How to start trading in Forex

Introduction to trading Forex

Cross ref :http://awanginvest.com/?p=692

August 28, 2008 – 6:17 pm

I am still acting moderator for Tradingsuccess blog as some urgent matters have claimed our mentor to fly off again.

Since the August  seminar at SMU is just over from last weekend, my post is aimed at the  newbies again.

Many of the attendees may not be familiar with the history or  terms  for forex trading.

Forex or FX  are  terms used to describe the trading of the world’s many currencies. The  Forex Market is the largest market in the world, with trades amounting to more than USD 3 trillion every day. Most Forex trading is speculative with  a low percentage of market activity representing governments’ and companies’ fundamental currency conversion needs.

There is also another aspect to fixed income market.  The term fixed income is used to describe a collection of securities which have predefined pay-out terms.  An example is the CD or Certificate of Deposit when one deposits an amount of money and receives a given amount of money which includes both the original deposit plus interest earned at maturity.

Fixed income securities come in various maturity dates.  Those with initial maturities of one year or less trade in what is the Money Market.  This term comes from short-term instruments which are very liquid and often trade between banks.  Money market instruments include Banker’s Acceptance or a Draft or Bill of Exchange, Municipal Notes, Certificates of Deposits, Treasury Bills,  and Commercial papers.

Most of these instruments are out of the  realm of the individual traders but a handful can be traded via the futures markets.

Since the fixed income market is driven by interest rates, ie prices are inversely related to yields, there are factors which impact on rates to influence prices.  The biggest driver of these rates is monetary policy, which central banks make in respect to the level of domestic interest rates.  Central banks directly control interest rates in the short-term at least, and they do have a heavy influence over the direction of interest rates.

Other less direct influencers are fiscal policy, general economic growth, employment, inflation and currency exchange rates and trades.

Hence, it is advisable to track the key  economic news data that are coming out each week which I post  almost every week day at IDkit at www.awanginvest.com under Archives.

There are some terms/scenarios  newbies must understand:

  • 24 hour trading

    One of the major advantages of trading Forex is the opportunity to trade 24 hours a day from Sunday evening (20:00 GMT) to Friday evening (22:00 GMT). This gives you a unique opportunity to react instantly to breaking news that is affecting the markets.

  • Superior liquidity

    The Forex market is so liquid that there are always buyers and sellers to trade with. The liquidity of this market, especially  of the major currencies, helps ensure price stability and narrow spreads. The liquidity comes mainly from banks that provide liquidity to investors, companies, institutions and other currency market players.

  • No commissions

    The fact that Forex is often traded without commissions makes it very attractive as an investment opportunity for investors who want to deal on a frequent basis.
    Trading the “majors” is also cheaper than trading other cross  because of the high level of liquidity. 100:1 Leverage for some trading platforms.

  • Leverage (gearing) enables you to hold a position worth up to 100 times more than your margin deposit. For example, a USD 10,000 deposit can command positions of up to USD 1,000,000 through leverage. You can leverage the first USD 25,000 of your investment up to 100 times and additional collateral up to 50 times. However, with money management, you would not trade with such high leverage permitted by the trading platforms.
  • Profit potential in falling markets

    Since the market is constantly moving, there are always trading opportunities, whether a currency is strengthening or weakening in relation to another currency. When you trade currencies, they literally work against each other. If the EURUSD declines,  it is because the US dollar gets stronger against the euro and vice versa. So, if you think the EURUSD will decline against the dollar, you would sell EUR now and then later you buy euro back at a lower price with a profit. The opposite trading scenario would occur if the EURUSD appreciates.

  • Spread

    The spread is the difference between the price that you can sell currency at or BID and the price you can buy currency at  ASK. The spread on majors is usually 3 pips under normal market conditions.

  • A pip is the smallest unit by which a cross price quote changes. When trading Forex you will often hear that there is a 3-pip spread when you trade the majors. This spread is revealed when you compare the bid and the ask price, for example EURUSD  is quoted at a bid price of 0.9875 and an ask price of 0.9878. The difference is USD 0.0003, which is equal to 3 “pips”.
  • On a contract or position, the value of a pip can easily be calculated. You know that the EURUSD is quoted with four decimals, so all you have to do is cancel out the four zeros on the amount you trade and you will have the value of one pip. Thus, on a EURUSD 100,000 contract, one pip is USD 10. On a USDJPY 100,000 contract, one pip is equal to 1000 yen, because USDJPY is quoted with only two decimals.

 You can read more about Forex if you learn to  use the search engine for more.

Bonne chance.

 ANA aka IDKIT

Ag Moderator

How long does it take to learn to trade?

I am back to the rescue – our mentor has been sitting up a little too long and this has taken a toll on him. I offer to take over whenever he finds it hard to sit up at his pc to write his piece. Today , he is reeling from fatigue, partially from taking a flight too soon, perhaps. So please bear with me with this blog which will appeal to those who are newbies, especially.

Lately, I came across newbies who paper-trade and who seem to think a successful paper trade is the end all . Those of us who have traded with real money know trading is probably one of the hardest professions in the world.

I would like to cover the most common question: “What is the single most important mental or emotional concern you have that is preventing you from being a successful trader?”

The answers could be many but the most common is that we are over-trading or trading too much before we are ready. In other words, we are probably trading at the wrong pace.Most of us start out at paper–trading. There is no actual money on the line, and you practise executing your trades the way your trading plan commands, a mechanical trade. There is no ego at stake. The phantom “equity” seems to rise with ease because there is no risk or stress involved.

So you chomp up the pace to trade with real money. This time you will trade with real emotions, following your trading plans, perhaps initially, with great success. When you experience the excitement of success you are looking for, you feel you are now ready to step up the pace of your trading at full speed!Only this time, the move is against you, and it is a big one which decimates your emotion or ego. So you succumb to the temptation to remove your stops believing the market will rebound and you will recover.Luckily, you recall that you must stick to your trading plan which includes not removing your stops!

The market takes out your stops, and you suffer what you are prepared to lose under your trading plan. Then the market keeps going against you, and you realize you have done the right thing by sticking to your plan. You are so proud of yourself you feel good in spite of losing some money.

This ideal scenario happens to only a minority of traders who are elite traders while the rest of us tend to up the pace too quickly and not emotionally ready to handle our plans.So, the only way we can join this trading elite is to develop our mind to develop our trading plans.

If we scale back, we may yet trade successfully with consistent profits over a period of time of up to three years as novice traders. After all, trading is no rocket science we hear , only we need good discipline with our trading plan, good money management and winning psychology to become successful.

 NUGGET OF WISDOM – TRADER  PAUL TUDOR JONES:

“Don’t focus on making money, focus on protecting what you have.”

ANA AKA IDKIT

AG MODERATOR

How I keep my journal

WHY do we as traders need to keep a journal?

With a balance of self-discipline and cognitive flexibility, rules can be applied to enhance trading performance.

This self-discipline includes:

1. Start every day fresh. Think of a mantra : “There’s a bullet coming toward my head today, and I’ve got to figure out where it’s coming from and how to stop it.” This mantra can bring down overconfidence, instill humility and encourage preparedness.

2. Invest an amount of money that is comfortable. If we invest on money that is on the line, or what we stand to gain, then judgment will be impaired. When emotions become overwhelming, ‘throw a maiden in the volcano.

3. Plan and Invest :Linda Bradford Raschke counsels, “Know what you are going to do BEFORE the market opens.” Mark Cook remarks: “Planning is the objective part of trading. Start with the worst case scenario and work from there.”

4. Learn from past mistakes. Keep a psychological journal. Journaling is the most commonly prescribed method as trading psychologist Dr Brett Steenbarger points out. Keeping a decision journal is an important part of a trader’s daily training and practice. While athletes exercise their bodies and hone their physical techniques, investors need to be aware of defects and advantages in their mental game. If athletes must spend hundreds of hours in practice and training for each hour of actual competition, journaling process may seem excessive and time consuming, but this is the price traders have to pay.

Some Questions for template of Psychological Decision Journal:

1. Pre-decision : What are my qualitative reasons for investing in this security? What is my level of confidence in this decision? What is my advantage? What objective changes in conditions will change my decision? What are my specific criteria for a buy/sell?

2. Post-decision : How am I feeling about the pre-outcome?

3. Post-outcome : Was it accurate ? Any flaws in the decision process? Can I find patterns to compare with my previous decisions? Did I deviate from my investment philosophy? What were the most successful aspects of this decision.

CONCLUSION

This psychological decision journal template should be used in conjunction with a spreadsheet journal with quantifiable statistics. They include style of trading, eg swing trade, intraday trade, long-term position etc. Also stop boundaries for both time and price and objectives including expected risk/reward probabilities, number of losing and winning trades, to find evidence of loss aversion.Biases towards periods of favorable sentiment can be detected on both templates BUT by dragging this out into the light of day, one can then try to solve the problem/s to become a better trader.

ANA aka IDKIT

Ag Moderator

Trader-Pitt

An insight into a former pit trader

from-the-pit.jpg

As trading has gradually moved from the floor of the exchange to the electronic screen, I am lucky to have persuaded a very shy former pit trader to share his views as to why he moved to the electronic screen. He is undoubtedly one of the best pit traders in Singapore. However, to give in to his request to remain anonymous, I shall call him Pitt.

Pitt unlike many of his former colleagues was the first to recognize the importance of moving forward with technology. I managed to get a few questions put to him which he has graciously consented to reply. He is a man of few words but his brain is ticking all the time, make no mistake about this.

Without further ado, let me pose the following questions with his laconic replies:

  • How did you start to be a student of Ray?

Pitt: In the year 2004 , when I realised that the pit was going to close soon , I told myself that what I used to do in the pit would not be the same as trading electronically. When the first seminar came along in Singapore conducted by Ray Barros on the nature of trends, I enrolled and became one of his earliest students.

  • What prompted you to get off the pit to learn electronic trading?

Pitt: I was convinced I had to acquire a new set of skills and a totally different mindset to prepare for electronic trading which was slowly taking over the pits all over the world. Either I acquire new skills or I perish in the pit!

  • Having commenced a course, what made you to continue with new seminars or courses run by Ray?

Pitt: After going through Ray’s seminar and getting to know him more, I realized that his seminars have helped me in my trading, especially the aspect on psychology. His concept and approach of the market suited my trading style. Whenever new and advance courses were held by Ray, I would be there as I believe in continuous education.

  • What did you find so different , trading in the pit, as opposed to trading electronically?

Pitt: Well, as a pit trader you had an edge over other players because you were right there where all the actions were. You would be the first to react when there was any breaking news. You could also lean on the tight spread of the bid and offer prices. In electronic trading , you are” blind” as you don’t hear the sound and see the sight of the floor. So most of the time you are lost, and the only way to be in the game is to have a set of skills and correct mindset.

  • What are your observations of other pit traders who would not learn new methods?

Pitt: Sorry, no comment; I only see they are still trading.

  • What is the single most important lesson that you take away from Ray?

Pitt: The most important lesson I learn from Ray is: trading is simple but not easy . To be successful we must always keep learning new things, and know when to change when market changes .

  • Have you any advice for newbies?

Pitt: Yes . One other thing I take away from Ray is “ capital preservation “ . We need capital to stay in the game – ” no money, no talk” . If you lose all your capital , you will not have a chance to make back your money. So always remember the saying : “ cut your losses short and let your profits ride.”

ANA aka IDKIT

Ag Moderator

Reflecting on my Path to Trading Success. – AnthonyB

This is the second testimonial from one of Ray’s STC mentor students . Such contributions will go a long way to enlighten those who may have bought NOT and find it hard to follow. Training and education go hand in hand as evident from Tom and Anthony.-ANA

PLEASE READ ON:

 

Like Tom, I am a STC graduate (July 07) and I read his contribution with interest as I know Tom and a bit about his journey. My trader education has been very different to Tom’s. As I reflect on my journey, I thought I would talk about my experiences with Ray and what I believe to be truly mind blowing – trading psychology.

First off, let me quickly talk about the title of this piece. I feel daring using the words ‘trading success’ in the presence of Ray Barros who is extremely successful. If I think about just how much progress I have made since STC, then I can consider using the above words with pride.

Secondly, with Ray’s hip dilemma he has asked some of his friends to write in his blog whilst he is laid up. I am not too sure which is the real reason. Is it to keep his readers occupied whilst he convalesces or was it to give him the encouragement to get up and continue his blog before we lower his incredible standard too far?

I wish Ray a speedy recovery, not to mention desperately waiting for him to recommence his blog.

What was it about Ray and STC?

The reason I came to Ray was because I had tried to learn by reading numerous trading books, attending small cheaper courses and joining the local Technical Analyst Association. The philosophy at the time was that new traders lose money for about 2 years and then realise that education is essential and this leads to another couple of years of not losing but also not making money, and then you achieve a level of learning and experience where you start to make money from your trading. Well I was making some money but certainly not enough. In fact, I could have done better by leaving it in the bank!

I had become an Indicator Junkie and was mixing up bits and pieces of methods and losing myself in different timeframes.

The STC method

The STC method is a very robust one where I use a discretionary approach.

‘The Nature of Trends’ pretty much covers the Barros Swing approach to defining the trend, will it continue or change, and where are we in that trend. This gives me the strategy, and then I look for Low Risk Entries. This involves a setup (chart pattern), at a zone with an entry trigger and an initial stop (both price and time).

A risk assessment is done on every trade and must exceed 2:1 before considering taking the trade.

One of the keys to success for me is creating scenarios of what the market may do and setting my benchmarks for those scenarios. I tended to take a very myopic view (Ray’s observation) regarding my analysis and positions.

Once in the trade I manage the position with the Rule of Three.

I also use the Ray Wave as a risk management tool.

Did I forget to mention that I didn’t have a trade plan? Ray insists not only on a trade plan, but a vision and a business plan as well! I am still working on those.

More importantly, I think even Ray would agree with me that it is not the method that will guarantee success; it is all the other things.

Dare I repeat the words trading psychology?

Ray insists on using a psyche journal to record your trades and your feelings about the market, your entry, your exit. It is because your feelings or emotions are like built up internal energy which will come out eventually, and sometimes the emotional energy when unaddressed, will cause you to take unplanned trades. That is either entries or exits that deviate from your plan. Before striking that Buy/Sell button ,you should ask yourself, is this part of my plan or are my emotions controlling the finger pushing the mouse button.

Ray emphasizes keeping your Psyche and equity journals up to date. Then regularly analyse and review both journals for evidence of unsuccessful and successful trading habits.

It was this psyche stuff that made the biggest difference to my trading. Not the method, not the money management, but the psychology. Alexander Elder likens it to a three- legged stool – method, money management and psychology. Take away any one leg and you will fall over.

Ray introduced me to Denise Shull at “Trader Psyches”. Denise says ‘emotions trump intellect’. We can’t control the emotions; we can control our actions. Denise helps you identify your repetition compulsions (Freud) or what Denise calls ‘Echoes of Perception’. An untruth you pick up as a child and carry through into adult life. That echo will affect the things that you try to achieve. These are usually along the lines of ‘not feeling good enough’. My echo was that I feel like ‘I don’t know’. Now that may seem silly, as I have 2 university degrees and have been reasonably successful in my profession.

Given that the markets are an environment of uncertainty and low predictability, my ‘I don’t know’ echo was really in its element. The funny thing is that I spent a lot of years searching for the perfect method when it was my ‘echo of perception’ that was interfering with my success.

Thanks to Denise and Ray, I can sit confidently on the three -legged stool. I now have tactics to deal with my echo and I am proud to announce that my trading is improving.

I guess my message here is don’t write off trading psychology – often it is not the method that lets traders down, it may be a lot closer home.

AnthonyB,

Australia

ANA aka IDKIT

Ag Moderator

A trader education – TomC

What better testimony than from a former student!

TomC is one mentor student of Ray, and he has submitted his contribution to this blog in response to my appeal for contributions, especially from Ray’s students. Readers will then get to know what to expect from Ray as a teacher and mentor for he suffers no fool but will go out of his way to impart more to those who are willing to learn and work hard. Many have fallen by the wayside because it is not easy to step out of one’s comfort zone. However, if one perseveres to get over the first few hurdles, it becomes second nature to pursue a daily routine of good habits to become a good trader, be it a novice trader for starters.

Without further ado, please read what Tom has to share hereunder:

Notes on Trader Education by TomC:

tom - ad

Typical ad which misleads novices

It’s generally accepted that traders need some initial education and those who initially don’t think so usually seek education when the losses come around.

Given that most traders get into trading to make money, the question becomes – Is it possible to find a book, a course, a mentor, a tipping service that will just once and for all provide you with the secret to financial success in the market ?

What’s the difference between trading education and studying for a Computer Science degree (BSc) or is there any !? Are those educators with the more complex, mathematically, statistically based approaches the best ? Should one seek continuous education or is an initial course enough ?

Or forget about all this ‘bunk’ , it is possible just to do a weekend seminar and come away with a money making system from day one , i.e. just follow the steps to riches. Or better still, why don’t I just subscribe to a trade recommendation service and just relax at home while the profits pour in.

In relation to my own experience, my initial interest was sparked in investments by my accountant who told me of large, easy profits by buying progressively company stocks. I realise now I probably only heard about the winners. I subsequently bought a few stocks following this , and yes, over time made money on them – probably, because I only looked at them once every 6 months, and because it was a bull market.

As a previous avid reader of computer science , I then decided to apply the same approach to investing. I proceeded to the stock exchange bookshop and bought some basic investment books. In addition, I was told that the bible was Trading for a Living by Elder – obviously I had to have it.

I read it and went on to buy more stuff from his website. I also read up and attended some lectures by Chris Tate who I highly recommend even now.

I somehow discovered and contacted Ray who asked for my trading plan (what plan!?). I was screened with preliminary questions and answers as is his mode of selection, and accepted as his student. However I moved country and postponed my start of mentorship program till 2 years later. After l settled down, I stumbled across the release of Nature of Trends ( First Edition) and again contacted Ray and re- applied again. I was accepted again and really started the STC mentorship program.
<!–[if !supportLineBreakNewLine]–>
<!–[endif]–>In between moving countries , I had some time off and attended a day seminar with Larry Williams. As with Dr Elder, I was not broke from trading but I did not make any money either !

So the STC study began and the original book was not as ‘user friendly’ as the current one. The current transition to swing charts took some time. The STC covers Trend identification using Barros Swing charts, changes in trend patterns, low risk entry, money management and practical trading under Ray’s guidance and mentoring program. Generally, I would meet Ray weekly on the Net, do the homework and consume the Nature of Trends.

Ray will suss up our weaknesses first, identify any issues the trader may have and introduce topics to suit the individual. He may also offer extra courses such as the Ray Wave or Market Profile depending on the student’s progress and capability. He is direct, expects his students to work hard and fully committed to their success. Then he is easy to work with and ultimately becomes a good friend to his students.

Now all this work is fine and nice to learn , but one’s life must continue while this is happening. So I took a break while I built a new house. STC is the kind of program that is great and could be really appreciated if one did not have to work, did not have any family or sporting commitments and have lots of trading capital. But I ask : if one were financially free, with no worries , would they take the time and effort to learn to trade ?- probably, NOT.

Oh yes, and then I was distracted with another trading system called VSA . My thoughts were :this looks so easy I just make some money while I am doing STC, and in addition, it looks like I could integrate this into STC by using STC to identify a zone and execute using these tools. Well guess what? – it was a distraction, a waste of money and not helpful !.

So I reviewed, settled down , studied hard, went to the practical trading portion of STC and eventually graduated. There really is no easy way out of it. I think all traders will have to put in their work and learn how the market works from their perspectives. The other main output from learning to trade is to know myself , and in the context of trading, how I must address them. For example, one can get relaxed after a winning position as if it will continue forever Solution: watch out for that and force myself to review the position daily .

What I have learned is how I learn, how I like to learn and how to make a proper assessment if a particular course or skill will enhance my performance. It is fine to be sceptical of education providers; it’s your money, you expect value.

NOW to end and to summarize my views on this topic and answer the questions raised:

1. Education is vital to the typical trader’s success in the market (with exceptions).

2.It transforms one’s thought process from thinking like the man in the street to thinking in probabilities and to cope with losses or to see them as part of doing business.

3.There is no get rich quick weekend trading course, no piece of software that will turn 300 to 100k in one year, no tipping service that will send you the winning ticket symbols with entry, stop, break-even and limits.

4.Once you know how to trade basically, find the most appropriate next training course for analysing your journal, especially your mistakes ie to identify the issue and fix it.

5.Once armed with this first education, the best way to learn to trade, is to start to trade and keep notes, review records. Education and a continuous one at that will certainly help but will not guarantee success, only a high probability of success . Doing the best you can is success in itself, and we can all be proud of that.

6.I also believe we should choose an educational partner that we can go back to, one with integrity, one who is prepared to help in times of SOS. In other words, a Mentor or Group you trust and committed to your progress.

7.Finally, one you can look up to and admire. For me Ray Barros is all that and more, and I know he has helped many others as well.

TomC, STC Graduate

 

ANA aka IDKIT

Ag Moderator

Thinking ‘Three Moves Ahead’ VI

This blog on ‘planning’ and luck’ will be the last in this series. Recall that I am dealing with the role of luck and planning in trading/investing.

Bob Rice, in “Three Moves Ahead”, takes the view that we give ourselves the opportunity to ‘get lucky’ if we act in accordance with a plan. Today I want to consider the nature of that planning.

In trading, planning is based on three pillars:

  1. Our philosophy of trading. Mine, I adapted from Trader’s Vic. He and I share the same foundational premise – ‘preservation of capital’. This first principle permeates my approach. For example, I am happy to have a lower ROI for a smoother equity curve i.e. I prefer to make 25% net pa with an average draw down below double figures than make 35% pa with an average draw down of 20% or more. Another trader may have a larger risk appetite and opt for the latter.
  2. Our generic (strategical) plan. This dictates the types of trades we’ll take. For example:
  • Except in some rare cases, I prefer to enter on correction and retests rather than breakouts.
  • My generic plan determines my normal risk- risk defined by my psychological risk profile and the statistical data of returns.

3. Our tactical plan. This plan executes our strategy on a trade-by-trade basis. It has 3 parts: entry and initial monitoring, subsequent monitoring (abort), target exit (planned conclusion).

Yesterday Baz wrote: “You can make some serious money in this business but you really must master yourself first as trading will expose every weakness.”

I am in total agreement. To master ourselves, we need two key traits: self-awareness and self-management. While the two traits overlap, they are separate and distinct.

It took me forever to learn the skill of self-awareness (my hubris and ego kept getting in the way). Whatever success I have in this area was the result of weekly therapy sessions with Dr. George Lianos (Sydney). George showed me that if I was to succeed, I had to open myself to those areas that I would normally deny, distort and generalize; he showed me I adopted these defenses so that I would not have to accept that ‘I was wrong’ or ‘I was doing something that was leading to my failure’. The key words being ‘wrong’ and ‘failure’.

An example of what I mean: this memory is as crystal clear today as it was when it happened some 20 years ago.

In those days I was trading using the RSI – normal stuff you see bandied around today. The difference is we had no computers. And since I was day-trading, I drew my line charts by hand. Chrisy, my wife, would watch the Reuters green screen for the 30 minutes closes; I would draw the chart, calculate the RSI and draw that on the chart.

One evening, Chrisy asked me a question to which I could not give an answer. But rather than admit to not knowing, I bluffed a reply even though I knew I did not know the answer. To avoid being ‘wrong, I denied.

This human tendency to protect ourselves from pain stops us from learning. If we can admit that we are the authors of our failure, we have taken the first step to our success – we have acknowledged the problem. This is akin to the first step in AA – admit the alcoholism. Once we know we have a problem, we can look for the solution.

Self-awareness is a trait we need to consciously adopt. I found that, with time, self-monitoring does become easier but it’s very easy to slip into denial, distortion and generalization. Hence I am constantly on my guard. Now, let’s turn to self-management.

The fact that we admit to having a problem is but the first step. The next step is to execute. Here I have found that preparation, especially visualization, is the key to success. Preparation reduces the probability of impulse trades. Last night provided a great example.

My structural stop for my ES M8 short was acceptance above 1406.75; my price stop 1427.75. Because of where the market was trading and because it was FOMC, I placed my price stop at 1406.75. If the FED did something unexpected, e.g. cut by 0.50% rather than 0.25%, the market would blow thorough 1406.75. Given the fact that my trading has been in an ebb state, I was unwilling to chance that.

My preparation included scenarios where the market would move above 1406.75 and provide a Market Profile rejection extreme. I created a price range where I would re-enter, depending on the high achieved after FOMC. I did get stopped out (bought almost the high) and re-entered at 1400.50.

With hindsight, I’d have been better off placing a stop at 1427.75 and monitoring the activity at 1406.75. But that is with hindsight. I reviewed the decision in my review session today and decided I made an acceptable decision. Based on that decision, I made a plan and I flawlessly executed the plan.

The trade was a loss. But on a rating basis, I gave myself the full 3 points for my entry and exit. (For the rating system I use, see http://tradingsuccess.com/blog/the-matrix-249.html). Self-awareness needs self-management and rating system in the quoted entry provided a statistical measure to measure my self-management.

Well folks, that concludes this series. Happy May Day!

Thinking ‘Three Moves Ahead’ V

In his chapter on luck, Bob Rice says: “The expression ‘the harder I work, the luckier I get,” is not just cute; it is mathematically correct.” In short, if we follow a plan, and execute it consistently, then we’ll place ourselves in a position to ‘get lucky’. While Bob is speaking about chess and business, the same can be said about trading.

Given the nature of the markets, we are at the mercy of randomness (luck) on a trade-by-trade basis. Our edge operates over a large sample size and we never know what ‘this’ trade will bring. Many ‘newbies’ confuse ‘luck’ with robust trading. In tonight’s blog, I’ll illustrate this idea by telling you two true stories.

For the first, let me introduce Abe. Abe is a ‘newbie’ in the sense that he has not had three consecutive profitable years. I met Abe in Singapore after he had bought the first edition of the “The Nature of Trends”. He told me that as a result of the book, he was now making money hand over fist and he wanted to apply for the mentor course. After the preliminary screening process, I told him he could not afford the course. He argued that since he had made ‘$X’ over the past few months, he could pay it in no time.

I told him he was overtrading and the foundation of his success would prove to be his undoing. “Reduce your size; trade more conservatively and you will survive. Don’t confuse being lucky with being good”. I turned him down for the mentorship.

After that, I saw Abe from time to time – at the presentations I do in the region and at a couple of my seminars. Each time the ‘rags-to-riches-to rags’ story repeated itself. I am told Abe is convinced that I am hiding the ‘real’ secret to trading success.

What Abe doesn’t realize is that success will continue to elude him until he realizes that ‘the secret’ lies in accepting that the market is a probability game; as such luck (randomness) will play its part. Sometimes we’ll be lucky, other times unlucky. When the latter occurs, we rely on our planning to insure that the loss is within tolerable limits. Trading this way does mean we won’t turn $10,000 into $100,000 in 3-months; on the other hand, trading this way does mean, we will accumulate wealth over time, and continue to trade for as long as we are physically and mentally able.

Now let’s turn to Bob. Unlike Abe, Bob is a true newbie and has just started trading. He is one Ana Wang’s first subscribers (www.awanginvest.com). Like Abe, Bob has to learn to formulate and implement a plan rather than trade aimlessly.

In her first recommendation, Ana shorted gold on stop at $912.4. Abe entered at $910.00. The target was around the $850 to $860 zone and the stop around $946.6. When the market rebounded off $876.3, Ana sent out a recommendation to lower the buy stop to $910.00. This was a defensive measure to protect the position.

Abe did not stop out; in fact he may not have had any stop because he wrote to Ana after gold come down from $956.2 to ask if he should hold on to his short at $910. The day before Ana had put out a recommendation to sell gold at $924.6 with a stop at $951.7 and a target of $851.7. A few days later, Bob wrote in to say that he had taken a $4.00 profit on his shorts.

Bob was lucky: Gold may have moved to the Primary Sell Zone at $1025 to $1000 on the first rally off $876.3 – the fact that it did not was the result of luck. Then, having borne an open loss of over $3,600.00, he grabbed a profit of US$400.0. At a risk reward of 9:1, Bob would need to have a win rate of 90% to secure an edge of a measley $0.40 per trade.

I would not like Bob’s chances of achieving that win rate.

The difference between Bob and Abe is Bob is still open to learning and, if he is prepared to accept the role of luck and the need for planning, can still make the grade. It will be harder for Abe. Unless he has changed (and one can only hope), he’ll continue to confuse luck with ability – and he’ll never make the grade’ at least not until he learns this lesson.

More on luck tomorrow.

Thinking ‘Three Moves Ahead’ IV

We are talking about the impact of time on trading. In my last blog I spoke about using time to manage our trades. In this blog, I want to consider the impact time has on risk.

I use the 18-day swing as my trader’s timeframe i.e. the monthly trend defines my strategy: ‘long’, or ‘short’, or ‘stay out’ if I am unclear if my trader’s timeframe trend is likely to continue or change. I hold my winning positions for a mean of 29 days, with a standard deviation of 17 days. I fully realize that the longer I am in a trade, the greater the probability that an adverse Black Swan event will occur.

To reduce this risk, I have certain minimum profit parameters that must be achieved for me to retain the initial size. Unless these targets are achieved, I start to reduce my size. This reduction can be anything from total exit to a 10% reduction: it’s all a function of how far the market has moved in my direction in the time under consideration.

Sharing my numbers would not serve any purpose because the reduction in size and the time I allow is a function of our trading results. But, I can share the factors I take into consideration.

  1. The type of setup for the trade: negative development or contraction or other.
  2. The instrument (I have found that each instrument has its own characteristics).
  3. The Maximum Adverse Excursion in Time and Price: On my results, how long do I normally hold a trade that has eventually resulted in a profit? On my results, how far has the market moved against me and has still resulted in a profit?
  4. On average what is the normal profit for this setup and what is the normal profit per day?

Items (2) and (3) provide me with good estimates of the probability of eventual success. Let’s say the market has gone against me by mean +2 in both time and price. In addition, let’s say the average profit is 12% ROI at a daily rate of 0.5%. The trade has had a lifespan of say 10 days. So if everything were proceeding normally, I could expect a profit of about 5% (10 x 0.5%). Suppose my profit is only 1%; in this situation, I’d exit the trade or at least drastically reduce my position size.

Do I miss out on some profitable trades? Sure I do; but most times I lose only the difference between my exit and re-entry. But what is more important is I miss out on quite a few large losers.

Notice that this is different from grabbing profits just because they are there to be had.

Let’s say in this trade I have achieved a core profit of 12% in a shorter than normal holding period, and let’s say that my Primary Zone exit would yield an 18% profit. In this situation, I would resist the urge to exit with a view to re-entering once the ‘inevitable correction’ is over. The problem is in the best trades, there is no correction and generally, in these cases, the market does not provide a low risk re-entry.

So, I use time to assess when the probabilities cease to favour the trade; if the trade is performing as I expect i.e. it does all I ask to remain in the trade and does not exhibit any signs that would cause me to exit a trade, I will hold the position.

Tomorrow I’ll consider the role of luck in trading.