30 March 2009

Sensex below 9600

Sensex remains bearish all through the session on the back of weakness across international markets and closes 480 points down.

Sensex that had surged over 1,100 points during the last five sessions witnessed a major sell-off today. Tracking weak Asian markets, Sensex was 146 points down at 9902 at the

opening bell, and continued to fall all through the day. After plunging below 9600 mark to touch the day's low of 9521, Sensex moved within a range though with a negative bias. A spell of panic selling towards the close led Sensex close 480 points down at 9568 whereas Nifty shed 131 points to close at 2978. Except consumer durables and health care that were marginally up, all other sectoral indices posted losses for the day. Banking and metals sectors were the worst hit, down 7-8% each, information technology, teck , capital goods power and public sector units sectors were down over 3-4% each.  Market breadth, the number of advancing shares to declining shares, was negative. Of the 2,473 stocks traded on BSE, 1,471 stocks declined, whereas 904 stocks advanced. Ninety eight stocks ended unchanged. Most of the index heavyweights ended in the red. JP Associates tumbled 12.34% at Rs78.50. ICICI Bank at Rs337.95, Tata Steel at Rs196.15, Reliance Infrastructure at Rs502.45, DLF at Rs165.55, State Bank of India at Rs1,022 and Tata Consultancy Services at Rs522.75 fell by around 9-12% each. Among other major losers, Hindalco Industries dropped 8.81% at Rs50.20, Tata Motors lost 8.74% at Rs172.30, HDFC fell 8.72% at Rs1,450.55 and Reliance Communications declined by 8.70% at Rs167.85. National Thermal Power Corporation, however, bucked the downtrend and gained 0.80% at Rs183.50. Sun Pharmaceutical Industries was up 0.25% at Rs1,079.50.  Banking stocks were among the worst hit. Kotak Bank dropped 11.02% at Rs268.45, Punjab National Bank slumped 9.97% at Rs397.15, Yes Bank shed 9.59% at Rs49.95 and Axis Bank slipped by 7.84% at Rs397.40. Bank of Baroda, Federal Bank, Union Bank, Indian Overseas Bank, Karnataka Bank, Bank of India and Oriental Bank of Commerce also ended weak. Over 1.63 crore shares of Cals Refineries changed hands on BSE followed by Reliance Natural Resources (1.31 crore shares), Unitech (1.21 crore shares), S Kumars (98.56 lakh shares) and Suzlon Energy (79 lakh shares).

Nifty Intraday Chart 30-03-2009

Click on Picture to enlarge

Dealing with Market Uncertainty

The nature of the markets is uncertainty. Human beings do not like uncertainty. In fact we fear it at the very depths of our soul. Much of our society has evolved in an effort to reduce the uncertainty we face in day to day life, through controlling the environment, and implementing a structure of laws, rules and regulations. This has been largely successful. Although uncertainty in life cannot be totally removed, we have managed to create a structure in which people can live with relative safety and generally a higher standard of living compared with previous generations.

The markets though are different. Unlike society, where we can influence the actions of other people, and where we have some level of influence over the environment, the typical retail trader will have no influence over the action of the market. None, at all!

When you enter a trade, no matter how skilled you are at analysis, there is no certainty in outcome.

So how do we, as technical analysts, attempt to work within the uncertainty of price action?

Generally the first step, because we're human, is to create structure where there is none. My preferred approach is through a framework of support and resistance lines, but there's certainly no shortage of other approaches - whether through an indicator based approach, trendlines and classic charting patterns, wave patterns, or cycles of lunar and planetary movement. Whatever approach people choose, they're overlaying price with an approximation of market movement that provides structure.

The purpose of this structure is to provide a framework within which the trader can identify low risk and/or high probability trades.

That's where a problem occurs for most novice traders. Not used to accepting uncertainty, these traders mistake the structure they've applied to the market, and the entry trigger they've chosen to get into trades, for the truth. They say they understand the probabilistic nature of the markets, but their actions do not show that. Rather, the novice trader trades as if their approximation of the market is actually the reality of the market. They act surprised when the trade goes against them, and wish and hope and pray for the trade to turn out profitable, rather than acting quickly to minimize risk. The novice trader consistently demonstrates poor risk control, poor money management and poor trade management.

Knowledge of technical analysis, whether indicator based or via classic charting patterns, is not the same as knowing the future direction of price

The structure you apply to the markets does not, and was never meant to, provide certainty. Rather it simply provides a framework within which you can understand past market movement, and hopefully identify low risk and/or high probability trades.

Note that I did not say zero risk, or guaranteed 100% profitable trades. No matter how certain you are, you're dealing with probabilities, and some trades will lose. Even a 99.9% profitable system will lose 1 out of a thousand times, and if you're betting everything on each trade it's only a matter of time till you're account is wiped out.

Successful traders have not found some magic system that provides certainty in the markets. Rather, they've learnt to live with the uncertainty.

How do they do this?

a. They have developed and tested a positive expectancy system.

b. They trade that positive expectancy system in a consistent manner, secure in the knowledge and understanding that the outcome of any single trade is not important. Success comes from consistent trading over a long series of trades.

c. They manage risk. No single trade is EVER allowed to place their future survival at risk.

d. And so they trade with confidence that the market cannot hurt them, and a confidence that they will take the correct actions to ensure consistent implementation of their trading plan.

So, if you're stuck in the never-ending cycle of going from course to course, or from forum strategy to forum strategy, STOP NOW. Ask yourself if you're trying to find certainty in the markets. Certainty doesn't exist - your approach is wrong. You're looking in the wrong place.

Rather than continuing to look for a better way to define market structure or enter your trades, just find one system that others are trading successfully, learn it, and learn how to manage risk, and improve your trading edge through better trade management and exits.

Do not confuse knowledge with knowing!

You may be a master analyst, but you cannot ever know future direction of the price.

Stop searching for certainty. Stop trading as if you can know the future. And just manage your risk. The nature of the markets is uncertainty. Human beings do not like uncertainty. In fact we fear it at the very depths of our soul. Much of our society has evolved in an effort to reduce the uncertainty we face in day to day life, through controlling the environment, and implementing a structure of laws, rules and regulations. This has been largely successful. Although uncertainty in life cannot be totally removed, we have managed to create a structure in which people can live with relative safety and generally a higher standard of living compared with previous generations.

Trading Problems - Maintaining Focus

I once heard a statement by Rebecca Fine of www.scienceofgettingrich.net that says something along the lines of "If what you're thinking about isn't something that you want to have happen in the next three minutes... get rid of the thought and think something else."

While that's a great way to live your whole life, and I certainly try to do so, it equally applies to the process of trading, specifically ensuring that we maintain focus during the conduct of our analysis.

Maintaining focus can be difficult. Not only will you face distractions from external sources, such as the phone ringing right during a prime setup, or your partner asking for a light bulb to be changed, or your children asking for help with their homework, but you also face internal distractions from your negative fear-based trading mindset. These internal distractions may be less obvious to the novice trader, but the results can be devastating for your profitability.

If you have not yet mastered your negative fear-based trading psychology, then you are going to face never ending distractions that divert your focus from the job at hand - consistent implementation of your trading plan.

Regardless of how these fears manifest within your trading - complacency, boredom, doubt, procrastination, denial - they will lead only to inconsistent and unprofessional application of your trading plan. And that cannot lead to long term consistent profits.

How do we deal with this negative fear-based trading psychology? Well, that subject cannot be addressed in one article. I'm currently working on a complete home-study program on the mastery of trading psychology, which will provide you with the tools, strategies and techniques for overcoming these issues.

However in the meantime this statement from Ms Fine provides you with a really simple tool to add to your trading toolkit, to ensure you maintain focus during your analysis despite any internal or external distractions.

The process is similar for both long term traders and short term traders. But let's talk short term first, because that's primarily what I do.

As a day trader, your success comes from consistent application of your trading plan. Success comes from conducting analysis on a regular basis throughout the trading session, either on the close of each candle or on a price-alert as price reaches a certain preset level, and then acting appropriately to enter, manage or exit your trades.

What do you need to do to ensure that your focus remains on the process of trading?

Here's what I do:

1.   Document the analysis and decision making process. Have clearly defined actionable steps that you need to carry out every candle to reach your decision to hold, enter, exit, or adjust your stop loss or profit targets.

2.   Set an alarm to go off prior to every candle. If I trade off 5 minute charts, I have an alarm go off 30 seconds before the close of each candle to allow me to pause and check my thoughts. If my thoughts are not related to the objective analysis of the market and the correct implementation of my plan, then they're discarded. My focus is then returned to the documented trading process.

This works regardless of timeframe. If I was trading off one hour charts, I'd set an alarm to activate just prior to the close of each one hour candle. If I was trading off one minute charts, I'd still set an alarm to go off just before the close of each one minute candle. If I was just waiting for a price setup at a particular price level, and had no intentions of trading until price hit that level, then I'd just set an alarm for price hitting that target.

Setting an alarm for timeframes of 15 minutes upwards is certainly a great idea, as you won't necessarily be sitting watching the screen the whole time in-between candles. However, you might ask whether it's really necessary for very short timeframes, such as one minute charts. The fact is though, that it is necessary, and it does work. It is amazing how often I find my mind wandering elsewhere. More often than not, it's thinking about something unrelated to my trading plan. The alarm interrupts this thought pattern, and allows a return of thought and focus to what's important.

Try it, and if you find yourself suddenly wondering what the MACD shows, and it's not part of your plan, discard that thought - it's irrelevant to this trade. If you find yourself suddenly thinking that you need to win this next trade to get back to breakeven, discard that thought - it's irrelevant to this trade. If you find yourself wondering where you should go next holidays, discard the thought. Once again, it's irrelevant. Interrupt any unwanted thoughts, and think something else that will help you trade your plan in a consistent manner.

Oh, and so that you don't burn out through having an alarm go off every minute for an eight hour trading session, let's add a step 3:

3.   If you are trading a very short timeframe, program breaks into your session, to get away from the markets. Relax, recharge and refresh yourself, so that you can keep up this pace.

For longer term traders, let's say someone trading off daily charts, the problems are the same. In your case, you have a process that needs to be followed to come up with your decisions to enter a trade, exit a trade, or modify target or stop levels.

In this case, you still need to implement step one, documented actionable steps that allow for consistent application of your plan. Consider something like a checklist, or flowchart.

You can probably dispense with the alarms, as you only need to complete the process once. However for longer term traders, I'd recommend including statements within your documented process to remind you to check your thoughts, and return them to the process of trading.

Perhaps prefix every step with a documented reminder such as, "I am a professional trader, and a professional trader trades their plan in a consistent manner". Then, the act of commencing each step of your nightly analysis, will serve as a regular interrupt to unwanted thoughts, and a return of your focus to the job at hand.

This way, there's no need to be going and checking other indicators for further confirmation, when it's not part of your plan. There's no need to be checking other news sources for further justification of your decisions, when it's not part of your plan. There's no need to be emailing or phoning your friends to seek their thoughts on a particular stock or chart, when it's not part of your documented process. These are actions of people who have lost focus, and whose trading destiny is being led by their fear and greed.

As a professional trader, you simply follow your steps. And use your alarms, or documented checklist steps, to interrupt any unwanted thoughts, and return your focus to the business of trading.

So, if you don't already have a checklist or flowchart set up for all actions that must be carried out during your analysis, then create one. And place in it reminders to monitor your thoughts, and reject anything that is unrelated to the current task at hand.

And if you day trade, set up an alarm, either price based if you simply wait for price to hit certain levels before making trading decisions, or a countdown timer if your decisions are time-based. Then reject any thoughts that are unrelated to the process of trading. And follow your plan with consistency.

Favorite Trading Strategy

What I'd like to do in this very short article is give you an overview, looking at the strategic level, of how I trade my favorite setup, which will be the one referred to in most of the analysis on my website. We're talking, 'the big picture'.

Too many people make a critical error in focusing exclusively on their entry triggers, and trying to enter on every occurrence of that signal, without ANY consideration for where that trigger is occurring within the bigger picture market structure.

Too many novice traders spend far too long trapped in this stage of learning. They discover a new trigger and a part of their mind then becomes excited that maybe they've found the holy grail of trading. It doesn't matter if it's an EMA 10/20 crossover, or perhaps a MACD crossing above zero, with stochastic rising, and RSI above 50. It is NOT the Holy Grail. It is just an entry trigger.

The fact is:

• Market Structure tells you where to trade.
• Entry triggers tell you when to get in and out of your trades.

Focus on defining the structure of the market first, and then look for a trigger.

Let's say for example that our entry trigger is a candlestick reversal pattern... in this case a Bullish Engulfing Candle. Where would you find the higher probability trade?

Would it be at the top of an extended rally, where the Bullish Engulfing pattern is pushing straight up into the overhead resistance?

Or is the higher probability trade where the Bullish Engulfing pattern shows that a major support level has held and there is significant profit potential still available from the entry point to a projected target at the overhead resistance level.

It's exactly the same entry trigger, but obviously the market structure tells us that the second entry is the higher probability trade.

REMEMBER: The market structure (in this case Support & Resistance) tells you where you should trade. The trigger tells you when to get in or out.

Now, market structure doesn't need to be just support and resistance. YOU need to consider, 'what is the reality of price action as you see it? What do you believe causes price to move?'

Have a look at a number of charts... What do you see?

Is it perhaps a framework of support and resistance levels defining areas of price stall or reversal in the market?

Do you see a "rubber band" type concept, with the market reaching extremes and then reverting to the mean, or centerline moving average? Moving back and forward between the upper channel line, the centerline, and the lower channel line

do you see swings? Higher highs & higher lows, lower highs and lower lows, with impulses of momentum in between

define how you see the bigger picture of market movement. What is it that you see when you look at charts? What is the market structure? And only then should you look for an entry trigger that gives you a low risk and/or high probability trade within the context of your bigger picture.

So, what do I see as the reality of price movement? How do I trade? What is my strategy?

Well, in this short article I can't go into the tactical level - I can't talk about my entry and exit triggers, and trade management strategies. It would take a whole book because it's not just a simple indicator based entry or exit. It's based on price action - on an understanding of the nature of movement of price. That takes a long time to develop, and it's something I'll cover in my website in a lot more detail.

However, for now I can share a very broad overview of my strategic level trading concept. At least my favorite one anyway

the reality of price movement for me is supply and demand. And that supply and demand leaves footprints that can be read in a price chart.

All price movement, all turn points, and all areas of support and resistance are a function of the balance or imbalance of supply and demand.

In particular, the key areas which allow for low risk or high probability entries are areas of support and resistance.

I trade within a framework of support and resistance.

I define all major support and resistance based on a higher timeframe, and then look to profit from movement between these areas on a smaller timeframe.

For me, my markets of choice are forex & equity indices. The longer timeframe for defining major support and resistance, is an hourly chart, and the trading timeframe is anywhere from a 1 to 5 minute chart.

The strategy works with other markets as well, because it's based on the truth of price movement. And because markets are largely fractal in nature, you can adjust the timeframe to suit. Say you wanted to trade the daily charts - then you just get your major support and resistance off the higher timeframes - being weekly or monthly charts.

So, the major support and resistance areas are placed on the chart, and I'm looking for any low risk or high probability trades (based on my entry triggers as defined in my trading plan), going long off major support or going short off major resistance.

And for the price movement in-between major support and resistance

if it's an uptrend I look for low risk or higher probability entries at areas of minor support.

If it's a downtrend I look to go short at low risk or high probability entries off minor resistance.

And if it's a sideways trend, then I aim to identify low risk or high probability entries off both minor support and resistance.

Key point though for all entries - It must be a low risk or high probability entry, based on the clearly defined criteria in my trading plan

so there you are... It sounds simple when looked at from this high level overview. The reality is though, that it's really hard. The statistics of failed traders clearly show that. Success takes a long period of time. Whether you relate to my view of the markets, or prefer some other method of defining market structure, spend a lot of time just watching price movement. Learn to 'read the tape' as it used to be called, internalizing the patterns and flow of movement of price. It takes time. Be patient, and embrace the challenge.

Stop just blindly entering at every occurrence of your entry trigger. Remember:

• Market Structure tells you where to trade.
• Entry triggers tell you when to get in and out of your trades.

 

Stop Losses - My Biggest Downfall

One of the common email questions I get through my website relates to difficulties in sticking with stop losses.

Some traders don't place one in the market at all, promising that they'll get out when price hits a certain level. Of course, when price gets to that level there's no shortage of reasons why they should hang in there just a little longer. If they let it run just a little further it's sure to move back into profits.

Other traders have no problem placing their stop. But for some reason, they decide to remove that order from the market before its hit.

Well, I got another email this morning - "...Sticking to stop losses is my biggest downfall, any suggestions?"

This particular question came from someone who says they're fairly new to trading, so I think it's great they've recognized this problem so early. Well done. But it's such an important question and such a common question, that I felt I should share my answer.

Firstly, difficulty in sticking to your stops is certainly a common problem - so don't feel too bad about it. This means it's not just you - others have been through the same issues, and overcome them. So there's no reason why you can't do this as well.

The difficulty is getting rid of this bad habit. Traders say that they understand the need for the stops - they see the danger in letting the trade run - but for some reason even if they had full intention of exiting at the stop loss, they still let it run, either by not placing the stops at all or by removing the stop once it's in the market.

Where does this problem come from? Well, I could write a whole book on this, but let's try to summarize it here.

Basically I believe the problem is fear. Not just the fear of a small loss of money occurring with this trade, but a much deeper fear at the very heart of your trading endeavor and your life. What does total failure to become a trader mean to you? What does losing all your money mean to you? What does that mean in terms of your opinion of yourself? What will your family think of you? What will your friends think of you?

This is what you're risking every trade, because every small loss takes you potentially one step closer to ultimate failure.

So, even if a person rationally understands the need for stops, and places a stop in the market with full intention of following their plan, they succumb to the greater fear as the trade approaches their stop loss and remove it from the market. After all, the nature of the market is 'uncertainty', so it can surely come back from here and get into profit again. And you can ALWAYS find further technical analysis to support your decision to remove the stop, and hold for just a little longer. And there will ALWAYS be other analyst or news opinions to support the decision to remove your stop.

Sorry if this sounds all rather dramatic, but its reality and it will continue to happen until a person learns to manage their trading decisions despite their emotions. (Note that I didn't say 'control' their emotions. Too many people say that you need to control your emotions, or trade without emotions. Rubbish! You're human and the emotions will happen no matter how much you want to control them. You cannot overcome them by willpower on a consistent basis. You rather need to find strategies to manage your trading decisions despite these emotions).

So, the way forward:

1. Establish total confidence in your system - ensure thorough back testing and forward testing so that you KNOW it provides you with an edge, despite small losses. This will reinforce the fact that small losses are part of the system, and can't hurt you over the long term.

2. Compare results had you let stops run - go over your historical trades, and compare results had you not got out at your stop. Initially you might find that many of them did come back. However work out how much money you can afford to draw down before you either lose everything, or the pain would become unbearable. Then all you have to do is find one or two that don't come back before getting to this point. This will reinforce the danger of letting your stops run.

3. Ensure stops are always placed in the market. If your broker doesn't allow for an exit order attached to an entry order, get a new broker. Despite the fact that some traders still remove the order once it's in place, it is still harder to do that than not placing one in the first place. So make sure you always place an exit order at the same time as your entry order.

4. Ensure you have a documented trading plan, and procedural steps (eg. checklist) for trade entry, management and exit. Ensure that there are no circumstances within your plan that allow for removal of your stop loss. Then as you trade these steps, act as if you were two people (stick with me here, I know it's getting weird) - firstly you're the trader, and secondly you're the boss of your trading firm who is a real fan of risk management and following rules. For every action that you as a trader make in entering or removing an order from the market, pause and assume the identity of the boss of the business - would you be happy with the decision that your employee is making, or would you overrule it? Would you sack the trader if he makes the decision he's about to make? Often this is sufficient to overcome the problem. Assuming the identity of the 'boss' or 'risk management guru' allows our rational side to come through and reinforce the need for taking our small losses.

5. Use an accountability partner. Explain your problem with someone independent from your trading, perhaps your wife, husband or a friend, and ask if they are happy to assist with your trading through ensuring compliance you're your plan. Then, after each trade (or trading session or week), show them each of your trades. Show them evidence of the stop placed at entry, and held till exit. Enforce some form of punishment if you break your rules - make it something you will really hate. Often we find that it's easier to hold the stops if someone else is depending on us to do so - the fear of embarrassing ourselves through showing poor discipline can often be enough to counter the fear of loss, and keep your stop order in the market.

It's a difficult problem to overcome. But through building confidence in your trading strategy through thorough testing, and through disciplined application of your plan with the assistance of your 'alter-ego' boss and your accountability partner, you can overcome this. Never give up.

The Hidden Secret of Technical Analysis

Did you know that there is a whole 'other world' of technical analysis that most novice traders are either totally ignorant of, or fear to go due to the fact that it might actually require some work?

Well, there is! And I'd suggest that if most novices fear to go there, then perhaps it might be worth some investigation.

What is technical analysis? For most novice traders it seems to be one of, or a combination of, the two following approaches:

a. The art of defining recent price action through classical charting techniques such as the Dow Theory definitions of an uptrend and downtrend, and recognition of patterns such as channels, triangles, head and shoulders, cup and handles, and on and on, or

b. The art of representing price action through the numerous indicators available on your charting platform, such as moving averages, stochastic, MACD, and on and on.

This is great. It's a good start. But the fact is that no matter how we define the structure of the market, whether based on Dow Theory, or Elliot Wave Theory, or through an indicator based approach, it is important to remember that this structure defines PAST market movement. It's a simplification that allows us to quickly identify what happened in the past.

Profits come from future price action though, not past price action. So having defined past price movement, these traders then use general rules associated with that past price action to justify an entry into the market.

For example:

• "The break below the neckline in a head and shoulders pattern is a great entry short, with a target equal to the distance from the neckline to the peak of the head." - so having identified a breakout down, they enter short.

• "A moving average crossover is an indication of a change of trend" - so identifying the EMA 10 crossing above the EMA 20, the novice trader enters long.

Once again, this is great - hopefully at least better than random entry. These general rules for entry are fine if you're satisfied they provide a slight edge, and you have a complete understanding of the probabilistic nature of price movement, and an appreciation for the necessity of position sizing and risk management. You may well make some profits.

However I'd suggest that there's a whole other world of technical analysis that you're not seeing. That still won't guarantee success (the elusive Holy Grail doesn't exist, so stop looking), but it will provide further opportunity to increase your edge. Use of this hidden world of technical analysis will allow you opportunities to enter lower risk and higher probability trades. Lower risk trades through getting earlier entries closer to support and resistance areas, so you can safely place tighter stops. Higher probability entries, through analysis based more closely on the truth behind price movement rather than a general rule for pattern or indicator based entry.

So where do we find this 'other world' of technical analysis?

Look behind your indicators, or behind the classic charting patterns, and what do you find?

Price action!

It doesn't matter how we define past price action - an uptrend, a downtrend, a range-bound sideways trend, a head and shoulders pattern, an ascending triangle, wave 4 of a five wave pattern. It's just a label that describes an approximation of past market movement.

The label is not important. What is important is the nature of price movement behind the pattern or indicator overlay.

Too many people will say that, because the price is above the 50 period moving averages, or because the 10 EMA is above the 20 EMA, or because they have identified a structure of higher highs and higher lows, the market is in an uptrend. They apply a label - uptrend. And that's it, end of story. No correspondence will be entered into. The market is in an uptrend, and they're looking for trades in the long direction.

Looking beyond the "uptrend" to see how price is really moving can allow us to see the internal strength or weakness of the trend. It can provide you with an insight into the fear, doubt or greed of the market participants that create the price action, which then creates the price trend or pattern, or moves the indicators.

I'm not saying you necessarily have to get rid of your indicators - just recognize them for what they are - a useful approximation of the market.

And recognize that if you want to improve your edge, you may need to look behind the pattern, look behind the indicators, look beyond the label, and see what price is really doing.

• Is the volatility of price movement changing, and what does that mean?

• Is the momentum increasing or decreasing? What does that mean?

• Is the momentum of this price move greater or less than the preceding swing, and what does that mean?

• Is the momentum of this price move greater or less than the previous swing in the same direction, and what does that mean?

• Let's go even deeper, and consider the thought processes and psychology of the people who are long (or short) in this trade, and currently sitting on a profit. Where are they looking to exit? Where are they going to take profits? Where are they going to place their stops? What does this mean for future price action?

• Let's consider the psychology of the traders who are currently fighting this move, sitting in drawdown, sweating on every tick and praying to the market Gods - "If you can just this once turn price around so I can get out at breakeven, I promise I'll never again take such a stupid trade". Where are these people trying to get out? At what point will the fear become so great that they'll just have to get out?

• Lets consider the psychology of the people sitting on the sidelines, having missed the start of the move. Some of these will be professional traders - where will they be identifying a low risk and/or high probability entry into this trend? Some of these will be novices - where is the absolute worst place to enter, having chased the market and entered simply out of fear of missing out on the move? Yes, some people do enter right at the very worst tick possible. Where potentially is that, and what does that mean for future market movement?

The answer to all these questions will make a great subject for future articles. For now I'd just like you to start looking beyond the indicators and patterns, and discover a whole other world of technical analysis - price action.

Examine the current internal nature of price movement - the speed, the momentum and the volatility. And consider how this is likely to influence the decision making of the novice traders who will be entering and exiting the market based on their own fear or greed.

And try to discover how you can use this information within your current strategy to lower the risk of entry, improve the probability of your entry being in the right place, and improve the management and exit of your position.

If you are interested in improving your current edge in the market, analysis of price action may be just what you're missing. Check it out now.

 

Trading Risk Management - Tight Stop Losses

Here's an extract from a great email conversation with one of the Your Trading Coach readers, in which he discusses the use of tight stops:

"I adopted this approach in the beginning, but got stopped out of the market so many times I started to widen them. I've had on too many occasions the market pull back on my stops only to find that it went on to do what I thought it would. Meaning, I lost out again on a good trade. However, I do admit the financial risk is higher. But expecting the market to move fast every time in your desired direction is a lot to ask."

This is a common observation. There's nothing more frustrating than being stopped out and then watching the trade move on to your target without you.

There's actually no right or wrong answer with regards stop placement, only what makes you money and what doesn't. So if wider stops provide a greater edge for your trading, then that's absolutely the right thing for you to do.

For me though, wider stops just don't fit with my trading style, risk tolerance or psychology.

In any case, I thought it might be beneficial for some traders to hear a little about what tight stops mean to me.

It is my belief that regardless of whether a trader uses a tight stop or a wide stop, it should be in exactly the same place.

Having tight stops doesn't mean finding an entry and then placing a stop loss a small fixed distance away and just hoping it isn't hit. Regardless of whether a trader's intention is to operate with a tight or wide stop, the stop loss should be placed in a position which invalidates the setup.

If my stop is hit then it means that either something has changed in the market, or my setup was invalid. Either way, I shouldn't be in the trade.

So for me, the stop should be in the same place, regardless of how large my risk. That place is where I have proof that my setup no longer provides an edge in the market.

The low risk (tight stop) comes NOT from positioning the stop close to the entry, but rather from positioning the entry close to the stop.

For example, if my intention is to enter LONG on a retracement to an area of support, my stop loss will be below the swing low which forms at support. Then, I'll aim to enter as close to that support as possible. This is how I get tight stops.

In some ways this is opposite to most traders. They'll find an entry and then work out the stop loss position. I'll be different in that I know where the stop is, and then work out the entry. And if I can't get an entry that allows sufficiently small risk, I'll just pass on that trade.

Oh, and one other important point - lower risk comes also from incorporating a time stop. If the trade doesn't go my way within a reasonable amount of time, then I'm outa there. I recommend reviewing your trades and gaining an understanding of how quickly your setups should be moving into profitability. Then if that time period passes and you're still stuck in the vicinity of the entry, or in a drawdown, then maybe your setup has lost its edge. Maybe it's time to stand aside and look for the next opportunity in the markets.

 

Introduction to Charts for the Beginning Technical Analyst

This is an introduction to charts and how to read them for beginning technical analysts. Technical analysts are investors who utilize technical analysis when conducting investment, focusing on price movements rather than on a company’s fundamentals. Fundamental analysts use fundamental analysis as an investment approach, which focuses on a company’s income, price-earnings ratios, assets and other indicators, unlike technical analysts. Technical analysts use charts to examine securities and forecast price movements. For the total beginner, “securities” refers to any tradable financial instrument such as stocks, bonds, futures or market indices, and other financial devices. Any security with data over time can be used to form price charts. Because charts provide a graphical representation of a security's price movement over time, they are also of use to fundamental analysts as well. A historical graphical record makes it simple to study the effects of events on price, performance over a period and a security's actual trading near highs, lows, or in between. The timeframe used for the chart varies according to the compression of the data: intraday, daily, weekly, monthly, quarterly or even annual data are the major timeframes commonly utilized.

What are the different kinds of data? Daily data is made up of intraday data that is compressed to show each day as a single data point, and weekly data is made up of daily data that is compressed to show each week as a single point. The shorter the timeframe and the less compressed the data, the more detail available. However, short-term charts can thus be volatile and contain a lot of “noise”, where noise is basically a distortion of the actual patterns or trends by events that are not important to the analysis. Large sudden price movements, wide high-low ranges and price gaps can affect volatility, which distorts the big picture. Investors usually focus on weekly and monthly charts to spot long-term trends, and because long-term charts cover a longer time frame, price movements do not appear as extreme and there is less noise. Some technical analysts use a combination of long-term and short-term charts, where long-term charts are good for technical analysts analyzing the big picture to get perspective of historical price action. Once the picture is examined, then a daily chart can be utilized next to focus closely on the last few months.

There are many charting methods, such as bar charts, line charts, candlestick charts, among other charting methods. The most popular charting method is the bar chart, in which the high, low and close are needed to form the price plot for each period. Bar charts can be effective for displaying a large amount of data. For example, line charts show less clutter, but do not offer as much detail. There are also candlestick charts. Candlestick charts are also rather popular nowadays. For a candlestick chart, the open, high, low and close are all presented. Many traders and investors believe that candlestick charts are easy to read, especially the relationship between the open and close.

 

Now for yet more technical words and technical aspects of technical analysis: There are two methods for showing the price scale along the y-axis: arithmetic and logarithmic methods. An arithmetic scale displays 10 points as the same vertical distance regardless of the price level. Each unit of measure is the same throughout the entire scale. A logarithmic scale measures price movements in percentage terms. However, arithmetic scales on the other hand are useful when the price range is confined within a relatively tight range. Arithmetic scales are useful for short-term trading. Price movements are shown in absolute dollar terms and reflect movements dollar for dollar.

In the final analysis, even though many different charting methods are available to the analyst, one charting method is not necessarily better than another technique. Why? The data is the same but you can see that each technique does provide its particular interpretation, with its benefits and disadvantages. The data is the same, hence, price action is what counts. Therefore, it is the examination of the price action that separates successful technical analysts from unsuccessful ones, and after all, that is the key to technical analysis. The choice of which charting technique to use will depend again on individual preferences and either personal trading or investing styles. Once you have chosen a particular methodology it is best to stay with it, and develop how best to read the signals using that method. Switching to other methods may cause confusion and destroy the clarity of your analyses, leading to bad evaluations. More investment research and education will definitely help you. Good luck with your technical analysis education and investment future.

Greed and Fear: What Does It Take to Get Rid of It?

We have heard it: the market is not driven by money but by greed and fear. The two biggest emotions that move markets up and down at random; they seem to fluctuate without any logic behind them.

Why do we get these emotions when we trade? After all, it's stocks we're trading, not playing sports where our bodies are physically working to exert energy and sweat. So why then does it take to so much emotion just to click a buy button and a sell button and watch the screen with numbers moving back and forth?

When it comes to money, it's the master of us all. It doesn't matter what walk of life we hold, we are taught that money is the only way to reflect us as successful and accomplished people. But in the end, does it come down to money to become successful in trading?

The answer is no. Why? Success comes from loving what you do, not from doing what you're doing for the sake of money. There are people who work at jobs they don't like. Many do it just to get by but do not have the drive to excel. People who love their jobs have higher probability to excel in their work because they don't see it as work but something they love to do. Many of us enter the market to make money, not lured by the challenge of figuring out how the market works. It is the reason why new investors and traders start by placing a large position thinking the trade in monetary value, profit or loss. They think will be quick and easy, not really giving thought on how to figure out this complex but interesting market first before committing money in there. By committing money, it's about the money, not the pleasure of learning about the markets.

This is where fear and greed comes in. This very first thought people make when entering is 'how much can I make?' and not 'I wonder how this market works?' There is a big difference in this mindset. When we don't worry about the money, we can view things in a more objective way. Believe it or not, there is a fine line from being in a trade and out of a trade, especially holding a big position. The emotions overtake judgment very quickly when a major loss is on the line with the prices fluctuating rapidly.

So how do deal with this? There are several things we can do keep greed and fear out of the trading plan:

1. Start trading smallest positions possible -The idea is to learn, improve and perfect trading while not thinking about the importance of gains or losses. This should subdue if not remove the fear and the greed.
2. Use stop loss order - Believe it or not, stop loss orders bring comfort and peace of mind that would otherwise bring many traders sleepless nights. Why? Not knowing how much the loss is, which can be unlimited, carry a major concern. This method will get rid of the fear factor.
3. Create a trading plan - Having a plan of attack, where to get in and where to get out in a certain market condition relieves the trader from having to think on his feet; without a plan will cause the trader to freeze and be indecisive and in turn cause more emotional stress.
4. Set target price - This may help in deciding before the trade when to take profits, not leaving to decide when to exit. Target profits helps against greedy feelings on thinking that the profits will continue to rise. When it doesn't and profits turning into losses, the tendency is to freeze and not take action. Having profit targets also help prevent the taking profits too early. This is also a fear stemming from being afraid the profits will disappear and turn into a loss.

This is the worst aspect of the trading: lack of self-control. Trading gives total freedom on deciding when and where to buy and sell but this is also why freedom becomes a hindrance. Discipline is the only method to alleviate fear and greed. Without it, it will set the tone a fear of losing everything and greed will prevent from taking profits when it's right the time to do so.

 

Using Simple Moving Average to Improve your Trading

The significant points are where the averages cross one another, and it is at these points which we must pay attention, and try to draw some conclusions from the price action. The crossover point can represent the change in sentiment from rising prices to falling prices (or the other way round) but be careful - when you watch these averages they will often cross over and return on their original path, so they are not a reliable indicator and remember also they are lagging. So treat them purely as a rough guide to what is happening - not a hard and fast rule. They are there to give an early warning to pay attention - nothing else!!

In summary, a simple moving average is an early warning system of POSSIBLE future changes in direction. Read them in conjunction with your candlesticks and volume interpretation to see if the alarm can be validated by your analysis from the chart readings. Do not use them in isolation, or try to use them as some sort of indicator - you will fail! They are a rough guide ONLY - no more no less.

Using Simple Moving Average to Improve your Trading

Technical analysis

Technical analysis is as the name suggests the observation of stocks using chart data in order to predict ups or downs of any given stock. Those who practice this are generally not concerned about the overall value of a company. They normally engage in short term trading with the idea of making a quick profit.

The idea behind any chart data is the recognition of pattern movements. The goal is to spot these patters and make money on them when you can. As a result of efficient data collection by the stock market on events such as natural disasters, terrorist attaches, and company performance the theory is that you will be able to make good calls on any given stock.

The thing to note with this type of investing is that this is not for longer term. The goal of such investors is to watch stock patterns. The fundamentals of company growth are not taken into consideration. Therefore long term performance of a given company is not the key component. The fundamental of technical analysis is the execution of profitable investments over the short term.

Investors using this data can take advantage of stocks that are either rising or falling. They can then implement a stop loss order to reduce losses on either end. This like any other technique with an objective in mind sets out to achieve a given result through the use of data collection over time and then predict outcomes based on that same data. These investors rely on charts and analysis of such charts to make profitable trades. That is the essence of technical analysis.

 

In the world of trading and investing, there are literally hundreds of technical indicators that have been developed over the years by a variety of people, fascinated by the markets. All the indicators have three things in common. Firstly they were developed as a silver bullet to tell you exactly when to open or close a position, secondly, they are all based on lagging information, and thirdly they all work some of the time!

The only indicator that I use in my daily trading is the simple moving average or SMA. They are the most basic and simple indicator of all, and whilst they are a fairly blunt tool in our tool kit, they do offer a very basic overview of what is happening on the chart, and provide simple guidance as to the possible future direction of prices.

As the name suggest a simple moving average is simply that - so a 20 day SMA is the last 20 days prices added together and divided by 20 to arrive at an average. I did say it was simple. That is all there is to it! - I only use 2 to keep the screen uncluttered and these are a 50 day and a 200 day. When you listen to commentary on the markets on the financial news stations, or on TV you will hear them refer to these figures - i.e.: ‘a commodities price has crossed below its 200 day moving average’ - so even the professionals use them! The reason that I only use two is that they give me a slightly different view of prices over different timescales, and the screen remains clutter free.

Strategies for day trading

Basic Rules:

·         Select liquid stocks only.

·         Select a few stocks only.

·         If you are already holding the stock wait for the peak or the bottom

·         Watch the general sentiment (Index Support/Resistance)

·         Don't be over enthusiastic.

·         Never challenge the market.

·         Place stop loss orders in a highly volatile market after long or short trades

 
Strategies:

Trade on unknown trends: When the market opens trade on a stock based on the previous day’s movements. Partially or fully cover the trade within half an hour

Trade on known trends: When the market is about to close (half an hour before) trade on a stock based on the day's movements

Trade on resting stocks: Stocks which have risen/fallen substantially will take rest for some time. Watch it and trade

Trade when trends are known: In a bull market raising stocks will raise further. Wait for correction and buy. In a bear market falling stocks will fall further. Wait for up move and sell.

Trade on news: The general philosophy is to buy on rumors and sell on news. When the news is favorable and the stock has risen considerably go short. When the news is unfavorable and the stock has fallen considerably go long.

Trade on appetite: If you think that you have made enough profit/loss stop trading.

Trade after trails: Start with small lots and go for volumes after enough study.

Trade on previous trend: Instead of buying a stock with previous days declining trend, it will be prudent to buy a stock with previous day’s uptrend on declines.

Instead of selling a stock with previous days up trend, it will be prudent to sell a stock with previous days downtrend on up move.

Trade on dates: Stocks rise/fall prior to announcement of results. Have knowledge on this date which will help in making decisions.

Trade on volumes: Rising/Falling Stocks which shrink in volume indicate that the run is nearing final state. Watch for change in trend.

Stock Market Returns

What the Real Traders’ Make

When I tell people I often make over 100% per annum in the stock market they look at me is disbelief. Why? Probably because they have been told by their, friendly financial advisor, the normal B*S* when it comes to what you realistically expect from the stock market

You know the kind of drivel we hear every day from these so called "experts" who have probably never read a book on stock trading never mind actually traded their own accounts. Words such as:

"Invest for the long term"

Usually after your portfolio is down about 50%

"Buy and Hold Blue Chip Stocks":

Their favorite stock has fallen 90% in the past 6 months.

"The stock market has gone up on average 15% over the past 50 years"-

Trying to explain why your account is down over 50% and their strategy stinks.

"Even the best funds rarely outperform the stock averages"-

The fact is most doing not even perform with the averages.

"Trading is risky and only professionals should do it"

Right.... Then why do so many fail dismally at it?

"No-one can outperform the stock market averages"

Trying to make you feel better after you see your pension fund is now down over 50% and you'll have to work an extra five years.

I don't see too many money managers worrying about trying to outperform the market. Do you ever ask your-self why not? They'll tell you it can't be done. WRONG. The fact is they get paid for MANAGING your money not from trying to create money for you.

If you don't think outstanding returns can be made from the stock markets then read on: Think of your 401k and pension fund as you see these staggering returns:

 

 Michael Marcus: Turned a $30,000 account into over $80 MILLION

 Tom Baldwin: $25,000 into over $2 Billion

 Paul Tudor Jones: Triple digit returns five years in a row.

 Ed Seykota: 250,000 percent returns on his account over 16 years!
Shall I carry on? Let's do so.

 Richard Dennis: Turned a $2,000 into $200 Million.

 Nicolas Darvas (the best): $25,000 into $2, 25 million (in 18 months)

 Jesse Livermore: $500 - $100 million - $0 - $100, million - ZERO....

 Michael Lauer: Provided investors with a 50-fold return over seven years.

 Mark Cook: Registered back to back gains of 563% and 322%.

 Steve Lescarbeau: Trading system that has averaged a 70% return ever year.

 Steve Cohen: Manages billions of dollars and averaged returns of 90% during the past seven years

 Mark Minervini: Averaged 220% annual returns in the past five years.

O.K, your first question might be who are these people?

They are real people, who not only make massive gains from the markets but do it with millions under management. These aren't day traders.

So the next time your mutual fund manager tries to fob you off with an excuse as to why he could not even match the stock market averages tell him about some of those traders listed above.

Pivot Point Trading

You are going to love this lesson. Using pivot points as a trading strategy has been around for a long time and was originally used by floor traders. This was a nice simple way for floor traders to have some idea of where the market was heading during the course of the day with only a few simple calculations.

The pivot point is the level at which the market direction changes for the day. Using some simple arithmetic and the previous days high, low and close, a series of points are derived. These points can be critical support and resistance levels. The pivot level, support and resistance levels calculated from that are collectively known as pivot levels.

Every day the market you are following has an open, high, low and a close for the day as this information basically contains all the data you need to use pivot points.

The reason pivot points are so popular is that they are predictive as opposed to lagging. You use the information of the previous day to calculate potential turning points for the day you are about to trade (present day).

Because so many traders follow pivot points you will often find that the market reacts at these levels. This gives you an opportunity to trade.

If you would rather work the pivot points out by yourself, the formula I use is below:

Resistance 3 = High + 2*(Pivot - Low)
Resistance 2 = Pivot + (R1 - S1)
Resistance 1 = 2 * Pivot - Low
Pivot Point = ( High + Close + Low )/3
Support 1 = 2 * Pivot - High
Support 2 = Pivot - (R1 - S1)
Support 3 = Low - 2*(High - Pivot)

As you can see from the above formula, just by having the previous days high, low and close you eventually finish up with 7 points, 3 resistance levels, 3 support levels and the actual pivot point.

If the market opens above the pivot point then the bias for the day is long trades. If the market opens below the pivot point then the bias for the day is for short trades.

The three most important pivot points are R1, S1 and the actual pivot point.

The general idea behind trading pivot points is to look for a reversal or break of R1 or S1. By the time the market reaches R2, R3 or S2, S3 the market will already be overbought or oversold and these levels should be used for exits rather than entries.

A perfect set would be for the market to open above the pivot level and then stall slightly at R1 then go on to R2. You would enter on a break of R1 with a target of R2 and if the market was really strong close half at R2 and target R3 with the remainder of your position.