Summary: This document provides guidelines for a specific trading strategy. It suggests exiting trades either in the direction of price movement or as the price reverses. The document discusses different types of trades, such as entering on a reaction or retrenchment. It also emphasizes the importance of setting protective stops and scaling out of trades as the market moves in the desired direction. The document includes examples of trades and explains the rationale behind the strategy.
Despite our constant pursuit of knowledge, the market itself assures there is no shortcut to obtaining our final degree. In the end, it is experience which is our ultimate teacher and there is no substitute. (View Highlight)
We can only choose the attitude with which we approach this process of learning to trade. We can accept the inevitable setbacks and learn from them, or we can yield to our natural human stubbornness and be forced to repeat the same lessons over and over again. (View Highlight)
The single most important secret is this: learn to listen to the markets and do not impose your own will upon them. (View Highlight)
Every successful trader we have known has also discovered the necessity for consistency. It is the key to everything-you must trade with a coherent methodology. You must follow a specific trading strategy. (View Highlight)
same essential starting point: minimizing risk first, looking to maximize gains only after risk has been defined and controlled. (View Highlight)
We hit it off well because our number one guiding belief is that you must, above all, find setups and entries which minimize exposure. The profits come on their own terms. (View Highlight)
The truth is, a few trading tricks and a little common sense will get you more mileage than all the books on technical analysis combined. (View Highlight)
Each pattern identifies a distinct market condition. After all, trading should be done on only the most recognizable and reliable patterns. (View Highlight)
swing trading we mean monitoring the market for support and resistance levels and actively trading around those areas. (View Highlight)
It is important to initially trade a new concept or strategy on paper. Only by seeing a pattern over and over again will you truly feel comfortable with it. You must believe in its ability to repeat itself. Don’t be surprised if you find yourself actually becoming excited as you see the patterns begin to set up. (View Highlight)
All you need is one pattern to make a living! Learn first to specialize in doing one thing well. We know two traders who do nothing but trade the “anti” pattern from a five-minute S&P chart. (View Highlight)
Your biggest enemy in trading is going to be a directional bias, an opinion about market direction (View Highlight)
Learn to concentrate on the “right-hand side” of the chart-in other words, on the pattern at hand. (View Highlight)
One of the things you will get out of this book is an increased ability to listen to the market.” Even if a chapter does not seem to suit your personal trading style, it should at least heighten your awareness of market action and price behaviour at critical points. (View Highlight)
Initial stop loss orders are essential! (View Highlight)
Stops are necessary for your protection against worst-case scenarios. (Remember, we are trading on probabilities only.) All it takes is getting sloppy once, or experiencing the “frozen rabbit syndrome” in a bad trade, to undo the efforts of the previous 20 trades. Placing initial protective stops must become a habit that is never broken. (View Highlight)
These tests are included to illustrate a market’s tendency; that an edge does indeed exist. (View Highlight)
“Speculation, in its truest sense, calls -for anticipation. Richard D. Wyckoff (View Highlight)
Swing trading is anticipating the market’s next move, and asking what is the most probable outcome. (View Highlight)
The main goal of each trade is to minimize risk rather than maximize profit. Positions are managed according to the market’s behaviour after we’ve made our trade. We can’t really predict the outcome. (View Highlight)
We are trying to achieve a “head start” in the right direction together with a chance to put in a tight stop. (View Highlight)
Swing trading depends on NOT riding out reactions or giving up profits already won. Trades should be exited either in the direction of price movement or just as the price reverses. (View Highlight)
Trading should take advantage of extremes in price action, high volume, and liquidity. (View Highlight)
but support cannot be established until there has been a test! It is after a successful test (that is, the market has tested a previous high or low and stopped there again), that many of our setup patterns occur. (View Highlight)
The second type of trade is made by entering on a reaction or retrenchment. (View Highlight)
but since the trade is entered in the direction of the prevailing trend, no test should be required. (View Highlight)
The most successful climax trades will occur in a high volatility environment, and AFTER the market has already reversed. (View Highlight)
You must see the “climax stop point” already in place before you enter your position! (View Highlight)
Swing trading is also learning to ANTICIPATE one of these three types of plays. (View Highlight)
However, over time, you should find that your tape reading skill (your ability to follow the market’s action) (View Highlight)
Stay in one time frame! Yes, it is important to be aware of the big picture, but it should not affect where you get into or out of a trade or how you manage it. Don’t turn short-term scalps into “big picture” trades. (View Highlight)
When in doubt, get out! If the market goes dull and quiet after you enter a trade and makes no progress in the direction of your entry, do not wait until your stop is hit. Just get out! Seek a more active market or better trading opportunity. All of the strategies in this book should reward you immediately. If they don’t, it is likely your trade will turn into a losing one. (View Highlight)
Don’t trade in quiet, dull markets. Dow, Livermore, Rhea, Taylor, Gann-all the greats say this over and over. There must be activity and liquidity in order to trade profitably. (View Highlight)
If the market offers you a windfall profit on a trade, lock it in! (Windfall means a much bigger profit than anticipated.) Take profits on half or all of the position. Trail an extremely tight stop on any balance! (View Highlight)
Finally, remember that both in short-term trading and mechanical systems, the distribution of winners is skewed. Most of a month’s profits might come from only two or three big trades. Much of the time the individual profits may seem small, but more importantly the losses should be small, too. (View Highlight)
It is vitally important to lock in” the best trades. Be defensive and don’t give back profits when swing trading! (View Highlight)
“Take every gain without showing remorse about missed profits, because an eel may escape sooner than you think. ” Joseph de la Vega, 1688, in an early manual on trading. (View Highlight)
must keep his losses to a minimum to ensure his survival. If you keep your losses to a minimum on every trade, you will have 80 percent of the battle won. (View Highlight)
The following principles will ensure your success in any type of short-term trading! (View Highlight)
Enter
the entire position at once! This means that if you trade in multiple
contracts, put on the whole position at the same time. Do not add to winning
positions. (View Highlight)
Place an initial protective stop on the entire position one or two ticks below the
most recent high
or low. (The market should not come back to this defined support
/resistance level, or “risk point!”) The exact timing to exit a trade is a subjective
matter. What is not subjective is the initial protective stop. (View Highlight)
Immediately look to scale out of your trade as the market moves in your direction. By taking some of the trade off, you are decreasing your risk and locking in profits. If you are trading on a one-contract basis, as you should if you are a beginner, move your resting stop to protect any gains. (View Highlight)
Important-if the market starts to move parabolically or has a range expansion move, take profits on the entire position. This is very likely climax! (View Highlight)
A range-expansion move is a very large trading bar caused by the last of the market’s participants (the emotional latecomers) dog piling into the market. When this last group of traders has entered, there is nobody. left to come in to continue to drive prices up or down. (View Highlight)
20-day high was made at least four trading sessions earlier (6/23) at 115-30. We go short in the 115-25 range with a protective stop one tick above today’s high (View Highlight)
The next day cotton trades at least five ticks below the previous da low and reverses. We go long at 85.80 with our stop in the 85.50 ran The market proceeds to rise over 200 points by the dose. (Remember this is a scalping strategy that exploits the daily reversal tendency of the previous day’s pattern. Large profits from 80-20’s are the exception, not the rule.) (View Highlight)
Let’s look again at the reasons why this trade works so well. First, the day-one setup indicates an exhaustion of buyers/sellers, just as the 8020’s setup does. This is because the momentum indicator functions
as a minor overbought/ oversold
indicator. Second, we are waiting for confirmation that the market is moving in our direction by entering on a first hour breakout. Quite often the market makes a reversal in the first hour, hits the buy/sell stop, and then moves in our favour for the rest of the day. This reversal tends to be a test of the previous day’s high/low. (View Highlight)
Both this indicator and the Momentum Pinball work best in nice choppy markets or after a runaway move has already occurred. Learn first to recognize when a market has good volatility and daily range. Then think about applying Taylor’s rules in conjunction with the short-term pivot point demonstrated above. (View Highlight)
Short-term momentum functions also serve as a departure point for use in mechanical trading systems. The studies presented in the Appendix show that this indicator provides a statistically significant edge. All the tests are run with just one variable. Apply
a longer-term trend indicator, a volatility filter, and a money-management algorithm, and you have a fine mechanical trading system! (View Highlight)
The basic principle is that a short-term trend will tend to resolve itself in the direction of the longer-term trend. Two different time frames or cycles moving in the same direction create a condition called “positive feedback.” This in turn creates some powerful, explosive moves. (View Highlight)
For this setup, trend will be defined by the slope of the slow %D stochastic. (The parameters are listed again below.) The first thing you might notice is that often the %D slope is positive while the slope of a moving average is negative (or vice versa). This is because we are really measuring the trend of the momentum. Momentum often precedes price, so it is useful to know when this line is leading or rolling over. (View Highlight)
This concept can also be applied to seasonals. Some of the best trends can be counter-seasonal moves. Just look at how the wheat market in the summer of 1995 defied the normal downside bias. The bottom line is, instead of trying to show the market how smart you are, take a step back and let it talk to you! It’s much smarter to observe the market’s response to a news event, seasonal tendency, or technical setup than it is to attempt to impose your beliefs on it. This is what true street smarts is really all about. (View Highlight)
There is no trading edge whatsoever in trying to base decisions on what the market should logically be doing. (View Highlight)
In fact, the more logical something is, the more likely you will lose when the market is moving in the opposite direction of the prevailing logic. (View Highlight)
Swing trading is profitable only when there are oscillations and good volatility. However, this volatility is quite cyclical in nature; the market experiences a constant ebb and flow of range contraction /range expansion. Toby Crabel elaborates on this principle in his book, Day Trading with Short-Term Price Patterns and Opening Range Breakout. He states that after the market has had a period of rest or range contraction, a trend day will often follow. (View Highlight)
A trend day is one in which the market opens at one extreme of its range and closes at the other extreme. It covers a lot of distance with very few retracements and can initially “creep,” picking up steam as the day progresses. (View Highlight)
The first step is to learn to identify ahead of time the conditions which lead to a trend day. Label these days as “breakout mode” and then only trade them from a volatility-expansion system or a specific rule set. (View Highlight)
It was presented as a long-term indicator and it was used as a summation index to pinpoint long-term tops and bottoms by looking for divergences in the index against the price action in the Dow. I use the concept on a short-term basis in an entirely different way which we’ll present to you here.
The smart money index is appropriate in a swing trading book if only to heighten a trader’s awareness of weak hands (public speculative money.) versus strong hands (smart, informed money), and the significance of morning reversals.
The general thesis is that weak hands (i.e., the public) tend to make emotional, uninformed decisions in the first hour of trading. The professionals represent the smart money and control the last hour of trading. (View Highlight)
It is also useful to be aware of any extreme intraday readings-high or low-in the tick, even if no divergence sets up. This information can help you anticipate a trade for the next day (the day after the high reading). For example, when a majority of stocks are on an uptick, and the market is able to register an intraday reading of greater than 400, this represents strong buying power. Everyone is buying! What happens the next day when nobody is left to buy?
If day one registers a reading of ticks greater than 400, then on day two we will look to short a morning rally. If day one registers a reading of lower than -400, then on day two we will look to buy a morning pull-back. Please remember to always use stops when entering on a reversal in the S&P. This pattern will not serve you particularly well in an extremely strong trending market. However, I used it throughout the bull market rally of 1995, and it worked quite well. It is also useful to watch the tick on an hourly chart. Look for two to three consecutive +/- 400 readings over one to two days to set up a reversal.
The main trick to successful S&P trading using this type of pattern is to look for 5-minute or 30-minute Turtle-Soup patterns on the bar chart. You must have the patience to wait for the test and not try to pick a bottom or top! (View Highlight)
The “edge” of a program was proxied by five different and complementary measures:
• Monthly compounded return-bottom line performance of a program or trader.
• Maximum monthly return-return on the most successful month. Proxy for the program’s return potential and whether it is trading at optimal levels.
• Sharpe Ratio-measure of returns per unit of standard deviation. Allows you compare returns of programs with different volatility.
• Skewness of returns- a positive number tells you that the program has a tendency to generate returns higher than the mean more often than normal.
• Kurtosis of returns-measures how returns are packed around the mean relative to a normal distribution. A positive number tells you that there is higher probability of finding returns near the mean compared to a normal distribution.
The first one is the monthly compounded rate of return over the life of the program. This measures the level of returns that the program has been able to yield over its life. To give you an idea of the range of returns that you can find among different programs over their lives, the maximum monthly return was 10.36 percent and the minimum monthly return was -6.04 percent.
The second measure of the edge was the return on the most successful month. This measure focuses on the magnitude of potential gains and gives you an idea of the magnitude of the program’s edge and whether the program is trading at optimal levels or not. The program with the most successful month had a return of 319 percent while the program with the smallest most successful month had a return of 0.8 percent. (View Highlight)
The third measure used was the Sharpe ratio. This is a measure of returns per unit of risk. It allows you to compare returns from programs with very different risk characteristics. Suppose that you have two programs A and B that have the same monthly compounded return, but program A has a Sharpe ratio that is two times as large as that of program B. What this means is that program A can generate the same returns as program B but with half the risk or volatility. The last two measures of the edge, skewness and kurtosis, are rather technical and give you an idea of how capable a program has been in generating larger returns with a high degree of probability.
just as edge measures increases in a CTMs equity curve, money management looks at the dips and recoveries in that curve.
The quality of the program’s money management was proxied by five different measures:
•
Standard deviation of returns-consistency with which programs achieve their returns. Gives you an idea of what kind of drawdowns and large returns to expect.
• Maximum monthly drawdown-magnitude of potential loses. Gives you an idea of risk controls and whether the program trades at optimal levels or not.
• Months to recover from worst drawdown-other things equal, programs with good money management will recover quicker than programs with poor money management.
• Standard deviation of times to recover from drawdown-measures consistency with which programs come out of drawdowns.
• Time to recover from worst drawdown as a percent of the program’s life indicates how much of a program’s business life was spent recovering from the worst drawdown.
The first one was the standard deviation of monthly returns. The standard deviation gives you an idea of the probability of big hits or large drawdowns relative to the program’s average monthly return. The second (View Highlight)
measure of money management was the maximum monthly drawdown. This measure focuses on the magnitude of potential losses and gives you an idea of both risk controls and whether the program is trading at optimal levels or not. To give you a better idea of the magnitude of drawdowns that you can find, the largest drawdown was 81 percent, while the smallest drawdown was no drawdown at all. The average monthly drawdown for all programs studied was 16 percent. Although looking at any single monthly drawdown is important, perhaps even more important is the amount of time that it takes a program to come out of a loss. For example, suppose that a program’s initial equity is 1,000,000andthatinthenextmonththeprogramexperiencesa25percentdrawdown,reducingitsequityto750,000. What is the maximum number of months that would take the program to bring the equity back to $1,000,000? This is what the third money management variable measures. It took 137 months for the worst program in this category to recover from its worst drawdown. It is not surprising that after failing to recover from its worst drawdown in more than 11 years, this program went out of business. It took an average of 20 months for the average program to recover from its worst drawdown. This measure is important because it can be theoretically shown that a program with good money management can recover from drawdowns much faster than a program with poor money management. What does this mean? It means that if you look at two traders that have the same edge (system), the one with better money management will recover from drawdowns faster. What if one trader has a larger edge than the other? If both traders use good money management, the one with the larger edge is likely to recover faster from drawdowns. So much for the academic explanation. What is more likely to happen out there?
I have looked at the most successful trend-follower traders out there and found that their distribution of monthly returns is remarkably similar; they have a comparable edge. The big difference between them is in their losses. The traders with the highest average returns have consistently smaller losses. This is an example of money management improving your existing edge.
The fourth money management variable measures the consistency with which programs recover from drawdowns. A large number for this measure means that programs do not recover consistently from their losses over time. This is probably related to both the edge of the program and its money management alike. (View Highlight)
The lesson from these results is clear: successful traders have a larger edge and much better money management than unsuccessful traders. (View Highlight)
Two of the most important components of successful trading are the edge of a system and sound money management. This study confirms this notion. Successful traders have a larger edge and better money management than unsuccessful traders. Unlike popular belief however, this study shows that the smaller edge of unsuccessful traders is not the cause of their failure. Traders failure can be explained almost exclusively by their poor money management practices. (View Highlight)