THE TRADER’S PSYCHE

THE TRADER’S PSYCHE



You know that you need a strategy. And you know that there’s more to trading than just having a strategy. In the previous chapter, you learned about the major mistakes that traders make, and you learned that your biggest enemy is not another trader, or market makers, or your broker – it’s YOU.

And YOU are your biggest enemy because of your emotions.

In this chapter, you’ll learn about the mindset and psyche of successful traders. Having a profitable trading strategy AND the right mindset will catapult you right into the 11.5% of successful traders we talked about earlier.

In order to develop the right mindset, you need to know what to expect when day trading.

Many traders mistakenly believe that trading will result in a consistentlyrising account balance, like having an ATM in their front yard.

But you already know that losses are a part of our business as traders. There will be some days and weeks when your trading exceeds your expectations, and there will be periods when your trading results are far worse than you expected.

It’s essential that you maintain a long-term perspective.

Day trading means playing a numbers game. You already know that you need to place at least 40 trades before you can look at the performance of the strategy. Most traders only evaluate their performance once a month, trying to have as many profitable months as possible. Hedge fundsevaluate their performances quarterly or yearly.

Long-term evaluations have their place, but if you look at your trading results daily, it will drive you crazy. That’s why we define weekly goals.

Sure, nobody likes going through a drawdown. But when you’re trading, it’s inevitable. The key is in how you deal with it.

In an interview with Jack D. Schwager for his book, Market Wizards: Interviews With Top Traders, the famous Richard Dennis said:

"It is totally counterproductive to get wrapped up in the results. You have to maintain your perspective. Being emotionally deflated would mean lacking confidence in what I am doing. I avoid that because I have always felt that it is misleading to focus onshort-term results."

And way too many traders focus on short-term results and lose their perspective. That's why they fail: they experience a loss or a bad week, and so they start trading a different strategy. And while the trading strategy they just abandoned is recovering from the drawdown, the new trading strategy may result in yet more losses, so again, they start looking for another.

It’s like a dog chasing too many rabbits: at the end of the day, he's totally exhausted and he has absolutely nothing to show for it, because he didn’t catch a single thing.

Day trading necessitates selective, wise, and patient trading methods. Successful day traders are practical, and do not go overboard when trading the market. They focus on the quality of each trade, not the quantity.


Here are some important characteristics of successful traders:

1.) Successful traders do not blame. They accept the losses they have, and they don’t dwell on them, or blame other people or conditions. They learn from their mistakes and move on with their trading.

2.) Successful traders have a system. They stick to their system of trading religiously.

3.) Successful traders have patience. They know that most positions will not be profitable the minute they are opened.

4.) Successful traders do not overtrade. They realize that overtrading puts their account at risk, and they know that not every day is a day for trading. They wait for high probability opportunities.

5.) Successful traders realize that nothing is 100% foolproof. They trust in their indicators, but they are aware of other factors that may influence their trades.

6.) Successful traders do not stay in a losing trade. They honor the stop losses that they set, and they do not hold their position in the hopes that the market will eventually “go their way.”

7.) Successful traders do not rush into trades. They take their time while selecting trades, and they are picky about which trades to jump on. They don’t place orders just for the sake of having a position in the market every second.

8.) Successful traders stick to a successful strategy. They have one to three techniques that really work, and they use them over, and over, and over again.

9.) Successful traders have the ability to adapt. They adjust their trading methods and decisions to changing market conditions.



10.) Successful traders know what type of trader they are. They don’t force themselves to trade with methods or strategies that do not fit their personality.

11.) Successful traders bank on consistent profits. They know that ignoring the small-profit trades and angling for a “grand slam” is a sure way to lose money.

12.) Successful traders take action. They don’t let their fear control their decisions or interfere with their trading.

13.) Successful traders use successful systems. Their trading methods and indicators focus on high probability trades, sound money management, keeping their strategies free of curve-fitting, and working their system into their business plans for successful implementation.

14.) Successful traders recognize a “good” trade. They don’t base their evaluation on profits or losses; they base it on whether or not they followed their trading plan to the letter. Even if they DID lose money, as long as they stuck to their plan, it is a “good” trade.

15.) Successful traders take time off. They realize the importance of taking breaks from trading and the markets to clear their heads.

16.) Successful traders do not fear losses. They realize that losses are a part of their business, and they expect them.

If you can adopt the right psychological mindset, then you’ll gain a significant edge in the market.

I can’t stress this enough:

The right mindset is one of the keys to investment success, and most traders fail to understand this.

Greed and Fear




When day trading, two emotions are constantly present: greed and fear. If your trade goes well, your natural inclination will be to trade even more, opening yourself up to significant loss. And if your trade goes wrong, fear will torture you. Fear of loss or fear of a further loss makes traders scared.

Greed and fear are destructive emotions, and all traders are influenced by them; they’re a natural part of every trader’s psychology. Greed and fear can make traders act irrationally: they may know what they should do, but they simply can’t do it.

The bottom line: if you’re scared or greedy, and you can’t control your emotions when day trading, then you’ll have a very difficult time being profitable.

But, when you trade well, in accordance with your trading plan, you will have a fantastic chance of success. Feel proud of yourself for good trades and decisions, but don’t dwell on them, or allow arrogance to set in. Keep your head up and continue to apply a sound trading strategy, even when you suffer losses – remember, they are just a part of the business.

Do not allow yourself to get caught up in positive or negative emotions understand the psychology behind trading and know that no trade is guaranteed.

Work on your mental state. If a trade goes wrong, try and work out why it did, and learn from it. Executing a trading method with discipline is the only way to overcome destructive emotions. Whether you’re a day trader or an investor, and whether you trade in commodities, stocks, or currencies, the fact is that your trading psychology WILL influence your results.

You should never trade without a solid reason. Don’t chase the market. If a market moves sharply, but you don’t participate in this move because your entry criteria weren’t met, don’t worry about it. If you miss a trade, another one will be just around the corner. Practice patience and discipline.

You need to control your emotions by having a specific plan to follow. Having the correct trading psychology is just as important as having a reliable trading strategy.

The more you are prepared mentally for trading, the better you will trade. Note my emphasis on better trading, not better winning. A good day in day trading is not defined by profits. Successful day traders define a good day as one that is researched and planned and follows their overall trading strategy.


The “Law of Attraction” says that “you get what you think about.” Here’s how to avoid negative emotions and to have a positive attitude:

Write down 10 “I Am” statements. These statements should reflect who you WANT to be, not necessarily who you are now.

Here are some examples of “I Am” statements:

I am a disciplined trader who follows his trading plan.
 
I am cool and relaxed when I am trading.
 
I am in control of my emotions.
 
I am a profitable trader.

Read these “I Am” statements every morning before you start trading. Read them aloud and read them like you mean it. Do it for two weeks, and I promise, you WILL notice a difference.


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SELECTING A TIMEFRAME

SELECTING A TIME FRAME



W hen day trading, you’ll obviously select a timeframe that is less than one day.

Popular intraday timeframes are 60-minute, 30-minute, 15-minute, 10- minute, 5-minute, 3-minute, and 1-minute.

When you select a smaller timeframe (less than 60 minutes), usually your average profit per trade is relatively low. On the other hand, you get more trading opportunities. When trading on a larger timeframe, your average profit per trade will be bigger, but you’ll have fewer trading opportunities.

Smaller timeframes mean smaller profits, but usually smaller risk, too. When you’re starting with a small trading account, you might want to select a small timeframe to make sure that you’re not over-leveraging your account.

However, when selecting a very small timeframe like 1-minute, 3- minute, or 5-minute, you might experience a lot of “noise” that is cause by hedge funds, by scalpers, and by automated trading.

You might think that you see an emerging trend just to realize that it was only a short manipulated move and that the trend is over as soon as you enter the market.



Therefore I recommend using 15-minute charts. This timeframe is small enough for you to capture the nice intraday moves, but it’s big enough to eliminate the noise in the market and correctly displays the “true trends.”

When developing a trading strategy, you should always experiment with different timeframes. A trading strategy that doesn’t work on a small timeframe might work on a larger timeframe and vice versa.

Start developing your trading strategy using 15-minute charts, and if you’re unhappy with the results, change the timeframe first before changing the entry or exit rules.




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MASTERING THE INTRADAY MARKET

MASTERING THE 

INTRADAY MARKET




 
The survivalist trader needs accurate feedback on open positions to take advantage of directional movement and to guard against traps, rinse jobs, and other unwelcome surprises. The best way to accomplish this daunting task is by observing and managing exposure continuously in the intraday markets. While watching every tick isn’t a viable option for many traders, it’s the preferred management route whenever possible. The remote strategies outlined in Part Four offer a useful alternative to folks with real lives away from the financial markets or commitments that keep them from the ticker tape.
In the real world, some positions will behave very well, while others go haywire and fall apart. This duality forces the trader to establish an adaptive profile that denotes the prechosen exposure and risk associated with all open positions. This macro control mechanism needs to match external market conditions which in turn require constant adjustment through position choice, share size, and holding period. The adaptive profile is far more important in a successful market strategy than any individual trade. The financial markets cycle through phases of danger or opportunity. 


It’s the trader’s job to identify the current phase and adapt, in real time if possible, by applying the right collar for that particular market. Collars signal when to let profits run, and when it’s the worst thing you can possibly do. They also define the right stock, futures contract, or currency pair to trade at any point in time. For example, it makes perfect sense to play volatile small caps when the collar is loose and the market is printing money but to stick with blue chips when opportunity is low and predators lurk in every dark shadow.


Adaptive profiling establishes the collar placed on each day’s market activity. This refers to the aggressive or defensive posture based on volatility, sentiment, and current positioning of the index futures. In a nutshell, the survivalist trader needs to be aggressive in times of greatest opportunity and defensive in times of greatest danger. This is one of the more subtle aspects of intraday strategy, because it demands a central theme that changes from day to day. Part Six will address this aspect of position management in greater detail.


GET READY

You’ve reviewed the trade setup a dozen times, calculated reward:risk, and found the perfect moment to enter the market. With a slight adrenaline rush you hit the magic button and open a position. Now what do you do?


First, digest feedback from the fill report. With a market order, your entry might show slippage and demand a recalculation of trade assumptions. So, if you get filled more than a few ticks away from expectations, reconfirm risk tolerance and recalculate the intended exit in case things go wrong. Next, take a second look at the charts to confirm that you made the right choice. We often see things differently when sitting on the sidelines, as opposed to being in the heat of battle with real money at risk. Finally, set a physical stop if that’s part of your trading plan. If not, target the price or specific conditions under which you’ll exit the position without hesitation.




Take your losses manually, whenever possible. This builds discipline because the action accepts responsibility for the trade. It also acknowledges how your stop loss points to an evolving calculation and not a fixed number. Update this mental escape hatch as each price bar modifies your assumptions, goals, and emotional state, getting out immediately when price hits the level where the trade proves to be wrong. The failure swing that demands your exit might turn out to be a whipsaw, but don’t delay action in an effort to find out the truth. A trade can always be reentered after a shakeout, but each position must stand on its own merits. This unbending rule requires a fresh analysis and revised targets for each entry. Keep in mind that subsequent trades often fail because the initial shakeout actually signaled a legitimate change in trend. If a weekend evaluation suggests you’re getting shaken out of good positions too often, then it’s time to revise your stop loss strategy so that trades are given more room to run.


Intraday charts sketch feedback in real time. Watch price action and anticipate how individual bars on 15-minute and 60-minute charts will close. Pay close attention to how buy and sell ticks affect the curvature of surrounding Bollinger Bands and evolving Stochastics. Watch out for thrusting candles that break through the top or bottom band, signaling a momentum peak. Look for small but significant gaps between candles at key price levels. Find the spot where the pattern says the bars should eject into a profit or break down into a loss. Then see if the buy-sell order flow matches your expectations. Measure the market’s pulse through 5-3-3 Stochastics. When a notable surge of buying or selling pressure doesn’t push price firmly in your favor, it may signal hidden supply or demand that will eventually trigger a reversal.


Use position scaling to address changing risk. Take partial profits when trades stretch toward profit targets ahead of schedule. Reduce size when price action gets erratic or external forces make prediction more difficult. Double or triple up when patterns fire on all cylinders or unexpected news lends support to an open position. In other words, trade larger when you’re getting clear signals, and reduce size when forces are in conflict.


Each position has a right size, regardless of account capital. This risk level shifts as price bars add fresh data into the trade feedback loop. Load up during winning streaks and supportive markets because performance implies reduced risk. Lighten up and wait for better times when you’re experiencing drawdowns or reversals of fortune. Inexperienced traders expose themselves to risk because they think total buying power must be committed to each position. These folks will survive a lot longer in the financial markets if and when they just learn to trade well, and stop worrying about making money. In the real world, profits come automatically when we take the time to become proactive managers of our open positions and apply the right collar to each trading day.


TAPE READING

 

You can’t become a successful trader without mastering the fine art of tape reading. That revelation could be a shock after the countless hours you’ve spent studying the charts and probing the indicators. Of course, you can trade without the tape, but you do so at your own risk because the charts paint pretty pictures that trigger perfectly wrong signals. Meanwhile, the flow of buying and selling pressure, as it unfolds on the ticker tape, exposes forces that remain hidden to charting purists. In a nutshell, those impulses uncover the real activities of market players, as opposed to the smoke and mirrors being fed to the trading public. In a word, the tape never lies.


When students ask me for a seminar on tape reading mastery, I usually tell them to sit down, pull up a notepad, and watch the numbers wiggle around for a few decades. They think I’m kidding, but I’m not. Literally, it can take 10 years or more of staring at the shifting numbers to decipher the games played by Wall Street and other market participants. However, it’s worth the considerable effort because, once you’ve learned to read the tape, you have a lifetime edge over less observant traders.


Here’s a tape trick to get a read on the crowd’s excitement level. Place a 30- or 60-day moving average of volume next to the real-time daily volume on your watch lists. The few issues that pace above their moving averages signal impending range expansion for that session. This side- by-side analysis works best when macro influences aren’t moving the broader tape. For example, a stock trades over 50% of its 60-day average volume in the first hour of the trading day although it’s stuck in a narrow range. You’re staring at an actionable signal that could yield a major rally or selloff by the closing bell.


Veteran trader Larry Pesavento points out a powerful tape reading tool called the “opening price principle.” Through years of observation, he discovered how the opening tick frequently serves as a pivot through an entire session. This comes into play in many ways but is most useful when price returns to retest the opening level, from above or below. To use this tool, draw a trendline across the opening prices on the S&P 500 and Nasdaq-100 index futures or their related funds. When price action retraces back to those levels during the intraday session, watch closely for a breakout, breakdown, or reversal, using those swings as trading signals for individual equities.






the opening price comes into play five sessions in a row on the Nasdaq-100 Trust (previously the Power shares QQQ Trust). Price tightens into narrow range (1) for nearly two hours on the first day, with the opening price marking the center pivot of a triangle that breaks to the downside in a steady selloff. The fund gaps down (2) on the second day, selling off into the lunch hour and then bouncing higher. The recovery stalls just a few cents from the opening price, which now marks resistance, and drops like a rock in the close. Price opens marginally lower (3) in the third session and zooms higher in a trend day that never retests the opening level. Whipsaws (4) hit the market on the fourth day, with upswings reversing at the opening price twice during the volatile session. The last day yields another downtrend (5) as selling pressure slams the market right at the opening bell. Note how the opening price comes within eight cents of marking the daily high.


Tape readers pay close attention to the relationship of current price to the daily range. Real-time quotes refer to this ratio as the “% in range.” This simple number can track the progress of a huge basket of financial instruments in just a few seconds. For example, there’s an hour to go and the market is down. Most of your watch list is scraping the bottom third of the daily range, but one or two stocks are popping near 100% on the % range quote. These leadership issues are breaking to new highs while the rest of the list is doing nosedives with the broad market. Guess what? You’ve just uncovered a bullish divergence for momentum plays into the close or an overnight hold, in anticipation of a morning reversal.


A simple display that shows only the last price traded and the bid-ask spread provides most of the data needed to read the ticker tape. The time and sales screen is helpful but not essential to your task, and I’d avoid the Level II screen entirely because it’s just a distraction. There’s a misconception that tape reading and technical analysis are separate but equal paths to market mastery. In truth, the effectiveness of your tape observations comes from identifying critical chart levels where buyers and sellers clash, with one side or the other finally taking control. When you uncover one of these contested levels, sit back and watch as the battle unfolds, understanding it might rage for hours or end in a few minutes.


Look for a defense of the boundary and if there’s enough excitement to overcome it. Decide whether the bulls or bears seem more determined and in control of the tape. What doesn’t happen during these conflicts is just as important as what does happen. For example, price lifts into a key resistance level, where sellers should be attacking the bid and attempting to trigger a reversal. Minutes pass, but no selling pressure emerges. This lack of activity yields a bullish divergence, telling the tape reader that bears have stepped aside for whatever reason, allowing bulls to trigger a breakout and much higher prices.


The most basic order flow manipulates price against crowd emotions. Simply stated, the ticker tape knows the chart better than you do. In a typical scenario, professionals and their program algorithms keep one eye on stocks and the other on cross-market forces. They push prices into and through support-resistance levels to test the waters and see how much volume is generated by their activity. Feedback loops then come into play, with a notable reversal when a specific level can’t be broken and a directional “pile-on” momentum when greed or fear triggers a breakout or breakdown.


Filter the ticker tape’s message through the most popular intraday technical tools. For example, the following extremes points to trend days in which the tape reader needs to avoid swing reversal strategies because support and resistance levels are unlikely to hold.

• NYSE TICK probing greater than 1,000 or less than –1,000 repeatedly

• Advance/decline greater than 1,500 or less than –1,500 on both exchanges

• Advance/decline greater than 2,000 or less than –2,000 on one exchange

• Up/down volume in both exchanges greater than 4:1 or less than 1:4

• S&P 500 and Nasdaq-100 index futures up or down more than 2%



No two issues trade alike on the tape, so it’s wise to observe ticker movement and check out certain risk characteristics before taking a position. Look for depth of participation and which players are spending the most time at the inside bid-ask. Measure volatility by comparing current price action against the width of a typical swing in a quiet market. Share size on the market depth screen is a total lie, due to rules that permit hidden orders, but the flow of buying and selling pressure might tell the truth, so average out total shares on one side of the market for several minutes and compare that number to relative price movement. This simple exercise could expose a few big whales swimming under the surface.


A QUICK CHECKLIST IN TAPE READING

 


1. Memorize key levels on your favorite charts. Then watch the tape whenever price approaches one of them. See if you can predict reversals before the crowd does.


2.  Look for divergences between sentiment and the tape flow. Are hidden buyers holding up prices in the middle of a selloff, or do rallies fizzle out for no apparent reason?


3. Ask if price action matches your expectations. Look for buyers at breakout levels and sellers at breakdown levels. When they don’t show up, stand aside or fade the trend.


4. Use the opening price principle. Draw a line across the opening tick on the S&P 500 and Nasdaq-100 using breakouts, breakdowns, and reversals as trading signals.


5. Track the relationship between price and the daily range. An instrument holding high in its daily range has hidden strength, while one hanging low has hidden weakness.


6. Follow professionals in quiet times and the public in wild times. Insiders chase volume during periods of conflict but lose control of the tape when the public enters the market.


7. Liquid stocks move in channeled ranges. Ignore oscillations in the middle of these zones, but focus undivided attention when prices reach upper or lower boundaries.


8. Most volume comes from scalping machines pushing prices around for a few pennies. Find the whales underneath these minnows to predict the next rally or selloff.


TAPE TRADING TELLS

Experienced tape readers keep a collection of key observations tucked away in their brains so they can act quickly whenever the tape cycles into analogous price action. This hodgepodge of personal signals, setups, and key tells can yield quick profits because the data come through personal experience instead of from reading a book or attending a seminar. Mr. Market plays a constant game of misdirection, but our accumulated tape knowledge lets us see through the veil and decipher key elements of the daily grind. Let’s look at the most potent of these small portents of market direction:


GLOBAL FUTURES

 


Look at premarket index futures and see where they’re trading relative to their day-session 15-minute 50-period moving averages. Expect a positive opening for stocks when index price sits on top of the average and a negative opening when it lies below. If the S&P 500 is above but the Nasdaq-100 is below, look for intraday rotation from tech and small caps, into the blue chips. Flip over this outlook when Nasdaq-100 is above and S&P 500 is below. On those days in particular, watch for speculative four letter stocks to take over the leadership mantle.


ADVANCERS/DECLINERS

 


Market breadth and up/down volume offer valuable data on hidden strength or weakness. Buy midday pullbacks when breadth shows greater than 1,000 advancing to declining issues. Sell midday bounces when breadth shows less than –1,000 advancing to declining issues. Up to down volume in both exchanges greater than 4:1 points to a trend day that favors the dominating side of the market. Assume there will be no intraday turnarounds when you see this type of price action. Instead, stop fighting the tape and focus intraday capital on 60-minute range breakouts or breakdowns that follow the prevailing trend.


BUY/SELL FLOW 

 

The NYSE TICK exposes the peaks and valleys of intraday swing cycles. Look for large-scale reversals after  the TICK hits an extreme reading, like plus or minus 1,400, for the third time in a single session. Use smaller TICK extremes to
pinpoint intraday swings that will carry price the other way in a 60- to 90-minute cycle.

 STEALTH BREAKOUTS

 

Watch for a breakout or breakdown when intraday price creeps toward a support or resistance level that it’s failed to exceed multiple times in the last three to five sessions. This slow crawl will print a series of small bars with no pullbacks on the 15-minute chart. Look for these issues to hit the contested level and then expand quickly through the barrier.Why does this type of price action predict a big rally or selloff? It’s a common scenario in which big players have entered the market and are accumulating or dumping shares under the radar, trying not to attract attention. They push prices slowly by hitting the spread with small shares at regular intervals while supporting their positions with decent size on the other side of the market. Momentum eventually gathers steam, and the stock cuts through support or resistance like butter.


 HISTORIC PRICE LEVELS



Stocks respond to every high or low on the chart, no matter how old or far away. Take profits and cut losses into big prints from prior years because they can easily stop a strong trend dead in its tracks. However, be patient because price often goes vertical into these magic numbers, yielding windfall gains. Highs and lows set into place five or ten years ago become excellent pivot points for new entries as well.


ALGORITHM GAMES


Stalk liquid stocks you want to buy on the pullback. Then watch as program algorithms take price down and down and down. Sit back and wait for the selloff to cut through short-term support. That happens because the eggheads writing
these programs know the charts better than many traders and want to shake out poorly placed stops. Finally, wait for the bottom to drop out, and then look for the bid to stretch 20, 30, or 40 cents below the last print while the ask hardly moves. This predicts the selling frenzy is nearly over, and positions can be taken for a rebound. You now have to hit the asking price, even though it’s much higher than the low printed by the falling bid.

Finally, here’s an observation that will add considerable power to your tape reading expertise. Look for price action to cycle through three distinct phases when it moves into a key position just above resistance or just below support. Like so many elements of market dynamics, these interrelated impulses track the action-reaction-resolution cycle.


1. Euphoria driven by the breakout or breakdown

2. Fear triggered by a fade against the breakout or breakdown

3. intensified euphoria or fear that confirms the breakout, breakdown, or pattern failure


Most traders focus their full attention on the excitement of the breakout or breakdown, jumping in when the ticker tape bursts with buying or selling activity. Of course, as I’ve argued throughout this text, this is a great way to lose money. In contrast, tape readers step back and examine the quality of this three-pronged conflict, which ultimately tells them whether the embryonic move is bona fide—or just a nasty trap waiting to be sprung.


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HOW PICKING A STOCKBROKER


HOW PICKING A STOCKBROKER


Stockbrokers come in many shapes and sizes. Some act as nothing more than a tool to receive the independent chimp’s stock orders. Others play a very active role in the investment strategy of their clients. Still others act as salespeople and can become very obnoxious and pushy.


Deciding what kind of broker is right for you can be a difficult undertaking, especially if you have no prior investing experience. Should you get an electronic broker first or wait a while? Do you want investment advice and stock ratings from your broker? Perhaps the two most important considerations are what makes you comfortable and what seems the most convenient. Don’t be discouraged if your first broker or even your first several brokers don’t work out. Be careful whom you pick to help you invest your hard-earned banana.

IF YOU’RE READY TO TRADE

 

So you’ve decided you’re ready to trade. You’ve got some risk capital, you’ve got some knowledge, and now you need an account. What are your choices? Nowadays, the major decision is to choose between online or traditional brokerage. Most online brokerages are considered discount brokerages because they offer low trade commissions and they don’t contact you often. If you’ve decided to use an online brokerage, then read on.


Where to Look


Names of popular online brokerage firms can be found in newspapers, television, magazines, and on the Internet. If you want a fairly comprehensive list of reputable online brokers, check out an Internet directory such as Yahoo!. Try looking in the Financial Services section for “Brokerage Firms” or “Brokerage Houses” and then under the “Electronic” or “Online” subcategory.


What to Look For


There are several major factors you should consider when choosing a brokerage firm. First of all, many brokerages have minimum starting account balances that you must meet in order to open an account. Depending on which firm you choose, this requirement may be as low as $500. And, depending on how much risk capital you have, this may be a major factor in opening an account.



Another very important factor is commission rates. If you have an account with a small amount of capital, it’s important to keep commission rates as low as you can. There are several ways to do this. Some brokerage firms advertise extremely low commission rates, but you may notice that once you’ve signed up you’re not getting those rates.


This may be due to the fact that those low rates are usually special offers. They apply to people who have a certain balance in their account, people who trade more than a certain number of times in a given time period, and so on. Before you set up your account, call the brokerage firm and actually talk to a broker. Try to bargain, and see if they can set up a lower commission rate for you.


Some stock brokerages offer more than others. And contrary to what your logic might tell you, the more expensive brokers don’t always offer more services. That’s why it’s important to shop around. Some brokerages will offer free real-time quotes, while others may charge a fee for quotes or require certain trading activity to receive them. Others may offer the option of automated telephone trading as well as the option of placing orders over the phone.


Also offered may be investment information services, which could help the average chimp learn about the basics of using a broker, investing, as well as news services and other catchy benefits. If you’re a big traveler, some brokers offer airline “miles” for trading or discounts on credit cards linked to banks associated with the brokerage firms. Check around; there’s no shortage of deals that could save you big bucks.


WHY ARE COMMISSION COSTS SO IMPORTANT?

To put it simply, it’s all relative. Let’s pretend that I open an account with an initial balance of $10,000. The starting commission rate at my brokerage firm is $20 per trade. When I make one trade, I’m spending .02 percent (or $20) of the money in my account to make that trade. However if I have $500, it’s a different story. Making one trade with a $20 commission requires that I spend 4 percent of the money in my account for every trade. That means that unless I make more than an average of $20 per trade, I will only be able to make twenty-five trades or fewer before I spend all the money in my account!


DO YOU NEED ALL THE FREE STUFF?

Not at all! Of course it’s nice to have free stuff. And, you might be really jealous when you see your coworkers taking advantage of their real-time, streaming quote, or trading right from their desk. However, too much information is more distracting than you may realize. Brokerage firms exist to generate commissions by executing your trades. As we’ve said before, you should be the one making the decisions about your trades, not brokers, not analysts, and, above all, not your emotions. So when you decide not to overstimulate yourself with loads of information, you are actually doing yourself a favor and making it easier to win the game.


WHAT’S THE DIFFERENCE?


There are two major categories of brokerages: full-service and discount. Increasingly, banks offer investment services as well, so if transferring money from account to account isn’t your cup of tea, try asking about this at your local bank. Choose your brokerage firm according to your style of investment. Ask yourself if you would feel better with an investment adviser and/or broker on the other end of the phone, or if you would feel just as confident without even talking to a person at all.


Full-Service Brokers


Full-service brokerages serve several purposes. First and foremost, they act as the go-between for buyers and sellers of stocks (this is the major purpose of any brokerage firm). Second, they act as a resource for individual investors. If you sign up with a full-service broker, don’t be surprised if some baboon gives you a call to tell you about hot stocks in which you should invest your bananas.


But be aware that these baboons are often like used-tree-house sales people; they may have ulterior motives. Your stockbroker may be asking you to buy a stock, which his or her brokerage firm is trying to move “off the shelves.” This would occur when your brokerage firm has been involved in the public offering of a company, or has a large number of shares that it needs to get off of its hands. In fact, brokerage houses often pay their brokers bonuses to push stocks like these.


If you’ve signed up with a full-service broker, don’t start hooting and hollering just yet. The stocks your full-service broker will tell you about will not always be “good” or “bad,” nor will they usually be stocks the firm has asked them to move. But always keep in mind that one of our cardinal rules of investing is that a market monkey should choose stocks for him or herself.


Discount Brokers

Discount brokers are divided into two subcategories: discount and deep discount. Discount and, to an even greater degree, deep discount brokers primarily facilitate the buying and selling of stocks. You will practically never have discount brokers call you and tell you about a stock. However, you may receive free materials, newsletters, or investment tools to help you make decisions on investments. Be aware that if you sign up with a discount broker, you will be in an extremely independent investment decision-making environment.


The major difference between all three types of brokerages beyond service is price. Brokers make some money on commissions (a fee charged for the execution of a trade). When a stockbroker assists you in deciding what to buy or sell, there will normally be a larger commission fee than otherwise. Solicited trades (when a broker asks you to buy a stock) will  also cost you more. If you don’t have a lot of cash in your account to start with, try to get the lowest trading fees possible. Chimp Elliott’s advice is to stick with a discount broker and make your own trading decisions once you have learned the basics of trading and order placement.



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PRINCIPLES OF SUCCESSFUL TRADING

PRINCIPLES OF
SUCCESSFUL TRADING

 



As we’ve discussed, trading can be a great business. However, the majority of people who trade fail to make money consistently. In this chapter, we’ll discuss trading principles that are the foundation of my trading. I urge you to read and reread this section. You must understand and apply these principles in your trading to succeed. I can’t stress this enough: The implementation of these principles in your day-to-day trading will allow you to develop emotional discipline. And only with emotional discipline can you become a successful long-term, independent trader.

Trade within Your Capital

In trading, everyone makes mistakes. Even the best, most experienced traders
occasionally misread the market. In addition, you may do everything right on a
trade, but something happens out of the blue that causes the market to reverse
direction. Either occurrence—a market misread or an out-of-the-blue event—will
result in a losing trade. Losing trades are part of the business. They happen to
everyone, and they will happen to you. That being the case, you always want to lose small.


To lose small, you must trade small relative to your overall capital. If you have a $20,000 account, you don’t want to risk $2,000 on a single trade. It’s too much of a hit to take given your overall capital. A small series of $2,000 losses is going to destroy your confidence and likely will cause you to stop trading entirely or take too much risk on an all-or-nothing trade in hopes of recouping your losses. To stay in the market for the long haul, you need to trade small.


I’ve often seen traders increase the size of their trades following a series of winning trades. Think about the logic of that for a moment. It’s axiomatic that losing trades are inevitable. After a series of winning trades, do you think a losing trade or series of losing trades is more or less likely? In my experience, a winning streak is usually followed by a losing period or at least a few losing trades. If you increase the size of your trades, you’re likely to give everything back and then some.



Beginning traders often come into the market with unrealistic ambitions. They
think they will consistently make money, continually raise the size of their trades
as their account grows, and within a short period of time, they’ll amass a small
fortune. A more realistic goal for a beginning trader is to learn the business while making modest profits and taking small losses. First, you learn to survive. Then you learn to thrive. Yes, you can grow your account and, at some point, increase your size. But you have to go after it like a turtle, not like a Ferrari.


There is another element to trading small. Every trader has a position size that he/she cannot exceed without endangering his or her emotional discipline. I call it my core position. Although I can trade much larger, my core position is 10 E-mini contracts, which is equivalent to two Standard & Poor’s (S&P) contracts. This is my maximum position. If I trade larger, I’ll begin to lose my emotional discipline. You need to find a position size that allows you to execute your trades objectively, unemotionally, and consistently. It may be much smaller than what you’re currently contemplating.


It might be 10 shares of a $100 stock. That’s fine. As you get comfortable, you can increase your position size—within reason. The point is that you never want to trade at a size where the emotions of hope, greed, and fear overwhelm your rational mind and objective decision-making process. The business of trading is all about controlling emotions. You should not fight the market or other traders. You should not fight yourself. You need to keep greed and fear low and discipline high. Hope is a great emotion in other aspects of life, but not in trading. Find your core position and stick with it.

Quiet Confidence

Of course, we are emotional creatures and we can’t completely strip emotions out of trading. The feeling that I recommend you cultivate is quiet confidence.
Quiet confidence comes from following your trading rules and faithfully executing high-probability trades. It comes from trading within your capital and exercising emotional discipline. And it comes from the knowledge that if you do the right things in trading, good results will follow.


When you have quiet confidence, you are in complete control of your trades.At a gambling casino, you have less than a 50/50 chance of winning. The odds always favor the house. I’ve read that a player’s odds in most Las Vegas establishments are about 46/54. What that means is that once you’ve rolled your dice at the craps table, you’re committed to a bet where the odds are stacked against you and you can’t do a darn thing about it. You never want to do that in trading. In trading—at least the way I go about it—you never really let go of the dice.



You wait for the high-probability trade to materialize. You make the trade. You
monitor the position. Depending on market action, you get out of the trade with
either a profit or, at worst, a small loss. In a sense, you never really let go of the dice in this type of trading. You remain in control throughout the process. When you lack confidence, you can’t win. The quickest way to lose your confidence is to violate one of your trading rules. It’s OK to make an incorrect call on the market. But it is not OK to violate a trading rule. Once you start making excuses for violating your rules, the entire foundation of your trading will crumble and you’ll be back to square one.


You are most vulnerable to breaking your rules following a string of good trades. For a period of time in the late 1970s and early 1980s, I found myself doing much better than normal. I attributed my improved results to better trading on my part. Thinking that I had now reached a higher level of trading proficiency, I increased my trading size. I remember getting emotional and little greedy. Then the inevitable happened.


The market went against me and I took a big hit. Lesson learned. If you are making more money than usual, it’s probably because the market conditions are creating more trading opportunities, not because you’re a better trader. When you’re doing well, refocus your energy on following your trading rules and avoid thinking about money. Don’t let quiet confidence develop into overconfidence.


Similarly, confidence should not cause you to become too committed to a market
view. Market conditions can change several times during an active day. A trader
needs to be pliable and adjust his/her viewpoint in concert with changing market
conditions. You can’t think that you know better than everyone else and you know better than the market. That’s not confidence—that’s arrogance. And arrogant traders never win.


When you are quietly confident, you can trade without beating yourself up over setbacks or getting too high after successes. Assuming you have a good trading process in place, you should trade the same regardless of your recent results. Don’t become more aggressive, and don’t become more cautious following success or failure. Don’t dwell on the past. Focus on the now and the next trade that’s in front of you.

Sell Too Soon, Not Too Late

I’m an in-and-out trader. I focus on short-term situations where I have an 80 percent chance of winning. On a typical day I make three or four trades. Given my style, it’s important for me to grab a quick profit or liquidate a trade if it doesn’t move in my favor. I exit quickly. Good traders don’t worry about missing a chunk of a big move. They take their profits without regrets. They know they can always get back into the market. In a sense, they’re content with taking a piece of the pie and coming back for seconds.



In trading, everyone agrees that you should cut your losses. However, you sometimes hear or read that you should ‘‘let your profits run.’’ The idea is that you wait until the move is exhausted before selling. I don’t agree with this tactic at all. Here’s why:It’s a rare event for a market to make a move early in the morning and then continue in that direction the entire day. Typically, there are pullbacks or small consolidation points along the way. Sometimes the market reverses, sometimes the trend continues, and sometimes the market transitions into a trading range. The patterns are endless. The trader who had the mind-set of letting his/her profits run is, in essence, hoping for an unusual market structure: a trend day that moves strongly in one direction and never looks back. Those days happen, but they are a rarity.


In most circumstances, if you ‘‘let your profits run,’’ you’ll end up waiting too long and selling after a protracted pullback. You’re likely to give back a good portion of your profits on the trade. Moreover, by overstaying the trade, you may miss out on the next trade. The pullback where you exited may be setting up for another 80/20 trade.The best time to sell is when the momentum is in your favor. You see the 80/20 trade. You get in. The market moves in your direction, and you have a nice profit on the trade. Take it. Get out and get ready for the next trade. Do this three or four times a day and you’ll end up winning most days and nearly every week.


That’s how a lot of professional traders make a living. You never want to find yourself wishing or hoping for the market to do something. You want to remain in control of the trade and in control of your emotions. Winners come into a trade for a quick profit. If it doesn’t work out, they get out. Losing traders hold on to hope. And if the trade doesn’t work for them, their hope usually turns to regret or despair over losing money. That’s not a path to long-term trading success.


As you gain experience in the market, you’ll get a better sense of market action
and the right time to get out. There will be times when you catch a trade just right and the momentum is very strong in your favor. In those cases, you can hold on a little longer than usual. In other cases, where the market doesn’t move much at all after putting on a trade, you might elect to get out earlier with maybe a scratch or a small profit.


You always want to control your trade. If you have doubt about a trade, get out of it right away and stay out until the situation becomes clearer to you. You always want to strive for an objective appraisal of the market and unemotional trade execution. Hope, doubt, fear, and greed are enemies of good trading.


Take Personal Responsibility for Your Trading

You alone are responsible for your results in trading. You get to pick how to trade, what to trade, and when to trade. You are the reason you succeed or fail in trading.A sure sign of a bad trader is one who places blame on factors other than himself for his results.


Bad traders can come up with a variety of excuses for a losing trade:

■I got a bad tip.

■ The pros went gunning for stops—and they got mine.

■ My broker gave me a bad fill.

■ My computer crashed.

■ The price quotes were delayed.

■ I was interrupted or distracted.

■ A news event caused the market to reverse.

■ And on and on.


Again, losses are inevitable in trading. You need to learn to handle them without
getting down on yourself or blaming an external factor. While it’s fine to analyze
a losing trade to understand what went wrong, don’t dwell on it. Don’t dwell on winners either. Get back to the market and get ready for the next trade. I make about 15 trades on the average week.


I expect about 12 of them to be profitable. Some will be marginally profitable, and some will be very profitable. The losses on the losing trades will be small. At the end of the week, I’m almost always in the black. That said, I do have losing days. That’s acceptable. If I have a losing week (which is very rare), I examine what I’ve done to see if some bad habits have crept into any aspect of my trading. A bad month is completely unacceptable.

Wait for 80/20 Trades


As I’ve said, the heart of my approach is to trade high-probability setups, which I
define as trades that have an 80 percent chance of winning. I have created templates, which I share in later chapters, to recognize these trades. The key for me is to wait patiently for the high-probability trade to materialize before putting on a trade.


There will be many times when you have a strong feeling that the market is going to move in a particular direction. Maybe the market has broken out from a trading range and looks ready to go higher. Or maybe an up move has run out of steam and the market is turning the other way. These types of situations happen all the time, and it’s natural as an observer of market action that you get a sense of the market’s next move. However—and I can’t emphasize this enough—do not trade on these feelings until they are corroborated by the 80/20 trading template.


I like to say I’m a ‘‘sore loser.’’ I do not trade 60/40 situations, and you shouldn’t either. At the end of the day, the profit margins are too small to make these trades worthwhile. And when you lose 40 percent of the time, you’re more prone to losing streaks, losing days, and losing weeks. Also, when your loss rate is 40 percent, you are more likely to second-guess your signals and have difficulty pulling the trigger. It’s OK to stay on the sidelines when the market is giving you mixed signals. I trade the market by my own set of rules. If the current market action doesn’t give me the kind of opportunity I demand, then I don’t play.

Play Great Defense

A good trader is more focused on controlling risk than maximizing profit. He or she does this by accomplishing the following:

■ Controlling emotions so that fear and greed do not undermine the decision-making process

■ Getting out of losing trades quickly

■ Following the trading rules

■ Trading small relative to the size of his/her capital.


It’s very important to get out of bad trades quickly. Always keep in mind that the
market continually presents new opportunities. If you overstay a bad trade, chances are you’ll miss the next good opportunity. Similarly, when a trade is working for you, don’t inflate the potential profits. Don’t expect too much from a single trade. Take your profits while they are ripe on the vine—when the momentum is still in your favor.


Everybody has good days in this business. And everybody has bad days, too. By
thinking defensively all the time, you can limit the damage done on bad days. When you handle bad days well, you are on your way to becoming a good trader.

Pull the Trigger

Trading is not for the weak-minded. You need to do the necessary background work before the market opens, and you need to have your trading templates in place.You need to monitor the market and anticipate 80/20 situations. And once the situation presents itself, you have to be decisive. Trading well requires a sense of urgency. Don’t fall victim to the ‘‘paralysis of analysis.’’ You have to act when the opportunity presents itself.


If you get a buy or sell signal on the template, then make the trade. Generally speaking, the better the opportunity, the shorter the time it will be available. There are many good traders in the market. When a great opportunity materializes, many of these traders will recognize the situation and act on it. As a result, the market will move quickly and decisively in one direction. If you wait too long to analyze the opportunity, it will pass you by.

Opinions Are for Pundits, Not Traders

Everywhere I go, people have an opinion about the stock market: on television, the Internet, and even on the golf course. It gets to the point where it’s hard for me not to have an opinion. People who know I’m a trader naturally ask me about the market. I’m sure the same thing happens to many of you. Remember, whatever your opinion is, we trade 80/20 opportunities, not our opinions.


I come into each day with an open mind, ready to go long or short as the market
action dictates. Based on my background work, I may think that there’s more potential for the market to go in one particular direction, but I don’t let that view
prevent me from trading in the opposite direction if the opportunity presents itself.

Strictly Follow Technical Data

The financial press usually attributes every move in the stock market to something in the news, most frequently an economic report. And security analysts look at corporate fundamentals to determine whether a stock is fairly valued. I purposefully ignore both economic and corporate fundamentals. It’s simply not my game.


Technical indicators and charts record all the buying and selling activity in the market, organized in a manner that allows me to spot high-probability trading situations. That’s all I need to focus on to make money in the market. As a trader, you can’t follow everything. Charts are very important for short-term trading because they show the underlying market psychology. And technical indicators help to time exit and entry points. Both are indispensable.


To get a better picture of market dynamics, it’s valuable to assess the market one time frame greater than your trading time frame. For example, if you are trading with a 5-minute chart, use a 30-minute chart to gain additional perspective. You want to be sure to get confirmation from technical indicators and charts before taking a position. For example, don’t buy or sell a market only because prices have dropped or risen substantially and the market seems hugely under- or overvalued. Wait for the indicators and charts to signal a buy or sell.


As you gain experience with charts and technical indicators, you’ll develop a
sense of anticipation about changes in trend. You’ll see momentum flagging, spot
divergences, and sense that the balance of power between buyers/sellers is shifting from one side to the other. When you see the trend changing, get focused on your trading templates and get ready to trade.


Market Entry Tactics: Use Limit Orders, Buy/Sell Zones, and Position Scaling


Regardless of the time frame that you trade, it’s very difficult to pick a precise top or bottom. Instead, based on your analysis, you should target a buy and sell zone where you project it’s safe to be long or short. Whenever possible, you should use limit orders to establish a position in your buy/sell zone. A limit order guarantees that you’ll get in at your price or better. While it’s possible that your limit order will not get filled and the market may move quickly in the direction you anticipated, I’ve found that rarely happens if I placed my limit order at a reasonable price. In many cases, I’ll scale into a position. For example, I may place a limit buy order for two E-minis. If I’ve caught the beginning of a strong move, I may purchase another two E-minis at a higher price and then perhaps another two E-minis at an even higher price.

Use Defensive Stops


I advocate the use of stops to limit potential losses. You can set them at specific
prices or at values created by your technical indicators. You need to be disciplined about setting stops with every trade so that you don’t allow a small loss to turn into a big loss. I typically place my initial stop two ticks away from my entry price. Once the market moves in my favor, I move my stop to lock in a profit. I won’t wait for the market to slow down or retreat before exiting. I’ll get out with the momentum still in my favor. If you’re trading on a longer time frame, your stops should be larger, more in the order of 5 to 10 ticks.


There will be times when you are right about market direction, but you’re wrong
on market timing. In those situations, you may very well get stopped out of your
trade. There’s nothing wrong with getting back in the market shortly thereafter if another 80/20 setup materializes. If the market moves in your favor, you should adjust your stops to lock in gains. Markets can move against you quickly; you don’t want to transform a nice profit into a loss. Again, if you get stopped out on a minor pullback after adjusting your stop, you can always get back in. If a trade is showing a loss toward the end of the day, I’ll liquidate the position before the market closes. I don’t want to hold losing positions overnight.


I may average up or down in certain situations; however, I do not average up or down above my core position. To average down means that you buy additional
stocks or contracts at a lower price after the market has dropped below your initial purchase price. To average up means you sell additional contracts at a higher price after the market has risen above your initial short position. Again, my core position is my maximum position based on my psychological comfort level. For me, it’s 10 E-mini contracts.

Track Your Results

At the end of each trading day, I note my profits and losses (P&L) for the day, for the week, and for the month. I’m very precise in my record keeping. I feel that precision carries over into my trading and helps keep me focused. I’m always aware of how each new trade contributes or detracts from my P&Ls. By focusing on high-probability trades, my P&Ls typically show continuous growth, with a few relatively small down periods. However, the returns are not consistent. You can extract from the market only what the market gives you, and your returns will vary depending on market conditions.


  You cannot demand consistency in your returns; it’s just not in the nature of the business. New traders, particularly those with a background in a structured business environment, need to understand and accept that their weekly and monthly P&Ls likely will show a wide range of returns. But while your returns will vary, you must demand consistency in your discipline and adherence to your trading rules. You should review your trades daily to determine if you acted in concert with your rules. You should reread and study your trading rules on a regular basis. Make them part of your trading DNA. They are the blueprint for your success.

Managing Your Trading Account

If you are showing consistent profits, for psychological reasons, it’s a good idea to pay yourself something from your trading account. You deserve to be rewarded for your success. It will help to keep you motivated and give you positive feelings about your trading.


You should not intermingle your trading account with your investment account.
In-and-out trading and long-term investing are two distinctly different disciplines.
By having the two activities in the same account, you may be tempted to change a trading position into an investment position, which is usually not a good idea. In addition, with the two accounts intermingled, it’s more difficult to segregate the trading P&L and evaluate your trading performance.

Take Advantage of Market Conditions



Trending markets and trading range markets present different opportunities and
require different strategies and tactics. First and foremost, you should be aggressive in trending markets in establishing a position in the direction of the trend. Given the profit potential in a trend, you can afford to give up a tick or two to get into the market. Be aware that prices usually move faster in downtrends than uptrends. In downtrends, protective stops get hit and investors close long positions.


To avoid losses, there is often a rush to the exits. In uptrends, investors are faced with a less pressing situation: establish a new long position, add to an existing long position, or close a long position for a profit. Investors have more time to make a decision. As a result, there’s a slower pace of buy orders and slower price movement on uptrends. There are times that the market goes into what I call a ‘‘white heat’’ condition where prices move very rapidly, sometimes gapping up or down.


If you’re fortunate enough to have a position in the direction of white heat, my advice is to take advantage of the situation and close your position while the momentum is still with you. If you wait until the white heat move loses steam, it very well may gap in the opposite direction. In trading range markets, you should be more selective in establishing a position. To the degree possible, you want to buy at the bid and sell at the offer.


The profit potential in trading range markets is smaller than in trending markets, so you want to get the best possible trade location. If a market has been in a trading range for three or four days, it’s likely that the market will make a big move when it finally breaks out of the range. In most situations, it’s best to trade in the direction of the short-term trend. However, you want to avoid chasing the market. Usually, there will be a pullback where you can get a better price than jumping on a breakout. As you gain experience in markets, you’ll develop a sense of market sentiment.


When the majority opinion is either bullish or bearish—and the market doesn’t move in the direction of the market consensus—the market will likely move strongly in the opposite direction. My indicators are sensitive to changing market conditions and will sometimes get me into positions a little early. Generally, that’s a good thing. You get a better feel for the market once you have a position.

And assuming the indicators were right, being early usually translates into a more profitable trade.

 Review the Rules Every Week

Please don’t read these rules, nod your head and agree that they make sense, and then pretty much forget about them. These rules are the product of my years of experience in the markets. If I had had the rules when I first started trading, my path to consistent profitability would have been much shorter. Read the rules regularly and make them your own.

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ONLY TREND FOLLOWING WORKS

ONLY TREND FOLLOWING WORKS


Do you think you can control the world? I do not believe it can be done. The world is a manifestation of change and cannot be controlled. Trying to control leads to ruin. Trying to grasp, we lose. Just as you breathe in and breathe out, the world is a manifestation of change; sometimes ahead, sometimes behind, sometimes dynamic, sometimes static, sometimes vigorous, sometimes feeble, sometimes being safe, sometimes being in danger. Therefore, refuse to distinguish excesses and extremes. See only oneness. Flow with Infinity and exist in peace and harmony.


All trading methods fall into one of two basic categories:

1. Trend-following methods
2. Against-trend methods


Trend-following methods try to “Flow with Infinity.” Against-trend methods try to
“control the world.” We will now see why the former approach is the intelligent way to engage the markets, while the latter approach cannot succeed in the long run.

Trend-Following Methods



Trend-following methods result mainly in “buy high, and sell higher” or “sell low and buy back lower.” A market’s trend is driven by its internal forces. It reflects the market’s own symmetry. Trend-following methods work because they act on the market’s actual direction, rather than acting on assumptions associated with the news or a trader’s own ideas. The market has its own character and personality. We cannot stop or change it. But to be successful we must merely ride on it. Its movement is natural and smooth. It can be ridden, just as easily as gliding on a boat downstream, and small efforts can achieve big results. See more about why trend following works in the pages that follow.

Against-Trend Methods


Unfortunately for them, the majority of traders trade against the market trend. They follow the precept of “buy low and sell high.” We were taught this strategy from a very young age. It feels natural to most people. If a store has a sale where it offers big discounts, people tend to buy more. If prices are up, people tend to buy less.

This approach does not work in the world of trading as a viable business plan. The money of traders who fight against the trend often becomes the fuel for increasing the movement of trends. Even so, there are many trading theories, methods, indicators, and systems that are designed as a result of these arbitrary ideas. Ten or so years ago a wellknown article was published with the title “Trend is your enemy.” 


Rather than following the market trend, many trading ideas and formulas, such as oscillators, cycles, turning points, Elliott wave, Stochastics (%K, and %D), and RSI, among others, are specifically designed to trade against the markets.
If you wish to trade the markets with consistent success, you must abandon against trend methods and begin to follow the natural law of trading with trends.

Why Trend Following Works

 

Trend Refers to the General Direction

If we know the general direction that the market is heading, we can achieve a profit by simply riding on the natural course of the market’s flow. The market itself determines the most highly probable direction in which it is likely to continue, coupled with support and resistance levels. The trend and support and resistance levels are defined by the market’s own prices. We cannot predict the trend—but we can follow it to our benefit. This is a major difference between the trading method that underlies Able Trend and other approaches to trading. The primary purpose of this book is to define a trend objectively so traders can follow the trend for profits in trading.

How much simpler—and more successful—trading becomes when we get out of the predicting business and get into the business of simply following trends as they unfold before us.

Act on Facts

Trend-following methods work because they act on facts—the actual market direction—rather than acting on assumptions associated with news or a trader’s
own ideas. Just think of how many times we feel that the market is “too high” or “too low,” or has gone “too far.” Then we try to fake out the market. Just think of how many times we hear a very bad or very good news report, and yet we see the market reacting  by going in the opposite direction from what we would expect. 

You might think it just doesn’t make any sense at all. And then you wonder what is going wrong, and what happens next? The market has reached another new high or another new low! Our minds just cannot accept the reality of the market. We try to justify in our minds why it should or shouldn’t be this way or that way, when all we really need to do is see what the market is telling us and act on that.


The Majority of Traders Trade Against the Market Trend

Again, bearing the standard of “buy low and sell high” before them. But when the market is nearing new highs, it is clearly saying, “I am going up now.” So why is it that so many people still don’t hear the market’s voice, but try to sell the market? In fact, no one can stop a market’s trend except the market itself. As I said earlier, the money of traders who fight against the trend becomes the fuel for further movement of the trend. (With regard to this, read about the “80-20” rule in this chapter.) I clearly remember something that happened when the British pound crashed in 1992.


When the pound crashed, one report said that the British central bank kept buying the pound in order to shore it up, but the British central bank still lost over $1 billion a day at that time, even with help from many other central banks. It just shows that even the most powerful forces cannot overcome the market trend. To trade against it will always be a losing proposition. Another example was provided by the U.S. stock market in 2008. After the DJIA index reached a top at 14,198 points on October 11, 2007, the U.S. stock market started to drop. 


When the market dropped to about 10,000 level in early October 2008, many mutual funds and big traders start to buy. They predicted that the market had reached the “bottom,” and this was a good time to “buy low.” However, the market has its own way, which could not be predicted by anyone. The market continued to move all the way down to 6,500 point level in March 2009. Most of those buyers panicked and sold out their positions as the DJIA index neared the 6,500 level—but it was too late.

Another example came when a big Hong Kong firm “hedged” the Australian dollar in 2008. In fact, they were not hedging, but purely speculating! After July 2008, the AUD/USD reached 0.9800, and the Hong Kong company predicted the U.S. dollar would become weaker due to the economic crisis that had started in the United States. They began to heavily buy AUD/USD. However, the AUD/USD kept dropping to 0.8800, then 0.7800 (that’s a loss of 2000 pips per contract, i.e., $20,000 loss per contract!). They kept buying more and more contracts. Eventually, their losing positions were too big to handle and they had to exit with a net loss greater than $2 billion near the low at 0.6000. In 2009, the CFO and CEO of the Hong Kong company were fired by their parent company in China.

Trend Is a Trader’s Best Friend, an Ally—the Strongest and Truest of All

As we have mentioned before, the trend flows like water, and as it goes it defines the course of the market. There is nothing in this world more supple and pliant than water, and nothing easier than to be in a boat, just floating along with the current downstream.This is more than just a poetic thought. It is a significant lesson that traders would be wise to take to heart. To trade by “following the way of the water”—that is, to move with the trend – is to trade effortlessly, without emotional upheaval. By this same analogy, moving against the trend is like trying to direct our boat against the natural flow of the current. It takes effort and we often end up where we never intended to go.


It’s All About the Market Price

The wish to “buy low and sell high” has been ingrained in our thinking since we were young. There are times when it paid off as we watched our parents buy groceries at the local store. If a store is offering a big discount on your favorite brand of coffee, it makes sense to stock up. When the price is high, it makes sense to buy less. But the question is, why does this work in our daily life, but not
in trading? 


The biggest difference is what we know about the price. Prices for goods at the store are far different from the prices paid at the trading markets. For tangible goods, such as a cup, or a pound of carrots, or clothes, or gasoline, or an automobile, we have a very good sense of what price is fair. However, when it comes to trading, what is the fair price for a stock, or a commodity, or a bond? The fair trading price is so hard to determine or to know that we cannot all agree with each other.


This is why there are buyers and sellers at all price levels as trading progresses. And this is also why trading is the most difficult thing in the world. Because we don’t know what the fair value price for a market is, and it certainly does no good to guess, we have to let the market tell us its own thought about what the correct price is. The way the market tells us is that it goes up if the fair price is above the current price, and it goes down if the fair price is below the current price. 


The hidden fair price always guides the way the market moves. We cannot see or know the fair value, therefore, we have to wait and let the market go ahead of us. Then we can follow it. Why is trading viewed as the most exciting game? It is mainly due to its unknown results and unpredictable nature. By following the trend, we let the market tell us the fair price, and that is how we make our decisions. We are no longer playing a game. We are acting scientifically on the facts. Isn’t that better than playing a game with your future?

Why AbleTrend Works


AbleTrend is a trend-following trading method. Based on trend definition and concepts that are described in Chapter 2, we designed four sets of proprietary AbleTrend indicators. AbleTrend uses these four sets of independently calculated indicators to truthfully follow and visually display a trend, and then to confirm its direction. It has been my experience that AbleTrend catches every trend in its early stage and never misses a big move. Using historical data, anyone can test AbleTrend’s performance with regard to a variety of major historic moves, such as “Black Monday” of 1987, 9/11 of 2001, and the economic crisis of 2008. If you take the time to do so, you will clearly see why I can say with confidence that AbleTrend never missed any big move in the past 20 years.


It is important to understand that a trend is not a trend until it is on its way. Therefore, AbleTrend cannot and is not designed to pick the top or bottom ahead of time, or even as it is happening. On the contrary, AbleTrend acts on the facts as they present themselves (i.e., what the market is doing now) and simply follows the market’s lead. We can only truly identify a top or bottom after prices confirm that a change in trend direction has occurred. AbleTrend never makes assumptions about what the market should be doing. 


AbleTrend is powerful because it creates the lens through which people can observe real market actions without altering what is seen. AbleTrend is live and updated with every coming tick in real time, so its data is always current. And because of the power of its mathematical formulas, AbleTrend can identify a change of trend with minimal data—and therefore, at its early stage. In its identification of where to place optimal stops (i.e., at support and resistance levels), AbleTrend furnishes traders with great flexibility for entering and re-entering the market.


Those stop values are directly driven from the market price’s action and reaction, not from any arbitrary idea. AbleTrend provides optimal stops for every trade objectively. And as my experience has shown me again and again, if you know where to exit the market, you can enter the market at virtually any time. Above all, AbleTrend is universal and based on the natural law, which works for any market and any time chart. It’s time-tested and timeless.

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