Dave Goodboy was kind enough to get me on the pages of Tradingmarkets. Now I feel like AustinP. If ET was like my favorite porn sites this article would be a "stickey" up top. Feel free to discuss, flame and disagree. Given the limited number of traders who ultimately experience profitability, few other fields have more published rules and guidelines than trading. After all there's no book titled Idiots Guide To Trial Defense. We've been inundated for decades with the old saws about cutting losses quickly and letting winners run. Still we see little improvement in the trading performance of most participants. Futures trading is truly a zero sum game. Each night the Clearing House pays out the same amount of money it collects. Toss in commissions, charts, research and the endeavor quickly reaches negative expectancy. Since I began trading on the CBOT floor in 1982 much has changed. Electronic access, FIFO and lower commissions have vastly leveled the playing field between professionals and the rest of us. While technological advancements have made trading short term more appealing than a generation ago, in my view retail traders should consider trading less. In fact rather than enhancing returns and cutting risk most short term strategies only accentuate the losses associated with futures trading. Allow me to share with you some cautionary aspects and a bit of advice that could help you clear some preliminary hurdles. Commissions: One of the least talked about advantages of being an Exchange member is ultra low commissions. I'll let you in on a dirty secret. The most legendary floor traders would have been net losers if they'd been paying the same commission schedule as you. In the larger financial products it was very typical for a floor trader to trade 1000 contracts a day in hopes of making just $1000 a day in profits. Superstar traders like Tom Baldwin would trade 20,000 lots on a busy day. I'd wager that many of you who've suffered grave drawdowns in your futures account are gross positive! Think about the paradox. Profitable trading yet net losses. If your trading style is of a scalping nature I have a couple of suggestions. If you're trading more than several hundred contracts a day then lease an exchange membership. I won't go into the details here but for larger traders a seat will reduce your commissions and exchange fees dramatically. If you choose to remain at the retail level then try trading on an exchange or product with lower fees. Eurex charges far less than it's American counterparts. If you must scalp in America then look at lower fee markets like Treasuries. Or if you want to scalp a non-fixed income product choose a market with a larger minimum tick size. Paying $4-5 a r/t to scalp markets with a $5 tick is nonsensical. Cutting transaction costs is one of your most viable edges. Short Term Technical Trading: I'm going to be both emphatic and controversial. There's is no system based on short term indicators generating anything other than real time random performance. It's utterly naive to believe the next few ticks can be handicapped by a stale set of variable equations. Now I know some of you are thinking I'm out of touch. That's because you've just successfully back tested some esoteric system with divergences, crossovers and filters. You're sure this new optimized system is gold. Think again. First the obvious. The Goldman's, Morgan's and big bucks CTA's with their vast computing power and impeccable tick data have already tested every conceivable indicator under the sun. Even if you're onto something remotely consistent you'll be subject to all the problems of high frequency short term trading such as commission costs, unable price orders and slippage. Now here's the good news. There's many signals derived from longer term strategies that will produce quality short term trades. Which signal has a more reliable chance of generating quick follow through? A new 5 minute high or a new monthly high? As a technician doesn't it make better sense to monitor a wider array of markets and spot higher percentage opportunities then to âspecializeâ in a single market and take a series of weak signals derived from noise? Trade The News: One of the pretexts of technical analysis is the theory that news is already reflected in price. Nonsense. Markets are organic. Market moving institutional participants are constantly reevaluating their positions based on evolving perceptions of fundamental information. Think of the market as a basketball game. We're watching a half court offense methodically passing the ball around the perimeter in search of a high percentage shot. Suddenly an athletic defender intercepts the pass and runs down the court uncontested for a slam dunk. That defender's name is News and he can spoil even the most conservative game plan. News often comes unannounced. News can be as unreported as a dry weekend in July when perceptive traders figure out there's a potential drought developing and then push futures to a limit up open. No matter how mechanical and detached your approach you'll be frequently confronted by decidingly anti-technical factors. Position Sizing: It only matters how much you bet. We've all made historic market calls only to take a small profit much too soon and then watch the market explode for weeks on end in the direction we anticipated Then the next time we try to milk a winning trade for just a bit more and see our open profit evaporate into loss. It seems that picking the markets direction is seemingly easier than extracting consistent profits. I preach two approaches. For folks who're reasonably well off and seeking stable returns I suggest you vastly under trade. Practice with scaling out of winners along with hard protective stops. Larger accounts should risk no more than 1-2% of their equity on each trade. For smaller accounts I advocate a more wide open strategy. You're probably not going to double your account 12 consecutive times trading for 1 tick at a time. None of us are that good. What you can do however is hit an occasional home run. I'm not saying just let it rip without an uncle point but you must intelligently look for opportunities that'll give you a quantum leap in return. Unless you're still a teenager, compounding $5000 by 20% a year isn't going to be a life changing experience. Learn About Options: Like futures themselves, options are increasingly traded electronically and have enjoyed tremendous surges in volume and liquidity. For small traders the ability to over leverage with a defined stop loss on equity is a boon to your big play potential. I'll give you a pertinent example. This past December I had strong resistance on the March e-mini S&P at 1511. I decided I wanted to risk $10,000 on a short position. Index futures margins would have allowed me to short just 2 contracts. A 100pt down move would in turn have resulted in a $10,000 profit ($50 per point x 2 contracts). Instead I bought $10,000 worth of put spreads with an expected 8-1 payoff if futures closed below 1400 at January expiration. Fortunately the trade worked and my 10k turned into a minor windfall of $80,000. Another advantage to long premium options trades is the ability to trade futures positions contrary to your options. If you're long calls you can then be a natural seller of futures. Often if you're in a rhythm you'll quickly pay the cost of your options with the proceeds from your delta hedging. Accept Your Psychological Shortcomings:We're all flawed in one way or another. Discretionary traders in particular are subject to the pitfalls of poor trade selection, over trading, undefined risk and revenge trading. A movie actor can vacillate between bi-polar feelings of arrogance and guilt but what makes his foibles different than a traders is the simple fact that he gets paid no matter what self destructive urges overtake him. Trading is akin to playing 18 at Augusta each day. We will never trade perfectly but must attempt to at least minimize our innately ruinous impulses. Keep a journal of your trades. Don't just mimic the information contained in your brokerage statement. Instead keep a log of how and what you felt emotionally about each trade. Like me you'll find there's commonalities with many of your losses. For instance if I fail to take a signal that would've resulted in a big winner I'll invariably take a sub-optimal trade next. Often I'll over trade it to boot. Doing nothing more than eliminating your âtrouble spotsâ will save you money that can be dedicated to the next good setup you perceive. Hopefully I'll have an opportunity to expand on these points in subsequent articles. Till then, best of trading and good health to all.
Fantastic fucking article. Very succint. I've been trading for 15 years and i'm constantly trying to articulate these principles to young guys on my desk, as a discretionary trader its not always easy for me to put things into language that just come naturally after trading close to a billion shares in my career. I'm going to print this out and use it if you don't mind. Thanks for sharing.
Excellent article. I am glad you are starting to write. A control of the subject matter without a desire to sell a hypothesis or a system. The ability to write like douglass but without a sales pitch like the author of winner take all or Grant Noble. (books I read when I started trading in the early 90s.) Why do floor traders seem so pragmatic?
"There's is no system based on short term indicators generating anything other than real time random performance. It's utterly naive to believe the next few ticks can be handicapped by a stale set of variable equations." Just because YOU don't know how to do it doesn't mean it can't be done.
Well I think you're being sarcastic because we both know Jack does it but can you find me ONE PERSON IN THE WORLD who can produce a profitable track record trading off short term technical indicators. I'm not talking about price action nor charts. I'm talking about indicators.
Very good article. I like it. Good way to articulate the use of options ... You deal effectively with a lot of issues: automated algo trading, options benefits, negative expectancy on most short term strategies, etc Very nice.
"Given the limited number of traders who ultimately experience profitability, few other fields have more published rules and guidelines than trading. After all there's no book titled Idiots Guide To Trial Defense. We've been inundated for decades with the old saws about cutting losses quickly and letting winners run. Still we see little improvement in the trading performance of most participants. Futures trading is truly a zero sum game. Each night the Clearing House pays out the same amount of money it collects. Toss in commissions, charts, research and the endeavor quickly reaches negative expectancy. Since I began trading on the CBOT floor in 1982 much has changed. Electronic access, FIFO and lower commissions have vastly leveled the playing field between professionals and the rest of us. While technological advancements have made trading short term more appealing than a generation ago, in my view retail traders should consider trading less. In fact rather than enhancing returns and cutting risk most short term strategies only accentuate the losses associated with futures trading. Allow me to share with you some cautionary aspects and a bit of advice that could help you clear some preliminary hurdles." Electronic trading from floor trading;there is at least one book right there especially from a floor broker perspective; open outcry for the most part is the boneyard with some few exceptions. Commissions: Big changes here, remember when a discount broker round trip was $80.00, wasn't that long ago. Short Term Technical Trading: You left out tape reading, front running and luck. Some dumb as shit lottery winners, asymmetric payoffs. Trade The News: Brilliant, this is an art form. Position Sizing: The Holy grail.