Archive for the 'Psychology' Category

Aug 11 2008

A Trading Pattern For The Impatient Or Time Sensitive Trader

Published by Dean under Discretionary System, Financial Market Fisherman, Psychology, SP500, Technical Analysis, Trade, Trading Plan, Trading System

Your major focus in trading should be the softer side of trading, the business and psychological side of it; the harder side which relates more to the technical side is a secondary thought, however in this article I am combining the two because one of my favourite patterns is an ideal pattern for the impatient trader who does not like to hold on to trades for too long.

Impatience is not a good trait to have in the markets when trading or investing. It breeds laziness when it comes to research, planning and analysis, it causes some to exit trades too early, and it causes other’s to constantly monitor their positions. To add to this, trades that linger on can incur costs such as time premium erosion for options traders, and interest costs for CFD traders or stock traders using margin, to name a couple.

Weaknesses are a part of human nature; your job is to ‘manage’ them, not to try and eliminate them or even turn them into strengths. We were brought up to take our weaknesses and try and turn them into strengths which I believe is the wrong approach. Build on your strengths and manage your weaknesses is the best motto I ever heard.

Some traders who don’t like to be in trades for too long will use an exit strategy that will force them out of the trade if the particular stock or market consolidates and moves sideways for a few days, which is a good strategy. Let’s look at an entry technique which is the trading pattern for the impatient trader.

This pattern signals a turning of the market. It does not necessarily signal a top or bottom, it will sometimes just signal a correction, either way; it tells you that a swift and sharp move the other way is imminent, and usually enough to give a good reward to risk. The emphasis here is ‘swift and sharp’, because this is what the impatient trader is looking for.

The pattern unfolds in 5 waves with the highs and lows of the waves overlapping each other to the point where the 5th wave ends in a spike. Here is a diagram showing what to expect at the end of a run up, and the end of a run down.

 

This is what you need to see and how to trade it:

1. You join the highs of wave 1 and 3 together, and the lows of wave 2 and 4 together if in an up market, and these lines need to converge [or lows of waves 1 and 3, and highs of waves 2 and 4 if in a down market].
2. You want the high of wave 5 to break the upper line and spike [low of wave 5 to break lower line and spike].
3. The break of the lower line is your entry [the break of upper line is your entry].
4. Your stop goes on the other side of the 5th wave.
5. You want your exit or your first profit target to be within the range between the low of wave 1 and wave 2.
6. You shouldn’t take the trade if this range does not offer you at least a reward to risk ratio of 1:1, however this is obviously a personal choice

This is an example that occurred on the SP500 index in July 2008 on a 30 minute chart.

Elliott Wave users will be familiar with this pattern, known as an ending, leading and 5th wave diagonal; others may know it as three drives pattern, and others may just say it’s a wedge pattern.

The point I wanted to make in this article, so as to benefit you is that when these patterns occur they produce swift and sharp moves and this is an obvious benefit to those who don’t like spending too much time in the markets, whether it’s due to being impatient or because of trading instruments that are time sensitive.

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May 30 2008

Your exit strategy determines your profits

Published by Dean under Backtest, Discretionary System, Financial Market Fisherman, Mechanical System, Money Management, Psychology, Technical Analysis, Terminate, Trading Plan, Trading System

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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