Preparation

I think most traders strategy involves the execution of the trade being the easy part. The preparation is what takes the most work and discipline. Going into the trade I already know all of the possible outcomes. I have my stop placed for if I am wrong. I will usually have a moment of reflection on a trade immediately the day after. My best trades have come as price action moves far away from entry in my favor. Here is oil after its sharp decline. This is one of the first real trades I posted with my new ‘system’ and it couldn’t have worked out better. Textbook failed breakdown entry, price moved quickly away and solid trend after.

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I just find it beneficial for my trading emotions that I use such a simple system to evaluate trades. I will either cut quickly for a small loss or I will quickly have gratification and just ride a trend. Trading really does not have to be complex sometimes. Sometimes it is simplicity that works so well.

Fun-DUH-mentals

I think one of the most frustrating things in trading is when someone questions your strategy. The other day I was emailing someone who works at a hedge fund. He asked me of my strategy and I told him. My strategy involves using only statistically proven edges in the market to provide entries. That combined with a successful risk management plan is all a trader needs to be successful (on a very simplified level).

After I told him of my strategy he immediately seemed like someone who did not believe in technicals and trading. He told me that there were billions of dollars and smarter traders who were trying to do the same thing as me. I totally agree with that but it does not take away from the fact that through my own hard work and analysis I have found a profitable strategy.

Furthermore he tried to tell me that I should focus strictly on fundamentals. The same guy who tried to convince me that I did not have an edge in the market through technicals tried convincing me that I should focus on fundamentals. Yes, I cringed also. They are called fun-DUH-mentals for a reason. Everybody can see them and they are immediately reacted upon. Obviously there are basic fundamental strategies combined with technicals to provide returns. But I think most traders understand that price action is the true indication of a market.  Look at oil, fundamentally we are at record levels of storage however oil continued to rally with each set of bad news! Someone trading based off of fundamentals would have been slaughtered in oil, a true trend follower easily took oil short from $95 to $45.

As you can tell I could not even answer the guy because it would have turned into a battle. It was also funny to see how this guy tried to discourage me from my trading goals. Do not let anyone ever tell you that you can not do something no matter who they are. If you do your due diligence have strength in your convictions!

The crystal ball

When everybody starts out in the trading world you are surrounded by opinions and biases. You hear on CNBC that Facebook is destined for $100, you read online that oil still can go down to $20 or you even hear friends talk about picking the coolest stocks. I think it is extremely interesting after a year to find out the best in this business have no opinions. Ask an amateur trader his stock picks and a veteran trader will tell you of his high probability low risk signals.

I have found that my trader psychology over this year has completely changed. I have trained myself away from telling friends “Tesla could go to $300 a share” to telling them “oil gave me a valid entry on a failed breakdown and I have entered a position as long as the trend is intact”. This is not to say that an average person gets extremely confused when someone who is known to be knowledgeable in stocks does not know where the market is headed this year. The average person is still looking for the hot tip or inside information. When asked where I think the market is headed this year I respond every time by saying “I do not know, my crystal ball still isn’t working”. People just do not understand that traders use that knowledge to our advantage. Most of us traders completely accept the fact we have no idea where the market is headed and just trade what the market gives/follow trends. Not only does it produce better trading results to avoid opinions but it is also easier on the trading emotions knowing that the market will do whatever it wants.

 

Let me know what you guys think.

 

 

Manual Backtesting

As I am forming my trading strategy I am using manual backtesting of securities to see how my entries/exits and overall trading plan would have performed. This leaves me with a couple of questions however…

How far back in time should I go to run my tests? A lot of people will run backtests with market data from 10, 20 or even 50 years ago and I think that can give a trader inaccurate data. I think market structure has changed immensely. The market used to be led by human greed and fear and today it seems as if the market has drifted away from that being the main structure. Before people go nuts let me just note that the truth is that intra-day market moves are mainly all run by computers which makes me think that data from 5o years ago needs to be looked at differently. People will say that the programs are made by humans therefore market structure has not changed but computer programs do not have human greed and fear it is a fact. Therefore, when I back test my system I will run it back only 10 years sometimes even only 5 years. The market is changing and so should our strategies of evaluating it.

How should I evaluate my bias of knowing that in the past five years I know for a fact we have been in a bull market? As I said earlier for my system going back 5-10 years is ideal. Then how do I deal with knowing that we entered a strong bull market in 2009 and have been in one since? I think for the most part a small bullish bias in general isn’t exactly a bad thing even going forward into the unknown. It is known that the market should go up over time and that stocks should only appreciate in value. (That is not to say that we have not had periods of succesive negative returns) I think that is why many traders have completely eliminated the possibility of shorting in their strategy. Furthermore, since I trade daily charts only I can know a stock is going from $50 to $300 but if my system gives me an appropriate short signal I will have no problem initiating that short.

Let me know what you guys think.

Traders vs. Investors

It always bothers me when people get in arguments over the difference between an investor and a trader. Many people argue the differences in timeframes, entries/exits or even the tools used to make decisions. (People who believe in fundamentals are usually associated as investors, traders are usually associated with technicals) I was thinking the other day that a glaring difference between these parties comes down to one sentence: Traders buy when prices go up and sell when they go down; investors buy when prices go down and sell when they go up.

Most traders base their core strategy around buying stocks that have made gains in the belief that winners will continue to win. (Trend following, momentum strategies) Additionally, these traders are in belief that it is vitally important to sell a security before a 1% loss could possibly turn into a 20% one. Traders always will hear the words that it is important in trading success to ride or add to winners for as long as possible and to keep the losses from wrong trades small.

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On the other hand investors are much more likely to buy when prices go down and sell when they go up given they are using the essential technique of rebalancing. By now many investors know it is required to rebalance a portfolio if the portfolio asset allocation has been changed drastically. Rebalancing has shown many benefits from outperforming non-rebalancing strategies to decreasing a portfolio’s volatility. Investors are comfortable buying what everyone is selling and selling what everyone is buying.

 

Trend Following

As many other traders, I am on a never-ending journey to find the most efficient and profitable trading system. Many may think that everybody’s journey is unique and obviously, everybody reaches their goals from many different paths. However, I think there is a very common based journey that all traders go through.

Everybody usually starts out by trading with no plan and experience, trading capital is lost and then finally comes the realization that a concrete system is needed to be profitable. Next is the part where a trader tries a bunch of different trading strategies and indicators, never really sticking with one strategy or indicator. This is the part of the trading journey that I am just emerging from. I had looked into a lot of different trading systems and countless technical indicators until I finally found a trading system that I truly believe in and indicators that are statistically significant. I have found my trading system in trend following. Many trading systems come and go because once too many people find out about the edge in the system it is exploited until the system no longer has that edge.

Through my research I have found that trend following has stood the test of time. I think it is because trends will always exist in financial markets and therefore it is almost impossible for the edges in trend following to become totally obsolete. Additionally, the logic behind trend following is the most valid of all the trading systems I have looked into. Trend following does not try to make predictions, trends are simply identified, entered and then exited when the trend is declared finished. I think this is refreshing coming from many traders who try to think of technical analysis as dealing in certainties rather than probabilities. I think it is the smart technical trader when asked about where a certain market or security is headed, answers by saying “I have no idea”. Nobody knows where things are going or what will happen so why try to look through the crystal ball? Trend following puts those ideas of predictions and forecasts to rest.

The last element of trend following I really enjoy is the psychological element. Many traders do not think of their own well being when constructing their trading system, the system must be able to fit the traders personality. I am a very laid back person and I think trend following is the perfect fit for my kind of personality. It is easy for me to remain at peace during my trading because I am not trying to make predictions; I am simply dealt my hand and accept the fact that anything can happen.