TraderNovice.com
You want to trade, are making efforts to learn to trade, but don't know where to start. What type of trading is best? What markets should you focus on? What style do you want to use? What interface.....etc., etc. There are many questions.
I thought about this as I was reviewing a recent issue of STOCKS AND COMMODITIES MAGAZINE and came across an article by Carley Garner from DeCarley Trading. The article was entitled FINDING THE BEST METHODS and was in the September 2011 issue. Read her one page article here.
Ms. Garner makes her case that countertrend trading will give the trader his best chance for success. There may be some credence to this, depending on how one classifies trading methodology. For example, if the "Across the box" trade that just happened in the Dow is classified as countertrend trading, then I think I might agree. (see that trade described here)
When I got started in trading one of the first books I read was Nicolas Darvis' HOW I MADE 2 MILLION DOLLARS IN THE STOCK MARKET . This book is a great read, full of laughs as well as information, and really was the epitome of the William O'Neil (founder: Investors Business Daily) methodology, before O'neil described his thoughts. It is a great story, true I presume, of how an average guy made lots of money by investing in stocks that Went UP. You can see some information on Darvas here.
Darvas was able to recognize stocks in balance, and breaking higher out of balance before charting was in fashion. His strategy, and that of William O'neil, is nothing more than a break from balance strategy where the trader goes with the breakout.
Most of you have probably heard of Darvas, and all of you of William O'neil. The first time I read O'neil's material I thought that I had found the holy grail to stock trading. Wow! It made incredible sense. Why had I not seen this before? I went to an Investors Business Daily presentation in Atlanta, watched slide after slide of stocks breaking higher that .........did what? Went higher still of course. This was incredible and I simply knew how much money was soon to come my way.
Unfortunately, Once I began to trade I recognized that Mr. O'neil might have left a few slides out of his presentation.........the trades that broke up then went DOWN .
That is the issue with breakout trading. Price may break out, but then back in,.......then back out....or not. Ms. Garner references these type of issues (mildly) in her article. She leans towards countertrend trading as if it does not fall subject to this same issue. But it does.
I trade the long bond. I love the market. It has incredible liquidity and trades in what is usually a more regular, less volatile fashion than equities. Bonds, like every other instrument, go through trends, balance, and trend again. No doubt that deciding when to get on board with a trade for a trend trader can be quite difficult. The same is true for break from balance as described above. Yet, it is also true for countertrend. I have seen many instances when the bond price would move higher, much higher than I anticipated. This has happened during intraday trading, but also longer term (like 2 weeks ago). When it occurs, and you KNOW that price has moved too high, too fast, and want to trade in a countertrend fashion.....you still have the same issues.
So what do you do? Do you initiate a short simply when you think price has gone TOO HIGH (picking tops)? If you do, then you have no defined stop and you WILL lose money. If not, then you have to wait for the market to begin its reversal before initiating the short. How long do you wait? How much time has to pass? How much volume has to be traded for you to be sure that the market will reverse and your countertrend trading will be successful? I cannot tell you how many times in many different time frames, I have seen the long bond go higher than IT SHOULD faster than it should. So I think COUNTERTREND. I watch the trading. I look at reference levels. I measure volume. I watch trading in sympathetic markets. I do all this, and still sometimes I am wrong.
So what then is the answer?
The answer, Unfortunately, is what no one wants to hear.
The answer is time, practice, self analysis, and a (slow) developing intuition. I hate even using the word INTUITION because the implication is
something far different than what I am referring to. The implication is that intuition is a gift, a talent, something one is born with, a perception
of the correct answer without deduction, as if a great trader could be born that way. But the truth is that intuition is not that at all, or at least it is
not what most people think. (please take a moment to read the tradernovice section on Intuition).
Intution may in fact be the act of finding the correct answer without reasoning or rational thought. But this makes no reference to where it comes from.
It is developed only one way, by repeated (correct) practice over a variety of circumstances in a variety of settings. It is EXPERIENCE.
(Please take a moment to read the story under "experience" in the trading essentials section here. Also Please
consider reading Sources of Power, a fabulous book on this topic).
Yes, once a trader develops intuition he may correctly assess a market situation, but that is only because he has seen it thousands upon thousands of times before. He has made mistakes. He has had successes. He has seen the situation he is confronted with and many, many other similar, but different situations..... AND STILL SOMETIMES HE IS WRONG. (Tradernovice has a few books to point out that explain some of these problems with intuition in ourbook reviewsection)
With all due respect to Ms. Garner and her article, the point I am trying to make is that regardless of the choice of methodology, a trader will have to put in countless hours of work to even begin to understand the nuances of the market. It is possible. It can be done. But it can never be done with certainty (thus the need for stops, or pre defined trades) and it can only be done, whatever the method, through hard work and countles hours of screen time.
I do think that there are situations where traders risks can be significantly reduced, by recognizing a limited upside or downside, but I think that this can happen with any methodology. More importantly, with time a trader likely needs to use all of the three methods described, just each at the most appropriate time.
Work. Prepare. Self-Analyze. Develop you intuition!
Your proper methodology will follow!
ANATOMY OF A BAD TRADE
I had been watching the markets for some time, but was averse to trading. I had been through a bad run. I decided to do what I have done in similar times in the past, and simply make notations and paper trade.
For the uninitiated, let me just say that this is not as easy as it seems. Paper trading is boring, seems dumb to most, carries little reward, and leaves you with nothing to show for diligent efforts. With that in mind, most traders who choose to paper trade do so in rather lackluster, lazy fashion. (Why put much work into this if it can garner you little gain?). So instead of trading in EXACTLY the same fashion as you would with real money (with the exception of the money or actual trade) most traders will approach this as a worthless exercise and fail to follow through on those things which are so vital to trading, including morning routines, daily review, clear definitions for the trade involved, profit and loss criteria CLEARLY spelled out, etc. When a trader approaches paper trading in this fashion it is incredibly easy to mislead your mind into believing that such and such was your plan (because you had no plan written) or that you would have gotten out of the trade at this point or doubled up at this point (no records can refute). So it is easy to fool yourself into believing that your winning percentage would have been much, (MUCH) higher than it really would have been. In this instance, I was one of those traders.
I had started out paper trading about a month ago, and I had been quite assiduous in my initial trades. I kept records. I even documented some the trades, or my thoughts going into them here on this site. I did my homework. I set guidelines. And do you know what happened? I had a very high profitable trade percentage. That, of course, can make you angry......having a high profitable percentage but no profit. So now it was time to trade.
My instinct and perception was that the equity market would retrace, once it traded back into the July ranges. Knowing that markets generally do not go from bear to bull, or bull to bear, I anticipated balance, and then a retreat. I knew that with the volatility we have had recently, that may or may not have happened, but I thought that if equities traded into the July range then retreated leaving excess, this would be a good place to go short.
Another important aspect to this trade was intermarket relationships. I had noticed that oil was trading in lockstep with equities, and of course bonds were trading in an opposite fashion. Suffice it to say that the major reason for this was economic growth estimates. But both oil and bonds were moving to a greater extent than equities. They were showing more volatility, and thus, I reasoned, more room for profit (I failed to think also more room for loss.
The DOW had an inside day on 10/31. But I just watched, knowing that I should trade, but I did not.
The Dow fell, and Oil fell.
Oil however, did not fall so much. This only increased my certainty that it was bound for a fall. Oil had, of course, gone up sharply in October from 76 to now in the mid 90's, a near 25 percent gain.< /p>
There were a few things that led my concerns about further Dow gains on Nov. 8. The pre market hours the next morning showed serious concerns over Italy and 7% bond price barrier, and I saw this as an opportunity. I wanted to go short. BUT, I chose to go short oil, rather than the DOW. Why, simply because the two had traded synonymously for a month, and now oil was nearing $100/barrel, AND, it had not fallen off in the overnight hours like the DOW had. Sometimes oil prices will follow equities, but lag a bit. I have seen it often. I chose to go short oil.
Without much pre meditation, I decided that the product I would use for my short would be a FUTURES OPTIONS PUT. I chose 90 as my strike price. This was a price out of the money by several dollars. I had not researched the best option to choose, nor compared pricing. I had just concluded that the Dow was likely to fall, and oil was trading in a like fashion but more volatile, so it would fall more. I bought the put for Jan. 2012, 90 strike.
Then a strange thing happened. The Dow fell HARD. It fell over 400 pts., ending up with a loss around 380......but oil fell minimally.
Now in a good trade, I would have had a few things to check. Was I correct in my analysis (here I was at least on my suspicion that equities may fall). Did my stop or my profit objective get hit? Nobody knew the answer to this in this trade because I had not bothered to set up either. Finally, a critical element of this trade was the intermarket relationship of oil and equities, and now they were not acting so similar. With the Dow down 380, Oil was down about a dollar, and with my strike out of the money, my gain was much less. Prudent analysis here would have realized that I might have made a mistake. I had a several hundred dollar gain though, so I left my trade alone.
I did not set up what if scenarios in my head. I did not decide on a profit price. I did not decide on a stop loss price. I simply left my trade alone, knowing that I had been right to a large extent, yet my choice of products had not performed as I expected. I simply left the trade alone.
The next day oil rose in price. My Futures option was down now and I would have to take a slight loss. I was on vacation. I did not spend much time analyzing the markets, or any time trying to understand why oil was staying higher. I chose to leave the trade alone.
The overnight markets did not look good and the next morning I could get out with a several hundred dollar loss. I could not do that. I had been right. How could I take a loss? Oil could not continue to go higher! could it?
I finally got out with a loss of over $1000.
I am embarrassed to review this trade. There were so many issues here, so many mistakes, so many things that I am simply surprised that I would still do.Noting the congruency between the oil market and the equity market was not a fault. Deciding to short oil was also not a fault. but here are some serious issues:
I could go on, but it is uncomfortable to do so. Which is why many traders do not review their losers.
The thing is, my initial premise was correct. The actual trade however, was miserable in many, many ways. Despite that, I could have recognized the clues and gotten out with a gain, or later small loss, but I did not.