everything right to win. If parts of you are pulling in opposite directions, the game is lost before you start.'     

For most of us, the task of beating the market is not difficult, it is the job of beating ourselves that proves to be overwhelming. In this sense, beating ourselves means mastering our emotions and attempting to think independently, as well as not being swayed by those around us.

TRADING PATIENCE
 

Capturing profits from relatively smaller price movements of 2 markets requires a bit more precision than trend following or swing trading. Carelessness will never be rewarded and neither will impatience. Patience is a trader's edge. Having an informed expectation about what the market will do and waiting patiently for the market to come to you gives you that edge.

Unfortunately no 'edge' is sold at the local department store, ready-made, one size fits all. It is just one more paradox of trading that in order to trade successfully you need an edge, but someone else's edge will do you no good. The saying, 'one man's sugar is another man's salt also applies to edge. You have to find your own and this fact is essential to having a winning strategy.

Edge rather comes down to this:
 

A uniquely independent strategy approach.

A personal discipline based on hard work, independence, and patience.

Heightened focus and concentration.

Well-defined risk and money management.

Acceptance of losing as part of the trading process.

IDENTIFIES TRADING OPPORTUNITIES

According to Anthony Robins, 'The difference between those who succeed and those who fail isn't what they have - it's what they choose to see and do with their resources and their experiences of life'. This also applies to trading. Your trading strategy should allow you to open your eyes and see market opportunities so that you can act.

TRADING FOCUS

The tighter your focus, and the finer the distinctions you bring to your trading focus, the better the results. Focus is one of those terms that sounds like a cliche unless you understand how to utilize it in your trading. It is through focus that one stays consistent and is able to maintain a high level of confidence. Focus derives from developing a specific strategy that allows you to feel certain and act accordingly.
 

Assumes personal responsibility for all market actions. It isn't your broker, your brother-in-law, the chairman of the board of the Fed, the fill, the computer, the unemployment report - it is you! It's a simple fact that that must be understood in the adoption of any trading strategy: You produce the results. Good or bad, the buck stops here! The Nordstrom Corporation Policy Manual has just one sentence in it: 'Use your own best judgment at all times'.

If the market does not perform as you anticipate, do not allow the emotions generated by the market make you chase after it. Stand back and determine if the market has really changed direction or the tining is wrong.
 

People who aren't successful with trading tend to want to catch every move in the market and in fact try to 'beat' the market.  

Successful trading, I think, is all involved in the search for 'the edge'. The edge meaning where you have some superior talent or some superior expertise that you can utilize successfully. You have to analyze yourself and know what your strengths and weaknesses are and do things that support that edge. Among the strengths that i have is a greater degree of patience.
 

It took me 20 years and a lot of hard study to figure out the game. Nobody else's system can work for you, because your individual makeup is different. Your tolerance for risk, your desire for excitement, your willingness to put time and resources into the study and the acquisition of knowledge. Bottom line, success or failure resides with you.