Thursday, December 29, 2011

AB=CD measured move

When the first leg of a trend move is reasonably strong (denoted by strong bars with closes near their highs, steep trendline, shallow pullbacks, etc), there is a very good chance that the first trendline break will result in a second leg that should go the same number of points.

The first leg today started with b1 and ended at the double top on b18 denoted by the purple line AB. The size of the leg was 7.5 points. This means the trader can expect the second leg to go about 7.5 points as well. The second leg denoted by the purple line CD also was 7.5 points and exceeded the expected move by 1t.

Measured moves are not guaranteed moves and sometimes the price fails to reach the target or moves way beyond the target. But on a reasonable day when the price action is normal, its a reasonable expectation.

The key to trading is to only take a deep pullback and only a strong leg's first deep pullback (i.e. TL break) at b21.

Wednesday, December 21, 2011

The need to be right

When a trade fails and the market moves against the trader, she may continue to re-enter in the same direction over and over again. At the end of the day, the trader may realize she has been shorting all the way to the top, usually unsuccessfully on a strong bull day. Similarly, some traders will buy every drop on a bear day, assuming that "it should turn anytime now".

Being married to the bias is a common failing. The trader insists he knows better than the market and it should turn and go in his direction anytime soon. The failing to recognize that the market is always right and the trader is always wrong is a fundamental error that can be the difference between one bad trade and a series of bad trades. Such a mindset is also liable to encourage the trader to add-on to a losing position because every failed entry results in a much better price if the price is going to reverse anyway.

A simple but hard way to deal with this is to not have bias. This means ignoring news, TV, economic and political analysis such as why the market should go down because of the misdeeds of politicians, why Europe is doomed or pretty much anything else since news is sensation-driven and does not reflect immediate demand and supply.

Even if you do have bias, if the trade goes against you for a large number of points, you should not enter in the same direction until there was an obvious trendline break and test of extreme.

Most important, do not be shocked that your trade has failed. No one can be right all the time. Keep your loss small by taking an early loss and sit out for a couple of bars if you need to clear your mind. Taking a step back and looking at the overall chart or a higher timeframe will often reset your bias and allow you to recognize trendlines and enter with-trend or sit out of choppy moves.

Monday, December 19, 2011

Going on Tilt

Poker players understand that when a player gets an especially bad beat, he is likely to go "on tilt" and especially when its a large pot. This generally means the player is likely to play the next few hands aggressively on weaker cards and in general make poor judgements trying to win his money back. Whenever anyone at a table has a bad beat, the rest of the table will turn on the player like vultures hoping to take the rest of his chip stack.

This is relevant to traders because a lot of traders approach trading like they approach gambling. A strong belief in luck and other superstition, trading larger size after a beat, bragging about your huge wins but not mentioning your losses, etc. are signs that you may be approaching trading as an alternative gambling system.

And just like gambling, most players will end up losing most of the time with an occasional win that you brag about. If this is the case with you, you are better off going to the casino and playing blackjack -- at least you will get free drinks.

A significant cause of a bad beat is the unexpectedness of the result. The player was expecting a win -- possibly a large win -- but was shocked to end up a loser. This shakes the player's confidence in his ability to read the cards and analyze the players' moves and in general play the game successfully. At this point he needs to win just to restore his confidence and he needs to win quickly. This urgent need will impair his judgement and force a lot of errors. Going on tilt in trading is psychologically very similar.

The way to approach this is to avoid having a large beat. Always enter fixed risk and size. Over time as your consistency improves, you may choose to increase the size but you should never trade arbitrary size just because you are "feeling lucky". You should also never loosen your stops or add-on to a losing position, since large losses are what will impair you psychologically.

In addition, your daily loss limit needs to be fixed. Just as you would leave the table when you realize you are the worst player, you should stop trading for the day if you have been beat 2 or 3 times in the day. Over time, the knowledge that your downside is limited per trade and per day, while your upside is much larger will give you confidence and eliminate the gambler's mentality.

Monday, December 5, 2011


Consistency requires practice and you just need experience with all sorts of price action. When the price action changes by either slowing down to tiny bars or being volatile with huge bars, your consistency will suffer some impairment. This will continue until your trading experience builds sufficient recall that you will be able to react effortlessly.

For many traders, the start of consistency brings a new enemy: Overconfidence. This will trick the trader into trying new setups, increasing size aggressively, taking larger risk and in general work hard on self-sabotaging and loss of their hard earned consistency.

For example, a trader making 2 points consistently by trading the first two-legged pullback of the day may become successful enough that he thinks he can add a new setup or perhaps incorporate a new trading style such as trading mid-bar or on limit. Chances are that the new addition negatively impacts his trading results and may flip him back to being a losing trader.

The devastation and loss of confidence that can follow is possibly severe. A trader may find himself between periods of consistency and inconsistency and lose hope of ever being able to trade consistently for a living.

Overconfidence is hard to treat because its hard to distinguish it from plain confidence when you have to judge yourself. The way to deal with this is to attempt only one new setup at a time and only try it once or twice a day. New styles such as limit trading and mid-bar entry should never be attempted since they are micro-optimizations. If most of your setups are expected to go 4 points, an additional one point by entering on limit is usually not worth the additional risk. Prove all new setups by trying them on disciplined SIM trading first and tabulate results. Many of them are probably not even worth trying.

Remember that success lies in taking a few profitable trades and working on increasing the volume. A trader with only one winning setup that is 70% successful is better off than one with a 100 setups that are overall 50% successful.

You need only one or two good setups. Even a single setup could take years to master so don't try to cram new techniques until you have mastered your current setup.

Saturday, December 3, 2011

Trading Discipline

When trading BPA, I try to follow the following rules:

  1. Clarity: I will not trade unless I read one of my proven setups. I want the setup to be as clear as possible. Any ambiguity probably means the move wont go too far. I want pullbacks to be deep and signal bars to be strong without a lot of overlap. If these characteristics are missing, I will usually wait for a second entry. If the setup is poor, I will often pass it up. I'm OK with not taking any trades on any given trading day. 
  2. Swingable entries: In general, I only prefer to enter setups that will go four points or more. I also want to only enter where I believe the price will not pullback to my entry price after moving away from the signal bar. Often these are second attempts.
  3. Firm stopsStops can only be tightened. Once the price moves a certain distance away from the entry price (say 2 points), I will move the stop to breakeven and lock in gains beyond every new swing point.
  4. A few good trades: In general, I prefer to take a few good trades rather than many mediocre ones. This is because I can be a winning trader with a modest percentage of successful trades as long as at least some of my winners go 2x to 4x the risk.
  5. Daily loss limit: Daily stops losses are crucial. Some days, my game is just off possibly due to lack of rest or unexpected price action. I prefer sitting out and keeping my winnings from my prior days over trading every day and losing everything I've made over the last few days.

Note that the above rules are applicable to any trading system and the important point is to stick to these simple rules since they will help you measure your success and isolate winning setups.

Rule 1 and 3 helps you measure your success and helps you to isolate winning entries.
Rule 2 and 3 improve your win/loss ratio.
Rule 2 and 4 helps you focus on larger moves and not be mesmerized by the current bar or two.
Rule 5 helps to protect you against outlier days when price action is not favorable to trading.

You can measure your progress by keeping a score card of each trade to see if you followed the rules you laid down. Soon you will be able to detect what areas you need to work on.

Thursday, December 1, 2011


Discipline is the ability to stick to your long term goals by successfully ignoring short term temptations. You probably already know if you have a modicum of self-discipline. Are you successfully able to stick to a diet or exercise regime? Are you a person who can stick to a decision to make a permanent change to your life such as waking up at 5:00 AM every weekday or to quit smoking cold turkey?

Most people would stop and wonder here and that means no. Discipline, like muscle strength needs to be trained and built upon and will atrophy when you stop working on it.

For a trader, discipline is the ability to stick to a plan and execute only that plan. For example, let us take a very simple trading plan: Trade the first two-legged HL or LH of the day with a stop loss and profit target of +2 points each. You could add an additional requirement of the entry side tail being 2 ticks or less.

If you want to follow this trading plan, you would wait for a two legged HL and buy above any bull bar with a 2 point stop and target. Similarly, you would wait for a two legged LH and sell below any bear bar. If the pattern does not trigger and turns into a HH or LL, you no longer take the trade and do no trade for the rest of the day (unless you have another setup in your plan).

On the other hand, if it does trigger there are only three ways you get out of the trade:

  1. You are stopped out
  2. Your target is filled
  3. A signal sets up in the opposite direction to your position and is triggered
Discipline is the precursor to consistency. Discipline does not itself lead to consistency, but it does tell you if any of your setups are worth working on or should be dropped from your list. You still do need to find setups that work and once you find one, you are on the way to consistency. New setups that you want to try can be added one by one and discipline is what helps you weed out setups that are not worth trading.