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My style is basically trend following, with some special pattern recognition and money management algorithms.
In order of importance to me are: (1) the long-term trend, (2) the current chart pattern, and (3) picking a good spot to buy or sell. Those are the three primary components of my trading. Way down in very distant fourth place are my fundamental ideas and, quite likely, on balance, they have cost me money.
I consider trend following to be a subset of charting. Charting is a little like surfing. You don't have to know a lot about the physics of tides, resonance, and fluid dynamics in order to catch a good wave. You just have to be able to sense when it’s happening and then have the drive to act at the right time.
Common patterns transcend individual market behavior (my note: i.e. price patterns are similar across different markets).
Trade with the long-term trend.
Cut your losses.
Let your profits ride.
Bet as much as you can handle and no more.
Buying on Breakouts
If I were buying, my point would be above the market. I try to identify a point at which I expect the market momentum to be strong in the direction of the trade, so as to reduce my probable risk.
I don’t try to pick a bottom or top.
If I am bullish, I neither buy on a reaction, nor wait for strength; I am already in. I turn bullish at the instant my buy stop is hit, and stay bullish until my sell stop is hit. Being bullish and not being long is illogical.
Only Exit When Stops are Hit and Set Stops Immediately
I set protective stops at the same time I enter a trade. I normally move these stops in to lock in a profit as the trend continues. Sometimes, I take profits when a market gets wild. This usually doesn't get me out any better than waiting for my stops to close in, but it does cut down on the volatility of the portfolio, which helps calm my nerves. Losing a position is aggravating, whereas losing your nerve is devastating.
Before I enter a trade, I set stops at a point at which the chart sours.
Learn to Get Back In
Getting back in is an essential part of trend following.
Hold Your Position Until the Trend is Invalidated, Do Not Let Go of Your Position. Be Willing to Experience Your Anxieties
Maintaining a commitment is particularly important when it comes up for a test.
Somewhere along the line of keeping your commitment you may get a feeling that you don't like.
If you are willing to experience the feeling, it can transform into an AHA that supports your commitment.
If you are unwilling to experience the feeling, you might abandon your commitment to try to make the feeling go away. That only results in having to feel the feeling after all.
The more you are willing to experience the feeling of bumping into walls, the less you have to bump into walls.
Trading requires skill at reading the markets and at managing your own anxieties.
People have a Conscious Mind and Fred. Fred wants to communicate feelings to CM so CM can experience them and gain experience and share it with Fred so Fred can learn how to react. This is how we manufacture wisdom. When we don’t like our feelings we tie them in k-nots and do not experience them. This interrupts the wisdom manufacture process, and draws drama into our lives.
K-nots, protect us from truth and keep our lives in drama. To untie k-nots, fully experience whatever appears in the moment.
When you keep your eye on the prize and are willing to experience all the feelings that arise, the prize soon becomes yours.
Do Not Shut Out or Ignore Your Fear
The positive intention of fear is risk control.
People who are unwilling to experience fear tend to take big risks and wind up in big drama in which the risk materializes.
People with poor risk control tend to bet heavy. So they tend to outperform others in good markets, and underperform them in poor ones.
Risk is the uncertain possibility of loss. If you could quantify risk exactly, it would no longer be risk.
Risk control has to do with your willingness to allow your stop to do its job.
Risk Below 5% of Equity Per Trade
I intend to risk below 5% on a trade, allowing for poor executions. Occasionally I have taken losses above that amount when major news caused a thin market to jump through my stops.
Risk no more than you can afford to lose, and also risk enough so that a win is meaningful. If there is no such amount, don’t play.
Speculate with less than 10% of your liquid net worth. Risk less than 1% of your speculative account on a trade. This tends to keep the fluctuations in the trading account small, relative to net worth. This is essential as large fluctuations can engage Fred and lead to feeling-justifying drama.
Betting more boldly produces more volatility. Good traders are familiar with both and keep their trading well within their tolerances.
I use a rule of thumb that you place less than 10% of your liquid net worth at risk and that you stop your losses at 50% of that – so you have net exposure of 5% of your liquid net worth. If you have a net worth of 1.5 million, you might have liquid net worth (cash, stocks, bonds, etc) of, say, about 500,000 (a wild guess). Then you might place $50,000 of that at risk and cut your loss if you lose $25,000.
The idea is to keep the venture below your threshold of financial importance, so nominal ups and downs do not trigger your emotional uncle point and motivate you to abandon the venture during drawdowns.
What Trend Trading Is (Ignore Fundamentals)
Reliance on Fundamentals indicates lack of faith in trend following.
For Trend Traders, understanding the markets is typically optional, often counter-productive.
When an up-trend happens, the price is moving up.
Trend Traders get a signal and pull the trigger without regard to the result of any individual trade.
Playing for comfort and searching for meanings are both counterproductive to Trend Following.
Trend Following systems do not speak about entry and exit prices.
Trend systems do not intend to pick tops or bottoms. They ride sides.
I don’t implement momentum; I notice it and align my trading with it.
There is no such thing as THE trend. Some of the shorter indicators are down while some of the longer ones are still up.
You Don’t Need to Get Caught Up in Intraday Market Movements / Do Not Day Trade
Having a quote machine is like having a slot machine on your desk— you end up feeding it all day long. I get my price data after the close each day.
Day Trading is an exercise in limiting profits while continuing to pay normal transaction costs. Day trading may provide a way to cover up deep feelings that the trader does not wish to face.
Short Term Trading is one good way to realize your intention of reducing account equity.
Intraday trading is tough since the moves are not as big as for long-term trading and there is no comparable reduction in transaction cost. In general, short-term trading systems succumb to transaction costs and execution friction. You might simulate your system over historical data and notice how sensitive it is to assumptions about where you get your fills.
The shorter the term, the smaller the move. So profit potential decreases with trading frequency. Meanwhile, transaction costs stay the same. To compensate for profit roll-off, short-term traders have to be very good guessers. To improve guessing skills, you can practice dealing cards from a standard deck, one at a time. When you become very good at it you might be able to make money with short term trading.
Prudent Money Management is the Key to Longevity
The key to long-term survival and prosperity has a lot to do with the money management techniques incorporated into the technical system. There are old traders and there are bold traders, but there are very few old, bold traders.
The manager has to decide how much risk to accept, which markets to play, and how aggressively to increase and decrease the trading base as a function of equity change. These decisions are quite important—often more important than trade timing.
I have incorporated some logic into my computer programs, such as modulating the trading activity depending on market behavior. Still, important decisions need to be made outside the mechanical system boundaries, such as how to maintain diversification for a growing account when some positions are at position limit or when markets are too thin.
I tend to alter my activity depending on performance. I tend to be more aggressive after I have been winning, and less so after losses.
Longevity is the Key to Success
The profitability of trading systems seems to move in cycles. Periods during which trend-following systems are highly successful will lead to their increased popularity. As the number of system users increases, and the markets shift from trending to directionless price action, these systems become unprofitable, and undercapitalized and inexperienced traders will get shaken out. Longevity is the key to success.
Do Not Pyramid Aggressively
Aggressive pyramiding, and other forms of accumulating monster positions are good ways to lose big money, even in a bull market.
The Trader and the Trading System Must Meet
Systems don’t need to be changed. The trick is for a trader to develop a system with which he is compatible.
My original system was very simple with hard-and-fast rules that didn't allow for any deviations. I found it difficult to stay with the system while disregarding my own feelings. I kept jumping on and off—often at just the wrong time. I thought I knew better than the system.
Also, it seemed a waste of my intellect and MIT education to just sit there and not try to figure out the markets.
Eventually, as I became more confident of trading with the trend, and more able to ignore the news, I became more comfortable with the approach. Also, as I continued to incorporate more “expert trader rules,” my system became more compatible with my trading style.
As I keep trading and learning, my system (that is the mechanical computer version of what I do) keeps evolving.
Over time, I have become more mechanical, since (1) I have become more trusting of trend trading, and (2) my mechanical programs have factored in more and more “tricks of the trade.” I still go through periods of thinking I can outperform my own system, but such excursions are often self-correcting through the process of losing money.
I don't think traders can follow rules for very long unless they reflect their own trading style. Eventually, a breaking point is reached and the trader has to quit or change, or find a new set of rules he can follow. This seems to be part of the process of evolution and growth of a trader.
A trading system is an agreement you make between yourself and the markets.
Trading Systems don’t eliminate whipsaws. They just include them as part of the process.
Do Not Predict Or Anticipate
A computer can follow a system and place orders without making predictions or feeling anticipation. Predictions and anticipations are objects you create. These objects may interfere with sticking to your system.
Take Care of Your Emotions
Sometimes I trade entirely off the mechanical part, sometimes I override the signals based on strong feelings, and sometimes I just quit altogether. The immediate trading result of this jumping around is probably break even to somewhat negative.
However, if I didn't allow myself the freedom to discharge my creative side, it might build up to some kind of blowout. Striking a workable ecology seems to promote trading longevity, which is one key to success.
Gut feel is important. If ignored, it may come out in subtle ways by coloring your logic. It can be dealt with through meditation and reflection to determine what’s behind it.
One of the best ways to increase profits is to do goal setting and visualizations in order to align the conscious and subconscious with making profits. I have worked with a number of traders in order to examine their priorities and align their goals. I use a combination of hypnosis, breathing, pacing, visualization, gestalt, massage, and so forth. The traders usually either (1) get much more successful, or (2) realize they didn't really want to be traders in the first place.
A fish at one with the water sees nothing between himself and his prey. A trader at one with his feelings feels nothing between himself and executing his method.
Cut Your Losses
The elements of good trading are: (1) cutting losses, (2) cutting losses, and (3) cutting losses. If you can follow these three rules, you may have a chance.
Don’t Play “Catch Up” After a Losing Streak
I handle losing streaks by trimming down my activity. I just wait it out. Trying to trade during a losing streak is emotionally devastating. Trying to play “catch up” is lethal.
Take a Break If Necessary
Sometimes I get to a personal breakpoint. When that happens, I just get out of the markets altogether and take a vacation until I feel that I am ready to follow the rules again.
A Winning Mindset is Required To Succeed
A losing trader can do little to transform himself into a winning trader. A losing trader is not going to want to transform himself. That’s the kind of thing winning traders do.
The winning traders have usually been winning at whatever field they are in for years.
It is a happy circumstance that when nature gives us true burning desires, she also gives us the means to satisfy them. Those who want to win and lack skill can get someone with skill to help them.
The “doing” part of trading is simple. You just pick up the phone and place orders. The “being” part is a bit more subtle. It’s like being an athlete. It’s commitment arid mission. To the committed, a world of support appears. All manner of unforeseen assistance materializes to support and propel the committed to meet grand destiny.
In your recipe for success, don’t forget commitment – and a deep belief in the inevitability of your success.