Left Brain Thinking Conclusion

BarroMetrics Views: Left Brain Thinking Conclusion

As a rule-based discretionary trader, I use my position sizing to reflect my risk assessment of the current structure. In turn the position sizing is also determined by whether I am seeking to manage the first, second or last third. Each has its own considerations and objectives.

Take the AUDUSD as an example.

I have only last thirds left.

With the last third, my general strategy is to bring the stop to breakeven and exit via a trailing stop; or exit the position on a change in trend pattern in my trader’s time frame. Sometimes the market does not make its intention clear. So, to the extent I am unsure, I reduce my position size.

In the AUDUSD, I assess we are at 12-month swing and 13-swing support. In addition, Figure 1 shows the Ray Wave count with a structure that says we may see a correction from the high at {c} (0.9350) to the current lows at 0.8032. A normal retracement would take me to the zone 0.8850 to 0.8550. There is no way I would ride my last thirds from 0.8032 to .8550, let alone .8850. I’d expect to have a Change in Trend pattern somewhere along the way.

The Ray Wave provides an early warning signal.

Yesterday’s move to 0.8254 (better would have been a move above 0.8300) suggests the possibility that the current down move is over. Normally we’d see a sideways period, that is followed by a change in trend. But, sometimes we see a V-bottom type pattern.

Given that the down move has been thrown into doubt, I lightened my short position at an average price of around 0.8257. I will exit the balance on a change in trend pattern or on any daily close above 0.8356.

I like managing a trade in this way. it suits my personality and attains my trading objectives.

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FIGURE 1 AUDUSD

Non-Farm, A Review

BarroMetrics Views: Non-Farm, A Review

On the surface, Friday’s Non-Farm Payrolls ought to have been good for the US dollar, and perhaps, even the S&P:

  • the headline number showed 252,000 new jobs. This was well above consensus expectations.
  • The unemployment rate dropped to 5.6% from November’s 5.8%. We have not seen this unemployment rate since 2008.

Given these numbers, why did the US dollar tank?

If we look beneath the surface, there were clouds on the sunny horizon:

  1. the average hourly earnings were down 2%.
  2. The long-term unemployment is at historical highs, with one-third not having a job in the past two years.
  3. Men not working is three times the number in 1960.
  4. Finally, the number who have dropped out from looking for a job, or have settled for a part-time job is at historical highs.

Given the above, it’s no wonder that the US dollar headed south. The question now is, whether the S&P will follow the dollar?

Figure 3 may provide the answer, this is the Market Delta chart of the E-mini nearest month futures.

We see that the selling pressure produces a lower number than the previous two of moves, and the selling pressure on January 5. This suggests to me that we should test the 2018 level. That test will probably be successful, and we should see an up move today. If the move up does occur, I shall be looking at the buying pressure to see whether or not that picks up as the S&P heads towards 2088.

The rationale for the up move? There may not be as much pressure on the FED to raise rates as the headline numbers suggest.

If I am wrong, and the market proceeds to head south, I shall be interested in the selling pressure to see whether or not it suggests we shall be testing the 1972 level.

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FIGURE 1 S&P Cash

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FIGURE 2 S&P Cash

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FIGURE ES NFM

Left Brain Thinking IV

BarroMetrics Views: Left Brain Thinking IV

Shame on me. For Left Brain III, I got lazy, did a minimum blog, and assumed all would be able to follow my line of thought. Thank goodness for readers like Sorin and Paul – they keep me focused.

For context to this piece, I’ll leave it to you to read Left Brain Thinking and Left Brain  Thinking II. Here, I’ll provide a detailed outline to my thinking.

To understand the approach, you need to bear in mind the functions of  my Rule of 3:

  1. The first third exit covers the loss on the remaining two-thirds. It’s function is purely defensive. If your approach is similar to mine, after entry, the trade tends to move in my favour even if subsequently stopped out. The first third seeks to make use of this pattern.
  2. The second third exit is the core profit. If I am to make money, it will be on the exit of this third.
  3. The last third, a friend once called, the ‘Blue Sky’ contract. It seeks to capture those moves that are greater than I expect. Often these moves fail to provide a location for safe entry; so, holding the last third removes much of the pressure.

OK, lets’ turn to the series…..

The point I was seeking to make was to illustrate the flaw so prevalent the plans of retail traders  (at least among those whom I have coached): they treat their profit target on an all or nothing basis i.e stop out or profit with nothing in between.

This is a fatal flaw – whether you are a discretionary rule-based trader or mechanical trader. If the latter, the omission is a trailing stop rule once the instrument moves into the Expectancy Ratio Profit Zone.

Here I am addressing the discussion Paul and I had. I agree that rule-based traders need to follow their rules; but that does not mean they cannot amend their rules should they see a weakness that needs correction – failing to have a trailing stop in this context would be such a weakness.

I use the Expectancy Ratio profit zone  to answer the question: when is there enough profit in a trade to say that we need to protect it: if we take too early, we are failing to let our profits run; if we take too late, we are guilty of allowing a profit turn to a loss or too small a profit.

In Left Brain  Thinking II, I referred you to an explanation on the calculation and use of the The Expectancy Ratio. I’ll leave it to you to read the piece before turning to the track records of Traders A &B (Figure 1).

Starting from C1:

  • Col C is the current low of the move.
  • Col D is the entry
  • Col E is the initial stop
  • Col F is the stop range (entry – stop)
  • Col G is the 2x stop range for the 1st third (not needed in this example).
  • Col H is the 1st third exit price  (not needed in this example).
  • Col I is the trader defined 2nd third profit target exit price.
  • Col J is the profit range.
  • Col L is the R:R (profit range/stop range)
  • Col M is the R:R required by the ExpRatio. We’ll be using this in our assessment of the ‘moat’ for the second third.
  • Col N is the ‘moat’ i.e. the number of points from the low that trader has before having to take profits  i.e. Trader B has a ‘moat 69’ points from 0.8034, i.e. at .8103, Trader B must take profits or risk losing money long-term even if he exits at a profitable price BUT above .8103.
  • Col O is the calculation of the price, in this case, .8103.
  • Col R win rate
  • Col S loss rate
  • Col T Avg $ win and
  • Col U Avg $ loss.
  • Col ExpReturn  (not needed in this example)
  • Col X ExpRatio: Notice that both Trader A & B have the same ratio by adjusting the R:R to allow for Trader’s A better win rate.

What Figure 1 tells us is allowing for the win rate and avg $win and avg $loss, both Traders have a 20% edge. Note that for the example, the winrate:lossrate is taken from the Traders’ own statistics.

With that in mind, let’s apply the ExpRatio.

We know that:

  • the trade’s R:R is 2.15:1.
  • we know that Trader B’s MUST have Reward:Risk is 2:1.
  • Subtracting (trade’s R:R) 2.15 – 2:00 (Must Have R:R)= .15 (Moat).

By multiplying the moat to the profit range and adding it to the low of the move, we have the maximum allowable retracement to stay with the R:R of 2:1.

Sorin asked why a R:R 2:1?

For the purposes of the example I have assumed that both traders want a 0.20% edge. After that I just adjusted the Col V inputs until I had the 0.20% edge. I am sure that there is a maths formula that covers the calculation. But, since I don’t know it, I used the trial and error method.

Turning now to Andrea Unger. In reply to Paul’s insight that Andrea does not use stops….I made the comment that other well-known traders. So?

My point is there has to be some quantification of what is ‘near’ enough to our price targets. Once that is defined, we can then create strategies to ensure we take second third profits close to that required by the Expectancy Ratio.

Final comments……

…For those who have done my courses, I remind you that the Rule of 3 is best applied to end-of-day trading. It is less useful when day trading. For day-trading, you are better off using expected range of the day….but that is another story.

…..Finally I posted today  because on Monday I want to talk about the S&P.

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FIGURE 1

Free Webinar Jan 17

BarroMetrics Views: Free Webinar Jan 17

In ‘Merry Xmas….An Invite‘, I invited you to submit questions that would form the content for a three-webinar series of 60-90 minutes each.

Well, the day for the first webinar is Jan 17, and we’ll be looking at winning psychology. Specifically, we’ll be looking at:

how to attain our trading goals through consistent execution

Do you have a fear of failure? Are unable to follow your rule? Lack the confidence to follow your plan? Are a victim to the four fears – loss, being wrong, leaving money on the table and missing out? Unable to let your profits run and cut short your losers?

By the end of the webinar, you will have a model that will enable you to overcome all these issues (and more). Is that worth a 60-90 minute investment? Only you can decide.

By the way, as I said in my Xmas invite, this is not a preview – just my way of saying thanks for a great ending to 2014.

The webinars will be looking at:

  • Mind: Jan 17 (10:30 am HK time; 13:30 Sydney; 21:30 Jan 16, US EST)
  • Money: Jan 24 (10:30 am HK time; 13:30 Sydney; 21:30 Jan 16, US EST)
  • Method: Jan 31 (10:30 am HK time; 13:30 Sydney; 21:30 Jan 16, US EST)

Here’s the link to the 3-webinars.

http://www.barrometrics.com/breakthrough-webinar-registration

FOCM Jan 9 2015

BarroMetrics Views: FOCM Jan 9 2015

I am looking for a below consensus headline number. Shadowstats has been warning of a possible downside surprise. If it is likely to come, it will come tomorrow – some market participants have yet to return and sentiment is high. In addition, a low number may prove to be the S&P’s cause celebration – in the hope that the FED won’t raise rates till June 2015 or later.

 Figure shows the expectations numbers for December 2014 and January 2015. You’ll see that the bottom end of the range has risen from 140K to 202K (as rise of 62K) and the upper end from 275K to 305K (a rise of 30K). I believe comparing the expectation numbers this way provides a better guide to the market sentiment than by just comparing the consensus numbers. 

What effect will a figure of, say 210K, have on the stock market and US$?

Not sure about the stock market. There will be an immediate downward blimp; but we may see the market close up for the day. Certainly the price action will provide clues about the current market structure and sentiment.

The US$ will probably head south and close down.  As a trader who is long the USD (last thirds), I am concerned about the universal bullishness in the USD market. A short squeeze environment is there for the taking – only needs a stimulus.

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FIGURE 1 Consensus Non-Farm

Left Brain Thinking III

BarroMetrics Views: Left Brain Thinking III

Yesterday I said that Trader B had to exit immediately. Why?

Figure 1 shows that, given his win rate, his required reward:risk return (2:1) is secured at 0.8103; in our example this was where the AUDUSD was trading. So, he had no safety moat; and with the AUDUSD now trading at long-term support, a bounce has to be included in the possible scenarios – especially with the view I have taken on the FOMC (see blog later tonight around 8:00 PM HK time).

For risk management reasons, then, Trader B needs to exit now.

Trader A on the other hand, given his win rate, can afford  a bounce of 520 pips. That being the case, Trader A can review his technicals to see where he can place his trailing stop in an attempt to maximise his core profit exit. As long as the trailing stop is below .8555, he will secure his targeted outcome, even if a bounce occurs.

So there you have it. Feel to comment.

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FIGURE 1

Left Brain Thinking II

BarroMetrics Views: Left Brain Thinking II

Thanks to all who left comments.

If I were answering the question, I’d split my answer into two parts:

  1. A risk management phase, then
  2. A trade management.

To understand why I have done the split,  it’s important to remember the function of the second third: it’s function is to deliver the method’s core profits.

The dilemma we face is: given our win rate, if we take profits too early, then in the long run, we’ll have a negative expectancy return; if we look to take profits too late, there may be no profits to speak of.

So, to find our way out the gordian  knot, we’ll turn to Expectancy Ratio, a cousin of our friend, Expectancy Return. (NB: The link has an explanation on use of the Expectancy Ratio, and shows the formula).

Figure 1 shows the Expectancy Ratio, and the expectancy data of two traders. Their results are identical except for their win rate. Both traders are looking for a 20% ROI. (For our purposes we can ignore the columns in green),

Now, let’s apply the  the Expectancy Ratio to a mock situation where the AUDUSD has made a low at .8034, and is currently trading at .8090. The price target for the second third is .8022. The question is should the traders take profits now, or should they look to manage the trade?

Based on Figure 1, Trader A can look to manage the trade; Trader B needs to exit.

Tomorrow we’ll look at why I say this.

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FIGURE 1

Left Brain Thinking

BarroMetrics Views: Left Brain Thinking

Picture this:

  • You are short the AUDUSD.
  • You have exited 1/3 of your positions so that the remaining 2/3s, if stopped out, would be a ‘no-‘loss’.
  • You are looking to exit the second third at .8055.
  • Your stop is some 200 pips away, say .8258.
  • The AUDUSD gets to .8065 and bounces, what do you do?

I am coaching a couple of students who, on Friday, sent me their trade management plan for the AUDUSD shorts; they were preparing for this week’s trading. One did not even consider the possibility of a bounce; the other, took the view that unless his second third target was met, he’d take the stop i.e. either .8055 or .8258 whichever comes first.

What would you do? Send me a comment. 

Oh, let me provide some context:

  • The first third exit covers the loss on the remaining open positions at the initial stop level.
  • The second third exit is taken at a level assessed by the trader. It represents his core profit level. On exit of the second third, the stop on the last third is brought to breakeven.
  • The last third is exited on a trailing stop basis or on a change in trend pattern occurring in the trader’s timeframe.
  • Rational for the process:
  1. the first third is for protection;
  2. the second is where you derive the bulk of your ‘normal’ profits;
  3. the last is the ‘exceptional return’: more often than not you are stopped out at breakeven. But the time when you are not stopped out at breakeven, the times when you see a return of exceptional gains, these times make up for the breakeven stops.

    More after your comments.

    Time and Price Stats Window – Video

    BarroMetrics Views: Time and Price Stats Window – Video

    Sorin asked two questions:

    • Did I still have the Barros Swing Videos from 2010? Answer: Unfortunately no. We lost the masters when we changed servers.
    • Could I give an example of the time and price stats windows mentioned in Nature of Trends.

    That was a great request because most readers may benefit from the example. Here is the link to the video example.

     https://dl.dropboxusercontent.com/u/10422981/sorin%202014-01-31.wmv

    A couple of points to note:

    1. The example focuses on the window.
    2. When deciding on a  zone, I consider the items below which I did not consider in the video….
    • What is the trend of the timeframe I am trading? Is it likely to continue or change?
    • What are the other zones projections, do we have overlap? (actually I gave this a cursory examination in the video)
    • What are the maximum and minimum boundaries of the zones? If the optimum boundary is exceeded, but the maximum boundary is intact, will I still consider taking the trade? (Answer: Usually yes, though I may reduce position size – depends on the type of trend, and other aspects of the context).
    • Assuming a breach of the maximum boundary, what do I have to see to invalidate the zone and look for a new set? (Answer: usually a directional bar against the zone e.g. a bullish-conviction close above a sell zone). What do I have to see to consider the zone still valid? (Answer: usually a rejection bar; but normally a breach of the maximum boundary would mean I reduce my position size).

    Time and price stats windows provide the context for low risk, high probability zones for my trading. They may also serve your trading. I hope so.

    Happy New Year! A Recommendation

    BarroMetrics Views: Happy New Year! A Recommendation

    Happy New Year, guys and gals!

    The time of year when we form our resolutions – resolutions that are honoured more by their breach. One of the reasons we don’t attain our resolutions is because we don’t manage ourselves – we ‘don’t manage our time’.

    If you fall into this category, I may be able to help……

    ……On New Year’s Eve, I attended a promotional webinar by Paul Evans on goal achievement and self-management.

    I signed up for the course because it is a great course: lots of new info, templates and a robust, integrated process. Best of all, you can sign up for the 5 Stone Course and software for US$20.00.

    That’s right $20.00! Fab value.

    So, if you are looking for a way to keep your New Year resolutions, have a squiz at http://launchyouryear.com/

    Here is something of great value. By the way, I am not affiliated  in any way with the recommendation. I am passing it on because I think it is great value. Open only till end of Jan 2, 2015.