Wednesday 2 April 2008

Trading Psychology and Range Days

My thoughts on trading psychology and range days today. Got a great question from Nilesh about Tuesday's explosive move. Here it is:

"I knew I should only trade from the long side. But in the last 2 hours I took 4 trades - all of them SHORT. Only the last trade cost me, however, it's cost me more in confidence. Any suggestions?"

What is a range day? A range day is any day where the market just keeps going, either up or down. We all know what they feel like. You're thinking "When will this runaway move stop? Where's the top/bottom?" Trust me, we're all thinking it - "When do I short this monster rally? When do I buy this over-sold market?"

So here are the stats on range days:

Emini Range Days Image

Emini Range Days (frequency of days with a particular range)

7% of Emini trading days have a range of greater than 2.5% of the previous day's close. These are large range days, either up or down. So you get on average of 1 to 2 range days a month. Note the "fat tail" at 3% or greater - classic Nassim Taleb.

Emini Range Day Bottoms Image

Emini Range Day Opens (frequency of days and how close the open is to the extreme)

Most of the time range days open near the low of the day if the market is going up, or near the high if the market is going down. The label on the chart is a little misleading as it looks like I'm only talking about up days. In fact the data includes both up and down days. Strictly speaking I should have said "there is a 59% chance that the open is within 20% of the extreme".

Emini Range Day Tops Image

Emini Range Day Closes (frequency of days and how close the close is to the extreme)

Now here's the good stuff. 71% of the time the market will close very near the extreme - near the high on an up day or near the low on a down day. There's no reason to short an up range day. Again the stats above include up and down range bars.

There's over a 25% chance that the market will close in the top 5% of the bars range on an up day! (and within 5% of the bottom on a down day). That's what you should be thinking as the market screams away - "I need to buy a pullback and hold to the close".

Emini Range Day Next Day Image

Day After Emini Range Days (frequency of days and the size of tomorrow's range compared to today)

Lastly, here's what happens on the next day. There's over a 40% chance that we'll get another range day tomorrow. Now I should have split this data into up days and down days - I'm sure down range days are more likely to be followed by another down range day. But you get the picture.

Tom Cruise and Days of Thunder

So those are the stats. Now this might sound a little peculiar - when I'm in the middle of a runaway "range" day I visualize Tom Cruise and Robert Duvall in the movie "Days of Thunder". I hope you've all seen it - after all it did have Nicole Kidman in it.

Anyway, it's about stock car racing and early in the movie Tom Cruise gets into a big crash and his confidence is shaken. Duvall takes him aside and tells him that when he sees an accident happening ahead of him, the cars will mostly likely slide down from the TOP of the banked track to the BOTTOM - and leave a clear path through the wrecks on the high side of the track.

The big race day comes, Cruise is losing to his arch enemy and in the middle of the race there's a big crash ahead of him. There's smoke all around and he can't see what's in front - but he remembers what Duvall said. "Go high. Pick a line that avoids the wrecks and you'll get through".

So even though there's smoke all around and he can't see where's he's going, he knows that there is a high probability that the wrecked cars have slid down from the top of the track and the safest route through is to "go high".

That's what I'm thinking as a range day develops - get long and hold on, because the highest probability outcome is that we'll close at the highs. I'm blinded by the smoke but I know that if I "go high" I'll be safe.

Good luck with your Emini trading. BTW the little contest I'm running is coming up real soon - stay tuned. And here's the movie trailer for Days of Thunder.

Trading Psychology (Days of Thunder)

Like this article? Sign up for Free Email Updates or subscribe to the RSS Feed.


Filed Under Trading Psychology

Thursday 27 March 2008

Trading Psychology and Reader Question Answered

Got a great question from Mitch yesterday which I'd like to answer in this article. But first a quick update on Thursday's Emini action.

Yesterday the Emini closed down 17.25 points on below average volume and range - showing a lack of selling pressure. Today the Emini closed down just 4.25 points but on higher volume. A large amount of volume came in at the end of the day, around 1,328, and the Better Volume indicator shows High Churn. My short swing trade has worked out well but it's time to take profits and watch for an upside break.

Now here's Mitch's question:

"I live on the East coast and only have 1 hour in the morning and 1 hour before the close to trade. I have always over-traded but now want to take no more than 1 trade per day. I prefer to look at just 1 time frame but I can handle 2 charts if needed.

I use TradeStation and have a $10,000 account. Even aggressive money management would suggest that I risk not more than $1,000 per trade. So my maximum trade size using a 4 point stop would be 5 contracts. I'd actually prefer to only start trading with 2 contracts, which would allow for more forgiving stops and bigger targets.

I'm looking for straightforward entry rules with targets and stops based on your indicators. Although it may seem like I am seeking a magic bullet, I really am just trying to find a good combination of time frame(s), indicator(s) and trading plan to identify 3-5 trades per week."

This question raises a number of points.

Trading Hours

It's definitely possible to be a day trader and only trade for a couple of hours a day. You need to pick your hours though. Personally, I like to look for trade setups a couple of hours after the European markets have opened. Then 30 minutes after the US markets open. Lastly about an hour before the US markets close.

There are also times I avoid. The first 20 minutes of the day can be tricky with a lot of positioning before a decent trend move (6 to 10 points) develops. Volume also dries up in the middle of the day (lunchtime) and whipsaw trades are more frequent. I also never open a new trade in the last 20 minutes of the day session. Lastly, I avoid the overnight session until after the European markets have been open for a while.

I use these windows of opportunity to start looking for setups. But the worst thing is to feel pressure to take a trade because you have a job or an appointment to get to - and the window of opportunity is about to close. You start to force trades, instead of letting the setups develop. You'll also exit winners sooner and end up reducing your average trade profit.

Of course if you're scalping for a 0.25 or 0.50 point these guidelines probably don't apply, but they make sense for me when I'm looking for 4+ point trades.

Multiple Charts

I strongly believe in using multiple time frames but the minimum number of trading indicators. My day trading screen has 3 tick charts side-by-side. The time frames I use are 233 tick, 699 tick and 2,097 tick. Having the charts side-by-side allows me to see price and volume patterns developing in different time frames. It also gives me enough back history to see previous important support and resistance levels.

However, on each chart I only have my Hilbert Sine Wave and Volume indicators. These are non-correlated indicators and so I am getting the maximum information about price and volume with the minimum number of indicators (and information overload).

On a second screen I also have my Trend Line indicators on the same 3 tick charts side-by-side. I use these charts to see if my trades break any significant trend lines, indicating that I might have got on board a "runner" and the profit target can be increased to 6 or 8 points.

Stop Loss & Position Sizing

With a $10,000 account I would only ever trade 1 Emini contract. You should never be in a hurry to make money - always focus on trading well and reducing mistakes. It's too easy to blow an account with too large a position.

You can easily have 3 losing trades in a row. With a 4 point stop that's $600 per contract. If you were trading 4 contracts your account would be down 25%. Once you're down that much you start saying to yourself "I'm not going to let the next trade be a loser". Once you've started down that dark path you start ignoring stops, cutting profits short, saying to yourself that this trade will work out in the end and treating it like a swing trade rather than a day trade.

We've all been there. The answer is - don't put yourself under the pressure. Just trade the 1 contract and focus on reducing mistakes.

I don't use fancy scaling in or scaling out of a trade. I'm either all in or I'm out. I find the volatility in the Emini too high to justify trailing stops - I'm more likely to make more getting taken out at a stretch target than trailing a stop and being taken out prematurely. This is a personal thing I suppose, but it's another reason why you don't need to use multiple contracts with a small account.

Trading Methodology

So should you be using a day trading or swing trading methodology (remember swing trading is holding more than a day, my definition at least). My swing trades are mostly system based with average trade drawdown of $600 and a maximum of $3,000 (trading 1 contract). This is too much risk to take on with a small account.

Instead I would focus on day trading and shooting for 4 points. Once you've made your 4 points then you're out until tomorrow. You could even start with just shooting for 2 points until you become more confident. Even consistently making 2 points generates plenty of opportunity to build up an account and then trading multiple contracts.

A good friend of mine says "Don't get greedy - Get out!" And he's right - be patient, wait for the right set up, take your profit and then walk away - then come back and do it again tomorrow.

You can read more about my particular Emini day trading methodology here. I'll be posting another couple of videos soon - one walks through a recent day trading example, the other goes into more detail about the Better Volume indicator (which is free). Remember you need to develop your own methodology.

A rambling post I know and no charts! But just my thoughts on trading psychology. Good luck with your Emini trading.

Like this article? Sign up for Free Email Updates or subscribe to the RSS Feed.


Filed Under Trading Psychology

Tuesday 1 January 2008

Trading Psychology and New Year's Resolutions

Happy New Year and I hope you're enjoying this break from trading. Just a quick post today about my end-of-year routine and New Year resolutions.

New Year's day is usually a quiet day and I take the opportunity to do 3 things:

  • Update my Net Worth spreadsheet
  • Go through my trading log and set a goal or resolution for the New Year, and
  • Decide on vacation destinations with my wife

Net Worth

I've kept a detailed spreadsheet of my net worth for the past 12 years. Sounds anal I know. In years gone by, I tracked all my daily expenditure as well as closing share prices of investments held. On any given day I could tell you my net worth almost to the dollar! These days I've mellowed and am happy to live with a more intuitive feel for incomings and outgoings.

However, at the end of each year I still take the time to update my net worth spreadsheet. It doesn't take long. I log into online accounts to check bank account, trading account and credit card balances. Then assess the current value of property and add any major asset purchases (or write-downs) made during the year. The end result in always enlightening, particularly because I track where the gains and losses have been made.

Over the years, what I've found is that my net worth will stay at similar levels for maybe 2 or 3 years and then take a step jump or two. I've never gone backwards, but each year there's always a lesson to be learned.

Trading Log

Since I started trading I've always kept a trading log. In the early years the log just recorded the result of each trade - mostly swing trades and so not too difficult. I then started to keep more detailed notes about lessons learned from each trade, how I felt about the trade, what to remember for next time. Frankly, this became too onerous and I hardly ever reviewed the log.

These days I keep it more simple. I record the daily total of my day trades (total points, total $ after brokerage, number of trades and number of contracts) and also keep track of my swing trades. Then each day I note whether I made any mistakes - moving profit targets, ignoring signals, not waiting for confirmation. You know the kind of thing!

I track it all in a spreadsheet with 1 line for each day. The trading errors are noted as crosses in a column and I have a column for each of my error types. Then at the end of each year it's pretty straightforward to see total performance and what errors I'm making.

This year I've been trying to pick tops and bottoms, entering too early and as a consequence trading against the trend. So my New Year's resolution is to focus on this - become more patient, wait for confirmation, trade the end of a trend.

Vacations

And lastly, my wife and I plan our vacations for the year. We travel as much as we can and even go on business trips together. With high-speed, wireless internet connections becoming the standard, trading from anywhere in the world has really become practical. Best of all, we always have something to look forward to.

Good luck with your trading and keeping your resolutions in the New Year.

Filed Under Trading Psychology

Popular Emini Trading Articles

Free Emini Trading Report

Emini Trading Report
Emini Trading - Free Report Coming Soon!

Subscribe to Emini-Watch