Financial Market Fisherman

In trading there is a factor known to many as the ‘R’ factor or risk factor. Traders determine their average or base risk per trade they’re willing to take and name it ‘R’, and then measure profits as a multiple of this ‘R’. For example, a 3R profitable trade means the trader has made 3 times the amount they risked. The idea is to determine the ‘R’ factor early on in the trading system building stage and keep it consistent, whether it is a fixed dollar amount or a percentage of available capital.

The benefits of using an ‘R’ factor include measurability, especially during back testing, which helps to determine a systems potential, and being able to track your trades from a systematic point of view rather than a monetary point of view. However it is the monetary point of view that I would like to address as I feel there could be another angle or point of view that could aid struggling traders, especially those that find themselves cutting winning trades short (breaking their systems rules).

First, let’s do a quick demonstration of the use of ‘R’. A trader has $20,000 in capital, and decides he wants to risk $200 of his available capital per trade. After much back testing, he finds that out of 100 trades, 40 were 1R winners, 10 were 3R winners and 50 were 1R losses. He now knows that after 100 trades he system will provide an estimated 20R profit (40R plus 30R minus 50R = 20R), and if ‘R’ is $200, then that equates to $4000. This trader can now use this information to help determine what he needs to do to reach his goals.

Now, when determining the ‘R’ factor, there is one element this trader has missed, and that is, what is his ‘R’ factor from a personal point of view? Why did he choose $200 and not $300 or $100, or some other figure? This in my view is a serious question that needs to be asked and then answered, and in order to do that, one must look at their personal finances and spending habits.

In your every day life you have small, medium and large expenditures all of which fall into the categories of either tangible or intangible. For the most part, most of us have no problems with medium to large tangible expenses, such as house or car payments, or a new TV as these are things we can see or touch. Medium to large intangible expenses are much harder, such as a seminar or course fee where the results are not guaranteed. Small expenses on the other hand are a different breed altogether.

How often will you go and spend money on something small and intangible and think nothing much of the actual expense? An example would be some lunch on the go; where you buy some food and drink and know that the cost won’t change things much for you so you don’t concern yourself with it too much. But let’s say you get home that evening and decide you like the idea of eating out for dinner. Do you now think twice about where you will go and how much you are willing to spend? If so, you have a threshold on the amount of money you are willing to spend (as most of us do), especially on intangible items or items quickly consumed.

This threshold or level of expenditure where you change from not thinking to thinking twice is a perfect example of where your comfort zone currently sits when it comes to the value of money relative to you. Go over it and you get uncomfortable and have to think twice.

In trading, it will be no different. You will find it much easier to take losses where the amount, or ‘R’ factor, is under your threshold, than if it is over. I know many people will respond to this comment with the issue of, by risking so little it will take too long to make any decent amount of money or even the fact that brokerage costs etc will start to become a heavy burden, and these are fair responses. However, the fact of the matter is, the act of trading is not going to change the way your brain responds to such losses because there is nothing to show for the loss (intangible), and if the loss is out of your comfort zone then your brain is not going to like it.

What’s more, imagine you are sitting on a nice paper profit which is in excess of your threshold; an amount that if you were to spend on something intangible would cause you to think twice. Your brain is way out of its comfort zone because a) it’s a lot of money to you, and b) you can’t realize the profit and thus bank it until you actually close out the position! When you are in such a position all sorts of justifications for breaking your rules start flooding your mind.

Both of these instances of not being able to take losses well and cutting winners short are major hurdles traders face all the time and much of the issue lies in their personal relationship to money and the value they place on it. If you have a low relative value of money, it doesn’t matter what the system you use is or how well it performs for others; you are only able to extract from it what your relative value to money is. If you don’t believe me, check out the free e-book and video at this site www.reprogrammingthemind.com and see for yourself on how and why we behave the way we do with money.

You should spend some time assessing your spending habits and determine where your threshold lies. If it is too low to even consider making substantial money in the markets, then you are faced with the tough decision of either looking for a different career or changing your threshold level. Much of the problem lies in the belief that money is something we generally lack, and that there never quite seems to be enough. Unfortunately, it doesn’t matter which way you look at it, this is a fundamental issue for most people, and it is no wonder 95% of trader fail.

Once again, you should check out the free e-book and video at this site www.reprogrammingthemind.com and see for yourself on how and why we behave the way we do with money.

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Candlesticks in trading have two main purposes;

One is to tell the trader the open, low, high and closing price of that particular time period, and two, whether the close was higher (green bodied), or lower (red bodied) than the open.

However they can alert the trained eye to pending reversals offering the chance for a trader to get a head start on a possible new trend, or to alert the trader who is already in the markets that the trend is ending and to tighten stops or take profits now.

The two candlestick patterns we are demonstrating here is the hammer (& hangman), and the tweezers (also known as railway tracks).

When looking at either pattern, they look quite different, however when it comes to what is going on in the market place, the same thing is happening. So let’s see what that is.

After a significant run up in price, the market will exhaust itself or be overbought; however this is when the most action usually takes place. The reason is because towards the end of the trend, the misinformed public are still buying, not wanting to miss out on what is probably a well talked about market and trend. However at the same time, the professional traders are the ones selling to the misinformed public.

This activity creates a resistance to any higher prices because all the late buying is being absorbed by the professional selling. On a candlestick chart, this will often be shown by either a bearish pair of tweezers or a hangman. Essentially price moves up and then moves all the way back down again, in the space of one or two candles (see diagram below).

Likewise, after a significant move down the market will exhaust itself or be oversold; the misinformed public are the ones selling because they can’t handle their losses anymore, and the professionals are the ones buying from them.

Again, this activity creates support for price and the candlestick patterns will show price move down and then all the way back up again. This is shown by a bullish pair of tweezers or a hammer.

The bearish tweezers pattern and the hangman show the same activity, price moves up, and then moves back down roughly the equivalent amount. The bullish tweezers pattern and the hammer show the same, price moves down and then moves back up roughly the same distance.

If you look at the diagram below, you’ll see this in action. The main difference between the tweezers and the hangman or hammer is the time period. The tweezers are two candles, but the activity is the same. The other difference is that the colour of the hangman or hammers body is not relevant because the open and close are very close to each other.

Two things that make these candlestick patterns more powerful is when the range of the candles are longer than the average range, and there is higher than average volume to go with it.

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Getting back to basics part 2

In my last article I spoke about getting back to the basics of trading when you find yourself struggling. I also mentioned that it was not the complete picture and that an exit strategy is more a function of the trader themselves. In this article I explain why.

There are many ways to formulate an exit strategy. Other than an initial stop loss, which is there to get you out of a bad trade, exit strategies are used to achieve a goal. A lot of traders don’t understand this concept and therefore pay little attention to it, spending more of their time worrying about entries.

Those that do consider the exit strategy important may still place more importance on finding the exit strategy that proves to be the most rewarding when back-testing. Although this is important it is only half the picture. An exit strategy also needs to support you the trader and help you achieve your goals.

An example: The three most popular methods for exiting a trade are to use profit targets, trailing stops, and indicators; some people may even use a combination. If you use a profit target as an exit strategy, there must be a reason. A long term investor, or someone who trades medium to long term has less need for profit targets and more need for catching trends; therefore trailing stops are more suited.

Someone who uses profit targets is more likely to be shorter term, someone looking to use the markets to generate income, or even be a novice looking for consistency to build confidence. You see if your goal was to generate some sort of long term result such as a decent return on your capital over 5 years, then profit targets are a waste of your valuable time. What you need is to catch trends, and an exit strategy that uses profit targets is not going to allow you to do that, because you never know how long the trend will last.

If you take the time to assess what it is you want from your trading, you’ll find that the exit strategy you employ is either going to fit or it isn’t. If your shorter term and looking for income, what’s important to you is knowing what your goal is for the week or month, knowing your average win to loss ratio, knowing your average profit to loss ratio, and setting profit targets based on that.

For example, if your goal is to generate $1000 a week from trading and your system has a 60% win to loss ratio, and you always set your profit target to the same as your risk (this means you have a 1:1 profit to loss ratio per trade), then each trade would have a $500 risk, and a $500 profit target. Let’s do the math here…

10 trades; each trade we risk $500, and we set a profit target of $500 (after commissions). We have 6 winners totaling $3000 profit. We have 4 losers totaling $2000 loss. Result - $1000 profit. In this situation, your exit strategy has helped you to achieve your goal.

Now let’s say you didn’t understand the concept of exit strategies and thought that the best way to exit your trades was to use trailing stops. This is fine if your goals are longer term, but if your goals are to create income, or even to create confidence in yourself as a trader, then using trailing stops takes away any short term certainty; something that you need if looking to generate income or gain confidence.

Let’s look at longer term exit strategies. If your goal is to build your wealth over a certain period then your more than likely looking to catch trends; the reason is because at any given time, some market some where is trending.

The Turtles made a name for this sort of strategy where their goal was not some monetary figure every month but merely to make sure they caught every trend that presented itself. In order to do this, they had to employ the right exit strategy. See how I said exit strategy and not entry strategy. Although important, the entry was merely a set of rules that ensured the Turtles entered every market that looked like it could trend, even if no trends eventuated for many months. The exit strategy was the system that allowed those markets that did trend to pay handsomely. One trending market was all it took in one year to more than offset all the many losses, and return a profit that most fund managers would frame and place on their walls.

The actual exit strategy the Turtles used is not the point; the point is to find a strategy that suits you and your goals. Worrying about whether to use a trailing stop, or a volatility stop that works out some weird percentage of the daily range, or even some indicator cross over is fine if you’re longer term, but most traders are not long term and so must pay special attention to their goals and what they are trying to achieve.

I firmly believe that all exit strategies if tested over a long enough periods will produce similar results. It’s how practical they for you and your trading business that is more important.

My suggestion is to assess where you are. If you’re looking for short term results such as income, use profit targets. If you’re new or even struggling, but are not too concerned with income right away, using a profit target is still the better option as it helps you build confidence. Only move to the longer term exit strategies such as trailing stops once you have gained confidence in yourself to let trades run, and have less need for the income.

Exercise:
Assess what you are trying to achieve and select exit strategies to suit. Then test them out over a decent sample of data along with your entry techniques you created from the last exercise.

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Find the right business

Hopefully at this point in time, you should now have some idea of what you want to do and a list of your resources. You should have prepared the following:

 - Your trading capital
 - Your goals (i.e. your desired monthly and yearly ROI) and when you want to reach them
 - Your available time for trading and learning
 - The market(s) you wish to look at trading
 - A list of brokers from these markets to approach
 - A list of forums
 - A list of your strengths and weaknesses, and preferences regarding trading styles
 - A list of your physical resources

One thing you can do is take your list of resources and approach some people who teach their trading system(s). I can tell you there’s plenty out there. What you want to do is visit some forums and ask some questions based on your list of resources. Find out what other people similar to you are having success with, and then approach the teachers. Contact them and ask them specifically; ‘Can I trade your system with this list of resources?”, and list them all out. If they can’t answer it fully, or if they don’t address every question or resource you have, then move on!

A lot of you, even after going through this whole process are still going to get sucked into hype and marketing dribble. It’s just the way the marketing is, and unfortunately, it’s really the only way companies can succeed against other’s in this world. To give you an idea of how marketing works, it is based on benefits. When you read a sales letter or sales page from someone selling a trading course or system, the aim of the sales letter is to point out the benefits that their trading system will bring you. On most occasions, the actual trader doesn’t even write the sales page, they hire someone to do it for them, and that someone knows what they are doing.

A list of benefits is a good thing, don’t get me wrong, but they still need to be realistically achievable using what you have at your disposal. A good demonstration of this was a sales page I saw which claimed to show you how to generate a five figure income in breakneck speed. Now this is a good benefit isn’t it, but it doesn’t tell you how much capital you need; is it aimed at those starting with $100,000 or can someone starting with $1000 achieve this and what does breakneck mean in terms of time?

There are going to be systems, courses, seminars, books, teachers, coaches, guru’s and mentors of all shapes and sizes out there. There are going to be trading systems aimed at just one particular market, or even one particular instrument. There will be courses aimed at teaching you how to trade any market at will. There will be systems aimed at trading during the day or a session only (meaning you only trade while your computer is on and do not have any trades open once you turn your computer off). There will be swing systems (trades only last a few hours to a few days), and longer term systems where you may hold trades for weeks and months. All of these variations have their pros and cons. There is no right or wrong system. What you need to do is find the right system for you.

After you have visited a few forums, and done some searching on the internet, you may have a list of people (teachers, coaches, companies selling systems etc) you want to approach. We’ve already mentioned that you should contact these people with your list of resources. But while you are doing this, you may want to also find out what their support level is like.

Support is an extremely important part of trading and without it, you may get left feeling like you’ve been ripped off, especially if you can’t understand a certain part of their system or material. However, there is also the element of cost. If someone offers to teach you to trade, and is only charging you $20-30 for this information, there is high chance they aren’t going to want to provide support, and why should they, you get what you pay for in life, whether it’s through money or time. But when you start paying big bucks whether it be a one off or a monthly fee, you deserve to get support.

One thing you’ll find is that if someone is not offering any form of support or the support is poor, there will be people complaining about it. In fact, this is one thing you’ll definitely find on a forum. Find out if people are getting their questions answered and if they are satisfied with the support they are receiving. But do read between the lines and don’t get this confused with a trader who is blaming other’s for his own failings.

Finally, there is nothing stopping you from building your own system. You have a better idea of what you have and what you can bring to the markets, all that is left is to find the tools and indicators to suit you. There are several systems available in our members area, along with some brief videos on some of the more famous indicators used by technical analysts. Take this information, digest it all and then pick and choose the parts that ring true with you.

Exercise:
If you haven’t already got your list completed from the past 4 exercises (see above) do them now.

Approach traders and teachers alike and ask if they can help you with your limited resources.

If you want to build your own system, begin looking at some key indicators and methods of analysis that are in tune with your preferred style.

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What are your skill levels and strengths (part of your resources)?

Understanding where you are strong means having an edge. For example, one that stands out for me is an options trader in Australia. Before becoming a trader he was in the navy, and one of the things you can associate with defense forces is the strict discipline they must learn. It’s very safe for you to assume right now that discipline is an important key in trading success; it is, and this man turned $10000 into 3 million in 3 years!

Unfortunately, many don’t find out what their strengths and weaknesses are until well after they have taken a solid beating from the markets. An example of this is getting involved in a trading system or buying a course where the meat of the trading is discretionary, meaning you analyse and make discretionary decisions based on your analysis. There is absolutely nothing wrong with this approach if it suits you, but for many it does not. Some people need a solid set of rules that require nothing more than if A = B, then do C, and this is called mechanical trading.

Both discretionary trading and mechanical trading have their place. An example of someone making a discretionary decision on their stock holdings was when a man went to visit the CEO of a company he owned stocks of. When he asked the CEO what his plans were to move the company forward, the CEO showed him by pulling out a few pieces of paper and writing it down. What the man noticed was that the paper he was writing on was extremely expensive paper, embossed with gold writing and very thick, yet after a few squiggles, he’d toss the paper in the bin and get a fresh piece. The CEO put forward a fairly impressive plan, but after speaking with the CEO, the man left and instantly called his broker to sell all of the shares he had in this company. His reason was simple; if this CEO felt that the companies money was best spent of expensive paper, then he doesn’t have the companies best interests at heart. Although you’re not going to be visiting CEO’s if you choose to become a discretionary trader, it illustrates the point that decisions are based on your observations and your analysis of those observations.

A mechanical example could be anything from a list of indicators on a chart that all line up, to a check list that once filled means you can proceed. A discretionary trader will most likely use lists as a way to build evidence to support their theory or view. This brings me to the next point which is technical analysis versus fundamental analysis. I want to say right now there is no right or wrong way. If there is a pet hate of mine it’s when an experienced trader says that fundamental analysis doesn’t work, and another investor says that technical analysis doesn’t work. It’s whatever works for you.

Technical analysis suits those that want to look at charts and use lines, indicators, volume and so on. Fundamental analysis is for those that like to understand the inner workings of a company, economics, supply and demand etc. Once again there’s no right or wrong way. It’s a matter of choice. Two famous forex traders stick out for me. One trades short term, but he uses fundamentals (i.e. he follows global monetary policies, interest rates etc) to gauge a longer term view, and he uses technical tools (his own tools I should add, not ones found in charting software) to base each individual trade on, as long as it corresponds with his longer term view. The other looks at how the market is positioned as a whole and whether this is in line with the real fundamentals. If not, it provides opportunity, from which he uses technical analysis.

At this point you are going to have to make some decisions. By now you should have a fair idea of what market(s) you’re thinking of trading. Now you have to decide whether you want to go mechanical vs. discretionary, and technical vs. fundamental, or a combination there of. There is so much information out there on these topics that I suggest just going to Google.com and typing in “mechanical vs. discretionary trading” and “technical vs. fundamental analysis” and spending a good few hours reading up on it.

What you should find while researching this information, is that there will be some things you’re attracted to and some you feel awkward with. Write these things down! This is your list of strengths and weaknesses. If you’re hopeless with numbers and hate maths, you’re certainly not going to get excited about trading systems that require you to crunch numbers (and yes they do exist!).

One thing you can do is visit some forums to find out if there are traders with similar resources to you, i.e. same available times to trade, similar trading capital, even similar temperaments (this is more important than you may realise) and find out what is working for them.

A note on forums: Be careful when visiting and participating on forums. Although extremely useful resources when used wisely, they can also become breeding grounds for those that only wish to spit venom for their shortcomings in life. Don’t get sucked into threads and posts that set out to derail or bad mouth trading or traders. Trading is a very humbling business, however many will never ever admit that their lack of success is due to their inability to be honest with themselves.

You’ll also do well to write down the physical resource you have such as your computer and it’s size (if your computer is too slow or old it will struggle with displaying charts), internet speed, whether you have an office or whether you’re trading from the kitchen table (it would be pointless deciding to trade intra-day if you will be subject to continual distractions), quick access to a telephone, software programs including accounting, charting (if you’ve already purchased something), office etc. Some of these may end up being irrelevant, but you’ll make better decisions when you know what you have and don’t have.

Exercise:
Do a google search on each of the following: mechanical trading, discretionary trading, technical analysis, and fundamental analysis.

Visit some forums and ask around for people’s preferred methods to see what gels with you.

List your resources.

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How much time a week can you devote to trading?

Also, what are those time slots? For example, if you can spare 10 hours a week to trading, what are those exact times? Are they evenings, mornings etc?

Now comes the heart breaker. What is your yearly ROI goal? Write it down. Now next to that, write down the number of hours you can allocate to trading. Now compare your results to the table below. Do they match up?

Hours a week available -  A reasonable expectation ROI% PA
 
              0-5                -                     0-10%
 
             5-10               -                     10-20%
 
            10-15              -                     20-30%
 
            15-20              -                     30-40%
 
            20-25              -                     40-50%
 
            25-30              -                     50-60%
 
            30-35              -                     60-70%
 
            35-40              -                     70-80%
 

These are just rough guidelines. They are mainly presented in this fashion to drive home an important point, and that is trading involves a lot more than just trading!

For example, as a beginner you not only have to physically trade, you need to do the following;

Learn the system; learn the jargon; learn the particular market you are trading; learn the software, the brokers platform, the data provider; learn the laws and taxation laws that affect you; learn your own strengths and weaknesses; assess you skill level; learn any necessary computer skills and so on.

It’s exactly like any other business. You need to learn the ropes. Someone who only has 5 hours a week to devote to trading can not be expected to learn all of the above and successfully out-perform fund managers who employ teams of full time staff and traders with years of experience.

However, if you have the desire to achieve great results, it will need a commitment from you. Allocating more time to your start up now, can lead to less required time from you in the future. For example, someone looking to make 60% per year and achieve this in 12 months may look to devote more than 25-30 hours per week, in fact more like 45-50. However the pay off is that this extra devotion may lead to finding a system that does indeed generate 60% returns with only a 10-15 hour a week commitment.

Exercise:
Determine how much time a week you can allocate to trading and then
split it into the following:

1. Actual trading (should be the least time)
2. Analyzing and seeking opportunities
3. Working on yourself and your trading business (should be the
most time).

Number 3 should be your biggest priority. Ensure you have at least
1 hour plus, to every one you spend on seeking opportunities.

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Where do you want to go?

Trading Forex, Stocks, Options, Commodities and Futures is a dream
for many, but a realization for a very few. The building blocks for
successful trading include the right plan, system and discipline,
and all these come from the right education. But first you need to
assess where you are right now and then where you want to go.

Whether you are a beginner or someone who has been trading a while,
it is safe to assume you believe you can out-perform most of the
fund managers out there. Before you go dismissing fund managers,
use the following link to perform a simple calculation. It will
open up a window with a simple calculator.

http://www.atradersuniverse.com/ROICalculator.html

Enter in your starting capital. This is the amount you plan to
allocate to your trading.

Next enter in your monthly goal, i.e. the amount per month you want
to be making from your trading. It could be an amount to replace
your current income, or an amount you’d like to see your capital
grow at (make sure it’s a money amount and not a %). It’s important
that you at least have a figure in mind.

Now click on ‘calculate’ and see what appears as a yearly ROI, and
then a monthly ROI. Take the yearly figure and then compare it
against the best fund managers. When comparing fund managers, it’s
best to look over a 5 year period as a minimum to gauge their
ability to make consistent returns. For a list of fund managers
see the link below.

The point to this first exercise is to determine whether you should
be embarking on a trading career or not. If you find a solid fund
manager who over a long period consistently achieves the returns
you are looking for, why spend time and money learning to do it
yourself.

Of course if you’re looking for a career and you want to
become an active trader, then setting a benchmark against fund
managers is a good place to start.

Exercise:

Determine your goals by entering in details in the following
http://www.atradersuniverse.com/ROICalculator.html

Visit the following link and check the results from the top
performing fund and money managers.

www.google.com/Top/Business/Investing/Money_Managers/

One other thing, some money managers are not your typical fund
managers, they are seasoned traders, and generally perform better
however they are harder to find.

Look around and see if someone who has the runs on the board can
achieve returns with your money that you can not (at least not yet).

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Claire asked me to clarify the use of trailing stops in the 4T’s system. I think this is a great chance to demonstrate the uses of exits as they are more dimensional than most realize.

In the 4T’s system I use a trailing stop that moves up (I am referring to longs - just think opposite for shorts), every time a new low forms. As I am using an ‘isolation low’ as my point of reference (after a trigger has taken place), to look for a trade, I suggest using the same when trailing the stops. The reason is because if you are looking for isolation lows after a trigger, you’ll become more familiar with the pattern, and thus making it easier to spot them during the trade to trail your stops.

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Mark asked me, “If I wanted to use the 4T’s system or any system like it and add Elliott Wave to it or fibonacci, then how am I supposed to back test it to determine my average profit etc.”

That’s a great question and the simple answer is you can’t. Well not technically anyway. A lot of the attraction to mechanical systems is that they are easy to back test, not only because there’s no decision making, but also because you can just plug a system into a piece of software and presto!

But there are several ways in which you can test a discretionary system.

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