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Then Don't Trade

I've been reading a lot of blogs lately and the common theme I am hearing has to do with confusion. People are unsure of what is going on in the market, are we in for a deep correction, will the market continue to climb, is the recession over, etc. For many there seems to be more questions than answers.

Unfortunately, I've also noticed that many people continue to trade even though they have so much uncertainty about what is going on with the market and many are losing money as the result. Some even continue to hold on to long positions even though the market seems weak and prices are continuing to fall as the result. Now is the time when poor investors and traders alike are prone to get poleaxed. Smart and unemotional traders are doing three things right now:

1) Closing out of weak positions, regardless of their P&L. Based on technicals and/or fundamentals, some positions need to be liquidated if they are not working out as originally planned. I am not saying to jump ship too early but if your original thesis for entering the market is no longer valid based on current indications then only a fool would keep the position on. In other words, cut your losses short.

2) The brave and equally intelligent traders are taking small positions in strong names that have a high probability of taking off should this turn out to be a mild pull back from recent highs. However the wise are not building their positions at once. Instead, they are carefully scaling in to their positions little by little, as per their PLAN while remaining willing to quickly admit if they are wrong by selling said positions before taking any large losses.

3) Many traders are simply sitting on the sidelines until they get a better sense for what is going on.  There is nothing wrong with not doing anything when you are unsure of yourself and/or the market. Protect your capital and simply don't trade; just wait it out a while.

The following chart of the VIX will suggest that while fear and volatility are increasing, there is still more room for it to get worse before it gets better. Again, perhaps it is worth waiting it out a little bit before putting any money at risk

As for me and my day trading, I am trading cautiously by trading light. As an intra-day trader focusing on a 3 and 15 minute chart, I am not all that concerned with the big picture. I am aware of it of course but I am not overly concerned by it since it does not directly impact my trading time frame. However I am trading light and conservative in the event I enter a trade that goes hard against me. 

My longer-term portfolio is in cash at the moment other than a few option trades that I am taking that can turn a profit regardless of market direction.  I just need enough volatility in price to get through my break-even zone but I am willing to take that risk in this environment. Otherwise, I am not choosing a direction at the moment because I am personally unsure of what might happen. But this is just me.

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Understanding Price Action

Just like many traders I am sure, I have fallen into the trap of thinking/hoping that there is some indicator out there that can offer me an edge.  I do believe that indicators are very useful for trading but I don't believe the indicator itself is what offers an edge as much as it is your ability to read and understand price action, relative to that indicator.

Being able to read price takes a lot of patience and practice and I don't believe it can be replaced by some "guru" trading class or special indicator.  Sure, those things can help point you in the right direction but ultimately, successful trading is all about being able to read what price is doing so you can accurately forecast what price is likely to do next. Mastering this skill simply takes time and a lot of it.

Only recently have I started to understand what this really means as I've been able to get a sense for what price is going to do next, simply by watching what it is doing and has been doing on my charts.  Instead of waiting for my indicator to tell me exactly what to do, I've been more willing to pay closer attention to what price is telling me and then acting accordingly, regardless of what the indicator is saying. Now, I am not suggesting we throw our indicators out the window (however less is more in my opinion) but in my experience, relying more on price when making decisions is superior to relying on an indicator.

Understanding how to read price takes practice and lots of experience.  I still have a long way to go myself but lately I've really started to notice the benefits of all of the experience I've been accumulating over time. Most importantly, my bottom line is also starting to reflect this reality and this is the point in the first place.

Buying Dips & Shorting Bounces

At this point in my trading career, I believe one of the best things I have learned so far is the virtue of buying dips and shorting bounces. This obviously is not the only way to trade but it certainly is very effective once you learn how to do it properly.

I think many traders, especially new traders fall in to the temptation of buying on new highs or shorting on new lows after a lot of momentum has already been pushing price to those points. This is different from break-out trading, which I also think is very effective. But with breakout trading, you are buying at a point where momentum and volume are just starting to take off once price has pushed through a meaningful support or resistance area. But entering the market after price has already asserted iteself in a particular direction is not the best strategy.

I think a great example for this was this past Thursday and Friday when the DOW was passing through 10,000. There was already a lot of momentum and volume in the market, and a lot of emotion and I am sure many people, again, especially novice traders were jumping on board when the pros had been entering in the weeks before while price was dipping again. Friday as we know, was a down day, so some people instantly lost money by getting into the market too late. Perhaps there is still some more gusto left in the short-term but from a probability standpoint, I believe the odds are higher that we will see a temporary pull back before another push higher by any meaningful amount.

This said, waiting for those dips in this current run up is a better strategy for entry. This takes some patience and fortitude but can certainly pay off in the long run.

I see this time and time again in my own trading where I almost excllusively focus on buying on the short-term pull backs away from the prevailing trend. Or as they say, buying the dips and selling the rips. I find it much more profitable to be trying to exit a trade when the masses are placing their market orders to enter. And it is much easier to get in to a trade when fear is high and people are willing to take anything just to get out of a trade.

Just like any strategy however, there is always a risk for loss so that is why proper money management strategies come in to play and this where I am currently focusing most of my efforts. I feel like once I master my money management and risk control, I will be in a position to make big and consistent gains. I can feel it getting closer and I am excited but not impatient.

It will be interesting to see what the market decides to do in the next few weeks but hopefully, it will present some great opportunities to enter on some nice dips that will take our profits even higher.

Testing Different Time Frames

Patience is not currently one of my strengths although I am getting much better at it. When it comes to trading, I believe you've got to have a lot of patience and discipline to remain consistently profitable, if profitable at all.

For the last few months I've been back testing and practicing my strategy on longer time frames to see how it performs in comparison to the three minute chart, which I've always traded. What I've noticed is that on a gross basis, my strategy tends to perform very similar on a 3 minute and 15 minute time frame.  However the 15 minute chart is much more profitable on a net basis because it is not taking nearly as many trades and it is also holding longer so the average profit per trade is much bigger, even compared to the average losses.

The challenge for me however is that a longer time frame requires much more patience and this is something I have to get used to. In general, the longer the time frame, the better my strategy performs so over time it looks like it will pay if I can learn more and more patience with my trading so I can maximize my profits.  This will take some time but the numbers are convincing so I am willing to work on it.

Today required a lot of patience.  I only placed two trades using the 15 minute chart but my strategy performed almost as good as 14 trades did on the 3 minute chart (I didn't take any of the 3 minute trades). However, forcing myself to wait by sticking to one time frame (as per my plan at the beginning of the day) was a good exercise for me and I believe more days like today will not only help me become a more patient trader but also a much more profitable one in the long-term. 

The point is, patience is good as long as you actually execute at some point.  Just like most things, it takes practice to develop. Secondly, if you haven't already, take a look at some other time frames and see how your strategy performs. The results have really surprised me so perhaps they will you too.

Cheers!

Calculating Your Per Trade ROI

The other day I came across an "educator" specializing in e-mini strategies and they told me (as is also stated in their marketing claims) that their students get a 10% return on their money trading the e-mini S&P's for every one point in profit. My first thought was, "you do? Wow, that must be some system." My second thought was, "you are retarded".

In reality I just sat there and smiled whilst they carried on about how fantastic their returns are but it got me thinking.

His math works like this: His broker gives him $500 day trading margins.  Every point on the ES is worth $50. Therefore, $50/$500 is 10%.  It looks even better for those of us trading the Russell (TF) since one point is $100 or 20% with $500 day trading margins.

I suppose there is some logic to this calculation but I still think it is flawed.

First, not all brokers will give you $500 day trading margins therefore, this 10% ROI trading the ES is not universally applied.  For example, TradeStation gives me $1375 day trading margins so my ROI is only 4% trading the ES - no wonder it feels like I'm hardly making any money!!

Second, to take advantage of the $500 margins you actually have to open an account with lets say, $2,000 (TS requires $5K, making my life even harder).  Therefore, you really have $2000 at work when trading that one contract. As an aside, I realize that you can still trade if your account drops below $2K after you open the account and I also realize you can theoretically hold four contracts with your comfortable $2K account balance but if you do that, I wholeheartedly stand by my second claim regarding retardation.  

Third, and following up from my second point, in reality, when smart traders are trading, they are not controlling as many contracts as their account will allow. To do this is suicidal. But unless you are doing this, then once again, these per trade ROI figures are bogus. 

Normally, when one calculates their ROI they do it on a per trade basis and then based on the overall account. Unfortunately however, I don't think there really is an easy answer for a per trade ROI when trading futures. Though it works differently with stocks, options and EFTs.

For example, today I closed out of an options trade I put on a few weeks ago. It looked like this:

Bought 1 Dec. 95 call (DIA: DAVLQ.X) for $3.57 per contract.  The actual debit from my account was $357 (plus commissions). Today I sold said contract for $6.25 and the actual credit to my account was $268 (again, less commissions).  Therefore my (gross) per trade ROI was 75%. If I add that $268 gain to my overall account balance, the ROI is much less, it's actually rather nominal.

At a minimum, futures traders should calculate their ROI based on the overall account balance but once again, I think it is very difficult to do it on a per trade basis and I don't think the method that spits out a 10% return as described above is the right way to do it. Furthermore, doing it this way to market your education business is flat out wrong, in my humble opinion. 

If I feel compelled to calculate my per trade ROI, which I currently don't, this is probably how I would go about it:

Per my rules, if I decide that I will control one contract for every $5K (choose your own number) of account equity, and I happen to have on 3 contracts during a particular trade, I actually used $15K of account equity to control that trade and therefore, my profit (or loss) on the trade would be divided by $15K to calculate the per trade ROI.  I know that doesn't sell very well in the education business, which is filled with hype and an abundance of bullshit but in my opinion, this is an appropriate way to think about it. 

If there are any other opinions on the matter, I would be interested to hear them.  In the meantime, congratulations to the DOW for crossing 10,000!!

I Miss My Blog

I am supposed to be in bed right now.  Before that, I was supposed to work out so I wouldn't get fat. Before that I was supposed to go over my trades so I could be a super trader and give quotes about my awesomeness to the Wall Street Journal and Stocks & Commodities Magazine.  Before that I was supposed to actually trade.  Before that, I can't really remember but I am sure there was something.

The point is, I miss my blog.

I keep saying I am going to get back to it but I obviously continue to wallow in the mire, as it were.  However I have noticed something, at certain times, blogging is a drag and it gets kind of old.  At other times, blogging is a fantastic motivational tool and it absolutely has had a positive impact on my trading. So...I need to stop spending so much time trying to figure out why my fantasy football team sucks so bad this year and instead come up with something meaningful to blog about; like how cool I am.

In other news, my wife and I had a baby this past weekend. Actually, she had the baby but I cut the chord whilst shooting footage and snapping pictures - I am multi-faceted like that. And don't worry, it is kid friendly footage that can be passed down for generations. 

We had a baby girl and I can now officially declare we are done!! The vasectomy will be scheduled soon since my massive deductible has now been met. So I have a good excuse for not trading the last couple of days; I've been changing diapers while wondering what the hell I've done...again...but she's too cute to complain.

Life is good but I still miss my blog.

I am going to bed now.