To Trade or Not to Trade

Some wise old men have told me the key to successful trading is identifying when you should not be trading.

When traders do static back testing with their chosen indicators they are usually checking to see if their system captured all the moves. A better use of time may be checking to see if their system kept them flat when there was no real trend in place.

Today's 34 tick range bar crude oil chart shows 2 nice short moves to trade. Virtually any trading system would have identified these 2 moves.

Looking backwards, with the clarity of hindsight, does your trading plan keep you flat outside of these 2 moves on the crude oil chart?


Crude Oil Sale Over

No more idiotic crude oil predictions from me. The beauty of day trading with the trend remains, I don't need to know where crude oil is going, I just follow.

Always a nice day to trade when there is only one direction.
(click on chart for better view)

An American and Iranian skirmish at sea set the price of crude oil up today, however it could not get over $120 a barrel. We shall see if that remains as resistance or if we move back down to the 34 EMA (white line).


Crude Oil on Sale?

The eternal question, how high will it go, just won't go away. That along with the blank stares when I tell them I don't know are starting to annoy me. So I will step out and say this may be it for a while.

So there it is my prediction, which I will stand by until it goes higher. :)

The downdrafts on crude oil today were quick and violent. There seemed to be a hint of panic selling at times today. If the street's money flow starts to move out of crude oil the reversal will be interesting.

Oh and by the way, I still don't care where the price of crude oil goes.


The Oil Sands

Crude Oil Mining

Interesting how the media works, Suncor has been in production north of Fort McMurray, Alberta since 1967. One item on American television and suddenly everyone wants to know about the "oil sands".

The price of crude oil has a little to do with it I'm sure. :)

How the world's demand for oil, while at the same time demanding lower carbon emissions, is going to work out I don't know.

It seems to me if the world really wanted lower carbon emissions the demand for crude oil would be going down not up.

Does do as we say not as we do sound familiar?

The sub title language is also interesting.


If You Can't Beat Them.....

The talking heads say crude oil prices are being driven by speculators, if that is the case then it is going to be a violent drop when the speculators leave, or turn short. For now there appears to be no limit to the upside.

Entry points for today 04/18/2008 NYMEX Light Sweet Crude Oil June Contract
(click on chart for better view and click again when chart opens for larger view)



I think Fortune magazine has the most talented editorial staff in the business field. They have been doing some great work following the recent wall street "issues".

Pick up a copy or have a look online.




You can click on the Fortune title to go to their home page.



“At the heart of all trading is the simplest of all concepts—that the bottom-line results must show a positive mathematical expectation in order for the trading method to be profitable.” Chuck Branscomb

Dr. Van Tharp has written extensively on the subject of expectancy and using R multiples to categorize your trading results. We have taken excerpts from his book, Financial Freedom via Electronic Day Trading, Van K Tharp & Brian June, and from his newsletters to summarize how he uses R multiples and expectancy.

Van Tharp categorizes the risk you have in each trade as an R (risk) multiple. So your trading system can be characterized as a distribution of the R multiples it generates and expectancy is simply the mean of the R multiples generated.

Many people feel that trading the futures markets is extremely risky as they have “heard” of people losing all their money, and then some. This can certainly be done with the use of margin and no risk management rules. However if your trading plan is a function of R multiples you cannot suffer this fate in one blow. You could however still die a death of a thousand small cuts if your system does not have a positive expectancy.

The secret to survival is determining your maximum losing R multiple. So even though we are trading a contract worth $113,000.00 (1 contract of crude oil = 1000 barrels X current price $113.00) we only risk a maximum of 1R on each trade.

For our system the hard stop is equal to our 1R multiple, so the maximum we are prepared to lose is 1R.

We determine what dollar value 1R will be based on 2 factors. The first, as per our risk management rules, is we will only risk up to a maximum 0.60% of our total capital on each trade. That number in itself may not be realistic depending on how much capital you have and the product you wish to trade. If we need to risk more than that as per our stats then we either have to quit trading, trade a different product, or add more capital.

The other factor in determining our 1R multiple comes from our sim and live trading statistics with the product traded. These stats tell us where we should be setting our hard stop in order to give the trade room to oscillate while protecting our capital in the event the trade does not work for us. Therefore as long as the hard stop (1R) required is less than or equal to 0.60% of our total capital we know we can trade this contract.

To put this in dollar terms based on our stats the hard stop for the crude contract traded within our system is $120.00. So even though we are trading a $110,000.00 contract the most we are prepared to lose per trade is $120.00. So in our system 1R is equal to $120.00.
With the dollar value of 1R in hand we then categorize our winning trades as multiples of R. For example a $240.00 winning trade would be a R2 win, a $600.00 winning trade a R5 win and so on.

When you have a series of profits and losses expressed as R multiples you have what Van Tharp calls an R multiple distribution. Once you have a database of trades providing your R multiple distribution you can do 2 very important things. One, you can determine your systems expectancy and two, you can project your systems results over many more hypothetical trades.

Expectancy gives you the average R value that you can expect from the system over many trades. Put another way, expectancy tells you how much you can expect to make on the average, per dollar risked, over a number of trades.

Expectancy is calculated as follows:

Expectancy {[(Average Profit) * (Probability of Winning)] Less [(Average Loss) * (Probability of Losing)]}/ Average Risk Amount

After this calculation is done and you have proven your system’s positive expectancy number (if it’s negative you go back to the drawing board) you can then take your R multiple distribution and project future results.

We use a software program called Money Expert provided by MTPredictor for this projection. This spreadsheet beautifully demonstrates for us what Mark Douglas talks about in his book, Trading in the Zone, as we have previously discussed in our probabilities section.

“The successful trader understands that each individual trade is independent of every other trade; each trade is a unique event where the outcome is random. If you focus on each trade individually there will be a random unpredictable distribution between wining and losing trades. However on a collective basis the exact opposite is true. If a large enough number of trades are tracked patterns will emerge that produce a consistent, predictable and statistically reliable outcome.” Mark Douglas, Trading in the Zone

The Money Expert software allows us to see this “random distribution” of trades from our own R multiple distribution. We have found this to be extremely useful as we can take a 100 trade sample and run the random distribution to see the results over thousands of trades. This numerically shows the trader how drawdowns and losing months will occur even with a very successful trading system.

It gives you a major deposit of “emotional capital” to help you withstand these drawdowns to your financial capital.


Trading Beans

Some more video from the floor. This is the last trading day of the year for the Chicago Board of Trade Soybean contract. The traders really get rolling toward the end of the video.

This is a good lesson for all electronic traders who trade a commodity that is also pit traded. The frantic opening and closing of the pit session is usually mirrored on the electronic contract and you don't want to miss the moves that can occur at those times.


Trading is Hard

And then termites eat all your money.

Thanks to J the FX trader for this one.

Termites feast on trader's money
By Amarnath Tewary

A trader in the Indian state of Bihar has lost his life savings after termites infesting his bank's safe deposit boxes ate them up.

Dwarika Prasad had deposited currency notes and investment papers worth hundreds of thousands of rupees in a bank safe in the state capital Patna.

The bank says it put up a notice warning customers of the termites.

Mr Prasad says he did not see it in time as he did not go to the bank for months after the notice went up.

Bank officials admit they did not inform the customers individually about the termite problem.


"I'm shattered. I do not know what to do as I had kept the money for my old age," Mr Prasad said.

The trader says he had deposited 450,000 rupees ($11,000) in currency notes, investment papers worth 232,000 rupees ($5,660) and some gold and silver jewellery in a safe deposit box of the government-owned Central Bank of India.

Mr Prasad says that relations with his wife and children were strained and he wanted to put the money in the safe box to keep it safe from them.

He started using the safe box in September 2005.

He says when he opened it on 29 January, there was nothing in the safe except termite dust and remains of currency notes and that his investment papers were "badly perforated".

The white ants did not even spare the ornaments and their sheen has vanished, he says.

"I wrote to the head office of the Central Bank of India and the regional offices of the Reserve Bank of India," Mr Prasad says. "Even after two months, I'm waiting for a response from them."

'Not liable'

Bank authorities say they put up a notice, dated 8 May 2007, outside the locker room warning customers about the termite infestation.

They advised customers to remove their documents and papers from their safe.

"We received a few complaints of termites in safe deposit boxes so after putting on the notice, we got pesticides sprayed in the bank," said bank manager YP Saha.

Mr Saha says the customer cannot blame the bank because he did not find his locker broken or damaged.

"The bank is not liable for the deposits kept inside the safe as it is only when a locker is found broken that the bank is answerable," he said.

Bank authorities say they have forwarded Mr Prasad's complaint to higher authorities but they say he is not entitled to any compensation for his loss.

Story from BBC NEWS:

Published: 2008/04/07 11:52:36 GMT



Trading Crude Oil: Counting Barrels

A new all time high for crude oil ($112.20) was hit today. All time high is quite a statement if you think about it. Crude oil has never cost this much in the history of the world. So that annoying question, how high will it go, is still out there. Pundits base their predictions on past history. This is all new history (is there such a thing as new history?) for this bull market in crude oil.

All traders can do is trade the direction that's in front of them. All consumers can do is stop driving or pay up.

We have another investment thesis that we may discuss in detail later, but the premise is to own companies that you pay hundreds of dollars to each and every month. That way when you "filler up" you are paying yourself, as you own the company. :)

At least today we have a reason for the large move in crude.

Every Wednesday the U.S. Department of Energy publishes their Petroleum Status Report. This is usually a good day for trading as we have the two requirements we need to trade, liquidity and range.

Today the the street was expecting a 2 million barrel increase in crude inventory, and instead got a 3 million barrel decrease. Thus we see action like this. That 3 minute bar after the report came out is a $2030.00 price move. In case you didn't quite get it, that's $2030 in 3 minutes.

Needless to say it's a report you need to be aware of if you trade crude oil. Price action like this will blast through limit orders and market orders will see just a tad of slippage.

It is fun to trade though.


Trading Crude Oil: How High is High?

The crude oil contract looks like it may break out to some new all time highs tomorrow. Or it could hit resistance (resistance in this case being its never been this high before) and turn around for a dramatic fall.

The nice part about intra day trading and trend following is you don't have to make this call. I don't know where crude is going to go tomorrow and I don't care. :)

I am going to follow whatever direction it goes and must start the day without any bias as to what direction that will be.

When people ask me what I do for a living, I get a long pause after the answer, then they ask how high is oil going to go.

I tell them I have no idea.

That is usually the end of the conversation.

(click on chart for better view)


The Core

The ultimate success or failure of your trading business will come down to one thing. Can you reverse the fear and greed psychology that is inherent in all of us? If you cannot you will not succeed as a trader.

This brain activity comes from our core fight or flight instincts that have been given or evolved, depending on your religion, to all man kind. These instincts have, and continue to serve us well in all aspects of life except trading and investing.

When confronted with a decision in the trading day our instincts let us down as they are dead wrong. If we see profit in front of us our flight/fear instinct says take the money and run. If we see a loss in front of us our fight/greed instinct says hang on and tough it out, we will be vindicated.

Again, both decisions are dead wrong.

This is why the simplest rule of trading is the most difficult; cut your losers quickly and let your profits run. It sounds so simple anyone should be able to do it. Statistics tell us that anywhere from 85% - 95% of people cannot do it.

This is the main reason why some "gurus" state that sim trading is useless, because the fear greed complex can only be tested with real money at stake. This is true, however we believe sim trading does provide the right path to test trading systems. Just because you can sim trade a system profitably does not mean you can duplicate the results with real money.

The key to reversing our fear greed complex starts with recognizing it first and then using our conscious mind to try and override our subconscious mind. Easier to say then do.

One way to help this is to provide the conscious mind with facts; statistics that you have done that show the results of cutting your losers quickly and letting your profits run.

The profit running side is the hardest for most traders to conquer. We have found that a trial database showing the results of different technical profit exits is a great method to provide concrete facts that prove the merits of "letting your winners run".

It could be that we can't completely reverse our fear greed complex, perhaps just understanding it will give the trader enough of an edge to find their way to the winning side of the game.


How to Trade?

Many people in the "trading" business are willing to sell you their trading system. This begs the obvious question, if the system is so good why would they sell it?

Even if the system is valid the vast majority of people would not make money trading it.


Because they will inevitably deviate from the system.


You must trade your own beliefs in the market, not someone else's. This failure to follow occurs whenever there is a drawdown in someone else’s system that you are trying to trade.

Trading is money and money is emotion and when these emotions are put to the fire you will fail if you are not dealing with your own belief system. In order to stick with “the plan” in a drawdown you must believe in your plan and this belief can only come from the very core of who you are and your psychological relationship with your money at risk in the marketplace.

You must develop, design, and build your own system based on your own research. You can then build a database of trades that provide the trader a statistical basis on which they validate their trading system.

Then you try and sell it to others. :)