What’s most important: trade entry, management or psychology?

In the last blog post, I mentioned that a trade entry process, management of the trade and the emotional challenges are each equally important.

The vast majority of the information available to us is, however, based solely on entry procedures.

Some gurus say (and for a good reason) that profitability is a function of the management only and—what is now becoming more realised—the emotional decisions we take with each trade.

I’m staying with the full package, evenly split approach—an exact entry requirement balanced with proven trade management and a no doubt (unemotional) exit strategy.

As for entries, there is a myriad of ways to trade. We have to find what works for us. I use a combination of trend and channel lines, price action and—thanks to Nick’s coding—unique indicators.

The channel lines are provided by James, who has a very natural affinity for this work. To look at the simple trend line structure below, you may get a false impression. Simple but—for anyone that has tried to do this for a living will attest— far from easy. To determine a workable contextual trend with barely one touch is exceptional.

The crosshairs in the chart above represent my short entry position in a trade last week.

The charts below show Nick’s objective indicator of the same trade. The lower red line (green line above if I were long) represents a 50% probability objective based on the yearly bar averages. The white dots are my ‘average true range’ to establish risk, and the shaded red and green areas represent the wicks of the prior daily bar that assist with macro price action.

The objective probability indicator is handy in a ranging or (medium to shallow) trending market.

We can see from the above example—of acceptable probability—how our entry, management and exit process might work in unison.

Of course, it is when it doesn’t go so well that the synchronicity or not of the three elements shows.

Beyond Mediocrity

In day trading, what is the most essential—process, management or emotion?

The answer is all three, equally. However, we naturally prioritise the ‘how to’. We ignore the second and nearly all of us are ignorant to the third.

But without each working synergistically success (the one per cent of trader’s status) is not possible.

Discretionary or system trader? A muddying of the water, as without an algorithmic programme we are both.

And when we are both (nearly all professional traders are), success depends on the resilience of our so-called system and management plan (and therefore our confidence) and the curtailment of discretion—in other words, keeping instinct (emotion) at bay.

Through backtesting or paper trading, we practise our trade entries and management. But it is only in live trading, and at an amount appropriate for our account, that emotion can interfere.

Instinct, psychology or emotion—by any name it is primarily responsible for a trader’s eventual mediocrity.

Discretion dominates in the first few years of a trader’s progression.

Our trade process then takes on a more systematic approach; we become consistently profitable.

Our trade management is precise and appropriate to all conditions.

We are on a roll!

However, without control of our emotions, we will only tick along.

A stoic approach in itself is not the answer. Indeed, by itself, it is a sure way from profitability back to mediocrity.

It is more. To achieve precision in our work is to trade without inappropriate emotive decisions interceding. It comes from preparation, mind and soul in harmony, systematic processes and the harnessing of ill-suited discretion.

It is beyond mediocrity.

1% profit—super

“There is a world of difference between a net profit trader and a super trader”, Schwager says in The New Market Wizards.

Getting to the level of net profitability is an exciting achievement. Not to be undermined. However, to graduate as a super trader, which I guess means being super-profitable, is every trader’s goal.

That sentence will mean entirely different things to each individual. But if we say it is relative to account, then the meaning ought to be proportional to everyone—to some extent or other.

But let’s not get too carried away with the term ‘super’. We’re not some Marvel reincarnation. Indeed, we should not associate the word exciting with trading. Better to use, calm, focused and flow.

What is possible

My aim is 1% profit per day. As a day trader, this is appropriate. Traders using, say, daily signals will need to determine their profit timeline. But that is the beauty of day trading—precisely bracketed, a start and a finish.

I previously thought that a profit for each trading session (a day for me) was inappropriate. I thought it was too precise and that a week, month or quarter was a better profit timeline. But it is too loose, too undefined. It allows inappropriate bets because we feel that we have time to correct. Trading is not an allowing game!

But I agree, a beautifully crafted methodology, edge and management come first. Once sorted, we take responsibility and narrow our profit goal to the finest of timelines.

Is it enough?

One per cent does not sound a lot. But over 200 trade days a year (allowing for weekends and time away) We are considering a 200% annual mark-up. Is this not worth the trading perseverance necessary? If we sensibly compound our risk-reward (such an increase is a challenge in itself), then we might conceivably be looking at a significant increase on the original sum.

Is this possible? It seems to have been for a very select few. But as Schwager mentioned in The New Market Wizards in the late ’80s, we are up against tens of thousands of professional traders.

Goodness knows what the figure is today and with computer algorithms.
However, if we work our edge with patience, confidence and attention, the consistent 1% incremental results are (super) achievable.

Don’t get trapped

When speculating in the currency pairings—the most significant market by far on a daily traded basis—we have to be on our toes not to get trapped.

Buzz day trades Forex. The only time he holds a trade overnight is when he’s trapped. An event (being trapped) that every trader has to strive to eliminate. But how do you do that?

(Trapped is not merely being out of the money, which is something a trader experiences on nearly every entry. Trapped is holding an out of the money event beyond a pre-agreed level—either through emotion or by mistake).

Being on the wrong side of a directional trade is the risk of doing business. It is part and parcel of the job. However, there is a world of difference in taking an acceptable loss and trapped.

Trapped suggests that a trader has held beyond an acceptable loss position and has ventured into account adjusting territory—not a smart place to be. Not only is the situation emotionally exhausting as well as potentially account debilitating, but it also distracts the trader from other trade opportunities.

Swimming with sharks

It may be difficult for an observer (a non-trader) to appreciate the implication. To trade currency pairings is only achieved via a derivative account of some form or other; to deal with leverage and margin.

A while ago, legislation limited the amount of margin possible on a (derivative) position for retail traders. Buzz believes that this was mostly a good thing. It helps prevent over-trading. However, he says, it also draws inexperienced traders into the lower timeframes—day trading in other words.

Margins of up to five per cent do not provide lucrative possibilities with a small account on daily Forex charts. Drawing the unsuspecting novice further down the timescales in search of riches but blind to the significant increase in risk. They go from pool dipping to shark-infested waters.

The lower timeframes bring the plethora of news events into play. One of the reasons Buzz trades the highest of the day trading periods, the hourly bars. Day trading requires a more focused and, therefore, dedicated management style than is necessary if trading daily charts.

Trade management

Trade management is a crucial skill to learn. But what is all the fuss? Have a method, backtest sufficiently to be sure of an edge and put it all into operation.

Unfortunately, live trading brings a whole new level of difficulty than is experienced in a systemised trial. The future market is not necessarily the same; live timeframes can seem both more expanded and contracted. Live markets bring emotion generated by the open bar, and not experienced in the benign backtest.

Trade management, arguably, can only be developed during live trading. It is therefore imperative that new systems are (live) traded small and over some time for the establishment of management rules.

As Buzz points out, to do otherwise significantly increases the probability of becoming a ‘trapped’ trader and in Forex, margin can grow at a blistering pace. Trade small, build slowly with particular attention on trade management rules and above all—don’t get trapped.

Hurry up and fail

Hurry up and fail (quickly) is, according to google, a well-known quote—I can’t remember where I first read it. However, the principle behind it sits well with learning to trade.

We must understand how the market works (for whatever instrument we trade) to the point that we can develop an independent strategy. It may not be a revolutionary trading method as most things have been tried, including trading via astrological patterns!

But within a trading system, how we do things have to be of our design. Tried, tested and failed—and started again. Over and over for what might seem a lifetime, which might be, or it might seem like it has been but in reality, is only a few years. If we think we can do this in a few months, then the likelihood is that we are still in the fail phase and haven’t realised it yet.

I think that to go through the fail quickly phase on one’s own is significantly more difficult. Probably why the vast majority don’t bother and buy a strategy instead, unfortunately, those that do so are, even those that win initially, still failing.

My thanks to James and Nick. James, for the daily technical analysis that far exceeds anyone else that I’ve witnessed. And Nick, for his mathematical and now, it seems, a coding genius in developing his non-lag indicators that work.

As a trader, I use James’ analysis to find value and breakout entries. Nick’s indicator confirms the validity of the trade, assists in its justification and, importantly, provides a probability objective.

From one of our trades this week the diagram below show’s James’ drawing of what we refer to as the confluence of the anchor and contextual lines. (In some instances, we may employ the micro and macro lines too). A value entry usually involves the anchor and contextual cues with the trend (or the appropriate ‘always in’ direction) associated with our timeframe.

The skill above is that most of the lines were drawn before many of the bars materialised. We also trade breakouts from the micro or anchor. And with the same directional stipulations as mentioned for the value trade.

The diagram below is Nick’s probability indicator which we use to assist with the entry and ascertain that we have a reasonable, 60% or 70% probability, reward/risk objective— taken from the prior 5,000 or so bars of the timeframe traded.

Value/breakout is an approach we have failed many times. But we have also had much success. It is one that makes the most sense to us and one we will continue to improve through intensive backtesting and analysis of our live trades.

Fund results to date.

Context is king

In technical trading, as in any other discipline, once one gets to a reasonable level of competence, any change in a method can have a complimentary or overly detrimental effect.

An example that often happens is the introduction of an indicator—one in which we place way too much reliance. We have all been there and done that.

As a price action trader, and other than a moving average, Buzz reads a chart without indicators. Some price action traders find a particular sign extremely useful in helping confirm the probable direction of trade or trade volume.

If a trader understands very precisely what they are doing, can replicate a trade time after time through market cycles that are, at the moment, somewhat uncertain and be profitable then they have an acceptable method.

The trick is being consistent enough and therefore build a record of similarly taken speculations to know what works and what doesn’t. We can follow another trader’s methodology like we would a recipe but rarely does that work as intended.

Possibly because of the complexity of trading, another trader’s method is not detailed enough to convey the exact desired intent of the teacher. It would be like trying to copy an Olympic track cyclist. We can buy the bike but without the Olympian’s training the detailed knowledge of how-to breath, specific muscles and a thousand other things we’re not going to get a medal.

In price action trading, James always points out the importance of determining value before recognising a breakout or bar pattern. Value, in this instance, is contextual and bar pattern is the shape or size of one or a group of bars.

Most price action traders rely wholly on bar patterns. They are relatively easy to learn and convincing. However, without the infinitely more difficult understanding of value (or context), their use in isolation would be detrimental to a traders account. More so, the lower the traded timeframe.

Buzz spends an excessive amount of time practising contextual reads. In his trading method, it is all contextual. To do otherwise, he says, would be like getting on that bike and going the wrong way around the track. That is what most of us (traders) do!

How champions think

Thank you JB for the game of golf a few weeks back. A beautiful walk in idyllic surroundings. JB played masterly, me not so much.

Having played golf regularly a couple of decades ago, I decided that before my game with JB, all I needed were a few concentrated practise sessions.

In turn, this led to finding and using some excellent on-line golf instruction. Unsurprising, for the short time that I had, this led to overthinking my swing.

In Dr Bob Rotella’s informative book ‘How Champions Think’ he points out that the majority of great golfing names (Nicklaus included) stayed with the same coach and swing throughout their careers.

They kept it simple—but that does not mean easy.

A trading style has the same battle. We’re forever tweaking, following guru advice and looking for the thing the other person is doing.

The week before last Nick and Zoe (and Rubix, a 14 kg puppy) visited staying in a holiday villa we’d booked nearby. I took the week off trading (sensibly), but this still allowed me a few hours each early morning to backtest and reflect on my trading strategy.

My most consistent results come from a simple trading method. An approach fundamentally unchanged for as long as I can recall but steadily improved upon within its bounds.

With this strategy, time after time, I know it when I see it—my entry method, risk and target. Bang, done. Emotion does not have much hope of interceding.

I’m pleasantly pleased with my results this week with my simplified routine.

I’d define it as a short-term micro breakout with context trade. I’m particularly content with the plans regimen and, as it’s a breakout, it’s often quick conclusion.

Fund results to follow in a while and in particular the stats—in isolation—of this micro breakout method.

Is July going to be the top for several months?

An edited piece from Al Brooks. For those with mid-term market investments and wondering what might happen in the markets over the next few months.

There is a tendency for the market to have selloffs in August through October time frame. The 1929 and 1987 crash both were in October. Both crashes had more than a 10% selloff in August.

We are entering that window. Also, the Emini is overbought, and it might try to become more neutral ahead of the (US) election.

These factors favour a reversal down to the middle of the 3-year trading range within a few months.

Larry Williams, who is a well-known trader, uses his reasoning to come to a similar conclusion. He recently said that he expects the market to rally to around the old high into around July 27 and then turn down.

But why is the market still going up? Liquidity. The single most important factor over the past four months is Fed Governor Neel Kashkari’s statement on 60 Minutes in March that the Fed has “an infinite amount of cash” to protect the economy.

But as powerful as the Fed is, it will not bother to stop a 15% correction. Therefore, a pullback to 2700 can take place, despite the Fed’s proclamation.

Emotions, no thanks

To trade is odd, romantic, exciting, challenging and mundane all rolled into one. Anyone wishing to partake in such a pastime will experience many different emotions.

But that is the point, emotions, as any successful trader will attest, are the thing to avoid. So how do we do that?

Firstly, let me clarify what I mean by financial trading. To me, trading is working to a structured and practised strategy and timeline. It also comes with a clear understanding of the probability of one’s method based on (losses and wins) exit rules.

A vehicle for financial trades is via derivative speculation—an account that provides leverage controlled by a tradable margin by percentage.

For example, this might be via a spot, futures, options or contracts for difference (CFD). Or, if resident in the UK it could also be via a much miss understood spread bet account. Each has their place depending on a trader’s geographical location (and therefore access), strategy, timeline, size of consideration and understanding.

But, has nothing to do with emotion. The above are groupings in which we conduct our bets. Within which we stamp our authority. If we approach these groupings with any uncertainty, lack of clarity or perspective, they will rule us. That includes not taking a blunderbuss approach.

It will seem that a derivatives trader is always on a knife-edge of emotions. For example, patient on entries but not hesitant—and precise in the loss but variable in wins.

It occurs to me that how we take away speculation and reduce emotion is to make the decisions, as far as is humanly possible, mathematically. What we are attempting to do is anticipate the loading of a market, either long or short, by a few dominant institutions.

I say a few because with major currency pairings it takes more than one institution to move the price. Moreover, trading is a zero-sum outcome, which means that there is always someone (an institution) taking the opposite side of the trade. Our job is to align our entries with the dominant few.

Computers do a more significant part of a price move. Machines construct most trades following algorithmically (unemotional) programmes of entry and exit. It behoves us, as far as is structurally possible, to (manually) do the same.

What aspects of our approach can be mathematically structured? The entry conditions, trade amount regardless of stop-loss position, method of entry, stop loss positioning, requirements for an early (manual) exit, desired outcome or automatic exit point and (more advanced) exit flexibility.

The latter is advanced as it often disrupts a trader’s results by encouraging us to inappropriately hold a bet hoping for an inordinately more significant than usual gain. Therefore, for my strategy, I’m not talking here about particularly massive changes in exit criteria.

We have to be clear in our outcome desire. (1) You only lose when you sell, so don’t have a strict exit criterion. (2) Take lots of small losses holding for a ‘black swan’ event. Or, (3) take lots of small wins with a strict exit criterion. (Number three is my method of choice).

As any ‘long term’ successful trader will attest, the first point above is a dud strategy. And the next two approaches do not, in my experience, coexist emotionally.

What is most important to the short-term trader?

What is the thing that I work on the most in my trading?

I get asked this question, or similar, a lot. It’s a bit like the question I got when a very junior pilot (actually, I was between flight training courses) when I had a week standing next to a plastic mock-up of a Hawk trainer on the south coast. That particular question, with little variation, was “how fast does it go (Mister)”. Closely followed by “what does the point on the front do—is it a gun?”

The answer to the trading point, like the pilot question, has a reply that can be simple or in-depth. For the Hawk response (to the beach holiday crowd, bless them) I realised the top speed in a relatable format irrespective of flight conditions—namely altitude—was everything.

I have to admit now, some 40 years after the event, and pre-Top Gun movie, that for the “point on the front” the answer being a pitot-static sensor understandably got blank looks far better that I did not disagree with the gun theory!

For the trading answer, it is context, entry identification, risk (including spread) and, last but not least, exit criteria. Okay, slightly more depth but you’re not the south coast beach holiday crowd.

Let’s consider spread again. I’ve talked about it previously (maybe a few times), but it always deserves a fresh look. I bring it back up now as recently my stop-loss positions have tightened. A stop-loss order ejects a trade automatically. Traditionally, it is a level at which a trader has ‘got it wrong’ and needs to get out.

The amount risked, from entry to stop, needs to be consistent with each trade.

As an aside, the risk is significantly more detailed. Nassim Taleb describes this best in his thought-provoking book ‘fooled by randomness’. Best read on an electronic device as, if like me, you’ll need to make good use of the thesaurus facility.

My ‘stop positions’ nestle well inside the ‘you’ve got it wrong’ level. Why I do this is for another discussion. But what it does reemphasise (because of the tightness) is the importance of working with the spread.

Note: If a trader is thinking of following suit with particularly tight stops without first solving the contextual, and other issues, as mentioned above, you will be throwing your money away rather rapidly.

Spread is similar to holiday money exchange. For example, today, we get 1.26 US dollars for a pound. But, of course, we don’t. Because of the exchange fee, we get nearer one for one. If we exchange £100 the cost is annoying but no big deal. If, however, we’re exchanging £100 dozens of times a week every week, then we can see why this would need careful consideration.

The spread in trading is the brokers’ fee. Investor deals entered with wide-stops, and over immense periods have little concern in this regard. A trader’s success, however—with tight stops and sharp targets—is defined in large part by the spread. (For the short-term trader, I notice that planned profit is adjusted down by a third due to this fee.)

The three things of concern to a trader are risk per trade defined as a percentage of the account, R (meaning reward/risk, or the amount of reward achieved on average over and above the average loss) and the win rate defined as a percentage.

Therefore, a trader’s R may signal a winning formula. But when we factor spread into the equation, the consequential reduction in R reverts the (probable) good results into a losing strategy.

A final point on the matter is that successful retail and professional traders have a method that one way or another follows on the coattails of winning institutions—institutions are not burdened unduly by the spread.
Trading is not a level playing field.

Short term traders that don’t consider all the implications of spread very, very carefully are the same as those who were happy to hear that it is a ‘gun’. Rather than acknowledge the more complicated and crucial truth that it is an essential (if not rather comparatively dull) ‘pitot-static system’.