Room 3
I used a simple technique that Victor Sperandeo taught in his Trader Vic – a simple trendline, then a break, followed by a pullback into a double bottom. After a double bottom was eastablished, I went long at the swing high.
I search for a postion that I can hold, and may have to attempt entry many times before finding the right one. On bad consequence is that you can have two or three stop-losses in a row. How can you minimize that? My solution is to take profits on half of my position at a point between half and two-thirds of the distance to the stop-loss. Ideally it would have been equal to stop-loss, but even at a half you cut risk by 75%. I found this technique at the end of Trading in the Zone by Mark Douglas. If you use breakout techniques, 9 times of 10 you will have this work for you.
Whenever you see a major market move followed by a short bar, it is a pretty good sign that the dominant trend is ending.
When prices fall by such a huge percentage (one third or more) from their peak, they act like a man who falls from a great height. He is not likely to get up and run anytime soon; he is going to lie on the ground for a while, just trying to breathe.
A serious warning to stand aside and wait comes from MACD-Histogram. It has traced a broad bottom from June to August and then rallied above zero. To give a strong buy signal, it needs to return below zero and bottom out at a more shallow level, creating a full-fledged bullish divergence. Its height at the right edge of the chart is more indicative of a top than of a bottom.
Andrea commented: People say divergences are among the best trading tools. I definitely do not accept that as a general rule: One needs to be more specific. I found that if the main trend is up and you look to enter on a retracement, bullish divergences are good. But divergences against the main trend do not work. Every day I see strong trends with major divergences that last for months, but the trend continues and runs away. I identify major reversals using double or triple tops and bottoms. There is a kind of myth about divergences. The work in ranges and in retracements, but not against the main trend.
As soon as I am in a shoring trade, I start using trailing stops, based on the weekly highs. I place my stop at the high of the previous week. Even if I like the trend, I’ll cover my short at the previous week’s high.
When your account starts to increase, keep humble and fight the feeling of arrogance. Whenever you get a strong opinion about the market, shut down the computer and take a long walk. Your opinion is not helpful; it can influence your judgment when you look at the chart. Trade your chart, never your opion.
To sum up my experience:
- Trade using a minimal part of your capital( money management).
- Follow your plan – you must have one, without any exceptions ( trade management).
- Take only the trades that are in compliance with your technical signals.
Room 4
The only way to stay in this game is not to take big losses. I have two articles of faith. One – no one can know the future, and so I am very skeptical of every tool. Technicals or fundamentals give us convictions for courage about making a move, but ultimately it may not work and we must be ready to get out of the way. Ultimately, the market is about the mind of the masses – and who can predict them? Two – most people in the market knows everything and discounts everything is nonsense. The only time we make money is when we are right ahead of the market, and if the market is efficient, we would never make money.
There are also the three main rules of trading. They are – use stops, use stops, and use stops. You have to protect yourself if you want to survive in the markets.
It seems to me that it makes sense to put a time stop on your trades and shoot lazy puppies after a reasonable interval. Set a date in advance when you’re going to get rid of those stocks which do not perform!
I decided to do this trade with options rather than S&P futures. For me, the biggest plus was that there was a fixed amount of money that could go to zero. The biggest negative with calls is that time runs against you. Also spreads are greater in options, but that’s the cost of doing business. I can afford to lose the option premium, but with futures I am afraid of another October ’87, especially if I am not watching the market intraday.
I almost always enter with limit orders. I also placed a stop-loss five points below my entry. You have to use stops because you could be wrong and it could be the start of a new downleg.
Divergences of MACD-Histogram and prices give perhaps the strongest signals in technical analysis. The fact that the second low is a few points lower than the first low put the icing on the cake. Buy new lows and short new highs when divergences are present!
When a rally is strong enough to blow out of a channel, it often gives us a second chance to buy, when prices pull back to the moving average after the breakout.
Notice how Force Index rises to approximately the same peak level during each rally – the bulls are maintaining their level of power in each rally without any divergence. Overall, this looks like a healthy uptrend.
Notice a new peak in MACD-Histogram in mid-August – it indicated a great inflow of bulls, calling for higher prices ahead.
It is very important to move your stop to a break-even level once a trade starts moving in your favor. This is essential for capital preservation. Without it, you ‘re not likely to become a long-term winner.
Markets are the least restrictive areas of society; no other area is as free. If this freedom has a flip side, it is impulsivity and irresponsibility.
“ Soft stops” – my favorite method – involves getting out of any trade whose weekly Impulse System goes against me 15 minutes before that market closes on Friday.
Soft signs are early warnings of a trend change. Hard signs tell that a trend is definitely in force. Soft signs include divergences of MACD-H or breakouts to a new low or a new high with no follow-through. Hard signs include the trend of a moving average on a weekly chart and a follow-through of a breakout, as prices accelerate in its direction. Experienced traders look for soft signs for entering trades, buying bullish divergences of MACD-Histogram or shorting apparently false upside breakouts. By the time the hard signs are in, it is often too late to enter a trade. On one hand, hard signs give a strong message to exit a trade. For example, if I go long after a soft sign, I may continue to hold even if that sign disappear, providing other signs remain. On the other hand, if a hard sign, such as a weekly moving average, is down by the end of the week, I will get out of a long trade before the weekend
Trading is completely different from investing. In the short term the markets can do anything – absolutely anything whatsoever, without any visible rhyme or reason. Short-term price action, for all intents and purposes, is arbitrary and capricious. Long-term investments must only be made on the basis of valuation, fundamental analysis, and du diligence.
John Maynard Keynes warned that the markets can afford to remain irrational longer than any rational investor can remain solvent while fighting irrational markets. A cursory scan of the historical charts shows that the madness of crowds often trumps sound fundamental judgement.
Room 5
As I do a post-mortem on this trade, I see that my problem was that I did not trade in the direction of the industry group. This is where I ‘ve had much success lately – watching industry groups and not individual stocks. I should not have traded against the group’s momentum.
The Impulse system is blue, permitting shorting, but there is no current bearish divergence of MACD-Histogram and prices are pretty far from the upper channel line where the best shorting is done.
The most satisfying feeling I have in trading is losing money for the right reasons. When you lose money for the right reason, you will be a very successful trader in the long run, because you will be taking smaller losses which will enable you to be around for the big trends.
Lately, I have been looking for the charts that have sold down and have the most convincing bottoms in the area of support – a double bottom, a triple bottom, or a tiny bottom with MACD-H making a bullish divergence.
Compare the fast rising speed of the rally with the slowness of the decline – this stock clearly does not want to go down.
At the right edge of the weekly chart, the bars had shortened, indicating that lower prices are not attracting public participation and the decline is running out of steam. MACD-H is bottoming out at a much higher level than in March. This is not a true divergence because the indicator never crossed above the centerline between the two bottoms. Such clear divergences are rarely seen on the weekly charts. Still, the current pattern tells us that bears are weaker today than they were in March 2004 – an important factor to keep in mind when deciding whether to go long or short.
If you want to try a different exit technique, I would suggest exiting the bulk of the trade with a more conservative technique at the channel line and holding a small fraction of his position to test something more adventurous. If you traded 1,000 shares, you could take profit on 900 shares and hold 100 for a different type of exit.
Channels are better tools for setting profit targets than support the resistance lines. Pros look for uncommon tools. Everyone knows about support ad resistance, since marking them requires nothing more than a pencil and a ruler. Channels, on the other hand, require a degree of computer sophistication and an investment in time. They are less obvious on the charts.
Room 6
I am convinced that having been a highly successful computer engineer has been a disadvantage to my trading rather than an advantage. It is a difficult task to quit thinking like an engineer after so many years of positive reinforcement.
The less experienced a trader, the less defined his method. To define a method takes a good number of traders – 10 is not meaningful, 100 is good. A trader often jumps to another method before he gets numbers where they should be. Trading is not about “Am I right or am I wrong?” but about “Did I apply my methods correctly?”
A fellow raised his hand in my class. He wanted to know how to reach the degree of expertise at which he could approach trading with a great feeling of confidence. “That is not likely to ever happen,” I said, “There is always a feeling of uncertainty in working on the edge. If you feel certain about a project or a trade that you’re getting into, it is probably going to be a loser” – AE
After 11 trading days, it did not look like this stock was going anywhere. MACD began to fall and Sotchastic crossed below its oversold line. So I sold the stock.
Yesterday a fellow asked you in class what was a common psychological trait among winning traders, and you answered: “eccentricity.”
Working on Trader’s Governor has given me tremendous appreciation for the value of record-keeping. Private traders can feel they are doing OK and not face up to their real performance. Having the Governor forces me to do that no matter how painful. I started a process of brutally punishing my ego by reporting to my wife. Now it is like work – good or bad, the boss wants to see the numbers.
Booklet: The unwritten laws of Engineering.
Traders looking for bullish and bearish signals tend to squint at the charts. Squint long enough, and you’ll recognize bullish or bearish signals—whichever you prefer. A much better thing to do, when in doubt, is to push back and look at the charts of a greater timeframe. If you feel confused by the dailies, look at the weeklies to make a strategic decision. Use them to decide whether you’re a bull or a bear before returning to the daily and deciding what to do with your trade.
The decline on the daily appears a little steep for buying just now. There was a bearish divergence in April, and from there the stock lost nearly 25% in less than two months, going down in a nearly straight line. At the right edge of the chart the Impulse has turned green, permitting buying, but there is no bullish divergence of MACD-H, of MACD lines, or even of Force Index. There is only an uptick of the histogram and a crossing of prices above the fast EMA. The would not be enough to get me from the sidelines and into a long position. Furthermore, it seems a little late to be entering this long trade. The purchase price of $8.10 is near the top tick of the day and closer to the center of the channel than to its bottom. If I was -going bottom-fishing, I would try to buy below value, in the vicinity of the lower channel line. At this point I would give a pass to this trade.
It is important to have a stop for your trades not only in terms of price but also in terms of time. It can be a mental stop, but you should know that if a stock does not do what you expected it to do within a reasonable time, you’ll be out of it.
My advice to new traders is to learn all you can about the three M’s and do it by diligently keeping good records. Thanks to that I am a better trader today than I was last year, and next year I will be a better trader than I am today!
Nobody has ever gone broke taking profits.
Room 7
Gerald Appel – The inventor of MACD
Before computers became available, there were more imbalances in the market. The game now is not what it used to be.
Right now there is no special advantage to buyers or sellers of options, and there are two opposing views. One – let’s buy them because they are cheap and the risk is small. The other – most options aren’t exercised, so let’s sell them and get the income. I think neither side is right or wrong. Buyers will make a lot of money a few times, sellers a little money many times, but in the end both will lose money to brokerage house because of expenses. The markets are very efficient these days, and if there is an advantage, all the big houses have computers to look for it. Everybody deals against the handicap of the expense. In a rising market you can make a consistent profit by selling options but at a cost of lost opportunity. Options are good for flat or slowly falling markets.
The NASDAQ had moved below its 4% band – that was an extremely oversold condition. Even in a downtrend, you can make money buying below this band, but here we had several additional signals. Prices stopped accelerating down and entered back into the band. MACD had been oversold and turned up. A nice clean downtrend line across MACD peaks was being broken. Prices were tracing a downward wedge, with lines converging, which was a bullish sign. I bought the day MACD.
I sold one half on the first move above the upper band and held the other half in case the rally kept going. The market turned up again but MACD began to weaken, its fast line turned down, and that’s when I sold the second half.
There was an interesting signal for a short sale in April as MACD was turning down, but I did not take it. Generally, the odds are not in favor of short sellers because the market has a long-term upward bias, except in a bear market. Being neutral overall made me less enthusiastic about shorting at this time.
One of the key differences between professionals and amateurs is the speed with which they recognize market signals and react to them. A beginner usually waits for a clear signal to emerge, for a breakout to fail, for an indicator to turn around. By the time a turnaround is clearly confirmed, the new trend is already underway. A professional sees his patterns and indicators starting to come together and acts without waiting for total clarity. This ability to act in an atmosphere of uncertainty is a hallmark of a professional trader.
Historically, speculative bubbles take a decade or more to resolve. What tends to happen after a bubble is that you get a decade of relatively quiet, below-average performance.
At the opening the next day (after I bought), my trade showed profit and I closed out half of my position. I often do that, since it take the pressure off the rest of the position.
When a beginner gets the feeling that a market is going to move a certain way, it is usually not an intuition but merely an itch, an attack of gas, or an urge to act. A beginner needs to have a list of clearly defined signals and a matching list of strictly defined actions. A beginner has no right to intuition until he or she has traded successfully for 18 months.
Room 8
A number of winner in a row, which usually takes place in a nicely trending or cyclical market, can feed greed, and perhaps even worse, those illusions of control, omniscience, and magic that often driver traders as much as the wish to support themselves financially through trading. Trying to trade every minor swing is like trying to serve an ace in tennis every time, often with the same poor result. The solution is the same as in sports. I have to back off, return to the basics, think more about myself and less about the market, try to get back into a relaxed frame of mind and back into the game. This is easier said than done but definitely possible.
I was like a hamster in a wheel and did not begin to change until I started printing every chart and marking it. At the end of the month I’d go back and make notes on my mistakes. After a while, I’d see a pattern—the same mistake over and over. I made a list of the most common mistakes and put that checklist next to the monitor, all these little rules based on past mistakes.
At the next page I set up money management. The better I’m doing, the closer to the 2% risk I raise my size. If I am not on a roll, I’ll raise it to 1 or 1.5% but after three losing trades in a row, I go back to 0.5%. I never hit the 6% monthly limit.
I prefer to enter orders after the open to avoid gaps. Also, if the hourly charts show a huge divergence against my planned trade, that’s a no-go.
I look for day-traders by tracking the S&P – first the hourly, then the five-minute chart. If they give me a signal, I toggle through my list of 26 day-trading stocks to find the one whose pattern is the closest to the S&P to put on a trade.
The five-minute chart shows a double bottom into the lower Bollinger band. It is not a perfect bottom – the closings on the two lows are not exactly the same. If the second low is that same or lower than the first, that divergence is good. If it is higher, that could be bad – the win/loss ration is not so good on those trades. I am overlooking that and let it slide because the hourly looks so good.
The momentum confirmed the bottom, and I entered a limit order one cent above the high of the last bar.
Contrary to Michael, I prefer to take each instrument individually – if the indexes give me a signal, I’ll trade index futures, and if a stock gives me a signal, I will trade that stock. Clearly, the markets are interrelated, and I have to keep an eye on one while trading the other, but ultimately each decision is separate.
Don’t quit your day job unless you have another means of support. However long you think it is going to take until trading for a living, triple that time. If you are under pressure to turn a profit to pay the bills, you can kiss that trading account good-bye.
Market volatility is constantly increasing or decreasing. Different trading systems work better under different market condition. If your system no longer gives you good setups, don’t throw it out; wait for conditions to change back. I’ve never found a pattern or method that gave me the same number of setups every month – some months are always busier than other.
Room 9
One of my favorite trades is when a stock is acting very quiet, boring, in a tight range, with little activity – I try to position myself in it because it will often explode. The trick is to figure out which way it will go. Riding it for a few days is very gratifying – you take what the market offers and then go elsewhere to look for a similar setup.
It is hard enough to figure what the market is going to do. If you do not know what you are going to do, the game is lost. Having a profit target works better for me, although sometimes it leads to selling too soon.
Matching your trading to your personality is the critical part of success. I like quick trades, and find it difficult to ride trades for a long period time; I do not have the patience. If I get in at 10 and the stock runs to 15, I do not like to ride it down to 12, even though the big trend might still be up.
“The Hound of the Baskervilles” signal: When the market does not do what strong technical signals say it is going to do, it is a warning that there is likely to be a strong move in t he contrary direction.
Many serious traders have a handful of patterns they like to trade. Success is a matter of accepting discipline and limitations. A professional does not chase every piece of cake; he knows that only a few patterns offer him an edge, and he does not trade unless he sees them.
I started concentrating on my own system, and that’s when my trading turned around. I still enjoy reading other people’s ideas, going to trade shows and conferences, and listening to what others have to say. Now if I hear someone and it does not make logical sense in the first few minutes, I am not interested.
Trading is a journey of self-discovery. In reviewing my trades I find that the more profitable ones are those in which I knew what I was pursuing. Even when such trades do not work out, the losses are held to a minimum because I quickly realize that what I was looking for is not there and exit to preserve precious capital. On the flip side, all trades in which losses are far greater than they should have been have one thing in common. They all have the ingredient of confusion and not knowing exactly what I was looking for in that trade. Finding a trading style that matches your personality is that most important factor in your success or failure. I remind myself every day to continue to observe myself.
Room 10
Option for the stock Investor by James Bittman, 1996
I always check earnings calendar. Normally stocks go up before earnings and down afterwards, no matter how good the earnings, because the good news is already out. I keep an earnings calendar for all my stocks the way younger woman keep menstrual calendars. The 14 days prior to earnings can be very volatile.
The lesson of the trade is that when a stock gaps up outside the envelope on good news and then stalls as the bad news comes out, it is crying out to be shorted.
In options trading, buyers as a group lose money, while sellers as a group make money. In talking to hundreds of options buyers over the years, I have never met one who made money in the long run. The main reason that options are so deadly is that they are wasting assets. As the expiration date approaches, their value drops towards zero. You can be right on the market, right on the sector, right on the stock – and still lose money on the option.
Room 11
Trading with the Elliott Wave Principle: A Practical Guide, by David Weis
Trade About to Happen: A Modern Adaptation of the Wyckoff Method. 2010
Studies in Tape Reading, by Richard Wyckoff
David pulled away from Elliott, calling it “an attempt to impose a static from on the dynamic structure of the market,” and focused instead on the price-volume relationship.
You have to concentrate on what’s right for you, and for me it was price-volume behavior. I focus on that and trying to rid myself of the Elliott Wave. As elegant as the Elliott Wave is, with all its mathematical qualities, it is trying to impose a static pattern on the dynamic entity that is price movement. Price-volume behavior is steeped in reality, and appeals to me more than that mathematical approach.
If you get a legitimate breakout, and later the market pulls back into that area and the ranges become narrow while the closes gravitate to the high of the bar, it is a sign of strength. Conversely, if after a breakdown the market pulls up in narrow ranges and closes low, it is a sign of weakness. When the market breaks out on high volume but there is no follow-through, it shows that a strong effort brings no reward, and it may be gearing up for an upthrust – a false upside breakout. Or it can do that on the way down, setting up a potential spring, a false downside breakout.
I try to buy where the reward is high and the risk is low. I do not like chasing breakouts. I like fading them after they start to fail. Another thing I watch for is what Wyckoff called absorption. The market is coming up to resistance – old longs sell, new shorts come in to establish positions. You can often tell when the market undergoes absorption – there is a great deal of volume, but not enough reward as the market gets read to reverse.
Mark Douglas.
There is an old market saying: “Run quickly or not at all.”
David pays a great deal of attention to the height of every bar. A tall bar indicates a relative ease of movement, but if it is followed by a short and stunted bar, it means that the trend is running into resistance. He is very attentive to the placement of the closing tick within each bar, reflecting the outcome of the battle between bulls and bears. He relies on these and other observations, trying to decide whether the current trend is likely to continue or to reverse.
David also pays a great deal of attention to volume, which he links with price changes. For example, he may refer to a narrow-range day with high volume as “a lot of effort for a minimal gain.” He sees that as a sign of resistance and expects a reversal of the preceding trend. For me, I think that the Force Index provides a clearer view of market activity than volume bars.
Buy new lows and short new highs.
If a support line is violated and then prices come back and close above it, they give one of the strongest buy signals, with limited risk. If prices break above resistance by a small margin and then return to close below that line, they offer a low-risk shorting opportunity.
I have distilled the study of price/volume behavior into the simple elements of price range, position of the close, effort versus reward, ease of movement, follow-through or lack of follow-through, and the interaction of various lines. The market is a kaleidoscope, in which the only certainty is uncertainty. Nothing is black or white; it is gray.
Room 12
The average guy looks at a daily chart, scarcely at weekly. I look at monthlies – and I remember those pictures. When stocks come out of their bases, they sprint, I look for long bases and trade breakouts. I am not smart enough to buy bottoms; I buy strength.
A stock erupting from a long base is like a rocket getting off a launch pad – it needs a powerful initial thrust to get going. Some people say it is overbought, but I say it is just the beginning. If a stock pulls back into its base, however, 9 out of 10 it will not be a winner – something is wrong with it. If a stock dies on me, I won’t look at it again.
I like stocks that are depressed, especially when they have a long sideways movement, building a base.
I am a great believer in “outside reversal” bars. They can occur on daily, weekly, or monthly charts, taking out both the high and the low of the previous bar and closing in the direction opposite to the preceding trend. This pattern works at bottoms and at tops, often marking the extreme points of the moves. I call any stock that falls more than 90% off its top and refuses to die “a fallen angel.” Some of the most attractive long-term buys come from this group, such as SINA. I take the reading of MACD-Histogram at a big discount when prices are so flat. This indicator shines by reflecting market psychology during price swings; when prices are flat, its messages are not that important. What is much more important to me here is that the weekly closing price is above both the 13-week and 26-week moving averages.
Compare the height of the bars at the left and right edges of the chart. They are becoming much taller, telling us that the public is rediscovering SINA after it lay half-dead on the floor for the better part of two years.
We tend to feel calm when other people tell us about their problems and offer them rational solutions. When we deal with our own problems, we often become more emotional. It is easier to give advice to others than to solve our own problems. As the level of emotion rises, the level of intelligence declines. This is why so many traders make harebrained decisions, buying tops and shorting bottoms.
Stocks or even groups of stocks will often sit out one bull cycle and be ready to go in the next one. I call this “recycling’, and it may take six to seven years from the previous price peak to the next breakout of importance. Prior to buying, I want to see a decline of a year or two to a depressed, down-and-out level. Then I want to see four to six years of sideways movement, of base development. I enter after the stock break above a significant resistance level, creates outside reversal bars on the weekly or even monthly chart, or when its relative price performance improves, especially during late-stage declines of your traditional once-every-four years bear markets. After studying everything under the sun, I settled in and became a specialist in simply “Big Base Patterns.”
Room 13
I would not enter a position against the daily impulse, but I would hold one even if the daily impulse turned against it; I would get out only if the weekly impulse turned against my trade.
Room 14
Commodities, unlike stocks, have natural floors and ceilings. A commodity, unlike a stock, cannot go down to zero and disappear. There will always be demand for cotton, wheat, copper, sugar, and other basic building blocks of human society. Price floors in commodities depend on the cost of production – if prices fall below that level, the farmers stop growing and the miners stop mining, reducing the supply and arresting the decline. In extreme conditions a commodity may briefly dip below its cost of production, but is cannot stay there for a long time.
There had been a sharp rally that fizzled out within three weeks. Such sharp rallies are indicative of short-covering: Late-coming amateurs’ shorts get squeezed and they cover in a panic, running prices up and triggering more short-covering. Once the panic is over, there is no follow-through to the buying and the downtrend resumes, taking prices down to new lows, much to the consternation of poor shorts who got squeezed out prematurely. The situation is very different at the bottom that is slowly forming near the right edge of the chart. There is no great volatility, and prices are turning slowly, creating a base that can support a major, lasting upmove.
Room 15
At the right edge of the chart, a powerful upswing is underway. The stock shot up above its upper channel line, with indicators rising to record levels. The next-to-last bar is extremely long, indicating a buying panic, such panic moves are caused by short-sellers caught on the wrong side of the market (regular buyers tend not to feel so urgent). Once the weakest players, the trapped short-sellers are shaken out, the stock is ready to pause or ever reverse.
I believe that insider trading is linked to the way the company is managed and its type of business. Large contracts involve multiple participants and take weeks to negotiate, creating more changes for information leaks. A company cannot change the way it does business or its management method – if it leaked information in the past, it will leak in the future. Because of this, I like to look at a company’s news for the past year to see whether there was a prior signal from Large Effective Volume. If the answer is yes, then the stock is probably a good candidate for my method.
Room 16
Almost all the traders in this book went through at least one severe drawdown. Many, including the author, went through more than one. It is not just the loss of money that rankles. Even worse is the foul mood that goes with it. A person come into the market, makes a few cautious trades, picks up a few dollars, feels invincible, and tosses a major portion of his capital at a seemingly easy trade. The market turns against him, he fails to take small loss, and soon find himself in a deep drawdown. Despairingly, he takes a huge loss, then makes several spastic trades in a desperate push to make back the money, but the more he trades, the deeper the hole he digs.
