Today we will be dealing with the discretionary, rule-based trading plan (DRB)

The best DRBs are those that based on a view of how the markets work. Examples of these theories are, for example, the Elliott Wave, Gann method, etc.

Now, speaking for myself, I have found that Wyckoff and the Market Profile (Market Auction Theory) provide the best explanation of price action.

And aside here…………..

when I say Market Profile, I mean that theories upon which Market Profile is based. For example, the Profile principle that “the function of markets is to facilitate trade”.

This principle is like Wyckoff’s “The Law of Supply and Demand”. I mention this because many newbies confuse the Market Profile visual graphic with its principles.

Some traders call these principles Market Auction Theory.

So, why we need an underlying theory?

An underlying theory is important because…..at times it will explain why markets are behaving in a certain manner. For example:

• After QE, US stock market indices did not respond to the volume analysis so favoured by Wyckoff and Steidlmayer.
• Understanding the underlying principles, we discerned that QE had placed a floor under the stock market.
• As a result, we knew that the low risk, high probability, trades were longs in the ES or other stock indices.

A theory explaining market action is then the first rule for a DRB. Next, I want to consider the various elements that comprise a robust DRB.

Firstly, the DRB needs to determine our strategy (i.e. determine if we are to initiate long or short positions). We start by asking two questions:

1. What is the trend of the trader’s timeframe? And,
2. Is the likely to continue or end?

Notice that we first have to determine the trader’s timeframe. In other words, we have to define the timeframe we are trading. ‘Definition’ can be done in any number of ways, for example using percentage swing charts. I prefer to use Barros Swings: these are swing charts that use both time and price as a variable. Their goal is to define the calendrical trend – we define trends as yearly, quarterly, monthly, etc.

More tomorrow