Trading principles, are they important?

In the previous three posts, I talked about distinct characteristics (principles) that may be necessary to help make us consistently profitable in technical, financial trading.

A process or a way that we can apply to any methodology, within reason. So, am I saying that the method or system by which we trade is secondary to some overarching principles? Yes, I am. The most significant of them being the trader’s psychology for which I’d highly recommend ‘Trading in the zone by Mark Douglas’.

I have chosen discipline, quantitative and discretionary as my trading hooks, my principles (and combined them with trading psychology). In other words, they are the platform to which I link my trading system.

Is a trading system not as important? When we start, we all look for a method first and are ignorant of the more critical needs of principles. I guess it would be like an athlete working tirelessly on technique but ignoring fitness.

Once I have my underlying principles sorted (my fitness), I can then more easily add systems as I need (technique).

More importantly, trading principles force us to be more selective about our system. The strict criteria of trading laws act as a standard for system selection and amendment; this is the same if we traded in price action, intraday currency pairings or was a gap trader of a daily equity chart.

P.S. For next month I’d like to discuss something that I’m working on at the moment, the need to combine both intuitive and systematic.

Instinctive is how most traders start and how we lose our money, often all of it! We learn that lesson and try again, but this time with a systematic approach, and if we do this well, we might not lose as much.

As a discretionary trader (i.e. not simply a systems trader) what I believe is necessary to tip the balance and propel us into creating a real trading account is a finely tuned and disciplined balance of both aspects. How to go about achieving this is something we’ll explore.

Quantitative t​​rad​er​

If we now know what a disciplined and a discretionary trader looks like why add quantitatively? If discipline is our safety net and discretionary is our process, then quantitativeness is our foundation. It is the confidence on which we base our trades.

In word order, I try to be a disciplined, quantitative, discretionary trader. Quantitatively in this instance, refers to trades based on a defined strategy that is successful a certain amount of the time from many simulations. In other words, I’m looking for at least a 70 per cent success rate of a strategy over a sample size of hundreds, if not thousands of tests. (A test run will usually not include the possibility of slippage or spread so live trades can come up short of test results).

The quantitative bit is best done by ourselves. We gain confidence in a strategy by doing this. However, this is not an easy thing to do. We either have to dedicate an excessive amount of time manually conducting the test and therefore have available to us the necessary historical charting capability to do so. Or, we have access to programmes (or design our own) that can automatically run a test of specific parameters; this also can be an issue if we do not keep the test parameters simple and very clearly defined.

And this in itself demands consideration. For example, if we like a strategy (we’re keen for it to work) we might find ourselves running a test adding more and more what if’s until we get the result we want. A better way to prove our strategy until we’ve mastered our quantitative analysis is to use someone else’s. They are available if we take the time to look. For myself, I’d recommend Adam Grimes and some of the selected work by Larry Connors and Cesar Alvarez.

Discretionary trader

Trade with a proven trading process, consistently.

In doing so, we need to decide if we are a systematic or discretionary trader?

With a system method, the rules ought to be precise; buy when the price is above the 200 days high, for example.

But as a discretionary trader, a trade is open to subjectivity. It may include, for example, an individuals interpretation of support and resistance; something that with ten traders will produce several different solutions.

Therefore, as a discretionary trader, a precise understanding of trade selectivity is crucial. In other words, as a discretionary trader, we trade as if we are system traders. That takes some time to grasp. But it is essential that we do.

In addition to either a systematic or discretionary approach, financial trading has so many facets; it is a challenge to know where to start. For example, the technical analysis which envelops the interpretation of charts, set-ups indicators and their associated patterns is vast.

To find a trading way that matches our personality is often a trial by error process. Even a method that works wonderfully well for one will more than likely not work ideally for another. And an edge in this competitive zero-sum game is fleeting.

A systematic trading model requires commitment.

A discretionary approach, however, requires constant practice and a real understanding for it to become our own; and then followed as if it were a system.

The discretionary angle never stops evolving. But, and probably an essential point, we only change slowly and never during a ‘live’ period.

Once we have established our grounding, we attract other thoughts and principles based only on our chosen way, and we can economically disregard everything else; this creates focus and the all-important consistent approach.

How would I describe my discretionary trading technique? I want to think that it is simple and conservative. It looks at a few markets and enters with momentum and dominance from a precise set-up with the appropriate trend.

Disciplined ​trader

As a financial trader, if we say we are performing well, we mean that we have substantial and consistent profits over a large sample size. But they are two different goals. ‘Consistent’ has to be achieved first and maintained as we gradually introduce the ‘substantial’. Each brings its challenge.
In doing so, one of the skills discretionary traders work hard to develop is the ability to see beyond arbitrary divisions in chart structure and to perceive the flow of the market for what it is.
However, the more we trade, the more we firmly realise that the market works in some wonderfully counterintuitive ways. And to add to that, there are significant differences in the ways that equities, futures, and currencies trade. We should not think that one trading system fits all.
My trading foundation is the knowledge that (as Grimes says) “markets tend to work in mean reversion mode after a period of expanded volatility, and in range expansion mode after a period of contracted volatility; this is a price-pattern expression of an underlying cycle in volatility. Cueing into this cycle, and being able to predict the most likely emerging volatility regime, is perhaps the most important skill for the discretionary trader.”
Grimes continues, “in the best case, discretionary trading techniques are an ideal fusion of reason and intuition—right-brain and left-brain thinking—that tap into the most powerful analytical and decision-making abilities of the human trader, but everything depends on a deep understanding of the true tendencies and forces behind market action.”
Once realised my job is to have a detailed trading plan that understands the above quantitatively proven occurrence and then to put on trades dictated by my methodology and setups.
In other words, as a trader, my role is to follow my trading process and to do what it tells me at the right time. That is the principle behind any disciplined trader.

A not for the faint-hearted FX set-up.

From our ‘live’ skype trade room chats. A couple of 70 per cent add-on tactics that are not for the faint-hearted. And a useful quote from the ‘Dealer’ book.

(Buzz) With a build-up below or above a round number set limit entries at zero, five pips and ten pips. Stop 20 pips. Exit 5 pips below (or above if long). 70% probability he (the author) says.

(Buzz) The author keeps 1/3 of the trade to take further as required.
That is Cable but applies to all.
The ‘dealers’ are going after the stops of those that entered short early with tight stops above.
It’s not our broker – not big enough. It’s the big banks.

Further on the above. It’s not real money that’s doing this. Imagine if you usually traded at the 100 million or higher level. And if you don’t do it too often, say you put a limit order in the system (one that you have no intention of activating) the computers would pick this up and make immediate alterations to the currency effected in anticipation. Once the order is removed as a non-event the market re-corrects.

According to Al Brooks, (since the publication of the ‘Dealer’ book), the market has moved on in size. It now apparently takes more than one bank to move the EUR/USD during London/NY open times. But the principle stays the same despite that.

Another comment from the ‘Dealers’ book)……In order to reach this pot of gold, you have to be able to find an approach that accurately trades market corrections rather than predicts them, since technical and fundamental analysis are simply not enough to beat the crowd. The secret to success is actually not such a big secret. Everyone knows that with proper money management and a half-decent strategy you can make money. Yet most still find themselves failing. To become truly successful, if you are a beginning trader you should immerse yourself completely (and I mean completely) in the subject in order to find your edge. If you are already a winning trader, then you had better make sure that you understand exactly what your edge is. What is it that sets you apart from the other 90 % of traders? Is it sheer luck or something different? Knowing what keeps you in the game is the only way to find your way back during tough times. In the end, no one can ever hope to master the FX market; but for those that manage to set the dollar signs apart and focus on the intellectual enjoyment trading provides them, a fortune usually lies along the way!

Silvani, Agustin. Beat the Forex Dealer (Wiley Trading) (pp. 146-148). Wiley. Kindle Edition.

(Nick) A lot to take in there, going to have to read all this a few times, but some fantastic ideas on first read through. (Referring to the above and several items not included).

The round number strategy again. This time Cable. Only works if the build-up is an extension. I’d be aware of a build-up any closer to the round number.

Exciting add on strategy for backtesting. It’s from the ‘Dealer’ book in this instance short at a test of the ten ema. Price action up to that point is critical. In this instance three engulfed bars. Also, as now with all my trades, the trend must be affirmed — exit on the first close above the ten ema. 50 pips.

The importance of the spread.

The following is from our Skype ‘live’ trading room chats. Includes: know when to trade and when not; sometimes a trade is too close to call; being stopped out is part of trading, accept it; and two book recommendations.

(Buzz) A case of not only knowing when to trade but knowing when NOT to.
The following trade looked okay. But the context was poor (double bottom 6-hours prior not shown) and again news about to be released. I also didn’t like the seven pip distance to a first stop option.

Know when not to trade.

(Buzz) It’s interesting how if I take a higher entry I’m reluctant to accept as easily a worse price even though it’s a better entry?

(James) I agree. The money isn’t yours until it’s cashed out of the trade. But it doesn’t seem that way when you’ve been 10 pips in profit.

(Buzz) If I hadn’t have taken the failed higher entry, I’d not have thought twice about the short at 7:45.
I’d probably have been entered at the 7:35 bar.
However, the 7:40 bar gave a hint of a reversal. If the 7:40 had closed as a stronger bull, it would have produced a trend break buy.
All in all, some just get missed or are best left.

Sometimes it’s too close to call, best left.

(James) It quite often puts it on a knife edge before it takes off. That was another example.

(Buzz) Took what I thought was a pbc (Pattern break combi). I was way too early. Got to work on the harmony of my takes—a 90-minute hold. Aimed for ten pips but took it off at nine pips profit. Three down and tailless bear close. At that time of night, I couldn’t face another pullback — still, nine pips to balance up some earlier losses.

The upper ellipse marks a high that came within a pip or so of the stop.

(James) Well done holding for that long! Especially at that time of night.

(Buzz) Started reading this, (below) good info so far.

Published 2008, but good insight into dealers.

(Buzz) An interesting point from the book I mentioned earlier, Take each 4-hour session and calculate the pivot point. It’s a guide. Above the pivot point for the follow-on session is only longs and below the pivot point just short. Here’s an example.

Example of how to calculate ‘pivot points’.

(James) Good point, these pivot points are critical.

(Buzz) A good price action trader can look at the chart and know where the pivot point is. The calculation, however, provides some confirmation.

Took the 11 pips profit at the close of the extension bar. But a continuation is on the cards.
Known as a ‘wedge’ which is often followed by a reversal.

(Buzz) In answer to a question. Reference Alan’s question about MT4. Designed specifically for FX. He needs to watch for the spread offered on MT4 as sometimes higher than a broker’s charts. I prefer MT4 to anything else I’ve tried except ProRealtime.

Another book recommendation.

(James) Haha nice hair doo! Good opening para.

(Buzz) Yes, ignore the 1980’s style; a classic and still very much relevant.

(Buzz) About MT4 and the spread that we talked about yesterday and Alan’s question; this is a footnote from the ‘dealers’ book. Spreads were much higher back in 2008. But the principle remains.

The importance of the spread.

Some skype trade room chat from this week (EUR/USD)

I’ve backtested and will continue to regularly backtest the last 10,000 units (about 4-weeks worth on the 5-minute chart). I’m not only working hard at ‘Bob‘ type entries but at my exit criteria. 20 pip is my goal, but I will adjust for market size, reversals, resistance and (something that Bob does not mention too much) price action. For example, an extended bar in a particular context (see below) will see me exit; I will also exit with engulfing bars too, but context always rules.

An example from my back testing.

The last hour makes for an interesting analysis. I took bar 4 below as a signal bar. However, it was much too weak against the pullback of bars 1, 2 and 3. Bar 5, my entry bar, touched a full pip below bar 4 – my entry. Bar 6 closed above the long-standing resistance, now making it support and a possible entry long on the following bar. Bar 7 provided a floor (ceiling) test. All a bit weak against the previous bear bars, but if not a long a good reason not to be short?

Signs to watch for that indicate a turn in the market.

My understanding had me orientated for a trade short for some odd reason only known to me. (see below)
Short at 1 and out at 2!
Then long (thank goodness) at the 11:40 bar.
I held thinking it would do the 20 pips. But It’s been consistent recently at 10-pips. (Refering to how much the market has been moving)

The importance of staying neutral as price action builds.

Good timing on the long! (Still on the chart above)

Out soon after the 12:05 reached a high and pulled back.

It did pull back, looked strong on the way up. 10-pips in this market is a good call. Reasonable resistance from yesterday at that level.

That’s the move of the day

…so far

On the last take, I entered on the first full pip above the 11:35 bar. The bar had closed above my pattern. However, the momentum came in at the ‘double’ pressure created a pip above the double top of the 10:20 bar. It’s not apparent looking at the bars now.

Below is an excellent entry set-up except for no signal bar.

No signal bar, let it go.

I was all ready to enter short at a full pip below the signal bar (pb horizontal) when the price shot down to the ema. It left me behind. The pullback, on the bar after the planned entry bar, was very slightly short of my desired entry position.

A still screen shot does not provide the speed of price movement. It’s often more difficult live.

I gave this one a small run for its money (See below). It was held to see if it would break the top, already reasonably high in this bull push.

A trade already high in a trend is an uncertain trade.

(Below) Bar 1 as an entry bar was against the trend. However, the prior legs were a lower low and a slightly lower high. I took this trade but came out after 3-pips as it ‘felt’ too early to be making a short. Bar 2 had no signal bar. The pullback to the horizontal pattern break was acceptable, and I would probably have entered at the pattern with bar 3. But a bunch of news was due for release on the following bar.

A good trend does not always provide good entries.

The patient day trader

“The stock market is a device for transferring money from the impatient to the patient.”- Warren Buffet

In this blog, I will talk about that rather apt comment by Mr Buffett and how it is relevant not only to the long term fundamental trader but, surprisingly to some, the day trader too.
I will also take a look at how the amount we place on each trade can often be an oxymoron.

The impatient.

Bob Volman says “The more a trader adheres to a strict set of entry and exit rules, the less likely they are to fall prey to challenges of the emotional kind”. From my own experience, I know the importance of those words. That is why many trading seminars can be dangerous for a traders bottom line.
Some such events provide a plethora of trading strategies, and this leaves a massive door open to an individuals interpretation and intuition. Or, in other words, a traders impatience. Successful traders refer to working without the need for a reward – if we want the money, it will be elusive for us. What keeps us emotionally separate to the financial outcome as much as is humanly possible is holding to an understood, extremely well practised, strategy. Within that strategy, we ought also to know without question where our boundaries are for an aggressive take and at what point we skip (but not through fear) a set-up even though we have waited for the longest time. That is a mature, unemotional, trader at work. Our success is not necessarily the trading system we adopt (or create), but how we apply it. An obvious consideration maybe, but probably the most significant reason that prevents a seasoned ‘breakeven’ trader from graduating.

The amount traded.

Connected to our thoughts above is the amount we place on each trade. At one extreme we have a demo account with no real risk attached, and at the other, we have an amount that is beyond reasonableness for our consideration. My blog ‘conservative breakout trading‘ covers this in mathematical detail. What I want to marry here is patience and the risk we give to each bet. Of course, it would be foolishness of the highest order to trade large within a strategic vacuum or where a strategy has not been tested, practised and, therefore, approved. However, once at this point in our trading journey, if we remain a light trader (that is a trading risk significantly below our potential), then we most certainly invite impatient trades back into the fold with its inevitable cousins, uncertainty and fear. A proficient day trader who regularly compounds their trade amount (say, to match a 2 per cent risk to account size but not beyond the margin requirements) have a trade approach that is, well, professional.

Margin-of-safety list March 2019

Companies selling at a discount was last reported by this blog back in March 2017. On that occasion we provided the figures from the FTSE 350 only.

Nick has recently rerun the programme to see where we are in respect of contenders. Twenty four companies from the S&P 500 and FTSE 350 combined qualified.

Therefore, 24 companies made the ‘value’ list from a total of 850. From our list in 2012 the share price increase has been dramatic but not particularly surprising as it was over a significantly bullish period.

What we are more pleased about is that only one company from that 2012 list came out with a lower share price today.

These are the prices in 2012 of the companies on Nick’s spreadsheet compared to their current value.

Altisource Portfolio Solutions – 5,000 to 15,000
Cognizant Technology Solutions Corp – 3,400 to 8,000
Google Inc – 31,100 to 120,000
EZCorp Inc – 3,000 to 1,000
Ebix Inc – 2,000 to 8,000
World Acceptance Corp – 7,000 to 13,000
Apple Computer Inc – 4,000 to 17,000
Oracle Corp – 2,500 to 5,000
Monster Beverage Corp – 1,000 to 6,000 Inc – 48,000 to 200,000
Western Digital Corp – 3,000 to 10,000
Balchem Corp – 4,000 to 10,000
Middleby Corp – 3,000 to 12,000

Nick’s list is a consequence of a detailed financial analysis of a companies figures inline with our ‘value’ criteria in providing investors with a financial ‘margin of safety’. What it does not provide is such things as the remuneration of management and whether a company has what Buffet refers to as a ‘moat’.

Finding discounted companies is an investment approach, whereas our day trading is a speculative angle. We keep both separate. They are of two extremes not only in attitude, as one is from purely fundamental information and the other technical, but also in a meaningful timeline context; one is in and out within a few hours, the other many years (or even a decade or two) would not be unusual.

Previous posts on value investing provide additional detail; however, the concept follows the teaching of Benjamin Graham. The general idea of which, best given in Graham’s (updated by Jason Zweig) book ‘The Intelligent Investor‘.

The Intelligent Investor by Benjamin Graham updated by Jason Zweig.

Below is a list of stocks and shares (March 2019) that satisfy our ‘value investment’ criteria of so-called buying a dollar bill for not more than 60 cents. In other words, we ‘look for values with a significant margin of safety relative to price’.

Nick’s value stocks and shares March 2019.

Note on P/E. Graham rates growth potential far more than quality of earnings when determining P/E ratio. He (Graham) looked at the long term potential of a company rather than the recent price. That’s why we only flag P/E in the spreadsheet rather than use it as an automatic filter. However, “a P/E ratio much above 25 made Graham grimace”. We feel that in today’s market a P/E of over 40 warrants consideration as to its suitability as an investment vehicle. Of particular attention in this regard, therefore, are Amazon P/E 83 and Netflix P/E 132.

The full pip and nothing but the pip

The following discussions represent a tiny sample of our Skype debates that are ongoing throughout the week. This small selection highlights the importance of measuring horizontal support and resistance in full pips. A real issue if trading the lower intraday timeframe.

Buzz, 10:29 Friday 1/3/2019

Worth a thought is the entry one pip beyond the signal bar. Bob’s bars are to a full pip, meaning a whole number. Therefore, we have the advantage of the complete price action but the disadvantage of the tail. In the example below the black arrow is at a total pip. The bit of tail beyond is 0.8 of a pip and therefore wouldn’t paint on Bob’s chart. His entry (if he took this) would be at about where our tail finishes, and as the bar clears the trend line and the ema.

The full pip and nothing but the pip.

James, 10:54
I see what you mean.

Buzz, 10:54
The arrows in the chart below show the full pip so a tail would have been evident to Bob also.

Buzz 11:00

This means we cannot disregard the tails, but a quick check of the whole pip would give a better idea of how the trade is viewed by algorithms and many traders. (The above was from th mornings chart/discussion.)

Buzz, 11:09

At the risk of going on about it too much, this example (black arrows below) shows the full pip. Bob’s chart would not paint the tail 0.8 of a pip below the black arrows. If Bob were to take an entry short (obviously not a setup), he would enter at the base of our tail where we would open a full pip beyond that. Worth a reflection I think.

Buzz, 09:15 Monday 4/3/2109

In my trade below I’ve drawn the horizontal support lines at a full pip as discussed on Friday.

A reasonable entry short from the break of a full pip support line.

Buzz 09:38

From the chart above, I had a larger box pattern which did not give me an entry, particularly against the bull power bars at the time of 6:20 and 7:10. However, this subsequent simpler break (which I only redrew later looking for the signal) provided a solution.


James’ chart screen shot showing a trade he’d taken.

Buzz 15:15

That was a very nice trade. (Referring to a screenshot above of James’ chart) Combi coupled with a pattern break of the 11,337 level as marked by the black arrow. Well done.

The same trade as above as it appeared on Buzz’s chart highlighting the break of the full pip support line.

Buzz 09:50 Friday 8/3/2019

I saw this possible entry last night. Almost took it but it was tea time. I didn’t like the tails on bars 1 and 2 which kept me out. The lows of bars 2 and 3 formed a support level the break of which provided a possible entry short at bar 5. A little distant from the ema for my comfort. I also think I would have ejected the trade at the bar 6 pullback — however, the full pip horizontal support lines working their magic again.

Price action bar by bar