Elements of a Successful Trading Plan--The Markets You Trade

Elements of a Successful Trading Plan--The Markets You Trade
Another trading plan consideration is the markets you trade. There are about forty futures markets with sufficient liquidity to allow prudent speculation. However, it is important to select a good universe of markets that are appropriate for your account size, risk level and trading style.
It also important that your market universe be diversified. There are always a number of big market moves every year, but no one knows in advance where they will be. If you trade a diversified portfolio, there is a greater chance that you will catch some of the truly big moves that make for successful trading.
Another consideration in choosing a market to trade is its historical propensity to have more big trending moves. Since the trend is your edge in trading, you can maximize your edge by selecting the most trendy markets. The following are some of the best trending markets in various trading sectors.
The currencies are the best trending sector. The currencies to trade are the Swiss Franc, the German Mark, the Japanese Yen and the British Pound.
Interest rate futures are also good trending markets. T-Bonds represent long-term interest rates and Eurodollars are for short-term interest rates.
In the energy complex, Crude Oil, Heating Oil and Natural Gas are good trading vehicles.
In the food sector, Coffee, Orange Juice and Sugar are recommended.
In metals, you can trade Gold, Silver and Copper.
In agriculturals, Corn, Oats, Soybeans and Cotton are the best.
Now you have the outline of an overall plan to trade commodities. The key to success is to test whatever strategy you intend to apply before you trade with it. Remember that the conventional wisdom that you read in books is mostly ineffective. When applied consistently, most trading methods don't work.
You can't test your plan unless it is specific. The rules must be precise and objective. Having a thoroughly tested plan is crucial to maintaining the confidence necessary to keep trading the plan through the inevitable losing periods that every good system and every good trader must endure.
The reliability of non-computerized testing is highly suspect. Using computer software that tests a particular approach or a variety of approaches is preferred. You must learn the correct way to test and evaluate trading approaches.

Elements of a Successful Trading Plan--Cut Losses Short

Elements of a Successful Trading Plan--Cut Losses Short
If you are following market trends rather than trying to anticipate them, the next important part of the plan is how to exit trades that don't work out. Here is where the second cardinal principle comes in. It is Cut Losses Short.
This is another sensible-sounding concept that is much easier to acknowledge than actually to execute when real money is on the line. No one wants to exit a trade with a loss. They don't want to lose money. More importantly, they don't want to admit they were wrong. You can always think of many reasons to hold on to a losing trade. You can hope that the market will suddenly turn around and give you a profit instead of a loss.
This is another example where successful traders have learned to do the hard thing. If there is one thing consistent in the stories of how good traders turned themselves around from being bad traders, it is their attitude about losses. Professional traders accept that losses are part of the game. Since the markets are mostly random, the best trading methods will always have numerous losses. Professionals do not equate losses with being wrong.
It is precisely because correct trading methods invariably generate many losses that it is important to keep the individual losses small in relation to the overall size of the account. In order to keep trading, you must preserve your capital. If you can keep trading in the direction of the trend, the big profits will come. However, if you take too many large losses, your capital will be wiped out before you can enjoy the big profitable trades.
The laws of probability insure that regardless of your approach, you will inevitably suffer some long strings of consecutive losses. If you are risking too high a percentage of your account on each trade, before long one of these unavoidable losing streaks will blow you away. Keeping losses to about one percent of your account size is optimal. With smaller accounts, the percentage will have to be larger. Five percent on one trade is probably the highest prudent level of risk.
Because of the randomness in commodity price action, you must allow the market a certain amount of leeway before giving up on a trade. In general, you must be willing to risk between $500 and $1,000 to trade most markets. For smaller accounts, the Mid America Exchange offers trading with smaller sized contracts that allow you to trade with lower risk.
While there are more sophisticated ways to decide when to exit a losing trade, getting out after a loss of a predetermined dollar amount is as good a way as any. The important thing is to respect your plan. You can place a stop-loss order with your broker that instructs him in advance to exit a trade if the market hits your loss limit. You should always do this to guard against inattention or changing your mind at the crucial moment.

Elements of a Successful Trading Plan--Let Profits Run

Elements of a Successful Trading Plan--Let Profits Run
The next part of the plan involves a more pleasant alternative: when to exit a trade that is profitable. The cardinal principle involved is Let Profits Run. In other words, stay with your profitable trades as long as possible because the trend is likely to continue and make your profits even larger.
Again, this is easy to understand but not so easy to do when real money is involved. The difficulty is that although your profit may become much larger if you stay with a trade, it may also decrease and even disappear. Human nature is such that it values a sure profit much more highly than the probability of a much higher profit. Thus, traders are inclined to take their profits too soon. This can be fatal to long-term success because big profits are necessary to overcome the inevitable collection of small losses.
There is a good way to let profits run while still guarding against the possibility that prices will turn around and take away much of your accumulated profits before the trend actually reverses. It is called a trailing stop. You include in your plan a method for moving an exit point along some distance behind your trade. As long as the trend keeps moving in your favor, you stay in the trade. If the market reverses direction by the amount of your trailing stop, you exit the trade at that point. You would also offset your trade and reverse position if the trend reversed.
One way to set a trailing stop is to protect a certain percentage of the accumulated profit. That will always insure that you keep some profit on a good trade.

Elements of a Successful Trading Plan--Getting Started

Elements of a Successful Trading Plan--Getting Started
The first element of any trading plan is the amount of capital you intend to invest. This is up to you, but you should understand that there is a direct relationship between the amount of capital you commit and your probability of success. The more you invest, the greater is the likelihood that you will make money.
What is the minimum advisable amount to start with? Most professionals agree that it takes a minimum of $10,000. If you try to trade with anything less, what happens to you will be luck. You won't have the capital necessary to apply proper risk management principles.
An important thing to keep in mind when deciding how much to commit initially to commodity trading is that the amount you invest must be "risk capital." Risk capital is defined as money you can afford to lose without affecting your standard of living. It should also be money that you feel comfortable risking. Think of your commodity account as an investment in a business. Many businesses fail. That's life. Make sure you won't be so afraid of losing money that it will affect your ability to make correct trading decisions.
The next part of your trading plan involves how you will make your actual buying and selling decisions. Under what conditions will you enter trades? When will you exit your trades? What markets will you trade?
There are four cardinal principles which should be part of every trading strategy. They are: 1) Trade with the trend, 2) Cut losses short, 3) Let profits run, and 4) Manage risk. These building blocks are so basic and important that I have written a whole book about them. You should make sure your strategy includes each of these requirements for success.

Elements of a Successful Trading Plan--Trade With The Trend

Elements of a Successful Trading Plan--Trade With The Trend
Trading with the trend is hard to do because a logical give-up exit point will be farther away, potentially causing a larger loss if you are wrong. This is a good example of why so few traders are successful. They can't bring themselves to trade in a psychologically difficult way.
You can define the concept of trend only in relation to a particular time frame. When you determine the trend, it must be, for example, the two-week trend or the six-month trend or the hourly trend. So an important part of a trading plan is deciding what time frame to use for making these decisions.
Do you want to be a long-term trader, also called a position trader? They hold positions for weeks or months. Do you want to be a short-term trader who holds positions only for a few days? There are even very short-term traders called day traders. They watch the markets during the day and always enter and exit their positions on the same day.
While it is perhaps easier psychologically to keep the time frame short, the best results come from longer-term trading. The longer you hold a trade, the greater your profit can be.
Day trading has great attraction because you can start each day fresh and sleep comfortably every night with no open positions. However, it is the most difficult kind of trading there is. Here's how legendary trader Larry Williams describes it: "Day trading is so stressful. You're going to end up frying your brain. All the day traders I talk with are losing money. Besides, it's really hard to come up with profitable day trading systems."
For the greatest chance of success, your time frame to measure trends should be at least four weeks. Thus, you should only enter trades in the direction of the price trend for the last four weeks or more. A good example of a trend-following entry rule would be to buy whenever today's closing price is higher than the closing price of 25 market days ago, and sell whenever today's closing price is lower than the closing price of 25 market days ago.
When you trade in the direction of this long a trend, you are truly following the markets rather than predicting them. Most unsuccessful traders spend their entire careers looking for better ways to predict the markets.

Learning To Trade Correctly

Learning To Trade Correctly
One way to learn how to trade correctly is to find a successful trader and have him or her teach you exactly how they do it. However, even if you could find such a person and even if they would be willing to spend the time with you, it would not necessarily make you a successful trader. You might not have the capital necessary to trade the way they do. You would definitely not have the years of experience they had developing their successful approach. You might not have the personality profile necessary to execute their style of trading.
Another way to learn is by trial and error. This is the method of choice for most people although they probably don't realize it. The trouble with trial and error in futures trading is that you don't always take a loss when you trade incorrectly and you don't always make a profit when you trade correctly. Some of the best methods generate losses more than half the time. You can take many losses in row applying a very effective system. On the other hand, if you are lucky, you can makes tons of money trading quite stupidly. Psychologists call this random reinforcement, and it makes good trading impossible to learn through trial and error.
The most obvious and practical way to learn how to trade correctly is to read books. Find the best books by the most respected authors and the best traders and learn from them. While this may work in other areas of life, it is more problematic in commodity trading.
One of the few real secrets in commodity trading is that most of what you read in books about how to trade does not work in the real world. Even books by respected authors are full of trading methods that lose money when put to the test. You may find this shocking, but almost no commodity authors demonstrate the effectiveness of the methods they advocate. The best you can hope for are some well-chosen examples or a few cursory tests.
Learning to trade is a combination of being exposed to ideas plus practical experience watching the markets on a day-to-day basis. This is not something that can happen in only a few weeks. On the other hand, you can become a great trader even with only average intelligence. Professional trader and money manager Russell Sands describes the makeup of a successful trader: "Intelligence alone does not make a great trader. Success is equal parts of intellect, applied psychology, practice, discipline, bankroll, self-understanding and emotional control."
Furthermore, to be successful you don't have to invent some complex approach that only a nuclear physicist could understand. In fact, successful trading plans tend to be simple. They follow the general principles of correct trading in a more or less unique way.

Separating the Winners and Losers

Separating the Winners and Losers
A very high percentage of those who try commodity trading eventually lose money. The ratio of losers could be as high as ninety-five percent. However, this does not necessarily mean that your chance of failure is that high. If, before you begin, you identify correctly the reasons most people lose, you can improve your odds significantly.
There is a small percentage of full-time professionals and highly skilled part-time traders who have learned how to trade correctly and generate consistent profits year after year. It is not impossible to determine what separates these people from the crowd.
Because trading well is not easy, you must approach the task very seriously. This is not something to treat as a hobby. Perhaps, first and foremost, this is what separates professionals from amateurs. Professionals look at their trading as a business. There are substantial profits to be made, and they will not just fall into your lap.
Another crucial difference between successful and unsuccessful traders is that the successful ones have a plan and they follow it. Considering the amount of money involved and the potential risks, it is remarkable how few traders actually have any kind of plan for their trading. They go from trade to trade applying various ideas they have learned without any consistency and without any testing. They make decisions based on hot tips, something they read, today's news. They are acting from emotion rather than using a proven methodology. While they may not want to admit it, they are really gambling in the futures markets rather than trading intelligently.
Trading by emotion in an unstructured way certainly adds fun and entertainment to the enterprise. Taking positions on instinct is exciting, especially when they work out . . . as they often do. But in the end, this kind of trading will lose money.
Good trading is boring because you've thought out your strategy and tactics in advance. You trade according to a carefully tested system or method, not from what moves you emotionally that day.
Two psychological traits that separate winners from losers are patience and discipline. It is not enough to have a carefully tested trading plan. You must also be able to follow it religiously. This is not as easy as you may think.
Every experienced trader knows how great the temptation is to stray from the plan. There is always what seems to be a good reason. The true professional can resist this temptation and stick to his plan. He has the patience to wait for his method to signal a trade and not take trades he may be emotionally attracted to that are outside his plan. He has the discipline to follow his plan and take all the trades that it signals even when there appear to be strong reasons to make an exception.
This may sound easy, but when real money is on the line--your money--nothing is more difficult. The kind of trading that really works is emotionally demanding.
It is hard work to create a winning trading plan. It is hard psychologically to follow the plan after you create it. This is why so many people fail. Perhaps you have what it takes to be an exception.

The Truth About the Commodity Markets

The Truth About the Commodity Markets
In order to be a successful trader, you must understand the true realities of the markets. You must learn how the professionals make money and what is possible. Most traders come into commodity trading, lose a substantial portion of their capital and then leave trading without ever having a correct perception of what good trading is all about.
For many years college professors have argued that the markets are both random and highly efficient. If this were true, it would be impossible to gain an edge on other investors by having superior knowledge or a superior approach.
Professional traders, who make their living trading rather than studying the markets from afar, have always laughed at these ivory tower theories. A good example is George Soros, who has made billions of dollars from trading and is perhaps the greatest trader of all time. Here is how he responds to these ivory tower academics: "The [random walk] theory is manifestly false--I have disproved it by consistently outperforming the averages over a period of twelve years. Institutions may be well advised to invest in index funds rather than making specific investment decisions, but the reason is to be found in their substandard performance, not in the impossibility of outperforming the averages."
Mathematicians have conclusively shown the financial markets to be what are called non-linear, dynamic systems. Chaos theory is the mathematics of analyzing such non-linear, dynamic systems. The commodity markets are chaotic systems. Such systems can produce random-looking results that are not truly random. Chaos research has proved that the markets are not efficient, and they are not forecastable. Commodity market price movement is highly random with a small trend component.
Most beginning traders assume that the way to make money is to learn how to predict where market prices are going next. As chaos theory suggests, the truth is that the markets are not predictable except in the most general way.
In his book, Methods of a Wall Street Master, famous trader Vic Sperandeo, whose nickname is "Trader Vic," warns: "Many people make the mistake of thinking that market behavior is truly predictable. Nonsense. Trading in the markets is an odds game, and the object is always keep the odds in your favor."
Luckily, as Trader Vic suggests, successful trading does not require effective prediction mechanisms. Good trading involves following trends in a time frame where you can be profitable.
The trend is your edge. If you follow trends with proper risk management methods and good market selection, you will make money in the long run. Good market selection refers to trading in good trending markets generally rather than selecting a particular situation likely to result in an immediate trend.
There are three related hurdles for traders. The first is finding a trading method that actually has a statistical edge. Second is following it with consistency. Third is consistently following the method long enough for the edge to manifest itself on the bottom line.
This statistical edge is what separates speculating from gambling. In fact, effective trading is actually like the gambling casino rather than the gambling customer. Professional trader Peter Brandt explains successful trading in just this way: "A successful commodity trading program must be based on the simple premise that no one really knows what the markets are going to do. We can guess, but we don't know. The best a commodity trader can hope for is an approach which provides a slight edge. Like a gambling casino, the trader must earn his profits by exploiting that edge over an extended series of trades. But on any given trade, like an individual casino bet, the edge is pretty meaningless."
Unsuccessful and frustrated commodity traders want to believe there is an order to the markets. They think prices move in systematic ways that are highly disguised. They hope they can somehow acquire the "secret" to the price system that will give them an advantage. They think successful trading will result from highly effective methods of predicting future price direction. These deluded souls have been falling for crackpot methods and systems since the markets started trading.
Prolific futures trading author Jake Bernstein describes how these desperate traders are victimized: "Futures trading is ultimately very simple. Any attempt to make trading complex is a smokescreen. Yet for self-serving reasons an army of greed-motivated promoters try to make things complicated. Too many market professionals consider it their mission in life to obfuscate. Why? Because in so doing they give the appearance that their efforts are scholarly and important. They create a need for more information, and then they fill it!"
Books on how to trade commodities are famous for showing a few well-chosen examples where a described prediction method previously worked. They never show what would have happened if you had applied the method religiously for many years in numerous markets. Those who have tested these methods have found that in the long run almost all of them don't work. Be wary of any trading method unless you see a detailed demonstration showing that it has worked for at least five to ten years in a variety of different markets using exactly the same rules.
The job of the person who wants to trade commodities rationally and prudently is to ignore the promises of those promoting pie-in-the-sky prediction mechanisms and concentrate on finding and implementing a proven, integrated methodology that follows market trends.

Making A Trade

Making A Trade
Assuming the trader has consulted his price charts, applied his trading plan's decision-making criteria and decided to make a trade, how does this actually take place? He will have a trading account open with a broker. Believing, for example, that the price of Silver will be going up in the near future, he calls his broker's trading desk, and the following conversation might occur.

"XYZ Discount Brokerage."This is Bruce Babcock. For account number 22656, buy one December Silver at the market.""Buying one December Silver at the market. Please hold."

The broker may enter the order into a computer or she may call the exchange floor directly. In either case, the order goes to the exchange trading floor in New York City. Once at the broker's desk on the edge of the trading floor, a runner may take the order to the trading pit to be filled or a clerk may transmit it to the pit by hand signals. In the trading pit, a floor broker executes the order with his fellow floor traders by a combination of shouting and hand signals. The process is then reversed as the trade price is communicated back to the customer.

"Hello. You bought one December Silver at 550.""I would like to enter my stop order. Good 'til cancelled, sell one December Silver at 540 stop."“For account number 22656, selling one December Silver at 540 stop. Good 'til cancelled.""Thank you."

The second sell order was an instruction to the broker to automatically offset the trade if Silver declined in price by $500. This was a prudent step to limit the loss in case price did not go up as the trader expected. Placing the order with the broker means that the trader will not have to monitor the market constantly to be sure the loss does not get too big if price goes down instead of up. The trader is not guaranteed to limit his loss to exactly $500, but he will usually be able offset his position fairly close to the requested price.

The trader can offset his position any time before the Silver contract expires in December. To the extent Silver's price is more than $5.50 an ounce when he offsets, the trader will profit by $50 for each cent. To the extent Silver's price is less than $5.50 when he offsets, the trader will lose $50 for each cent.
To do the same trade with less dollar risk, the trader could have instructed the broker to place the orders at the Mid America Exchange, where the Silver futures contract is only one-fifth the size of the regular New York contract. That would have yielded profits and losses of $10 for each cent rather than $50.

The Trading Process

The Trading Process
Here are some typical steps in the process of making a commodity trade including the trader's decision-making process and the procedures involved in actually placing the trade.
In order to make decisions about when to trade commodity futures, you must have a source of price data. Many daily newspapers carry some commodity prices in their financial sections. The Wall Street Journal has comprehensive commodity price listings. Investor's Business Dailyhas both price tables and numerous price charts
All experienced commodity traders prefer to look at price activity on a chart rather than trying to interpret tables of numbers. In financial analysis, charts are indispensable for quickly grasping the essence of historical and recent price action.
The typical commodity chart depicts daily price action as a thin vertical bar which indicates the day's high and low by the top and bottom of the bar. The opening and closing prices are shown as tiny dots attached to the left and right side of the bar. A typical daily price chart can show up to six months of price action this way.
It is easy to change the bar's time frame from days to weeks or months and thus show from two to twenty years of historical price action in the same format. For short-term trading you can change the bar's time frame to hours or even minutes.
Looking at such bar charts enables a trader to see the recent trend of prices--whether up, down or sideways--in whatever time frame he chooses. Following the current trend of prices is a cornerstone of successful trading.
There are a number of ways to obtain the price charts a trader needs to analyze the markets. You can make your own using graph paper. This sounds rather primitive, but some experts recommend it as a good way to put yourself in close touch with price activity and monitor risk.
Another source of charts is the printed chart service. There are about half a dozen of these. They typically mail a booklet of numerous charts covering all the tradeable markets after the markets close on Friday. There is space on the charts to update them daily during the following week until next chart book arrives. These printed chart books normally have a number of indicators plotted along with the price action and contain a wealth of additional information.
For computer owners there are many software programs that create fancy charts on the computer screen. You can input the price data manually or, via telephone modem, download comprehensive data after the markets close for the day. Those with larger budgets can install a small satellite dish and watch price changes in all the markets nearly instantaneously as they occur. The software creates charts dynamically on the computer screen as each trade takes place on the exchanges. You can put many different charts on the screen and thus watch numerous markets all around the world in real time. The cost can range from a few hundred to $1,000 a month depending on the software and the number of exchanges you subscribe to.
It is easy to believe that computers can make a big difference in trading success. Vendors of expensive software will tell you that since other traders, who are your competition, have expensive computer setups, you need one too. This isn't really true.
Those who can't trade profitably without a computer probably won't be helped too much by using a computer. It may actually be detrimental by causing an increase in trading frequency. While a computer will not make a bad trader into good one, they are fun to use, and they do make a trader's life easier.
There are two primary analytic methods for deciding when to take a futures position: fundamental analysis and technical analysis. Fundamental analysis involves using economic data relating to supply and demand to forecast likely future price action. Technical analysis involves analyzing past price action of the market itself to forecast the likely future price action.
While there are differences of opinion about the relative merits of the two approaches, almost all successful traders emphasize technical analysis. There are a number of reasons for this. First and foremost is the difficulty of obtaining accurate fundamental data. While various governments and private companies publish statistics concerning crop sizes and demand levels, these numbers are gross estimates at best. With the current global marketplace, even if you could obtain accurate current information, it would still be impossible to predict future supply and demand with enough accuracy to make commodity trading decisions.
Technical analysts argue that since the most knowledgeable commercial participants are actively trading in the markets, the current price trend is the most accurate assessment of future supply and demand. If someone is correct that for fundamental reasons, prices will likely move up strongly in the future, the commercial participants who have the greatest knowledge and influence on the markets should certainly be moving the price upward right now. If price instead is moving down, a lot of very knowledgeable people must think price in the future will likely be down, not up.
For this reason, almost all successful speculators learn to follow price action and not try futilely to predict turning points in advance. They seek to trade in tune with the large participants who move the markets.
In his classic book, Technical Analysis of the Futures Markets, famous analyst John Murphy summarizes the rationale for technical analysis: "The technician believes that anything that can possibly affect the market price of a commodity futures contract--fundamental, political, psychological or otherwise--is actually reflected in the price of that commodity. It follows, therefore, that a study of price action is all that is required. By studying price charts and supporting technical indicators, the technician lets the market tell him which way it is most likely to go. The chartist knows there are reasons why markets go up and down. He just doesn't believe that knowing what those reasons are is necessary.