A traders day of two halves

Very sensibly, most traders will not trade lower time frame charts because of the effect many news announcements have, seemingly unpredictably, on price.

Let me give an example by following me through a (common) recent day of trading.

The day I have chosen has a good array of news announcements, many of which have no effect on price but one does – the announcement that the UK interest rate will remain unchanged at 0.25%.

At mid day, and within a few seconds of the (seemingly) unspectacular news, this happened to the chart:

This is a chart of sterling to yen. The chart jumped just over 100 pips, which to a higher timeframe trader, say someone who trades using daily closed bars, and, as the chart will often move over 100 pips in a day, this is no big deal.

To the lower time frame trader it is not the amount of the move but the little time that it took. That is what scares people away from short-term trading, and on the lower time frame chart this can happen a few times each week.

However, through a combination of knowing when the news will be announced and (more importantly) reading the chart, we can be in the flow with price and very rarely risk being caught on the wrong side of such a price move. Conversely, because of risk, I’m rarely on the right side of such a large move either. That is not where I get my gains.

Here’s the day per trade before that event.

The chart always looks different prior to a big (relative to timeframe) move due to proportionality of the chart.

My day started early, about 6am on the chart, concentrating on the one chart. Due to a combination of low bar size (price change) and high spread a start at 8am (UK time) is probably better, but there is nothing set.

The close of bar number one was my first trade taken long. Not the best of trades as we have two small attempts to push up prior to bar one which ended up being a third and final, and possible exhaustion, push. A good out would have been the doji three bars later; however, I held and came out at a loss, but before my stop, as bar two crashed short.

I entered the close of bar two short. Changing direction of trade is not the easiest of things for a trader to do; and because of this I only entered with one-third of my usual amount.

I held that trade through the pull back. At the close of bar three I went short with the remaining two-thirds. I’m now fully committed short. The doji four bars later gave me pause for thought, but I held through until target which was a measured move to near the bottom of the next and large bar short.

Very good, we’re nicely in profit at this stage. The close of bar six was the next take short. This was an early take and I didn’t get my measure until the next but one bar and this provided another 18 pips of profit.

Bar five, for me, provided a good probability long. So I entered long at the close of bar five. My target was 17 pips above. Excellent, that worked.

Easily the most sure trade of the day was the close of bar six short. My target was below the low of the day, however, with the doji at the bottom of that leg, I exited the trade with 22 pips of profit. Moreover, the interest rate news announcement was imminent, so a great time to be flat.

After the news announcement and the rapid 100 pip bar long my strategy is to take the close of that bar long expecting another 100 pips. I didn’t as emotionally I was uncomfortable with the 100 pip risk. By early evening the move was completed.

I’m pleased that after the news announcement, I then positively managed one swing and two further scalps, but amounting to significantly less than the subsequent 100 pips on offer for the afternoon. That is not disappointment on my part (an emotion that a trader has to ignore) but a reinforcement of my strategy, maybe for next time.

Trade without bias

“No data yet!….It is a capital mistake to theorise before you have all the evidence, it biases the judgement.”                            Sherlock Holmes

We’ve previously touched on an issue that: doctors, engineers, solicitors etc may have when they try to trade – and I was no exception.

For a long time we have, through professional good habit, been comfortable predicting the way ahead based on our experience, good judgement and assumptions.

In technical trading, however, such attributes do not help. Having a preconceived idea of what the market will do blinds us to reading the market in the moment. Or, as Arthur Conan Doyle wrote, “it biases the judgement”.

We have previously considered (from Joshua Foer) that a grand master chess player does not look several moves ahead, as we all assume, but rather is coldly reacting, more or less, to the opposition pieces presented in that moment.

A form of trading, which I like a lot, is what I call “always in” trading. This is best done on a single market and timeframe. Always-in provides the dual meaning of direction of trade and committing to a trade direction wherever possible.

Whenever we are confident of an always-in trade direction, then we are to do everything we can to enter the trade.

In a neutral, or 50/50, event the trader waits. But as soon as the always-in is defined with some probability then the trader enters the trade.

Okay, there is more to it than that and why ‘always-in’ is a method, I think, for the experienced trader only – but bizarrely all beginners seem to start out with this or a similar methodology.

To do the same in my previous career, it would be like joining the Red Arrows before completing flying training.

 

A chart mix

My mother missed her step coming off a pavement and fell and broke her hip. She is doing remarkably well and I look forward next week to getting back to my trading, I’m a couple of weeks behind.

Trading GBP/JPY on the 5 minute charts works well for me. I like the size of this market and on many days GBP/JPY can be quite defined. Anyone familiar with EUR/USD or even GBP/USD will find GBP/JPY quite lively.

Many that trade major pairings will not take the spread into consideration, a mistake I think, but not a big one. Particularly if they trade from 15 minute charts or higher. GBP/JPY however, on a lower time frame, teaches us the necessity to consider the spread. To do otherwise, and be consistently profitable, is more difficult – I think.

To make the best of both possibilities I’m happy with my results of concurrently trading GBP/JPY on the 5 minutes chart (as the priority chart) with a watch on USD/CAD, Gold and EUR/USD – each of which are on the 15 minute chart. I tried many possibilities but these choices give me good opportunity, diversity, liquidity and a spread value that I prefer.

For example, GBP/JPY does not work with GBP/USD as both react almost in unison. Moreover, oil is often a mirror image of USD/CAD: so to trade one would have too much influence on the other. I do find that Gold and EUR/USD often have similar movements and on such days I consider a swap to AUD/USD or (and I’m in the early stages of this) the US 500 SPTRD.

Other FX pairings, and particularly exotics, are not considerations for me. Primarily due to spread but also we are dealing with randomness and probability, and we don’t need big uncertainty too. As already mentioned, I’ve looked carefully at the US 500 SPTRD and this is a possibility on the 15 minute chart with good liquidity once the US market has opened.

To trade the fund on the 4-hour charts is not possible (for me anyway) with already four intraday charts to manage. If my results are what I know they can be (and so far so good) over the next few weeks I will consider how to join the slow trader fund within this – more intensive – methodology.

The stabilisers have to come off, eventually

Who takes up retail financial market trading? I initially imagined that it would be young adults, the ones we see on the sports betting adverts, but I was wrong. It’s primarily professional people: engineers, doctors, dentists, lawyers and well-to-do retirees. But unlike our usual work, we struggle to be successful at financial trading.

Because, unlike our usual work, we are now dealing with uncertainty; and in this world, because we don’t understand the future, it is not possible to work rationally. To overcome this we look at the future by naive projection of the past.  We are now in a world where 60% certainty (if we’re very good) is as good as it gets. We therefore look to a method and indicators to help make what is irrational seem more rational.

That brings me onto the decision of how to trade. The ‘how to’ question is probably one of the most difficult and important decisions a financial trader makes. However, as with choosing a career when we’re young, we do not have the experience to be sure we are making the right choice. Therefore, we are overly influenced by those around us.

In trading we tend to go with the method that we learnt from the first seminar we attend. We try that to the point of financial exhaustion and either quit, or if we’re particularly determined, we will venture to try another seminar and another method. And so the cycle continues until we achieve expert or get lost in the ‘dip’ somewhere.

With a little thought it does not need to be so difficult. We first need to find the broad category of trading method that suits us. If we stay away from the ‘get rich quick’ merchants (those advertising the secret or ‘the one thing’) then there are a lot of excellent tutors available.

We do need to find that broad category first however: no point in learning chess when what we really enjoy is the simpler pace of draughts (checkers). Once we have that broad method that we determine is the one for us, we can then go to work on the finer detail.

It took me a long time to find ‘price action’ as my prefered trading method. I notice also, looking through the internet, at great beginner introductions to price action that are available. Many however provide confluence ideas of price action with indicators: moving averages, Fibonacci retracement, stochastic overbought and oversold to mention a few.

That’s fine, we all start with all of these; they’re supports and we feel, and were told, we would be foolish to attempt to trade without them. However, price action is much more than this (or I should say much less because with true price action indicators are a distraction at best). Once price action is learnt we can deal very well with the irrationality of it all and we can strip away the supports. After all, even Bradley Wiggins, probably earlier than most, had to take the stabilisers off at some point.

Reward/risk has to be right

Rather embarrassingly on my part, I discovered something simple but fundamentally wrong with my trading. I made the adjustment today, and amended the ‘algo to trade by’ page. Even a tweak, if it is a fundamental tweak, can make a profound difference.

As in many things, but I feel particularly in trading, I cannot be so keen on my backtest work that I’m not prepared to take a fresh look once I’m in the trading room for real. As Yogi Berra said, “in theory there is no difference between theory and practise; in practise there is.”

My foundation is my reward/risk, or what is referred to as R. To achieve a planned 2R (actual R can be much better) means that my planned reward is twice my planned risk. I had the minimum acceptable R as too small. Again, in theory (or backtest) it’s fine but in practise – often with a less precise entry point and a variable spread – working with less than 1R is not viable for me.

I call a 1R a scalp and a 2R a swing. My strategy, because of my abundance of less than 1R scalp opportunities, was scalp/swing. And this provided me with few swings. Moreover, the scalp element (less than 1R) required an 80% (win/loss) success rate to see accumulation of reward.

Changing to swing/scalp and limiting scalp to not less than 1R is greatly preferable. Profitable scalp percentage is now 60% – still high but that’s the issue with scalping. And the swing percentage to be profitable is 40%; anyone suggesting less does not have a spread to contend with (prop trader rather than retail trader) or they’ve ignored it.

To a non trader this all seems a lot about nothing. But it’s like a golfer playing a match without the long clubs and therefore having to take too many hits on the par 5 holes.

Downside, like Steve Jobs

Let us chat strategy for a moment. Wikipedia says strategy “is a high level plan to achieve one or more goals under conditions of uncertainty.”

Many that provide trading strategies have it wrong. What they are actually providing is a way to trade, or a  method, or a system. The way that I trade is contained within my ‘algorithm to trade by’ page and this is something I tinker with all the time. (I call it an algorithm so that I keep in mind that I’m up against algo-trading which is unemotional, timely and precise).

What I don’t tinker with, however, is my strategy; well, at least not without a great deal of consideration. A strategy is to be clear:

  • Multiple swing
  • Swing
  • Swing/scalp
  • scalp

(traders interpret a swing and a scalp differently, see ‘algorithms to trade by’ in the paragraph clarification)

I may use a multiple swing strategy for very long-term value investing such as with Nick’s top FTSE 350 shares; a swing only strategy is perfect for intermediate traders or experts not intraday or unable to watch the trade; swing/scalp (my passion) is the full-time experts choice; and scalp only is, well, a difficult strategy because of the often poor reward/risk ratio.

As I’m a swing/scalp strategist I also sub-divide that strategy into swing/scalp or scalp/swing; taking the first more determinedly than the second, but that’s for another time.

Each strategy requires little understanding, just rationality in comparing two outcomes (price up, price down), exercising the better option and holding for the desired target. I get out at break even if my algorithm tells me to. It’s about control of the downside and then about the maximisation of the upside.

The first sketch below was used by Steve Jobs at one of his presentations to show how he took (many) minimal downsides before he eventually got the big upside.

The same is for good trading. The next sketch might represent how much was made or lost each year with a longer term investment. If we checked the results, say, every three years we would only once see a decrease in our year on year portfolio results, therefore minimising emotional drain.  Each blue horizontal line might represent a £1,000 (or multiples of) year on year profit or loss.

Finally, a sketch of a day traders result for the day. A single blue horizontal line up or down represents a scalp win or loss; two horizontal lines is a swing. The bar with three horizontal bars up was a swing that was entered early and provided the extra profit. We should never see more than two bars at any one time to the downside. Each swing and scalp, therefore each horizontal blue bar, is the same in value whether the scalp was 10 pips or 30 pips. Each horizontal line represents the traders risk. A traders risk (each horizontal line) might be £60, or £600, or £6,000 – or any figure in between – depending on the traders account. But it has to be consistent.

The point here is that any downside (for the sake of emotional drain and our pocket) has to be known, acceptable and controlled. This is something most of us don’t understand when we start out. Steve Jobs understood this and he did okay.

A sucker game

A point worth serious thought from Nassim Taleb from his book “Antifagile: things that gain from disorder”.

Yes, he creates, I think, an appropriate new word (antifragile) to help get his meaning across. In one area Taleb presents his argument on medium risk (referral to a financial portfolio) and how he considers there to be no such thing as “moderate” risk.

His point is that in the event of a “Black Swan”, that is a catastrophic negative event, then all – low, medium and high – risk is going to get hit. (As an aside, I consider that a negative Black Swan, to an expert intraday trader, can become a positive Black Swan).

Fully committed to a “moderate” risk account is, actually, at full risk; at best, this provides medium upside potential but with all the possible downside. That is because medium risks can be subjected to huge measurement errors.

Taleb points out that: rather than being fully committed to a “moderate” risk portfolio (and in the event of a negative Black Swan, a potentially emotionally draining experience); better to be 90 or 80 percent in a boring, inflation proof, no risk cash (or: bond, cash, share mix – my words) account and 10 to 20 percent in a very high risk account. (Taleb uses 10 percent very high risk, I’m simply following Pareto’s law)

The 80/20 example means that we have little downside – assuming that 10 to 20 percent downside is acceptable – whilst still exposed to massive upside.

To finish, Taleb writes: “Someone with 100 percent in so-called ‘medium’ risk securities has a risk of total ruin from the miscomputation of risks”…..”that in fact is a sucker game”.