University Forex Futures Trading
Forex & Futures
Traders Education Article of
Financial Trading Articles & Tidbits - written by market expert Joe Ross.
1. Measuring Market Opinion and Sentiment
Hi Joe! What about Market Sentiment reports? Sometimes they seem to agree and sometimes disagree. What is your opinion on these market reports?
Although these reports sound scientific, nothing about the trading markets can be measured with scientific precision. Commodity futures & forex market measuring devices are simply not too accurate. There is no practical purpose for measuring a market precisely and most market measurement is at best only a rough estimate. When we measure futures markets, we are basically also measuring human behavior, and human behavior is not easily measured.
When it comes to forecasting financial market conditions or market sentiment it makes no sense to strive for extreme accuracy. Commodities futures and forex market prices are based on human opinion.
When measuring human behavior in the marketplace, the statistical error is substantial, generally running with results of plus or minus 5%. An estimate of trader or investor opinion is merely a guess because not everyone has the exact same opinion, and because it is difficult to accurately measure an opinion. The variation found in these two factors is reflected in the statistical “standard error.” The best a commodities market sentiment report can offer is a statement of probability based on a few important assumptions. Let’s face it a sentiment report assumes that the universe being measured is actually real. Another assumption is that the measurement of the opinion is reliable.
I have seen this phenomenon in action. When I owned a farm and mingled with other farmers at various meetings, it was obvious that the farmers never told the county agent their true planting intentions. Yet, the department of agriculture issues a report on “Planting Intentions.” Farmers intending to plant soybeans would tell the agent they were going to plant corn (and maybe also trade their corn trading system. Farmers intending to plant corn would tell the agent they were going to plant wheat.
The assumption that the universe was real was often met because the agent did indeed poll farmers. The second assumption that the opinion was reliable was hardly real because for various reasons some farmers may have lied to the agricultural agent. It's difficult to measure a market opinion. And just because an opinion or intent is stated, doesn’t mean the person giving it will act on what they say.
These issues have a direct bearing on forex, futures, stock market and commodity trading. As forex traders, unless we are trading (with 100% technical or forex chart analysis), we are also trying to assess current opinion, and anticipate what forex prices will do based be it up, down or sideways, based on that market direction opinion. Forex market price action is a reflection of what humans do and what they see and think others are doing, and many traders base their decisions on the potential reaction of other traders. So at the heart of trading is the idea that market opinion is measured accurately by the current commodity or stock price.
It's believed by forex market experts everything known about a market, which can affect global forex prices, is already mostly built-into the forex or futures price, and anything not known is not reflected in the action of the futures price. It is also accurate to say that on seeing the current forex price or latest market conditions, forex traders react in certain predictable ways. For the most part, when forex prices decline, forex traders tend to become fearful and sell their positions to protect their remaining capital, and buy again when they see prices rise so as to satisfy their greed. Of course, the opposite is true of Forex traders who tend to be short sellers. But fear of rising prices by short sellers and fear of falling prices by those who prefer to be long is hardly the main fear ingredient in the marketplace. The greater fear seems to be that of missing a move. That fear is directly tied to greed.
A major principle of all market theory is that Forex traders and investors react to certain market conditions in a consistent and predictable fashion. Famous old trader W. D. Gann visualized these reactions in the form of geometrical angles, shapes and patterns. Elliott saw them as waves (now known as Elliott Waves), and Charles Dow saw them as an interrelationship among the industrial, transportation, and utility sectors of the markets. However, there is good reason to doubt if market prices truly reflect the opinions of those who participate. There is also doubt as to whether or not market participants react to market situations consistently.
It seems like human behavior is too difficult to measure and people (including traders) do not consistently act on their opinions, attitudes, and beliefs. It has proven to be very difficult to measure human behavior, and people do not respond with regularity to situations, even identical situations.
When we assume that futures markets traders will react consistently to particular forex market conditions and thereby form the forex chart price patterns outlined in classical trader technical analysis texts, we are placing the trade horse before the cart. We are then assuming that humans will always act the same way to certain situations and conditions. However the truth is that forex trader do not act consistently. Rather they react consistently. Forex chart patterns are a reflection of all that is known in the forex marketplace. What we see when we trade from chart patterns is the way forex-traders and investors react to market conditions.
Our estimates of what futures traders and investors will do are merely best guesses, and potentially inaccurate ones. Market sentiment attempts to estimate how FX traders will act. That is where to a certain extent it loses its value. It is much more accurate to estimate how people will react to what happens in the Forex Market. So when you are trying to anticipate what forex-market traders will do, keep in mind that trader reactions are not necessarily seen with the precision of geometrical shapes, elliott wave counts, market sector relationships, or a market sentiment index. There is no such thing as trade certainty. When I meet the person who can tell me with complete accuracy and consistency where the next tick or pip will be, I will surely have found the Holy Grail of Forex Trading and forex day trading!
2. Getting in Step with the Forex & Futures Market
Early in the forex trading day, as part of your daily trader preparation (you do have a daily preparation, don’t you?) it's helpful to practice a little to get a "feel" for what you might do and how you might trade forex today. One way to do it is to make a few small trades, using just a small percentage of your normal trading size and your forex brokers account equity. Putting on a small trade position helps you focus.
Once you have entered the market, see how the commodity or forex trade is working out. If you use technical indicators look to see if they are in agreement with your prediction of the futures, stock or forex price action.
If you anticipated a good forex or commodities trade setup from the technical analysis indicator, did that actually happen? Was it good enough so you would trust it again? Forex traders who attempt to “trade in the zone,” try to get the feel of the price action. They want to be in step with the ups and downs of FX price movement.
Some days you just may not be as good as you are on other days. When you are not in tune with the fx market, it should be a signal to you that “this” isn’t your day. If it isn’t, don’t trade. Every trader will have trading slumps, periods when trades just don’t seem to work out. During trader slumps, it simply does not make much sense to keep trying. You are not fit to trade, so don’t. You will not be trading at your best.
Professional commodity futures and FX traders suggest standing aside when you or your trades are not having a good trading day. Ultimately, it’s a good idea to take a break from trading, to try again later. The break may be hours or days. When I’m in a slump, I take off an entire week. I don’t begin trading again until I see trades and markets going my way.
3. Don’t Deny Reality
If you want to be a successful forex or futures trader, you must make sure you do not deny reality in any phase of your trading. You cannot deny losses, price direction, mistakes you make, being undercapitalized, or a whole host of things you would rather not think about.
Many traders think the best way to deal with unpleasant ideas, events, or personal character flaws is to shut their eyes and pretend they don’t exist.
Let’s face it, FX and commodity trading can be difficult, at times very difficult and it's essential that you focus on reality. Denial takes your focus away from the very thing you need to be concentrating on—the action of prices—regardless of time frame. Your mind must be clear so that you can look at the market and see what is really there.
The way I learned to handle denial was to simply write down and confront all possible ideas I had trouble accepting. Some thoughts I could fix and others I just had to accept. But facing the truth of what and who you are is the only way to deal with denial. You have to realize that for the most part the only things you can change are in yourself. Other things you just have to accept. You have to accept the reality of slippage, for example. You have to realize that indicators often give false signals and that there is no magic moving average nor is there a magical oscillator.
You have to realize that some winning trades are just lucky trades and had nothing to do with your skill as a trader. By the same token, you will also experience the bad luck of having prices make a sudden and unexpected move against you.
Rather than wasting your time in denial, concentrate your mental energies on improving yourself and improving your trading skills. Work at improving your abilities to observe. Realize that you have to survive the markets in order to benefit from the experience of the markets.
There is really only one true problem with your trading—that problem is you! However, the problem manifests in two ways: 1. Market conditions have changed and you haven’t. 2. You are no longer doing what you did when you were winning. You have drifted. You are not consistent.
The first aspect of the problem is due to poor observation. The market has changed and you haven’t changed with it. Poor observation stems from a variety of lesser but very important problems. You have married a market, or a forex trade. You may have allowed your ego to get the best of you and you are no longer humble. I’ve named just a couple here. I challenge you to think about the many things that can distract you from seeing when market conditions have changed. Make a list of those things and confront them.
The second aspect of the problem stems from trader inconsistency. Here again, you should make a list of those things that cause you to be inconsistent.
"Perhaps I was a good trader at one time, but the market conditions have changed and I may not be able to keep my reputation up." This is an issue that all traders face at some point: keeping up their reputation. When one makes big profits trading, it's tempting to tell neighbors and friends how well you are doing. It's great when you're making the big profits, but keeping up appearances is often the downfall of even the most astute trader. Again, denying your need for fame and glory, or pretending that you can maintain an unrealistic reputation, will use up your psychological energy and interfere with your ability to concentrate. Huge profits tend to go to the humble, so try not to build up your reputation. Admit that you will have difficulty keeping up appearances and just quit doing it.
One fact that a trader wrestles with continuously is the notion, "Trading is not a legitimate job." Many traders struggle with the legitimacy of trading. Some traders find that they can simply remind themselves, "Trading provides liquidity and helps control prices." Other traders, however, think this isn't good enough and need to find more meaning in their daily trading activities. For example, they may focus on how trading helps them provide for their family, or may plan to donate some of their profits to charities they view as personally
valuable. The point is, don't deny the possible truth to such ideas. You will be better off acknowledging and working thru them, and then just moving on. Denying they exist, on the other hand, will use up both time and energy.
Unacceptable beliefs tend to lie in the back of your mind. They remain there, lurking, and when you are vulnerable, they can powerfully influence your outlook. So acknowledge unacceptable ideas, and once you admit the possible validity of such ideas, you will neutralize their potential influence. This will free up limited psychological resources, allowing you to focus all your energy on trading profitably and consistently well.
4. Trading losses
Hey Joe! Losses are a major problem for me. I know I’m supposed to “learn to love them.” How do you deal with these discouraging events?
After a series of highly successful trades, a trader should not become discouraged by normal successive losses and brokerage account equity drawdown, but learn to expect them. Notice I didn’t say, “learn to love them!”
Alright let’s say you just took a sizable hit and equity drawdown in the forex market. You feel guilty and angry. You wish it didn't happen. You would like it to go away. You tell yourself, “This is part of the price you pay to become a profitable and successful trader.”
Is this right thinking? Is this trading is all about? Do you really need to go into a trade expecting to lose?
Don’t you believe it! Though you see such statements set forth as truth, believing them is not going to help you to become a successful trader.
If you think to yourself, I just lost a lot of money and dwell on that thought you will soon be in trouble. If you think, “I can't just write it off,” then train yourself to think of it as a minor setback and move on. I know that’s difficult, but that's what you have to do.
As a forex market trader, you have to think of the long term. You have to believe that if you work smart enough, and make the good fx trades under the right market conditions, you'll come out ahead. However, there is no way that that kind of thinking comes easy. It takes an enormous amount of discipline and self-control to handle trading losses in a positive way. Why? Because losses hurt—they hurt no matter how long you’ve been trading.
If you have trouble taking a loss, you are not alone. All traders suffer losses. As a trader, the losses you take may be a fact of life, but that doesn't make them easy to handle, and you certainly don’t have to learn to love them.
As a trader you should control the amount of losses by keeping them small, and ride through the draw-down until another sequence of winning trades begins. Nevertheless, you may find yourself feeling guilty over taking a loss. Why do we have this feeling of guilt about losses? A part of that guilt feeling stems from a strong human urge to protect oneself. So when you lose money, even as a professional and active trader, it hurts when you think of the things for which you could have used the money you lost. You were probably taught to think that way.
The social and cultural values of protecting yourself were programmed into you at an early age. When you lose money on a trade, you feel guilty and maybe even a little panicky. It's quite natural and understandable, but who says that traders are natural or even that they act in an understandable way? As an active professional trader, you have to change your thinking about losses. You have to resist your natural inclinations and learn that losses are a part of every business. Retail stores take losses from breakage, shoplifting and employee theft. Insurance companies take losses from false claims. Tobacco companies are sued. Chemical companies make bad batches and have to throw them away. Farmers lose crops. Ranchers lose livestock. I cannot think of a business that does not experience losses.
So what do you do about the way you were programmed from childhood? You must confront your feelings and deal with them. Recognize that you are experiencing guilt. Understand why you are having those feelings. For each of us the underlying reason may differ in kind and intensity. It helps to admit the fact that there may be adverse consequences of taking risk with your hard earned money, and keep in mind that feelings of guilt associated with the loss of money that you cannot afford to lose is even worse. No one has any business trading with money they cannot afford to lose.
When trading with money which has been specifically set aside for trading, and you and your family (if you have one) all agree that this is money you can dispense with in the event of a loss it takes away a lot of the pressure of losing. Actively avoiding losses through intelligent risk management also helps to relieve stress and to lower the probability of a catastrophic loss. When you know that you've done everything you can to minimize risk and you feel certain that you can survive a major hit on your account scenario, you'll be able to more easily handle losses. Effective risk, money, and trade management go a long way towards building your confidence and relieving the stress from trade losses.
Once you have taken care of risk, money, and trade management issues, you must also ensure that you have sufficient trading capital. One of the most certain ways to end up a failure in the forex markets or other futures markets is to go into them under-capitalized. The largest percentage of business failures of all kinds are from under capitalization. The U.S. Small Business Association states that only 1 in 1,500 small businesses startups is successful at the end of 5-years. The majority of those business failures come from businesses that are undercapitalized.
It's not different for the business of forex and other futures trading. You have as much chance of succeeding in the trading business starting out with a small $5,000 account as you do of winning the State Lottery.” Regardless of what level you start out with you must cut trading losses immediately. The faster your trading takes a loss, the higher the probability you will eventually be profitable. By learning to take losses quickly you will succeed sooner.
Trading losses are a business expense. In one sense, trading losses are part of the cost of doing business. In another sense, the cost of losses is part of what you pay to learn the business of commodity futures trading.
Losses are a fact of life in a traders life. Losses are not easily accepted. But you certainly don’t have to learn to love them.
5. Trading Panics
Hey Joe! With all the talk of a possible panic, do you believe the government will intervene to ameliorate a crash?
When a trading panic is gripping the market, ask yourself what the government will do to restore sanity and protect its best financial interests. During stock markets panics, the Federal Reserve injects instant liquidity by repurchasing government securities, and lower interest rates. In October 1987, T-Bond futures rallied $10,000 per contract, when the Dow crashed 508 points in one day, which was considered a gigantic market crash based on the low DJIA during that time period. There were times when no NYSE stock was traded, because there were no buyers. It took one trader 4-days to get through to Charles Schwab to confirm a trade. The phone was on automatic redial from 7 AM to 7 PM, during that 4-day period. It took 14 days to confirm the trade!
It is my firm belief based on evidence in my possession that the government really does have a Plunge Protection Team, an offshore entity that enters the stock market at times when prices are falling too fast. This entity buys whatever, wherever, and whenever needed to keep the stock market from an outright crash.
When grain prices rise sharply due to flood damage news, is it in the best interests of the government to allow further price rises?
Consider the inflationary effect of the heavily grain weighted CRB Index. When grain prices increase due to growing problems, farmers feel resentment against Chicago traders, who may profit from farmers' misfortune. The government may issue false reports to drive grain prices lower. The 1993 floods affected 70% of the corn and 50% of the soybean producing states, yet yields were higher than 1991 production levels except for three states. How could this be? Were government figures altered to hold inflation down? You bet they were. Watch for late 1993-type bullish government grain market releases to propel grain markets substantially higher when conditions of flood or drought appear.
6. Hey Joe! I want to learn how to trade, but I’m having a conflict. Is trading futures gambling?
Trading futures is gambling only when you trade them without full knowledge of what you are doing. There is a good measure of self-knowledge required to choose the proper course to follow if you want to become a trader. It has even been postulated that many small traders in the commodity markets, without knowing it, secretly want to lose. They jump in with high hopes—but feeling vaguely guilty. Guilty over 'gambling' with the family's money, guilty over trying to get 'something for nothing,' or guilty over plunging in without really having done much research or analysis. Then they punish themselves, for these or other sins, by selling out, demoralized, at a loss.
A trader is gambling when he/she trades from ignorance. The gambler makes his trading decisions on gut feelings, hopes, dreams of getting rich quick, tips from the broker, “inside information” from friends, and from the improper understanding and use of indicators, oscillators, moving averages, and mechanical trading systems. In general, he is looking for a way to shortcut having to truly learn what is going on. Unfortunately, most new traders who attempt to trade futures fall into this category.
However, true trading is actually speculation (managed risk). The speculator is willing to accept the risk of price fluctuation in return for the greater leverage that comes with that risk in the hopes of earning a greater profit. The true speculator makes his trading decisions based on knowledge gathered from information about the behavior of the underlying, seasonality, historical and current market trends, technical chart analysis, commodity fundamentals, investment market dynamics, and knowledge of those who trade it.
7. Hey Joe! What about adding new positions when day trading?
A day trader should learn to press the market and add contracts at crucial trend confirmation intra day prices, moving all protective stops to break even with additional contracts. When a bull market makes new half day highs, instead of trading a one price unit size, trade two or more price units with a tighter stop. Either the market profitably explodes, or the trade is exited immediately.
When building bull-market trade positions, move protective stop-loss orders to break-even as new trade positions are added.
The best location for your protective stop-loss order is below a previous reaction low, swing-low, trendline, or psychological price resistance area. And keep in mind you are not adding to an existing position. You have it correct when you say adding “new” trade positions. They are new trading positions and must be managed as such, all the while remembering that each “new” position is put on that much closer to the end of the move and therefore carries increased trading risk of loss.
8. Hey Joe! Do you think there is any truth in that individual traders are affected by the overall mood of the financial and forex market?
I believe there is a lot of truth in that statement. I also believe you must learn to detach yourself from the financial market moves. I read something a long time ago and saved it. I don’t remember who wrote it, but here it is:
“Short-term trading must rank near the top of the list of the most unpredictable and exciting occupations on our planet. As the aggregate of market players ride the market to soaring heights and terrifying lows, the collective consciousness of the crowd soars to euphoria and falls in despair in concert with the price movement.
“If the crowd experiences a cumulative emotion—ranging from mild optimism, greed and euphoria, to minor anxiety, then fear and outright panic—it stands to reason that all but the most robotic of traders go through personal feelings that mirror the experience of the crowd.
“It's common to find traders who stay in high spirits when the market trends up, and feel dejected and depressed when the market declines. In past years, this may have had more significance because many traders refused to sell short; they missed out on market action when it tumbled. Another reason for the ‘up is good, down is bad’ emotion seesaw lies in the unfortunate fact that when markets fall, many novice traders ignore their stop-loss points. A falling market = falling account value.
The downside to this syndrome, however, is more than detrimental to your wealth. Attaching your emotions to market gyrations can adversely influence your relationship with your loved ones and friends.
“How do you stay disconnected and detached from market moods? First, we state the obvious: acquire the knowledge and discipline needed to make wise trading choices. Second, refine money management skills; it is an absolute ‘must.’ Establish an overall, big-picture plan for your trading business, so daily market gyrations don't look so daunting. ALWAYS plan your trade and trade your plan. When in doubt, get out. If you don't enjoy selling short, when the market ‘rolls over,’ take profits and stay on the sidelines until conditions improve. After all, when you are in cash, you will have no emotional connection tied to market activity.
“Once you learn to disconnect from market mood, you will shake off emotional limitations that may have hampered your trading decisions. And that should have a positive impact on your trading success.”
9. Hey Joe! I know I am an over-trader. I guess I just don’t understand why? In your overall management, where does over trading fit in?
Over-trading fits in under the topic of risk management. We are talking “risk control.”
First, I would say that risk management is one of the most important things that you really need to understand.
Second, you must begin to under-trade, under-trade, under-trade.
Whatever you think your trade position ought to be, cut it at least in half. My experience with novice traders is that they trade 3 to 5 times too big. Other than on spreads, they are taking 5 to 10 percent risks on a trade when they should be taking 1 to 2 percent risks.
The principle of preservation of capital implies that before you consider any potential market involvement, risk should be the prime concern. You should consider the potential reward, only in the context of the potential risk. Risk must become the determining factor in taking a position. This is the true meaning of risk/reward analysis. Properly applied, it sets the standard for evaluating not only whether to take a trade at all, but also to what degree. Preservation of capital—'refuse to lose'—becomes the basis for smart money management.
10. Is there order in the markets? Are there definable chart formations that form the basic building blocks of price action?
Yes, I believe there are, and I am happy to share them with you. I discovered them many years ago, over time and through the use of statistics. Three basic patterns have emerged that can be seen in any time frame on any chart that is capable of showing you the high and low values of prices. I am interested in the interpretation of these patterns as they apply to price movement. I call this discovery “The Law of Charts,” and it is available to readers of this publication at no charge simply by visiting our website. You can discover the Law of Charts on any kind of chart commonly used in market analysis today: the law can be seen on bar charts, candlestick charts, and point and figure charts.
The Law of Charts
The three basic patterns making up The Law of Charts are as follows:
- Ross hooks
Some of these may be further subdivided as follows:
- 1-2-3 highs
- 1-2-3 lows
- Trading ranges
For years traders have looked at price charts and wondered what they meant. Sometimes viewing a price chart is similar to looking at the stars and trying to figure out which ones to connect to show you the formation known as “Taurus, the bull.” All too often chart formations exist only in the eye of the beholder. At what point does a “pennant” formation become a pennant? What exactly constitutes a “coil,” and when is it a coil? Exactly how would you define a “head and shoulders” formation? When can you call a “megaphone” a megaphone? MORE IMPORTANTLY, what do any of these formations tell you?
The discovery of The Law of Charts was quite accidental—something on the order of Newton discovering the Law of Gravity when an apple fell on his head. As with most discoveries, The Law of Charts was discovered through simple observation—studying charts for many years until the formations just popped out and revealed themselves.
The details of the Law of Charts are seen in our ebook entitled, of all things, “The Law of Charts.” To see how this trader law is applied in regular trading, we are happy to share with you our weekly journal in which we show actual application of the law. The weekly journal, which we call “Chart Scan™,” is also available at no charge.
The Meaning of the Formations
1-2-3s occur only at the end of trends and swings. They are an indication of a change in trend. They take place when the directional momentum of a trend is diminishing. Exactly the way to identify 1-2-3 formations is detailed in our e-book. You will also find in the e-book how to register to receive our Chart scan journal.
Consolidations and the ability to identify them are of utmost importance because prices tend to move sideways far more than they tend to trend.
Ledges occur only when values are trending. They constitute a pause in the trend. The pause may be due to profit taking or, more usually, are reflective of uncertainty in the market. The traders e-book explains more fully how to deal with so called Ledges. Ledges are consolidation areas consisting of no less than four occurrences of price value and no more than ten occurrences of price value, having two matching highs and two matching lows.
Congestion areas are sideways consolidations of price value and reflect periods of accumulation and distribution. You might say that they indicate a market that is essentially at fair value with no significant changes in supply or demand. Congestion consists of from 11 to 20 occurrences of price value prior to a breakout.
Trading ranges are extended consolidations of price value. They consist of sideways movement lasting twenty-one bars or more. Interestingly, statistics show that breakouts from trading ranges occur most often on price value occurrences from twenty-one to twenty-nine. Furthermore, the narrower the trading range becomes, the more explosive tends to be the breakout, and the wider the trading range becomes, the less explosive will be any breakout from the sideways action. Trading ranges also reflect markets that are at fair value with little change in supply or demand.
Ross hooks always occur as the result of profit taking. A ross-hook is defined as the first failure of prices to continue in the direction they were previously moving following the breakout of a 1-2-3 formation, the breakout of any of the consolidation patterns mentioned above, or the breakout of a previous Ross hook.
Each one of the basic trade formations is able to be defined. The specific definitions are available in the previously mentioned e-book, “The Law of Charts.”
Since the basic formations occur in a variety of ways when seen on a chart depicting actual price action, we want to help you fully understand how to apply the law. There is considerably more to the Law of Charts than can possibly be described in this overview article. You can obtain a clear, thorough understanding of how we trade using The Law of Charts through the Chart Scan, which is sent out by E-mail each week.
We invite you to join us in a better understanding of what you see on a price chart.
Joe Ross’ Trading Educators is dedicated to helping serious traders to become better traders. Our staff and branch offices consist of real traders trading real markets. Trading Educators is involved in day trading and position trading in a variety of markets including futures, equities, and forex. In addition, our offices regularly trade futures spreads and options on futures.
11. Hey Joe! If I get all my forex buy and sell signals to work properly, I should come out a winner, right?
Wrong! The perennial questions are, “Should I buy? Should I sell?” All too many traders focus their efforts on identifying buy and sell signals. In fact, that’s what most trading books consist of—some way to find buy and sell signals. Trading systems are usually all about “where to get in.”
The research and analysis traders do is geared towards reaching the goal of getting that magic “base line” directive to guide their actions. How ignorant can you be?
Any successful, experienced trader will tell you that although properly identifying buy/sell signals is important, it’s not the key to being successful. Instead, the way you manage each trade is what will determine your success.
Traders who take the baseline approach tend to believe that the success of their trading activity is dependent on following the right buy/sell signals at the right time. Clearly, it’s important that a trader be able to understand the process of generating signals and to use the methods involved. Realistically though, almost any financial trader can find a way to generate signals (whether using technical methods already out there, coming up with their own system, or using their platform’s automated signal generation tools).
Any successful, experienced commodity futures and forex trader will tell you your trade doesn’t begin and end with a buy or sell. There’s a trade management process involved. For each commodity futures trade you make, you’re making a group of decisions. The way you manage and time those decisions is what will determine the success of your trade.
Let’ say 2 traders get the same trade signal at the same time and act on it. One’s trade may result in profits while the other’s results in losses. How is this possible? It can occur because each trader made a different combination of decisions throughout the course of the trade. The decisions may include scaling in and/or out of the trade, using or not using trailing stop-loss orders, setting or not setting profit price target objectives prior to entry, patience or lack thereof, etc.
The forex and commodities futures traders who made the most effective overall combination of trading decisions will have the better trade results in the end. Of course, there are time when pure chance, gives the better result to the worst trader.
It’s very important to regard trading as a process, and to understand that as a trader your efforts need to be focused on the activity of trading itself, as opposed to getting a quick base line answer. Because there are many things to take into consideration in making your trades successful, it’s essential that you educate and train yourself in all the different areas.
Learn how to develop better trading plans and to trade a sound and proven important trading technique and technical indicator, and learn how to apply what you have developed to the overall process of executing a trade vs the original impulse to enter or stay-out of a trade to the control of your thought processes and emotions in making and managing that trade.
12. Hey Joe! I’m a long-term trader. Any trading advice for me?
Note the yearly ranges for the commodities you trade. What is this yearly high and low, are they higher highs, lows and closes compared to last year? Does the close confirm price action? What is the long term trend? How does this years compare to last three years' average range? Should next year have greater volatility than this year?
How much based in dollars was the commodities price move from the annual lowest low to highest high price? How much did you take out of that range? What should next years high and low be for the commodities you trade based on the yearly trend analysis? These questions define the yearly long term vertical bars, use the monthly priced bars to answer them. Use weekly price bars to answer major trend questions for monthly highs and lows.
13. Hey Joe! At the trading seminar you said it’s a good idea to study military campaigns if you want to be a good trader. Would you elaborate on this a little?
Grant and Napoleon had one ability that separated them from other generals, the ability to maneuver troops and supplies to their most effective placements under rapidly changing circumstances. Traders should learn how to manage their funds, rework stop placements, and change their position size with changing market conditions. Conducting warfare and commodity trading have many common factors. All modern warfare is derived from the spear and shield, attack and defend, offense and defense. For trading markets, offense is trade entry and defense is the protective stop. Day trading is like guerrilla warfare, which was first used in Europe during the early 1800's when Napoleon placed his brother on the throne of Spain. Attack rapidly then retreat.
Value of Persistence: In the Battle of the Wilderness, Grant let the Southerners know one thing, he would never give up and would fight them under the harshest of conditions. After the battle was over, instead of retreating back to Washington to rest, as some past cowardly Northern generals had done, Grant moved south and stopped Lee from sending reinforcements to Atlanta, which fell to Sherman. The Civil War was won from the Battle of the Wilderness, which Grant is still incorrectly thought to have lost. Grant broke the South psychologically after the Battle of the Wilderness.
The stock market or futures trader is a successful human being for the courageous act of trying to become a success trader, regardless of his brokers account equity statement. Churchill said, "Never give up. Never, never, never give up." That statement defines persistence and commitment. There are many trading systems that are profitable, yet there is only one way to correctly analyze price action. Those lessons are contained by regular practice reading charts and working out what you see there. Don't give up and you will find them on the charts.
14. Hey Joe! I know you must have been a truly committed trader when you began. How do I get myself to be in control?
Statistics and society may predict, but you alone determine whether you will succeed or fail. You alone are in control; take responsibility for your performance and your life. There are always tremendous opportunities in the markets. It is not what happens; it is what you do with what happens that makes the difference between profit and loss.
Most traders move from trading method to trading method, over time, until they find one that suits them… one that is comfortable to run, and tests well first by trade back-testing, and then by real-time trade testing.
Some traders never stop looking for the “right” way to trade. That is a problem. There are many ways to trade that can generate nice profits over time. To settle on a right way for you to trade:
• First, you have to believe in the process which leads to the generation of your entry signals. Does that process make sense to you?
Maybe you’re a visual sort of person and you are drawn to Candlestick charting. Take the time to understand why the patters mean “reversal” and not just accept the “picture”. Go deep.
Choose a guru to follow. Maybe you learn best from mentoring. Choose wisely.
• Second, method you decide to go with, back-test it. In today’s modern world of software, there’s no excuse not to run all the back data you can through your method and see what the results would have been.
• Third, THINK about the process you are choosing and why it’s right for you. THINK about the results you get from your back-testing and your real-time testing of your system.
• Fourth, BE A MACHINE (DON’T THINK) when you are trading your method.
This is why I am a huge proponent of mental training for traders. Unless you can control yourself, you can never control your trading. In order to control yourself and your emotions, you have to believe totally in the way you trade. Do the work. Think. Then don’t think.
15. Hey Joe! If you had to come up with a set of steps that would bring trading success, what would those be.
I guess from time to time I would say this somewhat differently, but what comes to mind is as follows:
Here are five steps to becoming a successful trader
1. Focus on trading vehicles, strategies, and time horizons that suit your personality. You need to be comfortable.
2. Identify non-random price behavior, wherever you can find it.
3. Absolutely convince yourself that what you have found is statistically valid.
4. Set up trading rules.
5. Follow the rules, but don’t be afraid to break them if the don’t work.
In a nutshell, it all comes down to:
a. Do your own thing (independence);
b. And do the right thing (discipline).
16. Hey Joe! What about adding new positions when day trading?
Day traders should learn to press the market and add contracts at crucial trend confirmation intra day prices, moving all protective stops to break even with additional contracts. When a bull market makes new half day highs, instead of trading a one price unit size, trade two or more price units with a tighter stop. Either the market profitably explodes, or the trade is exited immediately.
When building bullish trading positions, move your protective stop-loss to break even as new positions are added. The location ideal for the protective stops are below a previous reaction low, a trend line, or psychological resistance price. And keep on mind that you are not adding to an existing position. You have it correct when you say adding “new” positions. They are new positions and must be managed as such, all the while remembering that each “new” position is put on that much closer to the end of the move and therefore carries increased risk.
17. What exactly is a hedger, and what is a hedge?
A hedger could be someone who grows and sells hedges, but in this case we are not talking about horticulture, although the idea of growing a hedge as a means of protection lends itself to the concept called “hedging” in the futures markets.
The details of hedging can be somewhat complex but the principle is simple. Hedgers are individuals and firms that make purchases and sales in the futures market solely for the purpose of establishing a known price level – weeks or months in advance –for something they later intend to buy or sell in the cash market (such as at a grain elevator or in the bond market). In this way they attempt to protect themselves against the risk of an unfavorable price change in the interim. Or hedgers may use futures to lock in an acceptable margin between their purchase cost and their selling price. Consider this example:
A jewelry manufacturer will need to buy additional gold from his supplier in six months. Between now and then, however, he fears the price quotes for gold may increase. That could be a problem because he has already published his catalog for one-year ahead.
To lock in the price level at which gold is presently being quoted for delivery in 6-months, he buys a futures contract at a price of say, $350 an ounce.
If, 6-months later, the cash market price of gold has risen to say $370, he will have to pay his supplier that amount to acquire gold. However, the extra $20 an ounce cost will be offset by a $20 an ounce profit when the futures contract bought at $350 is sold for $370. In effect, the hedge provided insurance (protection) against an increase in the price of gold. It locked in a net cost of $350, regardless of what happened to the cash market price of gold. Had the price of gold declined instead of risen, he would have incurred a loss on his futures position but this would have been offset by the lower cost of acquiring gold in the cash market.
The number and variety of hedging possibilities is practically limitless. A cattle feeder can hedge against a decline in livestock prices and a meat packer or supermarket chain can hedge against an increase in livestock prices. Borrowers can hedge against higher interest rates, and lenders against lower interest rates. Investors can hedge against an overall decline in stock prices, and those who anticipate having money to invest can hedge against an increase in the over-all level of stock prices. The list goes on.
Whatever the hedging strategy, the common denominator is that hedgers willingly give up the opportunity to benefit from favorable price changes in order to achieve protection against unfavorable price changes.
18. What’s the meaning of “Position Limits?”
Although the average trader is unlikely to ever approach them, exchanges and the Commodity Futures Trading Commission (CFTC) establish limits on the maximum speculative trade position any one trader can have at one time, in any one forex or futures market contract. The purpose is to prevent one buyer or seller from being able to exert undue influence on the market price in either the establishment or liquidation of positions. Position limits are stated in number of contracts or total units of the commodity. The easiest way to obtain the types of information just discussed is to ask your broker or other advisor to provide you with a copy of the contract specifications for the specific futures contracts you are thinking about trading. Better yet you can obtain the information from the exchange where the contract is traded.
Position Limits can dash the hope of even the most ambitious traders. With a certain number of contracts, you then have to report your intentions.
Along the lines of Position Limits, are certain limits built into any venture which limit a trader’s ability to trade large size. It is a common fallacy of most aspiring traders to think that if they could just learn to be successful trading a single contract, just think what they could do with 100 contracts, or 1,000 contracts. Besides becoming reportable, the trader runs smack up against two immutable laws:
• The law of diminishing returns
• The law of diminishing productivity
The larger the trading size of the trader, the fewer markets he can enter without becoming everyone’s target. When you trade too big, everyone is out to get you. If they catch you going the wrong way on a trade they will make mince-meat out of you. So that trader must stick only with markets that can absorb his size.
The more contracts you put on, the more problems you have with fills. It becomes difficult to get all contracts filled at a single price. Instead you find yourself managing a series of prices. No fun at all! You are so busy managing one trade, that you can no longer manage other trades. Having to manage a lot of different prices reduces your productive ability.
19. Oversold or overbought markets
One way to look at consolidation areas is to try to buy into a market when it is said to be “oversold” at support, or sell into one that is said to be “overbought” at resistance. In either case you do this as soon as it begins to move in the opposite direction. Overbought conditions are said to exist when a market has experienced rapid price increases. Intermediate resistance is a price, or clusters of prices, which have formed at price levels not exceeded for several days or weeks.
The opposite is true for oversold conditions. They are said to exist when a market has experienced a rapid decrease in prices. Intermediate support is a price, or clusters of prices, which have formed at price levels not violated for several days or weeks.
Timing such trades based upon the chart pattern greatly reduces risk and facilitates such a counter trend entry. The minimum price objective for this type of entry is generally about 50% of the price movement from the previous top to the previous bottom.
20. Three components of market timing
All market timing has three components: entry into the position with a protective stop, repositioning the protective stop, and exiting the trade when it is completed. Profits may take care of themselves, but losses require money management. These timing components must be built into every successful trading system. Good stop placements, relative to price action, are like fishing for big fish using a light line; the right amount of tension is required at all times.
Picture it this way: If a fish is given too much fishing line, i.e., too wide a stop placement, he will come towards the boat then explode outward, thus ripping the hook out of his mouth, i.e., taking the trader out of the market. If too much tension is applied, i.e., stop placements too close, the fisherman rips the hook out of the fish's mouth and loses the fish. The trader with too close a stop takes himself out of the market. The wise trader must know how to use stop placements, especially if he fishes at high risk bottoms or tops.
21. Pullback or trend reversal
When seasonal pressures favor a trend already underway, a pullback can offer attractive entry opportunities – if you know what to look for.
When seasonal influences coincide with an emerging trend, a reciprocal relationship can develop that generates dynamic price movement. Short-term pressures reinforce longer-term trends, and longer-term fundamental change promotes a greater sense of urgency in seasonal pressures. Consider the effect of a seasonal increase in demand when supplies are in structural decline amid a potential shortage.
A trend is a series of actions and reactions. When prices move too far too fast in one direction, they tend to pull back – almost like “two steps forward, one step back.”
Not only does this pullback allow the market to correct any imbalance, it also affords lower-risk entry opportunities before the trend reasserts itself. The questions, of course, are how much of a pullback and when is a pullback a reversal instead. Such is the trade-off in buying pullbacks, but general rules of thumb exist to help.
Probably the best rule of thumb is to determine whether or not the pullback is nothing more than profit taking. Profit taking will generally not cause more than three price bars of pullback. A trend reversal should be considered whenever there are more than 3 price bars in the pullback. More than 4 price bars gives a very strong indication that the move may be at least temporarily over and that immediate consolidation of some time period is in process.
22. Defined risk
Defined risk is something to be quite concerned about. We always want to keep it as small as possible relative to the anticipated reward. Risk can come in unexpected ways. As a rule, you don’t count on lousy or unreasonable fills. You don’t count on the market being under fast conditions at the time you enter. You don’t count on the fact that even though you are trading in a normally liquid market, today is the day when traders are just standing around. You don’t count on the fact that tick size may be unusually large just when you are entering the market. Perhaps you have a resting stop, and just when prices reach your stop, the market becomes fast or the tick size unusually large. You don’t count on a huge fund entering the market just at the time prices reach your resting order.
It is because there are so many unplanned for items that can exaggerate risk, that we learn to respect the trend. The reward can be surprising, the risk defined.
The market contains the knowledge of all the players, therefore it knows more than any one of its players. When a market trends, it does so for a reason. At times, the reason is never fully understood until afterward. Trends usually get underway slowly and then accelerate as they gain momentum. Momentum is potentially as helpful to a trader as a ocean waves are to a surfer. And because momentum is also a function of market psychology, trends can carry to even greater extremes than seem possible, thereby legitimizing the question, “How high is high?” or “How low is low?” It is human emotion that drives markets to extremes.
For instance, one definition of an up trend is a series of progressively higher highs and lows on a price chart. By that definition a trend becomes risky when there is penetration of the most recent prominent low. However, that fixed chart point can also help a trader to estimate the depth of corrections, and to identify possible entry points. By understanding the trend you can get a better idea of the amount of your risk exposure.
Trading with the trend can place the probabilities in favor of your ultimate success. When it comes to trading with the trend there may be as many ways as there are traders.
I prefer to “nibble” the trend, taking frequent profits as I go and then reentering if/when the trend continues.
When nibbling the market, I use no indicators of any kind. In a down trend, my trailing exit stop is always 1 tick above the high of the latest price bar. My entries are 1 tick below the latest price bar. If prices gap beyond my entry point I do not enter.
Sooner or later every trend breaks down, and not coming to the full realization of that seems to be the undoing of many traders. There is a tendency to hang on much too long.
23. Is it true that selling a market when it is limit up is usually a great strategy?
This “brilliant” strategy stems from the idea that selling a market at limit up, may result in the trader gaining two limit moves in his favor while theoretically not losing any money the day of entry.
I think is that this is an absurd idea. I don’t advise this high risk approach as a trading tactic.
Keep in mind that most markets that remain limit up on the close, will open sharply higher the next day over 90% of the time. The limit-up sell is recommended only as a partial profit taking measure, not to initiate short positions which may be considered on the next higher open.
If ever trapped into a limit up move situation try to buy deferred futures contracts or call options immediately and ask how many contracts there are to buy on the most active futures contract. If there are over 1000 contracts to buy, do not assume the most active futures contract will come off limit to trade the remainder of that day.
24. Rallies and Declines
The price relationship and magnitude of price movement, where rallies and declines occur, defines trend. A bull market has a higher high followed by a higher low which should be followed by a higher high the majority of the time. The magnitude of rallies is greater than the correction of declines. Examining the distances between highs and lows allows the lowest risk entries, and forecasts where and when market tops and bottoms should occur for profit taking exits and new position entries.
Buying bull market corrections makes good sense, since the next rally should be greater than the decline on which the position was taken. That, in essence is what we are doing with the Traders Trick Entry. Declines should not be lower than the previous price bottom. The same principle applies to day trading. It is the downward corrections in a bull market that quantify the strength of the market. With a chart pattern recognition approach, it is very possible to know where any market will trade days, weeks, or months in advance greater than 78% of the time. Too bad we don’t know exactly when!
25. Detecting the End of a Trend
One way to know that a trend is over is as follows:
Downtrend: A low is made and then a correction (retracement) follows. If the distance from the low to the high of the correction is greater than the height of the two corrections prior to making the low, you are probably looking at the end of a trend. The highest probability is for prices to now enter a consolidation, since few markets consistently make Vee bottoms.
Uptrend: A high is made and then a correction (retracement) follows. If the distance from the high to the low of the correction is greater than the depth of the two corrections prior to making the high, you are probably looking at the end of a trend. The probabilities are now equal for prices to consolidate or for an actual change in trends. Markets make Vee tops more often than they make Vee bottoms.
26. No more than two indicators are the maximum to confirm price action
Simplify your approach to technical analysis as much as possible. Emphasize price action analysis, de-emphasize indicator usage, and unless you are in a position to gain lots of information, totally ignore fundamental analysis. No more than two indicators are the maximum to confirm price action. At a trading seminar, at which I spoke, one trader there used 9 technical indicators to trade the futures markets. More than half of the trading seminar was devoted to technical analysis indicators and their usage in trading.
Wells Wilder wrote the best book ever written on trade indicators, "New Concepts in Commodity Trading Methods" and it should be read before oscillator usage or trading seminar attendance.
However, keep in mind Mr. Wilder eventually publicly disavowed every indicator except ADX. These days, I do not use Gann, Elliot, Fibonacci, open-interest, or RSI, in my technical analysis. I use mostly mental analysis of buying and selling pressures, as expressed in a series of price bars or chart patterns.
If you are going to trade with indicators despite my ranting and raving against them, the best way to trade them is to know what levels they achieve only 15% of the time when at a major top or bottom, and know the percentage of price action and indicator divergence for each market in which you use the indicator.
If only 15% of all Stochastic values go above 83 for Treasury Bonds, then upon reaching that value wait for confirming price action to generate a profitable sell signal. Traders may combine indicator values to specific time value tops and bottoms for counter-trend price objectives, but be sure to use non-correlating indicators to do the job.
The 15% level is different for each market. Price vs technical analysis divergence is an indicator value created when the market price moves to new higher levels, but the indicator remains below a previous indicator value level relevant to a previous price top. Corn used to have price action and stochastics divergence 80% of the time at bottoms. Knowing the percentage of divergence at tops and bottoms for each commodity makes money. What is the average counter trend price move when the Stochastics rise above 83 for T-Bonds with divergence? If you don’t know, you need to know.
Tell you what, it’s a lot easier learning to read a futures chart and to be stingy in your use of indicators.
27. TRADING THE ROSS HOOK™
The Ross hook™ (Rh)™ is always created as the result of profit-taking. It is defined in the following way:
• The first failure of prices to continue in the direction they were going regardless of time frame:
Subsequent to the breakout of the #2 point of a 1-2-3 formation subsequent to the breakout of any area of price consolidation containing at least 10 price bars
Let’s look at some examples, including a daily chart:
Of course the proper way to trade the Rh™ is through the use of the Traders Trick Entry™. The Traders Trick Entry™ and the Rh™ go hand in hand and are part and parcel of each other.
The 1-2-3 formation is part of the Law of Charts™, and the Traders Trick Entry™ is the best way to trade the Rh™ formation. Both are available to anyone as a free resource at Click-on Law of Charts™ and also on The Traders Trick Entry™ (Resources).
I give these links here in order to save precious space for the remainder of this trading article.
Now let’s look at a 5-minute chart.
Notice that every Rh™ is a potential #1 point for prices to move in the opposite direction.
It is important that you refrain from taking a breakout of the point of the Rh™. Too often this will place you in the market too late for capturing a sizable portion of each move.
There are numerous ways in which you can use the Rh™. I will present here just one of the methods. Hooks can be combined with indicators if you like. Here we will combine the 1-2-3, the hook and a simple moving average, as one way in which you might trade.
The chart shows trending prices underscored by a simple 9 bar moving average of the Opens.
To compute the moving average, simply add together the Opening prices of the latest 9 price bars, and divide by 9, and then plot.
Here are the rules for trading: First you must define a trend. I did it here by virtue of the violation of the #2 point of a 1-2-3 low formation.
We buy one tick above the #2 point as prices move higher (breakout) above the #2 point.
For protection, we tail a stop loss one tick below the previous bar’s value for the moving average.
In our example, prices do not move below the previous bar’s moving average until the price bar marked ‘Out.’
Let’s talk briefly about trade management. Assuming you bought 3 contracts upon entry you would cash one contract as soon as you could cover costs and take a small profit.
You would then use a trailing stop-loss protecting 50% of your unearned paper profits, and move one stop to break even. If you prefer, move both stops to break even.
Once prices move up a sufficient amount to where both stop losses can be placed above break even, trail one stop at 50% and another wherever it feels comfortable.
Keep in mind that ‘stop loss’ means protecting your position against a serious loss of margin (which can easily happen in the forex market in particular). Once the trade is in the clear, stop-loss means protecting your open position equity against loss of profits.
The simple trend following method we have shown you is not the ‘be-all to end-all’ method of following a trend. There is much more to learn about trading trends.
You might consider any of the following money management styles:
1. Taking all of your position off at once time at a specific objective of points, ticks, or dollars.
2. Taking 1/3rd of your position off at a first objective and then the remainder at a second objective.
3. Taking 2/3rds of your position off at a first objective and the remainder at a second objective.
4. Taking 1/2 of your position off at a first objective and 1/2 at a second objective.
All of the above methods involve only money management. Futures money-management involves setting monetary, tick, point, or even percentage trade objectives. The following methods involve money management for the first taking of profit at an objective, but then using a trailing stop (trade management) for one or more of the profit taking exits.
5. Taking 1/3rd of your position off at a first objective and trailing a stop with 2/3rds of your position.
6. Taking 2/3rds of your position off at a first objective and trailing a stop for the final 1/3rd of your position.
7. Taking 1/2 of your position off at a first objective and trailing a stop for the remaining 1/2 of your position.
I’m sure by now you can see that there are other management combinations as well.
By means of testing you should be able to determine which method works best for your chosen market and time frame. Also realize that no method of management is to be set in stone. Markets change constantly, and you must adapt your trading to the realities of your chosen market. Let me give you an example:
At one point in my trading career, when the currencies were heavily traded, a time prior to the creation of the stock indices and US dollar market, I found in trading the Swiss Franc I was able to consistently make 12-ticks on most Traders Trick Entries™. Trading was during time intervals very easy for me. All I had to do was place my entry stop order in the market, and contingent upon being filled, I would have a Market if Touched order resting 12 ticks beyond my proposed entry point. This method of management worked for almost a year.
Then one day I noticed that all I could get was 10 ticks – eventually only 8 ticks, then 6 ticks. This method of management was not worth trading for less than 6 ticks, because at 6 6ticks I had to double my position size to make the same amount as before.
When I could no longer get 6 ticks I abandoned the trading method. I moved to other markets and did well in those – mainly the British Pound and the Japanese Yen. However, in those markets I had to trade a bit differently than in the Swiss Franc currency market.
It took some time, and I periodically kept an eye on the Swiss franc. Then I noticed that it was once again possible to make 12 ticks. This time that niche lasted only 6 months and it was over, with Swissie moving back to under 6 ticks in a matter of days.
In 47 years of trading, I have not found a holy grail of trading. In today’s markets I find that I have to change and adapt more often than ever before.
Changes in today’s markets are many, and the markets continue to change more rapidly than ever before. New exchanges, new markets (such as Forex Currencies), computers and electronic trading systems, have all changed the markets – especially with them bringing many thousands of new market participants.
Since any commodity, futures or forex trading market is comprised of all its participants, the changes have been monumental. No longer are financial markets dominated by professional speculators and commercial interests. Today, much of day trading is heavily populated by newbie traders trying to get rich quick. The single phenomenon of amateur day traders has caused the forex and commodity futures markets they trade in to become chaotic and confusing.
You must change. You must adapt. You must coordinate your trading with what is really happening. To that extent, you must trade the Rh intelligently and with common sense. There is nothing magic about Ross hooks. They describe what happens when traders take profits during the course of a trend. There is nothing more to gain than the realization of the simple fact of profit taking and what it looks like on a market bar chart.
28. It’s our job to trade “Forex” not “Histories”
Throughout the years I’ve been trading and writing I've often written about mind set—having the right frame of mind for your trading so you become a winner.
I've stated that it is our job to trade "futures," not "histories."
The future is the next bar on your chart. You can't possibly know how it will develop, how fast prices will move, or where it will end up. Since none of us know where the very next tick will be, it's impossible to know where the tick after that will be, or the tick after that, etc. All we know at any one time is what we're seeing. Interestingly, what we're seeing may not be true.
If we are daytrading, we are not sure that what we're seeing is a bad tick, especially if it is not too far astray from the price action.
The daily price bar-chart doesn't always tell the truth, either. The open may not be where the first trade took place. The closing price is merely a consensus, and may be quite a bit distant from where the last trade took place. The high price may not have been the high, and the low price may not have been the low. If you don't believe that, then I challenge you to pick up any newspaper and take a look at some of the back months.
For example if the futures exchange has reported that a back month they opened at 9755, with a high of 9802, a low of 9760, and a close of 9784. Does that make any sense? How can the low be higher than the open? How can the close be higher than the high? Yet that's the kind of garbage we have to put up with in this business.
Now you know the problem with back testing of trades. Back testing and simulated non-real-time testing are based on nothing but lies. That's why they don't work when you actually put them to the test with real trading using real data.
In fact, there are many reasons why back-testing and trade simulations won't work, and I may as well dump them in your lap right here.
Because you don't really know where the high or low were, or if the market ever really traded there, you don't know if your simulated stop was taken out or not.
If you say you have a trading system in which if you get three up days followed by a down day, the market will be up twelve days from now 82% of the time, then your whole statistical universe may have been based on what is not true.
Have you ever watched the cocoa market from the open to the market close? You can clearly see it trading at the open, but by the time the market closes, the open will at times be placed opposite the close. That might be fifty or more points away from where you saw it open and trade, and also as born out by a report of time and sales.
The way they report cocoa prices is going to give a fit to a lot of candlestick traders. Why? Because they are going to see far too many "doji's" (open=close), more than are really there. Cocoa is not the only culprit, but historically, it is certainly one of the worst
When you see a completed bar on a chart, you have no idea which way prices moved first. You don't know if they moved down first or up first. You don't know whether or not prices opened and then moved to the high, went down to the low, and then traded in the lower half of the price range until the close, at which time prices soared up to the high and closed there. You have no idea of the overlap. I've seen prices trade from one extreme to the other more than once at each extreme.
In any of those instances, your protective stop could have been taken out intra day.
You know nothing of the market volatility on any given day, once you see a completed price bar. Were prices ticking their normal, exchange minimum tick, or were they ticking two or three times the minimum every time prices ticked?
Even if you purchased intra day tick data for your simulation, showing every single tick the market made, you don't know what the volatility was. For instance, you don't know if the S&P was ticking five minimum fluctuations per tick or twenty-five minimum fluctuations per tick, and if it was doing it quickly or slowly. You don't know and you can't know, and anyone who tells you their simulated system works, based on such phony baloney, is a liar.
Not knowing how fast the market was means you can't really know what the slippage might have been. The faster the market, the greater the slippage potential. You can sit there and say you would have gotten in at a certain price or that you would have exited at a certain price, but if you don't know the market volatility, and how fast the market was, you do not know enough to say that you would have done such and such. Not knowing how fast the market was, you have no way of knowing how much slippage there would have been on your entry or your exit. Without knowledge of slippage, you can't possibly know the risk.
That is also true of volatility. Volatility is made up of range of movement, speed, and tick size. If you don't know the extent of slippage, you will not know the extent of the risk you would have encountered.
As if that's not bad enough, you also don't know how thin the market was at the time you would have traded it. If you are position trading, you can't go by the reported daily volume (which is always too late to do you any good), because there is no way to know what the volume was at the time your price would have been hit. So here again you have no idea of what slippage you might have encountered, and once more you would not have known the risk.
If you want to spend your money on a commodity or forex trading system based upon the unknown, then you must assume the risk of doing so. Since this is a business of assuming risk, you are entitled to insure prices in any market that you care to.
Insurance companies spend a lot of money to make sure that the risks they take are actuarially sound. That is the equivalent of finding good, well-formed, liquid markets to trade in. But any market can become totally chaotic. Markets can become extremely fast, and they can become quite volatile. So even if your system was back-tested in a liquid market, when that market becomes fast and/or volatile, your back-tested, simulated system will not be able to cope with it and you will lose. It's like going out to write life insurance on a battle front.
If your back-tested, simulated system does factor in some room for fast and/or volatile markets, then, when you will be trading in slow, non-volatile markets with the built in factor, you will be utilizing a system that is totally inappropriate for the slow, non-volatile market you are in. The best you can hope for is an "optimized" system. How can you possibly expect to compete with traders who are acting and reacting to the reality that is at hand at the time?
Extensive back-testing is for historians, not traders. It is the wrong view of the markets. Your trading must be forward looking without being ridiculous about seeing into the future.
If you don't know where the next tick is, how can you possibly know where the next market turning point will be? Can you see into the future?
Perhaps you may like to trade using astrology, as it has been said the famous old-time trader (from the 1920's thru 1950's era) Mr. W. D. Gann (William D Gann's photo to the left) used to trade financial markets successfully in his personal trading of stocks & commodities. Astrological traders are always trying to peer into the future.
In the automobile business they have a saying, "There's an ass for every seat." Likewise, there's a fool for every fortune teller who claims he can see into the future. You can always go out to your local coven and hire a witch to tell you what beans will do tomorrow. She may even be right from time-to-time.
You could always do as one charlatan did and run the biorhythm for each market based on the day it first started to trade. Or, you can cast the markets horoscope based on the same date. With the biorhythm, you'll know what time of day the market should be on its highs, and what time of day it will be on its lows.
You'll know which day the market will be ecstatic and reach a new high, and which day it will be down in the dumps and make a new low. However, you'll find that from time to time the market will reach new lows on the day it was supposed to reach new highs. Well, that's easy enough to explain. You can tell everyone "We've had an inversion. Until the market inverts again, the lows will be the highs, and the highs will be the lows!"
29. Help with Trading Orders
One way I can help is to suggest that you pick up a copy of our 4 cassette tape-set and manual called “Trading Order Power Strategies.” m
No one has ever produced a product quite like it and many of our trader readers have told us that it was of immense help to them. However, until you get your copy, learn the following:
When the market trades above a buy-stop price order, it becomes a market order. The first down tick, after the market order price is activated, determines the highest price a buy stop order may be filled. The rule to remember placing stops is this, "Buy above and sell below." Buy-stops are placed above the current market price and sell-stops are placed below the current market price.
If a buy-stop price is hit, the order then becomes an at-the-market order to be filled by the pit broker at the best price possible. If an S&P buy stop is hit at 40 and the market trades 40, 45, 50, then 45, the worst fill a trader can receive is a 50, because 45 is the first down tick. The exception to this rule comes under “fast market” condition, when brokers are not legally held to any prices, or in some New York markets, where pit brokers possess a license to steal.
Avoid trading fast markets (fast-market are common in the forex currency markets). A fast market condition exists when extremely volatile price action results from a large amount of orders executed or entered into the pit, almost simultaneously. These market conditions reflect emotional reactions usually in response to the most recent government statistics like crop reports, or unemployment data etc. Whenever you are able, avoid placing trade orders under fast market conditions because of the high probability that you will receive excessive trade slippage.
In general use at-the-market orders when it's absolutely necessary, unless your commodity or forex trading strategy calls for you to use them. “Slippage” is the price difference between the stop-loss-order price and the actual fill price; this becomes dangerously excessive in fast markets, when brokers have no restrictions on order prices.
Ask your futures broker about which government statistics can move the markets, thereby causing extreme price volatility. Try to avoid being in the market during the most critical governmental statistic release, when fast market conditions are likely to occur. It is wise to stay out for about an hour or unless the fast market condition calms down. “Triple Witching Day” involves the expiration of stock options, index options, and futures contracts. Always know when these days exist and try to avoid trading on these days, which are marked by excessive slippage, poor market fills due to extreme price volatility. All exchanges issue commodity report calendars that will be sent to traders upon request.
The New York markets usually have more slippage than Chicago commodity markets, and estimated $100 per trade slippage and commodity broker commission deduction should be used when producing hypothetical testing results from a futures trading system. The New York markets have less restrictions on their floor brokers and customers orders are accepted on a “not held responsible” basis. Recent reports of 10-cents slippage in a slow silver futures market are not uncommon. For Chicago markets you can use $50 to $75 slippage and commission for testing purposes.
30. Hey Joe, I’m never sure about trade position reversing. It is scary, isn’t it?
The only reason to reverse a daily chart short term position is because the intra-day buying and selling pressures have reversed the short term trend direction. When only intra day trend changes, a reversal is not mandated unless longer-term time and price objectives have been satisfied. If the short term market trend does not change but a technical stop-order is generated, then a trade exit without a reversal is mandated. Powerful trading signals, like an outside daily or weekly vertical bar, a previous five-day resistance top or support bottom violation, demand immediate reversals.
The above holds true for any time frame. If you are trading a 3-minute chart, and the trend reverses on the 1-minute price chart, it's either time to get out of the market or time to consider reversing your market position. You are correct about reversing being scary. It most certainly is, and I would not suggest doing so unless you 1.) Know what you are doing. 2.) Have the stomach for it, sufficiently fast on your feet.
Developing a stomach for trade position reversing takes practice and the self-assuredness that comes with the courage of your personal strength and convictions.
Joe Ross - tradingeducators.com
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