A Review of the S&P 01-09-2008 II

I often get asked: “Why do you set out so many scenarios when preparing your trade? Why not create a simple plan e.g. buy at xxxx.xx with a stop at xxxx.xx?”

I answer: “It’s because I don’t know what future will bring”.

By this I mean how a market does something, is at least as equally important as how it does it. Yesterday’ price action in the S&P is a great example of what I mean.

In yesterday’s blog, I set out four scenarios. The one I felt to be most probable was the one speculating on a smaller than normal range day. At time that I was writing the piece, the market was up about 9 points. Hence I focused on what I would look for if the market broke the highs. I suggested that the level representing 50% of the gap would hold. This was the second favoured scenario.

However, by the time the market opened yesterday, it was only 1.5 points up. At the open this is what we knew:

  • Tuesday’s high was 1436.5 and its low was 1396.5;
  • On Jan 9, Wed, the ESH8 opened at 1398.

Given the above, at the open on Jan 9, the greatest probability occurrence was the 1st scenario that provided for a small range day but now we’d be looking for a breach of the lows. Notice that although, I shifted from looking for a breach of the highs to one looking for a breach of the lows, the essential nature of the scenario remained unchanged – I was looking for a smaller than normal range day.

What does ‘normal’ mean? I define normal as being mean +1 to mean 0.5 standard deviation.

A more important point: recall that I had, as a third scenario, canvassed the possibility that the market would break to new lows. For the reasons stated in Tuesday’s blog, I had decided not to participate in any further shorting.

Now, let’s turn to the picture when yesterday, the market broke to new lows on two occasions: (Market Profile’s) ‘E’ period and then the ‘I’ period. When we broke for the first time, (‘E’ period), we had a True Range of 16 points. This was in keeping with what I was expecting – a smaller than normal range. Mean 25 points and we have a standard deviation of 10. Hence I was looking for a range no more than mean -0.5 stdev i.e. 20.The ‘I’ period extended the True Range to 22: we now had normal and when it rotated back into the day’s range, it raised alarm bells for my short positions.

Here’s what I noted:

  1. Yesterday was the 9th consecutive day of lower lows and lower highs. On a 1-day swing, the market was statistically overbought.
  2. The market was in the Primary Sell Zone: an area that would support a rejection of the down move IF the uptrend was still intact.
  3. If the market now extended the range up, we’d have a Market Profile Neutral Day. If a Neutral Day closes in the middle, we have a balanced day that warns us of a possible trend change; a close in the top quartile is stronger evidence of a reversal since it provides for Free Exposure.

So when the market returned to the day’s range, I decided to:

  • Place stops on half my remaining shorts above the day’s high
  • Place stops above the Tuesday’s high on the balance
  • Exit if the market closed in the top quartile.
  • Go ¼ size long if the market closed in the top quartile.

Given the close, I ended the day being ¼ size long. I’ll manage the trade using Free Exposure guidelines.

The blog today I feel is one of my most important ones. It sets out how I manage trades using present tense information.

Chart 1 shows the Profile


Chart 1 Market Profile

A Review of the S&P 01-09-2008

I believe we have tipped over the edge on the S&P. In this post, I’ll set out why I say this and suggest some parameters to monitor.

To summarise this blog, the Ray Wave count suggests that we have topped out with a 5th Failure and ‘normal’ technical analysis’ supports the view.  The one drawback: The Whisper Number’s sentiment reading is oversold as are the other SI readings but not to the same extent as Whisper Numbers; this is an amber signal for me not to get too aggressively short.


The chart below shows the Ray Wave Count on the quarterly trend (13-week swing) 


CHART 1 13-W Ray Wave

In the next chart I zoom in on the price action and go down to the 18-day (monthly trend)


Chart 2 18-D

The S&P reached the Primary Buy Zone at 1370.6 to 1431.6 (basis cash) after reaching a swing on 12-11-2007. But note that the swing high failed to reach the minimum 78.6% retracement area in an established sideways market.

Ideas corner: when you are in a sideways market, the market moves from high to low, low to high; if the market returns to an extreme without first achieving the opposite extreme’s minimum target, we can expect the opposing the price boundary to be breached. In this case, we are at the Primary Buy Zone without having reached the minimum upside target. I am looking for 1370.6 to be breached.

Chart 3 shows the ESH8. You’ll notice that the price action on Jan 4th created a gap on the day the market popped into the Primary Buy Zone. The question in my mind was whether the gap was common gap or a breakaway gap. Last night’s price action suggests the latter.

When yesterday, the market open gapped up after a rest day, and failed to close the gap in the 1st 90 minutes, I thought the S&P would rally. I closed out my shorts and went long at the bottom of the developing value area with a stop for the longs below the lows of the day. You know I got stopped out. However once the lows were violated, the probability of the gap being a breakaway gap substantially increased. I waited for a rally to reinstate and increase my shorts. 


Chart 3 ESH8


1) The S&P has been down for 8 consecutive days (excluding one inside day); it’s time for a breather and I would expect another inside day today. For this reason, I have created Primary Zones base on yesterday’s open and close. I’d expect those zones to hold.

2) If the market breaks above yesterday’s high, then the key areas to watch are 1447 to 1443 (basis cash). Apart from being 50% of the gap, there are a number of other ratios coming into this area.

Acceptance above 1147 suggests the gap will close. That in turn suggests the market is heading back up the Primary Sell Zone. I rate this the lowest probability scenario.

3)  A more likely scenario is the market will break above yesterday’s high and the 1447 to 1443 zone will hold. Should the market reach 1447 to 1443, I’d lean against this area to go short and look for intraday setups and triggers to enter.

4) The second lowest probability scenario is another strong day down. Acceptance below yesterday’s low on volume would warn us this is occurring. Since I dislike jumping on board a directional move once the 1-d swing is statistically overbought, I’ll give trading the ES a miss if this occurs; I’ll be content to manage my current short position.

Best of luck and do take care!

Routine & Habits VII: The Routines and Habits

Well folks this is the biggie. All I have written before in this series comes down to this post.

It’s my belief that participants attending seminars would obtain greater benefit from a seminar if they adopted, for 30 days after the seminar, a set routine to internalize the seminar concepts. At the end of the 30 days, the routine would become a habit and the seminar participant is then free to choose whether to adopt all, some or none of the content. The key point is that until he has internalized the seminar content, he is not in a position to choose.

I remember my first Market Profile seminar. I flew from Sydney with two mates: one was a technical trader working as a technical analyst for a broking firm (let’s call him John); the other was a day-trader (let’s call him Paul).  Paul and I ‘lost’ John pretty early in the piece. By the middle of the first day, John was doodling and post session discussions revealed that he had taken the view that the Profile was not for him – it was too far removed from what he knew.

Paul and I liked the idea of the Profile but we struggled with the application. It took me 9 months before I got comfortable trading the Profile way – what enabled me to persevere was the fact that I set a daily routine to follow. Each day I set the goal for that day and followed the set routine.  Part of the routine involved reviewing whether I achieved the day’s goal and if not what I had to do the next day to complete it. I would not move to the next topic until I was satisfied I had mastered each day’s goal.

Trading routines have a similar objective. Their outcome is to produce habits of success. The routine you set is one that is personal to you. Below is the one I follow – it suits my personality; treat it simply as an example.  Experiment with a routine, content, time of day, order of activities until you find one that sits comfortably.

Monthly Routines: 

  • Review summary of the psychology and equity journals. Are there any empowering patterns? Are there any disempowering ones? I look for the patterns under the headings: setups, instruments, and personal behavioural patterns. For example: is there an instrument that bore the preponderance of losses for the month? If so, did the losses occur for a particular setup? What was the difference between the current environment and the most recent environment that I made money in this instrument? In this setup?
  • Review equity journals to determine if I am on track. I look to make about 22% per year so I am looking to make about 2% per month. If I am not on track, where can I make improvements? What has to happen for me to return to budget? Etc……

It’s important to understand that I make these enquiries from a stance of curiosity – there is no question of blaming myself for errors or feeling anxiety because I am behind the eight-ball. True if I have had 4 consecutive losing months or more than 12% loss in any rolling period, I take an enforced holiday of at least a week. But this is in the form of a breather to put a space between the losses and me and not as a form of self-punishment.


  • Analysis of markets with a view to preparing a short list of possible trades in the coming weeks and a watch list where trades are unlikely but possible if certain events occur.
  • Analysis of psychology journal – summary of daily entries for possible patterns (see above entry in Monthly Routines).
  • Analysis of equity journal – to ensure that there are no out of boundary losses.


  • Download and update data
  • Update psychological journal
  • Update equity journal
  • Prepare for trades – plan, and visualize
  • Ensure day’s activities are planned around trading activities.
  • During the trading day, a series of routines to ensure my ‘rat brain’ is not running my trading.

That’s it. I hope you have enjoyed the series.

Routine and Habits VI: The Pyschological Plan

What is Winning Psychology? For me it’s a combination of traits and tools that provide the environment whereby a trader consistently executes his trading plan. In this blog, I’ll look at some of the tools at the trader’s disposal.

The first is preparation: whether you are a day trader, or longer time-frame trader, preparation is essential. The preparation takes place firstly at the conscious level and then at the subconscious. I set out some of steps of the preparation in my previous blogs in this series. Once we have completed the preparation consciously, I recommend we visualize in the alpha state the various step of the preparation. It’s beyond the scope of this blog to describe the visualization process but there are any number of good books on the subject. By visualizing our planned response to the various scenarios, we reduce the probability that we’ll breach our plan.

The second tool I like is a bio-feed device. The one I use is the 3100 WristOx from www.bio-medical.com but there are less expensive devices that do as good a job. The bio-feed back device warns me when my ‘rat-brain’ is starting to take control and before it totally takes over.

The final tool is the trading psychological journal. The purpose of my journal is to identify empowering as well as disempowering patterns. For example: a pattern that identifies when we are likely to over-trade. Once I find the pattern, I like to visualize:

  1. The events that created the environment
  2. Visualize an alternative response for a number of days
  3. Check to see if the next real-time event results in new behaviour. If it does, no further action is necessary. If it doesn’t, re-do steps (1) and (2).

For empowering patterns, I seek to create the pattern each time I trade.

I like to create weekly, monthly and 3-monthly summaries of the various patterns. In this way. I find it is easier to spot recurring patterns.

Routine and Habits V: The Money Management Plan

The money management plan balances the risk of ruin with maximization of profitability. In other words, it seeks to give us the biggest bang for our investment dollar with the greatest measure of safety: the name of the game is to survive a series of consecutive losses.

The Money Management plan seeks to answer:

  • What risk shall I take on this trade?
  • Given my stop loss, and my risk assessment of the trade, what is the maximum size I can place? If you have different levels of size, then the questions are: What is the maximum normal size and what size shall I have for this trade?
  • If you trade more than one instrument,  what is the maximum portfolio risk?
  • What maximum loss will I incur before I take a rest from trading?
  • At what point do I make my profits available to my position sizing?

To answer the questions, you have two components to consider:

  1. A psychological component: the dollar amount we risk needs to be within our risk profile’s comfort level; otherwise the probability is we’ll not follow our trading plan. If your current level of risk is above your comfort zone, increase your size incrementally – slowly boil the frog technique. Raise the size so slowly that your increased size doesn’t cause your subconscious to send out distress signals.
  2. A technical component: the inputs to your money management algorithm. There is your trade results: your win/loss rate, your Avg$win/Avg$loss, your avg$win for longs, your avg$win for shorts, the mean and standard deviation of possible consecutive losses, your maximum drawdown, the means and standard deviation of possible consecutive wins, your high water mark, your maximum adverse excursion, your maximum favourable excursion. There is also the market volatility: I use ATR to measure volatility.

All these factors impact the amount of risk you take. If you want a ‘quick and dirty algorithm’, there is the Turtle formulation that considers only the volatility of the market and the amount you want to risk – however you decide that:

(% Capital to risk x Capital)/(S value of ATR) = # of contracts. For example, let’s say you have US$20k and you want to risk 2% and trade the ES. Let’s take a 45 day – the ES has an ATR of about 25. The $ value is 25 x 50 = $1250. So the number of contracts you can trade is:

(2% x 20,000) = 400/1250 = 0

That’s right, a US$20k is not enough to trade 1 contract in the ES. The formula can be applied to any timeframe.

Money Management is one of those subjects that can be as simple or as complicated as you want to make it. I recommend you start with the Turtle formulation and move on from there.

Routine and Habits IV (B): The Trading Plan

Today I am going to write about aspects of a discretionary plan. Discretionary plan are first and foremost a reflection of our beliefs about the nature and structure of markets. Someone who believes in the market efficiency theory will use a different plan to someone who believes they are chaotic.

I believe that markets are chaotic. Consequently, I believe:

  • Markets have a discernable structure
  • They rhyme rather than repeat i.e. there are patterns we can exploit but these patterns are repeated’ similarly rather than exactly’.
  • The market rhymes because the patterns are a reflection of the emotional tug-of-war between the buyer and the seller.
  • The context in which the patterns occur are critical to the plan.

A discretionary plan is also a reflection of our psychology including our appetite for risk; this refection is articulated in our trading philosophy. In Trader Vic–Methods of a Wall Street Master by Victor Sperandeo, I found a statement that mirrored my values:

  1. Preservation of Capital – this is the overriding principle
  2. Consistency of Returns – this goes hand-in-hand with (1)
  3. Superior Returns – only when (1) and (2) have been secured

My plan and results reflect the three characteristics; for example I use the Rule of 3 not because it increases my bottom line. Indeed, in a strongly trending market, the rule reduces my profits. I use the rule because it smooths my equity curve.

I believe a discretionary plan has certain critical elements:

  • A way of identifying the trend of a timeframe and when the trend changes or is likely to change. Once we identify that a trend is likely to continue, or that it is likely to change, we have our strategy. That strategy is rooted in the timeframe we are trading and includes the effects on our the trend by higher time frames.
  • Tools to identify price levels where a trade may take place (zones) . As my nature favours a responsive trade, I look to buy support in an uptrend and sell resistance in a downtrend. I very seldom buy/sell breakouts of my timeframe.
  • Chart patterns that indicate a zone has held (setups) and entry patterns that tell me ‘now is the time to take a trade’ (triggers). The setup and trigger define the price stop placement. In addition to the price stop, I look to define the qualitative conditions that will cause me to exit a trade.
  • Chart patterns that define the core profit target in the Rule of 3. This core profit target versus the stop defines the Risk:Reward expectancy: I need to see around 2:1 or better to take a trade.
  • The relationship between the price stop, my risk assessment of the trade, and money management plan govern my position size. I have three sizes: normal, 1/2 above normal and above normal (usually 1.5 or 2.0 times normal).
  • A set of rules (Rule of 3) that govern my subsequent trade management i.e. the management of the trade once it starts to move in my favour.

What tools do I use?

  • TREND: Barros Swings and the Ray Wave
  • ZONES: Statistics of waves, MIDAS (see www.tradingsuccess.com free section’ for Paul Levine’s lectures on this tool), and various ratios.
  • SETUPS: Negative Development and Contraction
  • TRIGGERS: Intra-day volume on Market Delta software
  • INITIAL QUALITATIVE EXIT STRATEGIES: Based on Market Profile and Wyckoff
  • INITIAL PRICE STOPS: Barros Swings and The Ray Wave

Once you have your tools, you need to create a plan. I have found that classifying the rules under ‘Buy & Sell’ and giving a setup and trigger a separate rule number, is the best way of creating a data base to assess the efficacy of the rule. I’ll discuss this farther in the blog on ‘Stats to Keep’.

A couple of final comments. I believe all traders should have a passing acquaintance with statistical and probability theory. This comes from someone who was mathematically a complete dunce until well into his mid-30s. “Salvation” was found in two books by Derek Rowntree:

  1. Statistics Without Tears
  2. Probability Without Tears

Finally if you see yourself as a serious trader (as against someone having a ‘flutter’ i.e. a gamble for pleasure), you owe to yourself to back test your setups and triggers. Generally because a discretionary trader relies so much on context, it is difficult for most back testing programs to test the trading rules. However, you can certainly test the setups and triggers. In back testing, you are looking for evidence of robustness and if you lack the skills to do it yourself (like me), then find someone who’ll do it for you.

Routines & Habits IV: The Trading Plan

Plans can be fundamentally and/or technically based and if the latter, mechanical and/or discretionary. The fundamental based plans that I know of are all discretionary approaches; I have never seen a mechanical, fundamental plan but that doesn’t mean they don’t exist.

The best place to start is to define my terms:

  • Fundamental plans are based on inputs such as supply and demand, value etc
  • Technical plans are based on technical analysis
  • Mechanical plans: rule based plans, no trades are taken outside the rules
  • Discretionary plans: rule based plans with a rule that says ‘entries and exits need not follow the rules’. In essence, this allows intuition to play a role.
  • Subjective plans: a trading style that is totally based on intuition. Most of the pit traders I have met and some of their replacements, the ‘on screen scalper’.

I am a monthly trend discretionary trader – that’s my niche. But in today’s post, I’ll be writing about mechanical plans. I stress that in this area, my knowledge is vicariously derived – from books, my students and my peers who have been kind enough to share.

Before I get into the discussion, there are two points I want to make.

  1. I subscribe to a view put forward by Mark Douglas: that whatever style best suits an individual, the optimum path is first start as a mechanical trader. The mechanical approach teaches us to trade what we see, not what we’d like to see.
  2. The style we ultimately adopt is the one that suits our personality. In his latest video, Stephen Pierce makes the point that to succeed in business we first must choose the environment that provides the greatest opportunity for success (http://www.dtalpha.com/talkback/?p=17). Part of the trader’s environment is his personality. As we’ll see later, it’s not only in the realm of trading plans that a trader needs to take his personality into account.

Points (1) and (2) may seem contradictory, but my experience as a mentor suggests otherwise. Traders that move straight into discretionary trading more will confuse ‘intuition’ with ‘into wishing’. It’s worthwhile remembering that intuition is borne from experience of lessons learnt from our successes and failures. So unless you have built up the experience base, your ‘intuition’ is likely to be flawed.

The best mechanical plans I have seen have the following characteristics:

  • They contain around three buy and three sell rules: entry, stop and profit taking.
  • They are based on some observation about the nature of the market rather than  being based on just ‘data-mining’ i.e. some computer generated relationship.
  • Sound testing of the system for robustness is a must.
  • If the system trades more than one instrument, the testing needs to incorporate testing on portfolio basis. The testing program recommended was ‘Trading Recipes’; this has been replaced by Mechanica Software (http://www.mechanicasoftware.com/).

The best books I have read on the subject are the two by Thomas Stridsman: “Trading Systems and Money Management” and Trading Systems that Work”. Thomas makes a point that I have incorporated into the testing of systems. The testing for robustness is found in the normalization of results and not just by the dollars made or lost. He argues that $100.00 made on the S&P is very different from $100.00 made in oats because of the different volatility between the two instruments. We can take this a step farther and argue that the same can be said about the same instrument in different times. For example in 1987 a drop of 100 points in the Dow was a cause for concern; today, it happens almost routinely.

To normalize results, Thomas suggests we use on a one-contract basis, the result divided by the price initiating the trade: we have a result in percentages rather than dollars. In this way, we compare apples with apples between different instruments and different times.

By their very nature, the best mechanical plans ignore the context in which a trade takes place. Consequently, as long as the environment remains stable i.e. the system is operating within the conditions that suit it, it will make money. Indeed, given human nature, and taken as a whole, I believe mechanical traders will make more money than discretionary traders in this environment.

But in an unstable environment or one in a transitional phase, the mechanical trader will fare worse than the discretionary trader.

In the next blog, I’ll commence the series on discretionary trading plans.

Routines and Habits: A Detour

I was going to write on trading plans, a subject that will probably take a couple of posts. But Ms A. Wang sent me a blog by Dr. Brett Steenbarger, Virtual Trading Groups: Getting to the Next Level, which contained a topic I thought more appropriate to end 2007.

In that blog, Brett writes that traders would benefit by interacting with their peers provided the group consisted of members “sufficiently experienced to offer value to others, ones sufficiently committed to putting time and effort into learning, and–perhaps most of all–ones sufficiently secure to maintain an open kimono and share all the successes, failures, lessons, and letdowns”

The question I’d ask is: who would join and are they the ones that would most benefit from such interaction?

My experience with groups is: those most willing to join the groups are the ones that need it least. Who would join? Usually the classes NLP practitioners call ‘unconsciously competent (the experts) and the consciously, unconsciously competent (the master teachers)’.

What class of traders would benefit most? Two classes:

  1. Those NLP practitioner’s call ‘consciously incompetent’ (those that know they don’t know and want to do something about it) and
  2. The ‘consciously competent’ (those that have yet to internalize the habits of success).

But yet it is precisely groups (1) and (2) that either fail to join or fail to persevere with the group.

At least that has been my experience.

There are major benefits from joining such a group – not the tips, you learn little from tips; it’s in the exponential growth of the learning curve that we most benefit. For the novice the benefits lie in:

  • The exposure to a probability mindset and the different ways that mindset finds its voice.
  • In the fact that there are many ways to make money;
  • In the fact that the successful traders will lose money in many trades; but
  • Most of all, the novice learns that success lies in keeping a gulf between the Avg$win and Avg$loss.

For the successful trader, the group forces him to challenge his assumptions and heuristics – a challenge that may go unheeded when trading alone. In a sense, the successful trader will benefit less than the novice but he will be the one more likely to join and stay.

In 2008, I’d like to see the idea of virtual trading groups take hold and proliferate. I’d like to see consigned to the rubbish bin (where it belongs), the idea that trading/investing is a profession that has a license to print money. In this part of the world, we have ad after ad telling us how to ‘turn $10k into $1M in 12 months for just 15 minutes a day!’ This unrealistic expectation is probably the most important reason for the dismal rate of success among newbies. Finally, I’d like to see the percentage of successful newbies rise from the current 10% to 20% to 40% and more.

When I started trading over 30 years ago, we did not have the assistance newbies have today -unless you were a local in the pits, you learned by trial and error. Now, it’s very different – today, we traders live in a privileged world where success is there for the taking – we only have to do whatever it takes to succeed. Our success lies entirely in our hands; let’s make 2008 the best year ever!

Happy New Year!

Routines and Habits III: The Disaster Plan

In these plans, I look to prepare for Murphy’s Law: “if there’s anything that can go wrong it will’ (BTW did you know there is a whole web site dedicated to Murphy’s Law? www.murphys-laws.com).

The important point here is to prepare for these contingencies before they happen.

Let’s take the most difficult problem first.

  • What happens if your internet connection goes down? Now that may be from a baby inconvenience from ‘my modem’ has stopped working to a granddaddy of a disaster where ‘your whole country’s ISP service goes down’. Don’t say that can’t happen – it happened to me when an undersea earthquake brought down all of Hong Kong’s connections. In my case, my contingency plans swung into action. I told a colleague of the problem and he placed interim stops and profit targets and the next day I was in Singapore where there was no problem.
  • In the same vein, let me ask you if your broker takes phone orders? If he does, what types of orders will he accept? IB, for example, will take only market orders.
  • This brings me to the next major problem: what happens if your broker’s platform goes down? Or worse still if his access to the exchange goes down. Allied to this is the problem of what will you do, if the exchange on which you are trading goes down (e.g. as a result of a terrorist attack)?

Think about this. It may be your account size does not warrant precautions, but then again it might.

The three ‘disasters’ above head my list because to a large extent, the ability to protect yourself depends on others: a friend, having other accounts, hedging on a different exchange etc. The next two on my list are more within our control to remedy but are no less stressful:

  1. Having the market gap against you, big-time! I am not talking about say a 2% gap on the ES but something extraordinary like Oct 1987. If you have a 10% gap against you, what will you do?
  2. The last one: you find you have an open position, an open position you were unaware of and it’s against you by 5%, 10% or more, what do you do in the circumstance?

My solution to both problems is to cut the position. This leaves me free to decide on my next course of action.

By the way, problem (2) did happen to me. I forgot to cancel a GTC stop order when I went on a holiday. Though I have someone who checks my positions daily, he, unfortunately, was having marital problems and failed to check the open positions during the break. I came home and found I was short the Hang Seng in raging bull market and down 10%. I cut the position and I was thankful I did: it finished lower the day I cut it and again the next day. But three days later, I’d have been down close to 13% and the loss would have increased the longer I held it.

The solution to major and minor disasters is preparation. Think them through and then rehearse them in your mind so that your responses are automatic. In the long run the preparation you put in may save your life.

Tomorrow I’ll start the posts on trading plans.