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a strategy that will generate a significantly higher percentage of winning trades than losing trades. Often, it is necessary for such a system to develop at least 65 percent winning trades in order to show a reasonable profit. This is also in sharp contrast to the longer-term approach, where one is often forced to accept a higher percentage of losers than winners.
When attempting to create a short-term, high-percentage-profitable trading method, there is a common pitfall that must judiciously be avoided. It is relatively simple to create a system with a high percentage of winning trades simply by using a stop loss strategy that places stop points a great distance from the entry point and by having a comparatively smaller, although reasonable, profit target. Systems can be created this way that will show over 90 percent winning trades. The difficulty is that the stop, being relatively large when compared to the profit target, can eat up the profits from a significant number of winning trades when it is hit. Although the testing of such a system can show a net profit over the testing period, a very slight change in market activity can create a situation resulting in only a few more losing trades than experienced during the testing period. This comparatively small change in market activity can result in a disastrous series of losses in real-time trading. Even though the testing of back data had shown the system to be profitable with a small profit target and a relatively large stop point, the slightest of changes in market activity can lead to a few large losses that can doom the system. Since these additional losses are fairly hefty, the net profitability of the system can suffer dramatically with the appearance of just a few additional losses.
After working with both long-term and short-term day trading strategies for a period of time, you will soon become aware that certain stock issues respond more effectively to the long-term strategy while others seem to prefer the short-term approach.
Generally, the more active stocks with comparatively larger average daily ranges will be the issues that will be best traded by the longer-term approach. Those issues exhibiting narrower ranges and comparatively less volatility will more likely be candidates for the shorter-term approach.
It will be worth your while to spend a considerable amount of time selecting your favorite issues to trade using any day trading system you might eventually create. A wide variety of responses to different strategies will soon become apparent. Finding the proper issue or contract that fits your trading system and style will contribute greatly to your day trading success.
TRADER STYLE AND PERSONALITY
The individual trading style and personality type of the trader certainly have an impact on the selection of an effective day trading strategy. Traders with a more aggressive trading style and personality will probably find the faster moving posture of a short-term strategy more appealing. Those with a more conservative style will prefer the longer-term strategy. The whole point here is that, when formulating your own day trading strategy, you must take into account more than the frequency of trades, stop placement, entry techniques, and so forth. If you are to indeed succeed in the day trading arena you must not only have a logical approach to trading, you must also be comfortable with the operation of the system on a day-to-day basis. If the pressure of trading a certain strategy that is incompatible with your ability to handle stress becomes such that your mental state is affected, it is just a matter of time until your trading results will be adversely impacted. Trades will be taken or not taken in accordance with mood swings, not the logical reasoning that created a good system.
Much has been written on the subject of trader psychology. Please be aware that this is a very important factor in the development and implementation of an effective day trading strategy and should not be taken lightly. I would certainly suggest that you carefully study the material published on this topic as you move through the process of creating a profitable approach to day trading.
BUILD YOUR OWN SYSTEM
The simple indicators and trading methods that will be described in the remainder of this book can be used by the individual trader to either enhance your own already effective trading style or actually
build a sound strategy from the ground up. A short-term or long-term system, such as those discussed earlier, can be effectively created and managed using the methods you will learn as you work through the remaining material presented here. Application of these tools and strategies to shorter time frames such as one- or two-minute charts will create a more aggressive, short-term system that will generate several trades per day, depending on the volatility of the underlying issue. The same indicators and theories applied to a 5- or 30-minute chart of the same security or commodity contract will generate progressively fewer trades per day as the time frame involved increases. Additionally, on a chart of any time frame, individual settings for the commonly used indicators, applied as suggested later in this book, can also be altered to create varied frequencies of trading.
1. Both long-term and short-term strategies exist within the general framework referred to as day trading.
2. Many parameters exist that further define these varying approaches.
3. Trader personality and individual trading style have a significant impact on the design and implementation of an effective trading strategy.
4. Principles and methods detailed in later chapters can be used to create a new trading system or enhance an existing methodology
WHY TRADERS LOSE
The fact that trader psychology is covered extensively in the print and electronic media certainly emphasizes the importance of this topic as it relates to the eventual success or failure of a trader.
In working with many traders over the years I have made several observations concerning what makes a good trader and what keeps very capable, intelligent people from becoming as successful in this enterprise as they have been in their other business and personal activities. I offer the following commentary not as criticism of these individuals, but rather as general observations on a perplexing situation.
During my involvement in production agriculture for many years I have had the opportunity to discuss and observe at length one of the most pervasive problems encountered by traders-fear and greed. Watching agricultural producers deal with commodity markets is indeed a study in human behavior. Nobody is more bullish at the top or more bearish at the bottom.
When the commodity market is rallying in the face of an extended
drought, everyone is absolutely certain that the market can do nothing but continue to move higher. So sure are producers that they will purchase a few contracts right at the top of the market before an overnight rain washes away all their potential to market a crop at a good price.
As the market drops precipitously to historical lows in the face of burdensome supplies, everyone is certain that no one ever again will have use for meat or grain and their whole inventory will be absolutely worthless in just a month or two. Everything is sold at the bottom of the market simply due to the fear of all producers assets becoming worthless before the snow flies.
The same is true of many traders. Convinced that their current profitable position is certain to be the big trade that will wipe out all previous losses, these folks hang onto positions without regard to obvious market conditions that dictate the position should be liquidated. Their greed has become successful in clouding their judgment to the point that their tried-and-true trading system is ignored, usually leading to a losing trade.
On the opposite side, fear of taking even a small loss has doomed many a good trader. Its one thing to work on a system, observe its inherent drawdowns, and think to oneself, "Hey, I can handle that!" Its quite another when the bullets begin to fly and the palms become sweaty with the stomach approaching nausea. Many traders simply arent able to handle losing any money at all and will liquidate their positions just from the fear that their condition might worsen.
Emotion is a fact of life that we all must deal with in one manner or another. Perhaps everyone does not have the psychological structure that is required to be a good stock or commodity trader. These individuals need to recognize this fact early on and perhaps realize that this is not the arena in which they should be operating.
One effective way to combat these emotional swings is to realize that trading must be treated as any other business venture, not as a game, a pastime, or other frivolous activity. All businesses have expenses and unforeseen problems that turn into business losses. Trading is no different.
I have worked with a significant number of traders who have spent an incredible amount of time, effort, and money on the development
of a trading system that makes sense from a trading standpoint and looks acceptable after being programmed and back-tested. Then it comes time to try the system in real time. After one or two losses its time to completely revise the system that took months to develop. I have actually revised systems for traders almost on an hourly basis.
These traders cant stick with a strategy long enough to see whether it works. They will abandon a plan with one or two losses, even if the plan was formulated over years of data.
Traders constantly second-guess themselves when actually executing a trade. This is not the time to formulate a theory. This is the time to execute the trade before your hesitancy executes you. Imperfect action is usually superior to perfect inaction.
Do your thinking and question yourself during the formative stages of your system. There are two basic reasons for formation of an automated system. One is to be able to thoroughly back-test your strategy and confirm that your theories are indeed sound. The other, less recognizable reason is that you wont have to think about the trade that you are about to execute. You have done all the thinking and planning necessary for the trade long ago. Stopping and thinking about each trade as it comes up only leads you to second-guess yourself and wind up skipping trades that would have turned out to be profitable.
Not following systems is another habit that plagues many well-intentioned traders. The first thing they will try to do with a proven system is pick which trades to take. Trying to beat the system and prove yourself smarter than the program usually does not work.
Some traders, when they realize they are wrong, frequently attempt to talk themselves into thinking that the trade just has to come in their favor. As the position moves further and further into the red, they rationalize more and more reasons why they were really right-the market is just wrong so far today. It is much easier and more sensible just to pull the plug on a trade when its obvious you are in trouble.
Dont beat yourself up after each loss. I know traders who, after a single $150 loss, will abstain from trading for several days, perhaps weeks, staring at the screen. They watch the good trades go by with regularity, realizing with each one that they havent picked up
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