Trade Without Stress or Taking Heat
2009.November.20 @ 3:00 AM Eastern | 15 Comments
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Directional trading is not rocket science. In fact, it’s more like karaoke where we just follow the big bouncing ball. The trick is to not overthink it.
But if you heard my voice during Wednesday’s real-time trading session, it was pretty obvious that I am failing to convey the simplicity, so let’s try it again.
Reframing the Approach
First off, 99.9% of people enter trading with the belief that there is order in chaos, and therefore, forecasting (with fundamentals, indicators, cycles, E-wave, Fibonacci numbers, etc.) becomes the focus of their research efforts. From what I have observed, history does repeat mainly because people behave somewhat predictably in that their reaction to events goes through typical phases. The catch is that circumstances are never exactly like the last time.
Michael Mauboussin just came out with a new book called Think Twice: Harnessing the Power of Counterintuition. I highly recommend listening to the podcast to refill your idea jar.
Mauboussin Discusses His Book ‘Think Twice’: Audio
Listen to the Podcast
Nov. 10 (Bloomberg) — Michael Mauboussin, chief investment strategist at Legg Mason Capital Management, talks with Bloomberg’s Tom Keene about his book “Think Twice: Harnessing the Power of Counterintuition.”
Justin Mamis also had an interesting observation in the last Letter:
How to Lose Money, while knowing what you are doing
Long, long ago, we both sold, and cashed, tickets at a race track (win, place, and show, previous races and previous days) and we were astonished at how many people bet against themselves, buying “win” tickets on two different horses in the same race, or two tickets to “place” because the better couldn’t make his mind up which horse to bet on, or a “win” and “show” ticket on the theory that if his hunch didn’t win, he might at least get some money back … and today’s behaviour seems born of the same kind of minds.
Reading The Crowd
The trick is to understand that people behave in certain ways under certain circumstances and their thinking goes through certain phases. For more, read the section on investor sentiment. The crowd — think of them as a giant focus group — collectively tells us how they anticipate events to unfold and what signposts they need to see in order to confirm their outlook.
With experience, we can handicap the outcomes accordingly but even that’s not 100% important since we cannot make a large bet on any particular outcome, ever! Based on what we learn from the crowd, knowing what they are looking for allows us to create scenarios where we do X if they do Y, etc. since we have a good idea of how they will react to any given development.
Scalping vs. Trend Trading
Let’s take a look at a few charts.
This is a bar chart, a plain bar chart.
This is the same bar chart with swing lines (Smarter.Swings) applied. Watch the swing structure closely. Uptrends feature upswings longer than downswings, with higher swing highs and higher swing lows moving up in a “staircase” fashion.
The price action is obviously in an upswing. The course of action is to be long with the trend. Shorting as price action is going straight up is not something to try at home.
This is the bar chart with swing lines and stops (Smarter.Stops) applied.
IF you are trend trading, that is, directional trading with the trend and want to get as much of the move as possible, THEN pink dots below provide guidance as to when to sell your long position.
Just go with the flow until stopped out. Do not attempt to short the uptrend just because price closes below the pink dot; other criteria must be fullfilled before going against the trend.
Traders with more experience should now apply the Smarter.Bars paintbar indicator. Price bars are classified according to the definitions below and colored accordingly. Price bars that do not fit the definition are not colored.
- UP (green) = higher high and higher low than the previous bar.
- DOWN (red) = lower low and lower high than the previous bar.
- INSIDE (yellow) = lower high and higher low than than the previous bar.
- OUTSIDE (cyan) = higher high and lower low than the previous bar.
IF you are scalping, that is, hit and run trading the swings connected by the swing lines, THEN use the red bars to position entries on the long side (or green bars to position entries on the short side). This is the technique used to trade E-mini stock index futures during the real-time trading sessions.
The objective is to grab a couple of bars in your direction and take your money. Imagine yourself walking along a train track that goes east to west. You wish to go west, so any train moving fast enough in the correct direction is fine to hitch onto, so long as it takes you west for a little while, preferably at a good speed. If the train changes direction when it pulls out of the next station, get off.
To learn more about bars and swings, read New Blueprints for Gains in Stocks and Grains. It’s not an easy read, but it is worth the effort.
There are only a handful of chart patterns that we want to trade. They are listed in The Playbook of Discretionary Trading.
i like that, “follow the bouncing ball”, although i must say there are days where it feels like a bad game of dodgeball.
“forecasting becomes the focus of their research”…and when they put a trade on, their ego becomes involved: they’ve made a forecast and now every fiber of their being and their total worth as a human rests on this one decision being proved correct and pretty soon they are taking heat
i have a question about trading the e-mini that maybe others who are also new to it might have.
is there anything critical in the timing of switching over from the december to the march contract? i guess there are two aspects to the question. the 1st is if you are flat at the end of the day is there a specific day when you want to switch to the newer contract or is it a range of a couple of days where each contract has reasonable volume. the 2nd would be if you are holding a contract, do you want to make sure you close it out before a given day or is there an advantage / disadvantage as to when you close it out.
alternatively, is there a mechanism that simply transforms one holding into another?
if it sounds like a stupid question, then think of it as a newbie question.
Could you say just a few words about stops in the example above? Is it the bottom of the red bar where you placed your buy stop and got filled? Or are you using SmaterStops? The latter would give the trade a lot of room in some cases and not much in others just looking at the last couple of days on the 5 minute ES. Sometimes the stop might also be overhead. So I am guessing the former is the right stop. The bottom of red bar that you placed the buy stop on that got filled or a tick below the bottom.
John, buy stops are placed above the red bars on the upswings, with the idea that the market has probably (not always) completed its pull-back and is now moving your way. The idea of not “taking heat” means not jumping in to a long trade when the market is falling in the hopes that you have picked the exact moment of the turn… at least that is what I glean from T’s instruction.
think of the bus analogy that was used in bootcamp. the idea is to wait at the stop for the bus to come to you traveling in the correct direction. you get on board, take a ride, and get off.
this, as opposed to running to catch the bus, or getting on the bus when its going in the wrong direction, because you think its going to change direction and go the way you want. while sometimes this happens, most times it doesn’t, unless there’s a lot of evidence to the contrary. and thats when you need to have decided ahead of time that if it doesn’t reverse, that you are getting off at the next stop.
now if only i could take my own advice and learn some patience, life would be good.
No, I am talking about the stop that gets you out if you are wrong after your buy stop is hit, in the case we are discussing a sell stop. I am thinking it goes somewhere just below the bottom of the red bar. SmarterStops may be giving a sell signal when you enter the trade so I don’t think you would use SmarterStops in this type of trading.
In other words how much are you going to risk or how much room are you going to give the trade to go your way. In the discresionary trading done in the Boot Camp not much room or time for that matter was given. In most cases if you did not get your trade in 1-3 bars you were out and tight stops were placed on risk. And the advice was not to keep stabbing at it.
Also the buy stop in Boot Camp would be placed a tick below the top of the red bar not above it. Unless logistically there was a problem, i.e., the current price was not giving you room to place the buy stop with out just in essence buying the market. At least this is how I understood it in the hit and run trading done in the first hour of the market.
John, Sorry I misunderstood the question… didn’t mean to insult your understanding. Your question is a very good one, and, depending on your trading style, you could have different answers, but yes, IMHO, on a daily chart, you could put your exit stop below the red bar that brought you into the trade. However, position sizing is critical, so that you are not risking too much of your account on one trade. You should also take into consideration the daily volatility of the instrument you are trading… maybe the range of one red bar is not enough based on the recent behavior of the instrument you are trading.
There are other approaches, though. maybe others have their own ideas….
And don’t forget T’s advice on stops…
Thats ok I am just looking for the best place to put a stop loss once I am in one of these bouncing ball trades. I am mainly interested in trying this on ES, mini S&P on five minute chart.
“Commercial hedgers in the NDX at an extreme net short”.
http://twitpic.com/qa361
Not really about trading. But then again maybe it is.
Let’s see if I’ve learned to post links:
Macro-man on the feel of the current rally
Nope, doesn’t seem to wor. Hence, see macro-man column 11/20.
If you want, you can always just paste in the actual link. ;-)
Dear Teresa:
Very well done. If there was one post that I would show to a friend about your trading (not investing method, that is the retirementbuilder.org site) I would use this post. I have been here since March and still learning. I had taken some charting courses before, traded futures, read some books on trading and investing; yet when I got on here it took a lot of study or lurking ;-). The integrating of it gets harder as we get older but with time it comes; or else we stick with investing. Also, like you say, it takes a certain personality. Keep up the good work. Wm
Once again not really about the headline topic but this (at the moment)is the latest.
I really wish there was one more NEXT as part of the home page. Maybe titled, Brain dump or Do you want to know what I know? or 20 years experiences yours for the reading or…
There is so much good stuff in the Knowledge Base that I would hate to see it not taken advantage of. It is like gold in them there hills just waiting to be found.