Tracking The Quality of Our Trades

BarroMetrics Views: Tracking The Quality of Our Trades

In the comments section today, D asked how do I track the quality of my trades.

My answer…

I keep two types of journals:

  • a qualitative journal – my ‘psyche’ journal. This journal has 3 aims:
  1. to identify patterns of success and failure in my qualitative environment. For example, if I have 10 consecutive winning trades, do my processes change? Do I stop doing what has brought me success? If so what will I do differently next time. I seek to record any changes or significant events in my psychological environment just before and during a trade.
  2. a safe place where I can vent – a place where I can pour out my frustrations, anxieties, and fears on the one hand; and on the other, the successes, elation and rewards.
  • a quantitative journal where I keep the stats I use to assess my trading. Over various time frames I keep:
  1. Ave$ win
  2. Ave$ loss
  3. Win Rate
  4. Loss Rate
  5. Date, day and time  of trade
  6. Consecutive wins
  7. Consecutive losses
  8. Rating for trade where 3 points means I enter and exit in line with my rules; 1 point means I enter OR exit in line with my rules; 0 points means my entry and exit were not in line with my rules OR I failed to make a trade my rules said I should. My aim is to achieve 90% of the possible points in any month.

The ratings are a rich source of information. For example if I scored less than 90% and had the best ever dollar result, I would want to know how I did this. Questions to consider:

a) Has my intuition found a new pattern?

b) If I had followed my rules, would my result have been better or worse? etc.

Trust that answers the question.

Emerging New Perpectives

Cross ref

http://idkitana.wordpress.com/

New  Perspectives emerging in 2011

With the game-changers in global markets in 2010,  financial institutions are changing their perspectives in 2011.

UBS is taking the lead to set  up a team to understand the needs of  UHNW  (ultra high net worth) clients in the Asia Pacific region.

With emerging markets in this region, there are now ultra high net worth individuals  who have businesses across the region or globally.   They travel frequently and have a good understanding of investment opportunities.  They usually have family members across the globe, and are very sophisticated .  They require a different level of advice and expertise only available at global integrated banks.

These  UHNW clients fall into three tiers:

1.       Investment

2.       Business

3.       Family needs.

UBS  has this team under Amy Lo,  its Regional Head for UHNW clients.  The team will be specially trained and supported by dedicated UHNW competency teams which leverage expertise across Wealth Management, Investment Bank and Global Asset Management businesses.

She explains that to be competitive, UBS must have a model capable of the following:

1.       Accommodating the local regulatory environment

2.       A broad geographical footprint in key markets

3.       A robust approach to managing risk without sacrificing agility

4.       Access to a  deep pool of talent

5.       A broad product offering

6.       A strong and trusted brand name

She has the vision to translate building a sustainable and high-quality wealth management business which creates value for its clients.

MY  TAKE

With memories of LTCM and the rogue trader of Barings debacles still fresh in our mind, I rate risk and money management top criteria in any investment strategy.

 IDKIT aka Ana

Hail King Midas!

We indirectly owe our Money Management to King Midas.  How so?  Please read on:

Cross ref

http://anatrader07.wordpress.com/2010/09/28/hail-king-midas/

The Midas Touch

As we reminisced over our school days, many of us would have heard or read about King Midas, his initial greed and his distaste for the yellow metal when everything he looked upon and touched,  turned to Gold, including his beloved daughter.

Now, Midas hated the gift he had coveted. He prayed to Bacchus, begging to be delivered from starvation as his food also turned to gold.  Bacchus heard, and consented; he told Midas to wash in the river Pactolus.

Midas did so, and when he touched the waters, the power flowed into the river, and the river sands turned into gold. This explained why the river Pactolus was so rich in gold, and the wealth of the dynasty claiming Midas as its forefather no doubt the impetus for this aetiological myth.

Midas  also angered Apollo the god who turned his ears into ‘donkey ears. He attempted to hide his misfortune under an ample turban or headdress, but his barber of course knew the secret, so was told not to mention it. However, the barber could not keep the secret; he went out into the meadow, dug a hole in the ground, whispered the story into it, then covered the hole up. A thick bed of reeds later sprang up in the meadow, and began whispering the story, saying “King Midas has donkey’s ear.

All these may be just myths but from King Midas, we learn about the Midas Touch which is the lesson to remember.  

The Midas Touch is just really  good Money Management.

Gold is so important that it is synonymous for wealth. But having gold nuggets, coins, or futures contracts does not mean your portfolio value is rising or safe.

Most of the gold supplied to the market each year goes into manufactured products; the remainder goes to private investors and to monetary reserves. Gold has a long history of use as currency or as a reserve backing for other forms of money; however, the gold standard is not currently used by any government, having been replaced completely by fiat currency.

Investing in the financial markets demands the ability to change perspectives over time. If gold bars or Krugerrands (a one-ounce South African gold coin) are purchased, then the physical possession of that gold remains the same regardless of the market price. Investment is a choice to risk capital with the hope of gain; however, ownership is for the sake of ownership regardless of whether there is a gain.  Unquote.

With gold punching the $1,300 mark, thoughts of what a gold mania will be like has crossed many minds, including mine.  We could see a gold rush of historic proportions  looming ahead of us.  So tread carefully.

I reiterate:  The Midas Touch is just really good Money Management.

Idkit aka Ana

Ag Moderator

Stops and their Use III – Hedging

BarroMetrics Views: Stops and their Use III – Hedging

Today I’ll conclude this series.

Let me first say that this is my view and I don’t expect to change anyone’s mind. Let me also say that I believe ‘hedging’ to be one of the worst practices novices can adopt.

Let’s be clear about what I mean by ‘hedging’: I mean taking opposite positions in the same instrument. If trading futures, it usually is in the same month but I have known traders who ‘hedge’ in different months. In the latter case, it is the trader’s intention that distinguishes ‘hedging’ from ‘arbitrage’.

In this blog, I’ll make it simple and talk about ‘hedging’ in the same month. The same principles would apply for those trading FX and I’ll use AUDUSD 60-minute chart as an example.

The practice is simple to illustrate:

  1. A trader initiates a position e.g. let’s say in Figure 1, I go long at .8673 on a breakup above .8666.
  2. As the AUDUSD  declines below 50% of the range, rather than stopping out, I go short .8614. In other words, I keep the long and short of the same instrument as two separate trades.
  3. At around the previous low at .8581, I cover my shorts for a profit of around 30 pips.
  4. I am now long and exit those at .8679 for a profit of 6 pips.
  5. I make a total 36 pips on the trade.

Sounds good?

Let me postulate another scenario:

  • I go long at .8673 and stop out at .8614 = loss of 59
  • I go long again at .8581 and  exit at .8679 = Profit of .98
  • Net profit = 39 pips.

Note that I used exactly the same numbers in both examples.

In short there is little difference in the Profit and Loss numbers if you take two trades rather than hedge. So, why do so many traders swear by it?

I don’t know – perhaps it’s a way of avoiding the ‘pain’ of a loss; perhaps it’s a way assuaging the fear of missing out. What I do know is it makes no sense, at least to me.

  • Firstly, a ‘buy’ and ‘sell’ in the same instrument is one round turn i.e a trade that is closed out. The fact that the trader separates the two does not make it less so.
  • Secondly, the trader is faced with an ‘open’ loss the moment he lifts, one leg. That loss will turn into a profit as long as the sideways trading range continues. If there is a breakout, the trader will be faced with dealing with the open loss.
  • Finally, in my view, ‘hedging’ encourages dishonesty with ourselves. It’s easy to slip into the idea that there is no loss because we are ‘hedged’; the reality is there is a loss – the difference between the long and the short. (I have never known anyone to ‘hedge’ a profit).

Hedging in FX is now illegal in the USA.

It seems to me that rather than ‘hedge, we’d become better traders by becoming more self-aware (why am I ‘hedging’ since there is no logical reason for the practice) and become better acquainted with the stages of a market (understanding the high probability trading zones of a sideways market).

blog-2010-06-17-hedging-adus60m.jpg

FIGURE 1 AUDUSD 60-minutes

Stops and their Use II

BarroMetrics Views: Stops and their Use II

With the interest in the “Stops and their Use”, I thought I’d cover the topic a little more fully.

I believe hard stops (i.e. stops that are in the market) placed are necessary to guard against catastrophic loss. I place my stops at a point beyond which I am not prepared to accept more loss whatever I may think the market is doing.  This stop is partially technical and partially statistical.

  • Technical: I place a stop where if hit, my reason for the trade is invalidated.  I also incorporate Maximum Adverse Excursion.
  • Statistical: The stop needs to be within my money management guidelines. These are governed by my Expectancy Return, the volatility of the market (as measured by the Average True Range [ATR]) and tic value of the instrument. The size of the position is also determined by my assessment of the stage I am in: Flow, Normal or Ebb.

If my technical stop exceeds my guidelines, I pass on the trade.

But stops are not the only way I exit trades. I also use time and structural stops.

By time stops, I mean that for some trades, I set a specific number of days that a trade needs to move mean +1 ATR from entry. The time is set according to the Maximum Adverse Excursion concept (but based on time rather than price) and my assessment of the context.

By structural stops, I mean what the market should not do given the setup (reason)  for the trade. My setups have certain price action that ought not to  occur if I have read the conditions for the trade correctly.

The problem for the novice trader (and he is the person I am trying to reach in my educational activities) is time and structural stops require experience; this experience the novice has not acquired.  So for him,  using subjective exits is tantamount to committing trading suicide.

Tomorrow I’ll address the idea of ‘hedging’. While I would never attempt to dissuade anyone from a behaviour that works for him, ‘hedging’ is a subject on which I have strong views.

Stops and their Use

BarroMetrics Views: Stops and their Use

The other day, I came across a blog that found that on a R:R of 1:1, a drop at or below 65% and the equity curve became unstable. He also found by adding stops the win rate would cause the win rate to drop and he also found that his stopped out trades were larger than his profits.

Some of  his suggested solutions include reducing leverage and not using stops and trading more often and not using stops. But as he says “Each of these solutions actually will raise a new set of problems”

This leads me to an area that is too often neglected.

It would seem to be that the problem here is the Reward to Risk ratio for the time frame. There is a relationship between:

Timeframe, potential risk, the potential profit, the win rate and loss rate.

The shorter the time frame, the larger win rate needs to be,  and the smaller the R:R needs to be for a stable equity curve. The best example of this are the scalpers. They have large size, large win rate and the R:R is close to 1:1. Other timeframe traders e.g. a monthly trend trader, would have smaller size, smaller win and a higher R:R.

Sometimes the solution to the problem like the one posed lies with tweaking the profit target or changing where the stops are placed. Sometimes, larger stops are called for.

This may just be a personal conviction but as a professional trader, I need to trade a size that given my knowledge and experience will merit the risk. I may be able to buy 100 shares at $10 a share and let it go to $0 if need be, but I would hardly be optimizing my return. If I increase my size enough to make the risk worthwhile, it follows that the risk will be large enough to cause me concern if I trade without a stop.

Now we may need to reduce and use larger stops; or we may need to change where we take profits; or we may need to do both.  The point is not having a stop in the market to guard against a Black Swan event is one risk I’d be unwilling to take.

Change in Methodology (II)

BarroMetrics Views:  Change in Methodology (II)

Our trading methodology needs to fit our personality. That being the case, my search for a new approach meant that I would need need to look for an answer among indicators and moving averages. My personality looks for ‘price structure alone’ rather than ‘price structure as moderated by some indicator’.

I had some other requirements: the approach had to be price-based and had to provide a more refined measurement for trade management.

It took a while. But I finally found an idea I could adapt. The initial tests have been excellent. The Expectancy Return per trade is just under 1% of capital. It is unlikely the results will be maintained over a large sample size but even a 50% diminition would be very acceptable.

Those following the Forum-Twitter service were exposed to the idea yesterday when I said that I was looking for a move to 1.3281 over the medium term; but to do that, we needed to see acceptance below  1.3438.

Instead we saw 1.3438 provide support. So,, for now, as long as we do not see acceptance below 1.3438, the probability is we’ll see 1.3594.  From there we’ll need to see whether the EURUSD will turn down and retest 1.3438 or move to 1.3750.

Following on from yesterday’s comment, today I placed a specific day-trading recommendation on the Forum. It will be interesting to see how the idea turns out. And no, I shall not be teaching the support/resistance method – at least not in the foreseeable future. If you are following the Forum recommendations, remember that I look for setup and an entry bar at the zone.

I have some more real-time testing to do. But I am sure that the support and resistance levels add a new dimension to my set of tools. Even better, is there robustness is apparently unaffected in the lower timeframes

Figure 1 is the Daily EURUSD containing only the new levels. I have omitted Barros Swings and MIDAS lines.

f-t-2010-04-19-euus-d.jpg

FIGURE 1 EURUSD Daily

Change in Methodology

BarroMetrics Views:  Change in Methodology

Two readers have raised important questions about the change in methodology and timeframe.

The questions will take up a couple of blogs.

I’ll take Joe’s question because that will also answer Peter’s. Joe asks: “I assume that you are now trading with much shorter time frames with more frequent entries and exit( hence more opportunities) in order to generate the income to meet your target.

My question is has your methodology changed- setup, etc , been modified to trade these shorter time frames?

If so in what way have they changed?”

Before I talk about the change in methodology, I need first to address what I believe may be an erroneous assumption.

The first part of Joe’s question seems to associate the shorter timeframe with more opportunity and therefore more profit. But more opportunities can also mean more opportunity for loss. The key question is whether the trader can utilize the opportunities to increase his Expectancy Return [(Avg$Win x Wrate) – (Avg#Loss x Lrate)].

And that brings me to the nub of the problem that has been facing since last year.

I’ll use the S&P as an example but the problem runs the gamut of the instruments.

Figure 1 shows the S&P weekly since the March 2009 lows.  I’d have liked to have used the daily chart but it was far too compressed to illustrate what I wanted to show.

Notice the areas in red, the market was climbing without support of the volume and range studies I adopt. Moreover, if you bring up a Barros Swing chart (Figure 2), you’ll note that the 18-day has not had even a 5-d pull back in the move up since February 2010. Now in a strong market, that’s not a problem. I would treat it as an R2/3 (see Nature of Trends) and I have tools to deal with that type of trend.

But in this case, since the Volume and Range were not confirming the price move, I could not classify it as an R2/3.

So the S&P represented the first problem: where the ‘internals’ I use were not confirming the price structure. A lack of internals usually means a lack of swing structures,  and I use swing structures not only to identify the trend but also to provide change in trend patterns, setups etc.

The second problem was the failure of trades to reach their normal targets – too often, my trades were retracing  before they hit the profit target.

The end result was my Expectancy Return moved below the minimum $0.80 of my Expectancy Return range. I have been here before. The last time was ended around 1999-2000 when for 3-years, I was unable to return a profitable return.

When markets adopt this environment, I have a two-fold problem:

  •  My normal approach fails to identify the change in direction early enough to enter to provide an adequate return when the market changes direction and
  • My stops are too far away so that the profit targets become more than the market is willing to give.

Those were the problems. Tomorrow I’ll deal with the generic solutions.

f-t-sp-2010-04-16-mktvol.jpg

FIGURE 1 Weekly S&P

f-t-sp-2010-04-16-18d.jpg

FIGURE 2 S&P 18-day Swing

The Education of a Trader (3)

BarroMetrics Views: The Education of a Trader (3)

So far I have been  considering the ‘how’; I am answering the question, ‘how I acquire the knowledge I need’? In this blog, I want to turn to the ‘what’?.

Most of us have heard and read that success depends on acquiring the know-how to construct a set of rules that form the base of our trading strategy and risk management. We have also heard that we need ‘winning psychology’.

I define winning psychology as a set of tools and concepts that facilitate consistent execution of our rules. That said, you can immediately discern that it would be  intensely personal to craft the tools and concepts. Some areas you may want to consider are:

  1. What will I need so I can improve ?At the very least, we’d need a journal that records our emotional responses and observations about the market. We also need to keep a record of our trades. The latter will form the basis for analyzing our performance.
  2. How to integrate your emotions and your reason. It is now known that the best decisions are the ones that come about when both are in sync.
  3. What are the habits and routines that I want to establish that will help my trading success.

On risk management, you need a strategy on how to manage winning positions – what I call trade management and a set of tools to manage position sizing and risk control.  Here I’d start by focusing on determining what constitutes a ‘normal’ position size. True, you would need a set of stats that many of us don’t keep.

If you fall into this category,  the Turtle position-sizing formula is as good as any.

(% of capital to risk x Capital)/(Dollar Value of 10-day ATR).

What the formula lacks is the trader’s variables: his average dollar win, average dollar loss, win and loss ratio. There are better position-sizing formulas around but all require the trader’s personal input.

In this area, you also need to consider:

  1. maximum portfolio risk (when you are trading more than one instrument)
  2. when to allocate winnings to the trading capital base and when to deduct losses from the base.
  3. when not to trade.  What number of consecutive losses are you prepared to bear before calling a break? What maximum loss will suggest you need a sabbatical from trading?

I’ll conclude the series in the next blog.