Swapping those bananas for new slippers!
Last time we discussed changing our market stall when our current product range is no longer in favour with our customers. That is a great analogy to the situation we face in the markets today. The S&P is completely untradeable at the moment, has been for quite some time now and quite possibly will continue to be like this for a while longer.
So we know we need to find a more fashionable product, one that people are actually interested in. But how do we choose that product? That’s what I want to go over today. Here is how I answered that question myself over the last few weeks…
The first question to ask is – “What attributes make for an attractive market?”
My answer to this is 4 things – “Volume, volatility, clean behaviour and personal preferences.”
Let’s tackle volume and volatility together, as these will both be present in an ideal market. Volume is all about the ease of getting orders filled vs. giving up the bid-ask spread (and more often). Volatility is about sufficient movement to make worthwhile profits. Individually they are less helpful. Take for example Eurodollars and Natural Gas. Eurodollars have huge volume but are totally inappropriate as they don’t move. Natural Gas is the opposite. No one would argue about the volatility in Nattie, but its volume is less than ideal, especially as it tends to suffer from “air pockets” where the volume is discontinuous. If you have ever been stopped out in this market and your stop was within an air pocket you will know exactly what I am describing here!
So what short of markets list can we come up with which have both volume and volatility? I looked at 4 markets – Gold, Crude Oil, British Pound and Euro (currency). These are all high volume markets with decent volatility. There are others too but they also fall within the same groups – metals, energies and currencies. So I would prefer to concentrate on the “leaders” within each group (that’s my first personal preference creeping in).
My third attribute I call “clean behaviour” which is qualitatively the way a market moves in relatively clean swings and waves versus lots of spikes and sharp movements etc. This is about maintaining decent risk/reward ratios, i.e. not having to use unreasonably wide stops for fear of quick spikes. Using this as a selection criterion, the currencies seemed most attractive, Crude the least attractive and Gold somewhere in the middle. I wouldn’t rule any out based on this alone but it helps in starting to prioritise them.
Now let’s talk about preferences. For me there were two things I wanted to consider (a) time zone and (b) dependence on speculators. In terms of time zone my ideal would be to be able to trade during either or both of the main European and American sessions, to give me flexibility in my day.
The second is more vague and based on no more than a gut feeling I have that people have considerably less appetite for speculation than they used to have. If there is any validity to this it is probably due to a combination of the economic environment plus the recent memory of markets in meltdown. Neither of which is going to subside for some years. The evidence is the total lack of volume in the stock market, which is a purely speculative market after all. So ideally I would choose a market that has little dependence on speculation for its volume.
These factors again put currencies in a more favourable position than Gold or Crude. The volume in the currency markets is predominantly reliant on international trade. Whereas Gold has not been driven to its current levels just be people wanting to make jewellery for sure!
So having homed in on the currencies as being the more likely candidates, is it the Pound or the Euro? Actually this was an easy decision. The Euro has considerably higher volume, especially during the European session. In addition the contract size is twice as big and hence would consume half the brokerage and execution costs.
So just to get back to where we started, having identified the Euro as our prime candidate, how does volume and volatility look?
I looked back at the last few weeks, breaking the day into 30 minute segments to examine the average volume and average range within those periods. In case you are wondering why I used a small sample size it is because I am only interested in what is happing now and not what happened 3 years ago etc. Take the S&P as an example, you would get great stats looking back 3 years but it would not reflect what is happening today at all.
During the European session (within which I like to trade 7:30 – 11:30am UK time) the Euro is typically trading 5000 contracts and a 20 point range per 30 minute segment. This is perfectly tradable and is actually very impressive for a Chicago listed contract in the middle of the American night.
The American session (within which I like to trade 1:30 – 5:30pm UK time) sees a slightly better range of around 25 points combined with the obvious explosion in volume that would be expected.
These are clearly great trading environments during both sessions and not too surprisingly we have selected the Euro as our main market whilst taking great delight in kicking the S&P into touch for the time being.
There is also one other factor that makes the Euro attractive. Like all currency markets it is predominantly a cash market (circa 95% cash), with derivatives being miniscule “add ons” that have no influence whatsoever on the market. So the futures, which we prefer to trade, simply track the cash. Therefore we don’t have to worry about events such as contract rollovers, option expirations etc, which can have significant impacts in the stock market for example. The currency markets don’t give a damn about such things, so we don’t have to either.
Disclaimer, risk warning and copyright notice apply to all articles published on this site.
Copyright © Simon Townshend Ltd 2010, all rights reserved
It’s all a question of bananas and slippers!
If you are an S&P trader I am prepared to bet you are struggling right now. I know I am. As I wrote earlier this year, if you can tread water without giving too much back that is a great outcome in this environment. I regard myself as fortunate to be hanging around within a tiny percentage of equity highs – up a bit one week, down a bit the next. This is frustrating for sure but preferable to being in a big hole.
I speak with quite a few traders and I have not found any that have been making money in this market recently – not a single one. A few are holding their ground like me and most are grateful to be doing so. But the majority tell me they are going backwards, a few to alarming degrees.
Why is this? Didn’t we used to pitch up to work each day and most days go home with a profit? Every trader recognises the drop in volatility over recent months and for sure this is not helping the situation. But there is another factor in play here too, one that has even more impact on our ability to earn a living today – volume.
Many traders get confused by volume. I often see traders saying “oh the volume today is quite good”, when actually it is dreadful. They make the mistake of looking at the future volume, when the volume that really matters is the volume in the cash market. Why does cash volume matter, when we trade the futures? Simply put, the futures are going nowhere without the cash market. So if the cash market is dead, no one is going anywhere. In addition much of the futures volume is just computers trading contracts back and forth between themselves, skewing that picture even further.
So cash is king as far as volume is concerned, so what has happened to it of late? Basically volume has halved over the last few months as you can see in this chart which shows a 30 day average of the NYSE daily volume:
2bn shares per day drop to just 1bn
It is almost a decade since we last witnessed volume this low and that isn’t even the worst problem. A decade ago it was OK for the volume to be at this level as that was normal volume in those days. Today we are geared up for much higher volume. In other words we have over capacity! Any other industry that saw its volume halved would be taking its begging bowl to the governments of the world asking for bailouts!
But market makers, traders, short term liquidity providers suffer in silence. Most blame themselves for at best not making money and losing money in many other cases.
So what should we do about it then? Well we all have different portfolios of activity, but I can share my thinking with you. Firstly I looked at my activity and did a crude cost/benefit appraisal. It wasn’t a great feeling either. I have 2 main activities – short term trading the S&P and swing trading in a range of commodity markets.
- The S&P occupies 7 hours per day, transacts considerable turnover and hence incurs considerable brokerage costs, yet has been dead flat profit wise for months.
- The swing trades occupy 30 minutes a day, are on small size so have little cost and have made great profits every single month, in fact the last losing trade was in November!
Hmmm, time to adjust the game slightly I think!
As for the S&P dilemma, here is a wonderful analogy one of my partners uses to describe the situation: Imagine a visit to your local village market, where stall holders are selling all manner of different products – food, textiles, shoes, picture frames etc. In this market we are selling bananas. We buy them for 12p and sell them for 15p. When the market is busy we do this all day long – buying wholesale, selling retail if you like. But when the market is quiet or the people in the market are only interested in buying slippers or picture frames, our bananas are just sitting there. It doesn’t matter that the price we are offering is the best price in town. If people don’t want bananas we are stuck with them until the end of the day we cut them down to 8p just to clear the shelves!
Solution – let’s just sell slippers! If that’s where the action is. The product is different, but the process is the same. We don’t need to be slipper experts as we are not actually banana experts. Our expertise is in the process not the product – in buying wholesale and selling retail. So until bananas come back into fashion, let’s move to a product that is in fashion! That is exactly what we are going to do. We will still keep a few bananas (S&Ps) on our stall, but concentrate more of our effort each day on a new product. What will that product be? I’ll share those thoughts with you next time.
For the commodity swing trades, we decided to increase our trade size by 50% now and to consider a further increase in another 3 months time. If we hadn’t had such a good run, I would have considered a bigger increase right now. But sooner or later we will get some losers so I would prefer to ratchet the size up in stages. If we double or triple our size in one hit I know that will instantly precipitate a couple of losers – I am sure you know what I mean!!!
By the way, these swing trades are the S-I-R system that many readers have expressed interest in using themselves. The good news is we are launching it right now after all these months of delay. I have a handful of traders working with me, trying it out and making sure everything is working well before I invite any more members to join. If it all goes smoothly then later this month I will open up a few more places. If you have registered interest previously then you can expect an invitation over the next few weeks. If you haven’t but would be interested in taking a look then www.SeriousInvestmentReturns.com is the place to go.
If you are primarily an S&P trader, don’t despair, things will improve again it’s just a question of when. Until then have a think about where else your skills could be usefully applied. Remember this – in the old days if a market suddenly died for a while a floor trader could walk into a different pit and work in a market where there was activity. These days all we have to do is press a few buttons to achieve the same transition, yet for some reason we are more reluctant to do so. Why?
Disclaimer, risk warning and copyright notice apply to all articles published on this site.
Copyright © Simon Townshend Ltd 2010, all rights reserved
Think longer-term
Well as I said last time, things will come back to life all of a sudden. It now seems like they already have, which is wonderful news.
Aside from bringing the shorter-term S&P business back to providing much better and more frequent opportunities than we have seen for many months, there is another factor we need to be aware of right now.
I also mentioned a few weeks ago that I felt we were close to significant inflection points across a whole range of markets. I still stand by that view and believe we have now seen longer-term tops and bottoms put in across a wide range of markets; commodities, currencies, equities, energies, metals. A quick look at the daily charts will give you good feel for which markets are showing new directions and which are still just slopping around. The only market group that I am less convinced about are bonds, where I don’t really have any good insight at present.
I think many markets are in the process of starting new longer-term trends. In fact I have no less than 17 markets on my watch list for next week, for possible early entries into new trends. That is a lot of markets. Of course they won’t all set up suitable low risk, high probability entries which we look for. But with or without us on board I am looking for new trends to develop. Some markets such as the Dollar and the Euro are already well ahead of the rest having established new trends some weeks ago.
If I am correct (!) this provides one of those relatively rare opportunities to think longer-term. I don’t mean holding onto individual positions for longer necessarily, but changing perspective slightly to take advantage of a relatively unique situation. These opportunities only show up every couple of years or so, but here is how I believe we should capitalise on them when we are able to.
- Trade absolutely as normal – use the same entry setups, trade management and exits as you always do.
- However where you are able to, keep a small piece on, rather than exiting the whole trade each time. Tuck these small positions away with a breakeven, or close to breakeven stop.
- Forget about them! Don’t fiddle around or micro-manage. Think in terms of weeks, not hours or days. If you get some runners you will need to handle contract rollovers and in the future you can tighten up and start trailing stops.
- As the new trends progress and new trades setup – repeat the process, leave another tiny piece on. Keep repeating for as long as new opportunities present themselves.
- When adding to an existing position use a breakeven stop based upon the average entry price of both (or all) small positions. This gives the market plenty of room to work, but without risking any of your own capital.
- Aside from any necessary rollovers, give these speculative trades a few months (yes months!) to work and see what happens. Some will work and some will not. If you catch major moves on just 2 or 3 markets that could be a heck of a big bonus this summer. If you don’t get lucky the cost should be minimal, if anything at all.
I’ll leave you to play with the concept and see if your own trading style and approach can adopt a little add-on of this nature to take advantage of this particular situation.
Disclaimer, risk warning and copyright notice apply to all articles published on this site.
Copyright © Simon Townshend Ltd 2010, all rights reserved
Keeping out of trouble
I know many readers of my articles are S&P traders. If this is your primary, or only market, then this article is aimed squarely at you. If you trade other markets then the same concept applies to all markets, but each market reaches this point in its own cycle at different times.
In my opinion the S&P is currently presenting the most difficult environment that we have to face. Volatility has collapsed and volume is extremely light. This is a continuation of the declining environment that we saw over the last few months of 2009. This is the most dangerous place for a trader to be trying to eke out a living. The true opportunities are very few and far between and when they do present themselves the risk / reward ratio is well below the realistic levels we should all be striving to achieve most of the time.
The loss per trade should be much smaller than normal with reduced volatility, so you shouldn’t be doing too much damage to your capital with a few losers. However the percentage of winning trades will be well down against most traders normal strike rate too, so the losses may be smaller but potentially there will be a lot more of them.
The reason I regard this as is the most dangerous of environments is that there is a real risk of serious overtrading. Frustrated, eager traders find it very difficult to sit on their hands for long periods of time and that is precisely what a professional trader must do at this time. In the essentially random noise that we have been seeing over recent times it is all too easy to think you have spotted a worthwhile trade only to discover that it is actually just noise and your trade is a loser, albeit a smallish loser.
Really good days present relatively few trading opportunities if you think about it, yet it is all too easy to “keep spotting setups” in the current rubbish environment. So you can easily find lots and lots of those small losers. Guess what, at the end of the day a lot of small losers add up. This potential death by a thousand cuts is why I regard this as such a dangerous place to be.
So should you stop trading? My advice is to try to continue as normal provided you have or can develop the personal discipline necessary to take very few trades. When this market suddenly all comes good again you want to be there in the saddle and in touch with the market, not reading about it in a newspaper lying on the beach somewhere. As easy as it may sound, such discipline in extremely rare and only comes with experience. That experience must also include living though times like this I am afraid!
If you find you do not yet have that level of discipline to rein in your trade frequency, then my second piece of advice is to put in place mechanical rules to prevent overtrading. As an example I have a simple rule in my own trading plan that I may only take a maximum of 3 losing trades in a day and if reached we shut up shop for the day. That is 3 losers in total by the way, not just 3 in a row etc. Even if we had 5 winners mixed in with the losers, once 3 is hit then that’s the day over.
In this environment I tighten that up even further. 2 losers and I’m done for the day. Your risk per trade is probably only half what it would normally be. So you can take a couple of small losers per day for a long time before doing any real damage to your capital and that is really what we are trying to achieve here – keeping your hand in, whilst protecting your capital.
When this all changes as it will eventually (and probably all of a sudden), you want to be at worst only a few percent below your equity high. If you burn off 30% of your account unnecessarily in this junk today, then you will waste a lot of the profit from the new good environment just climbing back up to where you were before. Believe me I have done this in the past and working hard just to get back to where you were before is even more frustrating than losing the money in the first place! That’s why I am never going there again.
If you have little or no ground to recover when things get good again, then those first 30% of profits go straight to the bottom line where you want them. That is worth developing the discipline for and being patient in these challenging times.
If you find that you just don’t have the discipline to stop at the maximum number of losers per day that you have set yourself then further action is called for. (I have been here before too and it is another place I have chosen never to revisit again!). Speak with your broker and ask for a maximum daily loss limit to be set on your account. This is an amount more than which you cannot lose. Once the limit is reached your platform will shut off trading access for the rest of day. This way you are forced to stick to your rules, whether you have the discipline to do it yourself or not.
Finally don’t despair! This will change and probably very soon. This reminds me very much of the last throws of the bull market in back in 2007. Volume slowly fizzled out as all of the buyers reached the end of their cash reserves. As the volume dried up the volatility diminished to the point where you often wondered if the market was even open at times (sound familiar?). Just when you thought everything had changed for good and you would never see money flowing through the market again – Bam! The market turned down under its own weight and before long the sellers were only to keen to jack up the volume once again.
I am no forecaster, but my gut feel is that 2010 is going to be a great year. If I am right (and I hope I am of course) the key to maximising success this year is starting off from a good place and not at the bottom of an ugly drawdown. So have faith, keep your powder dry and preserve your capital.
I wish you a very successful 2010.
Disclaimer, risk warning and copyright notice apply to all articles published on this site.
Copyright © Simon Townshend Ltd 2010, all rights reserved
FAQ Part 2
This afternoon the second part of my “Friends and Quinto” interview was released. In this we discuss when to buy a retracement in an up trending market and when to short it.
You can listen to this on my speaking events page http://www.simon-townshend.com/speaking-events or download it as a podcast from itunes by searching for “Jeff Quinto”.
Disclaimer, risk warning and copyright notice apply to all articles published on this site.
Copyright © Simon Townshend Ltd 2009, all rights reserved
S&P is a Short!
I know it sounds insane and yes it is a darned aggressive stance to take. But last week closed with a sell setup on the weekly timeframe, the first sell signal since January. That is what the system says, so who am I to argue. The system is right around 8 times out of 10 and if I traded based on emotion I certainly wouldn’t be. That’s why we use a model in the first place after all, to prevent our human shortcomings getting in the way of success.
There have been a few sells on the daily chart in recent months which have led to retracements only. This weekly setup might be just the same, there is just no way of telling if we will get a retracement only or a more significant turn back down. It might not even work at all.
Here’s the catch: We have a sell setup, but at the moment no entry trigger. In my book a trade can only be taken if there is a valid setup and then an independent trigger to execute the entry. Using a trigger prevents a trader from jumping the gun and that leads to significant improvements in performance. What we really need is one more week for this to properly “ripen”. A down close next week would probably be sufficient to have the system pulling the trigger.
So if its important not to jump the gun, why am I? Well actually I am not as I don’t actually trade on such a big timeframe. But I am putting both of us on notice that there is a sell setup in place now, so this is a time to be very cautious with long trades and to be open to taking short setups on smaller timeframes if they occur. My fear is that this could kick in early and waiting for next weeks close means we could be entering way lower. Instinct tells me that there are going to be a whole heap of sell stops in the 1060-1070 region. If a few big ones get elected they could easily trigger more and result in rapid escalation as everyone heads for the exit ramp all at the same time.
I could be totally and utterly wrong of course and the sell signal itself might not get formally triggered at all. My gut says we are reaching a significant inflection point in many of these markets. But I have to ignore that and go with the system and that says wait for next Friday and see if we trigger. Darn it so what should I do?
I have concluded that last weeks and high and low should be used as key reference points. If we trade above the high, the sell signal would be invalidated anyway and the market should then continue with more of the same low volatility crawl that recent weeks have seen. If we slice through last weeks lows with good momentum on an intra-day timeframe and accompanied by high volume, then we could well be off to the races and short-term bounces will become short entries. I would then look to build a longer term position by following my usual short-term scalping signals and rather than exiting each trade completely, leaving just a tiny piece on each time in case this thing finally cracks hard.
At least that’s how I will be playing it, whilst my system will be waiting to make its mind up on Friday night. Of course if I’m right I’ll be telling myself “well this is a thinking persons game” and if I’m wrong I’ll be saying “follow the damn system!” Choices, choices! There are so many ways to skin a cat (as the rather ugly saying goes). Anyway I hope this internal debate I have been having with myself today might give you a few ideas to think about yourself.
Disclaimer, risk warning and copyright notice apply to all articles published on this site.
Copyright © Simon Townshend Ltd 2009, all rights reserved
That tiger had teeth!
This is a follow up to my article of June 26th – Catching a tiger by the tail. (Its on the home page www.Simon-Townshend.com if you are a more recent subscriber.)
If you recall we were looking at the sugar market and discussing how to manage a long position in what we thought would be one of those rare examples of of an “outlier” trade. At the time I wrote:
“…when trailing a stop with the objective of catching an outlier event, remember to leave the market room to breathe, don’t trail the stop too tightly. Here we saw nice follow through on Wednesday and Thursday, but the chances are that the market will pause and consolidate for a few days very soon. If the stop is too tight we risk getting nicked out too soon. So we will keep it well back for now, still being guaranteed a decent profit. Once the market has consolidated and left behind a new swing low, then we will ratchet our stop up again and just see what unfolds from there…”
- When a market goes parabolic its time to beware
Now it is time to reverse that recommendation and tighten the stop right up close to the market.
This is how this has been unfolding:
The first retracement held well above the mid-point of the expansion day that we used to provide our first wide trailing stop location. As the trend continued the stop could have been slowly ratcheted up still keeping it well away from the market.
Now the market has gone parabolic and we need to rethink the strategy again. The first thing to know about a market that looks like this is that the biggest part of the move may well still be in front of us, as incredible as that might sound! Once a market starts going parabolic it can really accelerate hard. But when a parabolic move ends it usually ends spectacularly in a massive V-reversal. You do not want to be holding the position when that happens as the down move can be at least as violent as the initial move up.
So we would like to give this a little bit more chance to show us whether or not it has more to give to the upside, but we don’t want to be holding on once this swing has ended. Overall we have to remember we are traders here to make profits. If you are still holding this you have an enormous unrealised profit under your belt. You have achieved the almost impossible task of spotting and catching an outlier. So first and foremost you must hold onto that profit. The market will take it back from you if you don’t grab it!
Now the strategy is to lock in this outsized profit. There is still an outside chance that this market will continue to explode higher, so dont just exit but do tighten that stop right up tight to ensure any give back is only a small percentage of your open profit. A true parabolic market will keep making a higher high and a higher low every single day until the end when you dont want to be holding the baby any longer. So you can now trail a stop right up to yestreday’s low each day that a new high is made (i.e. ignore inside days). At some point, maybe today, you will get taken out and you will bank one of the biggest profits you will make all year. At the same time you are still giving yourself the chance to increase that profit even further.
An awful lot can happen in a day from this point on. So now is definitely the time to be on your toes.
Disclaimer, risk warning and copyright notice apply to all articles published on this site.
Copyright © Simon Townshend Ltd 2009, all rights reserved
Pound hits the buffers
For 7 months now we have been watching this rally in the Pound. It has been a very clean and well behaved move. But now it looks like it has hit the buffers. Let’s take a look at all of the coincidental factors conspiring to end this party.
- Daily Chart: Four of the last five days were spent with the market braking up and holding above the previous range high, but on Friday it failed and dropped back down into that previous range. This smells suspiciously like a bull trap and if so we can expect expect to see a swift move back down to the 1.58 – 1.60 area as its first port of call.
- Weekly Chart: We closed last week with an S-I-R sell signal on this timeframe. We don’t actually trade this large a timeframe but the signal is just as valid whatever timeframe is being used. The first objective off this sell signal would coincidentally be 1.60 and the second would be 1.54, for what its worth but following weekly signals requires far more patience than I personally have. (Heck I often get impatient with 1 minute charts!)
- Monthly Chart: 1.70 is absolutely bang in the middle of the markets historic range. The GBP-USD has spent 90% of its time in the last few decades in the 1.40 to 2.00 range. So 1.70 is the absolute centre and could be regarded as its “normal” price. Some might also argue that 1.70 represents a 50% retracement of the move down over the last 18 months. Personally I don’t think that carries and real significance, but the 1.70 level clearly does as it is a very obvious resistance area with last weeks high coming within just 3 ticks of the 2005 swing low.
The daily trend is still up, but unless it punches convincingly through 1.70 over the next few days that weekly sell will kick in, supported by the monthly resistance and start to turn this market back down again.
Disclaimer, risk warning and copyright notice apply to all articles published on this site.
Copyright © Simon Townshend Ltd 2009, all rights reserved
Don’t throw your money away
In many speeches, workshops and written articles I have made the point that long term profits come from managing short term risk. You may well have heard me say this before, but it is so important that I want to address this yet again with a simple little example from yesterday’s trading.
This was brought to mind during a discussion with another trader who had been getting beaten up rather in the current market, which without a doubt is a difficult environment due to the collapse in volatility over recent weeks. The trader concerned had fallen into the trap of giving trades way too much room before taking a loss and moving on.
In this case he was trading the S&P and using 3 point stop losses which, in my opinion, is miles too much risk at the present time. It is easy to understand why – this was a habit left over from last year when giving a trade 3 points of room was about right. That was a high volatility environment of course where successful trades regularly yielded 3, 6, 9 even 12 point profits. Today profitable trades typically produce 1.5 to 3 point profits, so you cannot possibly throw 3 points away on losing trades and expect to be profitable overall. The numbers simply do not add up.
So this leads us to the obvious question – how much room should you give a trade to work out? Many traders like to use a fixed number of points, a fixed dollar amount or some sort of ATR (average true range) factor. I don’t actually like any of those approaches and I hope the example above will help to illustrate why. As with most of my work, my approach to stop placement is very simple – if the market reaches a price that would invalidate the original rationale for taking the trade, then I don’t want to be in it any longer. It’s that simple! So before entering any trade simply ask the question – where should the market NOT go? That is then where your stop should be placed.
Protective stop goes where the market shouldn't
So here is a simple example, that coincidentally occurred right at the time yesterday when I was suggesting to this other trader that his stops were too large. This is a 1 minute chart of the S&P.
Firstly what is the rationale for this trade?
On the move up to point D, we know that the buyers have the upper hand. The progressive higher highs being made at B, C and D demonstrate that they hold the balance of power. However at E, buying is insufficient to drive the market up to new highs.
The buyers have temporarily run out of the money needed to push the market higher. So the logical expectation is for the sellers now to take the lead and bring the market back down. Hence for us this is an opportunity for a short sale at 875.00
So where does our protective stop go? Well if our hypothesis is correct that the buyers are spent out and the sellers are now in control then the market should not get back up to the old high at E, so that is the perfect place for our stop at 875.75 Were the market to go back up there our hypothesis is clearly incorrect so we would want to be stopped out for a small loss of 0.75 points.
We don’t need to lose 3.00 points to know that we are wrong, when 0.75 points is sufficient to confirm that fact.
In this example you can see the market only came in another 1.50 points before stalling out, so this wasn’t much of a trade. You could have banked 1.0 to 1.5 points and in this low volatility environment that would have been exactly the thing to do when a trade stalls. At the very least you should have pulled your stop down to breakeven. Although this environment only gives small moves, you would still have been in the trade for over 20 minutes before it got back to breakeven, so there is really no excuse for letting a winner turn into a loser. Even if you managed the trade really badly, your worst case was still only a 0.75 point loss but at no point could risking 3.0 points ever be justified.
So in summary the amount of room a trade should be given is governed by (a) the rationale for the trade and (b) the prevailing volatility. Together these two factors give you the right answer and it does vary from one trade to the next, hence my personal view that the “one size fits all” approach cannot be right.
Disclaimer, risk warning and copyright notice apply to all articles published on this site.
Copyright © Simon Townshend Ltd 2009, all rights reserved
Catching a tiger by the tail
In Golden Rule 1, we discussed the importance of having a robust, quantified and clearly defined exit strategy for each and every trade or investment.
Irrespective of the style, strategy or timeframe, successful trading is very much about understanding and working with probabilities. This has to be so in a world where there are no certainties, unless you are able to forecast the future. In 30 years I have never found a single person ever who is able to forecast the future, so I am prepared to bet that you are in exactly the same position as me – having to work with a statistical advantage and allow probability to make profits for you over the long run.
Consequently our exit strategies must be designed within this same statistical framework and then there is one particular fact to accommodate – the bigger the profit you shoot for the less chance you have of achieving it. This is why the best traders don’t play for home runs. They treat trading as a business of slowly grinding out regular more modest profits. “A day’s work for a day’s pay” is the mantra. Notice how opposite this mentality is to that of a gambler who is constantly thinking that “the next one will be the big one”, only to be disappointed yet again.
With the chances of hitting big home runs being so low, most exit strategies should almost ignore that possibility. But that does not mean that we won’t occasionally find we have caught a tiger by the tail. So we also have to know how to adapt when luck, which is all it is, lends a helping hand. Here is a great example of how we adapt our exits to handle a potential outlier event.
Sweet move in the sugar market
Let’s take a look at the sugar market – usually a pretty dull, boring market that for some reason flew into life this week handing us an unexpected gift. On this chart I have marked up the last four days, Monday to Thursday.
Over the weekend our S-I-R swing trading system flashed up a buy signal in sugar. So on Monday morning we dutifully bought some. We got lucky on the entry buying fairly close to the low of the day. As usual (Golden Rule 1) our exits were predetermined so exit orders were placed as soon as we were filled on the buy order. Monday passed uneventfully for this trade, although I was pleased to see it close on the high of the day. The best trades always work immediately and without giving you any grief so this was a good sign.
Tuesday arrived and blast off! For some unknown reason (unknown to me at least) the whole world must have decided to buy sugar and we had this explosive move that you can see in this huge bar on the chart. Our trades are exited in 3 equal parts and the first two exit orders were both filled during this big Tuesday rally. Each exit has a specific purpose within our trading plan and a predetermined price. Now here is the first trick – It is very unusual for two exits to be achieved the same day, so when this happens I know something unusual is going on.
Because two exits in a day is an outlier event, I switch tactic for the third and final exit. As we potentially have the proverbial tiger by tail here I cancel that final exit order. Instead we switch to using a trailing stop as there is now a very good chance that it will reward us disproportionately for holding on.
Here is the second trick – If the move is for real a huge range like we saw here on Tuesday will not be retraced into very far so the stop can be placed initially around the mid-point of the day’s range, i.e. around 16.50 here in Sugar. This in itself will lock in a nice profit if triggered, so we will do OK even if Tuesday turns out just to be a one day wonder. However the odds favour a much bigger move and as that move unfolds the stop can be progressively raised locking further profits in.
But when trailing a stop with the objective of catching an outlier event, remember to leave the market room to breathe, don’t trail the stop too tightly. Here we saw nice follow through on Wednesday and Thursday, but the chances are that the market will pause and consolidate for a few days very soon. If the stop is too tight we risk getting nicked out too soon. So we will keep it well back for now, still being guaranteed a decent profit. Once the market has consolidated and left behind a new swing low, then we will ratchet our stop up again and just see what unfolds from there.
Disclaimer, risk warning and copyright notice apply to all articles published on this site.
Copyright © Simon Townshend Ltd 2009, all rights reserved
Friends and Partners
Free Publication
