Attributes that will make me a better trader. To always be prepared and be patient and thoughtful in review. Ability to operate in all conditions according to a plan. Acknowledge my emotions and not let them lead my decision making. An overarching belief in one s ability and the market. I understand the reality is I need to survive the learning curve to get an understanding of what works for me and how to approach the market. Along the way I will make mistakes which are inevitable. I will learn from those mistakes and move on. Nothing splendid has ever been achieved except by those who dared to believe that something inside them was superior to circumstance. My Trading Business Plan Fixed cost Items. Total Ongoing Cost Total Time Skills
R = Risk R = Return Risk management of my Trading account. My capital is $ My position size is $ as a % of my account is % R = Risk R = Return R $risk can be equated to R $return The stop is R ( risk ) = % of account = Return as R Trade Risk $ % of account Return Actual R Return $ $ $ $ $ $ $ $ $ $ $ $ *Volatility as risk can be calculated by using Average true range of 2 days. Example: ATR of 2 days is 26 cents Stock price is $5.60 Volatility risk is.26 / 5.60 =.046 X 100 = 4.6% The Plan. 1. 2. 3. Risk Reward 4. Stop Value Expectancy is
Prediction is not a trading plan. Finding a rule based system. There are many methods out there that attempt to predict the markets next move. There are many esoteric methods including Elliott Wave and Gann Analysis. However, it is important to understand that trying to predict the market is almost impossible and leads to an underlying bias. Such biases takes you off what really matters- price action. Many traders have come to realise that prediction is nigh on impossible. We have become increasingly prone to shocks and surprising events which have a major impact on the markets. With increasing government intervention and volatility in the markets, how can one possibly predict or forecast with any kind of certainty in this environment? Instead try to identify key risk/reward areas and heed the underlying price action at such junctures. The best traders are able to follow what the market does and react. Finding a rule based system. The pathway to finding a method can be as hard as you make it. There are many trials and experiments along the way. The temptation is to look for a particular indicator or a set of optimised moving averages and back test these over past data. The problem with this is that the market is constantly changing! This is also classic curve fitting. No doubt many indicators do work at certain times. However, novice traders often pile many of these indicators onto their screens. What this does is complicate the picture and hinder decision making. Traders become so caught up with the different messages that they forget the most important thing what price is actually doing. Trend following indicators work in trending markets. Range bound indicators work in choppy markets. However, the problem is that every trend eventually fades into a trading range, and periods of consolidation or choppiness are the prelude to strong breakouts and trends. It is extremely difficult to know in advance when the market environment is going to change from one condition to another. Thus, having all these indicators leads to confusing signals that impede effective decision making. Most novice traders will run a few scans pre market, turn on their screens and then shut it all down come the market close. They are not spending enough time preparing for the day ahead. They are not spending enough time critically reviewing their trading- both what worked for them and what didn t work for them. Like any professional endeavour, it takes time to build knowledge and the required skills. Yet many traders do not put in the hard yards to get to this level of expertise. Solution KISS keep it simple!
Setting up rule based trading systems. - Do not leave trading to chance. - As with any business, the operator of the business needs a business plan. - This plan should cover all contingencies of operating the business. - Within the plan are the rules of the business, these rules are how the business is conducted on a day to day basis. - The rules of a business plan when adhered to can give a measurable outcome. - If a business does not have rules than the outcome cannot be monitored or measured and is effectively left to chance. - With any business, projected sales and bottom line figures should always be monitored and acted on when challenged. - And so it is with trading, the business of trading requires a plan with rules and a projected outcome. - In putting the plan together the trader must consider the market/s they want to participate in and the time zones that apply to these markets. - What the starting capital will be, if margin is being used there is an interest component to be added in to the day to day running costs of conducting the business. - Many investors choose to trade within a company structure or a superannuation fund, these entity s are subject to accounting and auditing costs weather they make a profit or not. - When trading, there are data fees and subscription fees that need to be factored into the operating costs of this business. - Before any business activity takes place.
How to put a rule based trading system together. - Rule based trading system are the business end of the trading business. - Trading systems can be built on many different ways. - They can have a fundamental influence combined with a Technical entry. - There can be just a purely Technical entry and exit method, these types of Rule based systems can have an infinite number of variables. - And it for this reason a Rule based trading system needs to be back checked over at least 500 bars of trading data of the time frame you are working with. - Rule based trading systems can be built to just focus on one instrument or multiple instruments, but must be back checked to verify results rather than leave to chance. - Any rule based trading system must incorporate position size, as volatility can invoke margin calls and stop outs while the instrument is behaving in a normal market manner. In summary Rule based trading systems are designed in stages. Fundamental trading systems will rely on company reports and the financial health of a company, this type of rule based system will require the trader / investor has some understanding of company accounting practices and reporting procedures. Various metrics can be used starting with the Price to earnings ratio, PE. Earnings per share EPS is also a very telling metric for company health. This type of Rule based trading system can be back checked over many years of data to ensure the company being analysed has been growing and using the shareholder funds to the benefit of the shareholders. A rule based trading system called a trading plan would look like this. The basic rules would be, a company with a PE ratio between X% and X% with an EPS above X%, this is based on the trader / investors determination for each company. My stop loss will be, 1. A change in company metrics. 2. A negative announcement.
Technical systems are based on pure price action, or a combination of price action and an indicator. This is where the basic understanding of tools being used is required. For an example of this, many traders use the Stochastic Indicator in an underlying trend. However the real use as designed by George C Lane was for its use when price is range trading between support and resistance levels to quickly identify the turning point. So in defining a Technical Rule based trading system, the trader must do some real work on what is appropriate for the desired trading plan. This type of rule based system will require some basic starting guidelines, for example. Decide what type of market this system will be based on including the amount of actual time that will be allocated to implementing the rule based trading system in the selected market. Select the time frame, eg daily, hourly or longer time frames like weekly for the implementation of the trading system. Select the technical method of price or a combination of price and using an indicator. A rule based trading system called a trading plan would look like this. The amount of money in my account. $100,000 The type of market I will trade. The amount of time required. Australian Equities 2 Hours per day My trading rules are: 1. Allocate 2% of my trading account. 2. open a position when price is higher than the high of 4 days ago. 3. open a position in the direction of the longer primary trend. 4. Stop loss when price closes below the previous day s low price. 5. Enter the trade into my journal.
Let's take a look at some very simple rule based systems. RULE BASED SYTEM 1. With Indicators. Time frame = Daily Time required 1 hour at market open, 1 hour at market close. Rule 1. Buying in the top 25% of the daily range when above a 50 day and 20 day Moving average. End of the trading time frame type of trading. Rule 2. Stop loss is taken when Market trades below the pivot point low. This can be adjusted to avoid being stopped to early.
RULE BASED SYTEM 2. With Indicators. Buy and hold when Indicators remain positive. Time frame = Daily Time required 1 hour at market open, 1 hour at market close. Rule 1. Buy and hold when the Relative strength Indicator (14) is above 50. Confirmed by the Commodities channel Indicator CCI ( 20 ) is above 0 Rule 2. Stop when RSI or CCI crosses below the signal line. Two very simple trading systems based on 2 rules. Rule based trading systems can be as simple as the two systems shown or can be as complicated as the trader care to make them. Keep in mind it is only the price moving in the anticipated direction that will make a profitable trade. Complicated systems can keep the trader engaged while still losing money.
RULE BASED SYSTEM 3. Price based Rules. Time frame = Weekly chart and Daily Time required 1 hour at market open, 1 hour at market close. A price based rule system can be developed on the observation of chart signals in the shape of the candle or the OHLC bar. A pivot point trading system is ideal when used with a setup in the price movement. This method can look for the day of balance in price movement, described in a candle chart as the Doji candle where the price of the open is the same as the closing price for the session. Rule 1. Wait for the Doji to be displayed in the price chart, then take a position when the price closes above the high price of the Doji in following price action.. Stops for this type of price movement should also be set from the following price action. The first stop is set off the low of the signal Doji. The stop is then moved up under the low of each trading period until stopped out. The important message is any Rule based trading system should be simple to understand and operate If we all went about our business without rules there would be chaos and extreme risk for our financial wellbeing. Understanding that risk is a part of the business of trading and controlling that risk is good business planning. It's not having to know when you are right or wrong but how you manage the outcome will determine your success.
A short lesson on trend. - Trend following will provide the highest probable outcome for trading by looking at the trend of the individual stock. - Traders should look for established trends and trade in that direction. - Trends happen in all time frames, from 1 minute to monthly timeframes. - Trend following systems are based on the PRIMARY TREND. - The primary trend is found on a WEEKLY chart and is identified by observing the high points and low points. - This may take many months to unfold. - The old adage of higher high and higher low holds true for an UP trend, and lower highs and lower lows apply for a down trend, this method should be used by every trader, even short term traders By following the Primary trend, higher probability trades will occur in other lower time frames. A Rising market. During the primary phase of the rising market new highs are made and higher lows are made with buyers not wanting to wait for lower prices. A rising trend can be Identified by way of Higher highs and higher lows.(troughs) Remembering this applies to both Primary and secondary markets. Higher peak 1 st peak The start of an Uptrend is Identified when the price makes a new high AFTER making a higher low. Higher low Low
Falling Markets During the Primary phase of the falling market new lows are made and Lower highs are made. A falling trend can be identified by way of Lower highs and lower Lows. ( troughs ) The start of the down trend is High Identified when the price makes a lower HIGH followed by a lower LOW. Lower High Lower Low Lower High
Conclusion Trading can be as hard or easy as you make it. The reality is that traders just need to survive the learning curve to get an understanding of what works for them and how to approach the market. Along the way you will make mistakes which is inevitable. You will also be wrong. It is rather sobering BUT this is all part of the learning curve. The successful and improved traders prove that you can be successful in the market if you just learn from your mistakes. I hope this article has identified some common traps and makes you better prepared in your own journey. Use your mistakes in your own self advancement to trading success. g.burton@fpmarkets.com.au Ph 02 82526816