Trend Indicators and Price Components

Trend Indicators and Price Components
Since trading with the trend is essential to exploiting the trend component of market price action, successful systems and approaches employ some method of identifying trend. A popular idea is a separate trend filter. This is an algorithm that preliminarily looks at recent price action and determines whether the trend is up, down or neutral.
It is not essential that every approach have a separate trend filter. Some methods, such as moving averages, incorporate a trend indicator into the entry technique. Others (not recommended by me) try to predict an imminent change in trend and are therefore entering when the trend is against them at the time.
Many traders attempt to complicate the problem of trend identification. They invent all kinds of fancy mathematical equations and methods of massaging past price action to more precisely determine whether the trend is up or down. I have long argued that this is pointless. Like all things in trading, simplicity is the best route.
Of course, trend is only relevant in conjunction with a particular time frame. But once you identify the time frame, there is nothing fancy about the concept of trend. The price is either moving up or it is moving down during that time period. You can look at a chart and in most cases quickly determine whether price is moving up or down in your time frame. Why should it be any more complicated than that? Perhaps in cases of price congestion, it is slightly more difficult to say with certainty what the trend is by quickly looking at a chart. However, this is no reason to unnecessarily complicate the trend determination process.
In creating simple trend indicators, there is one intriguing issue. What price components should you use to construct the indicator? There are four choices: the open, high, low and close. You could use them separately or in combination. Can research help determine whether one or more price components does a better job of indicating trend than the others? Or are they allequivalent in trend-identifying ability?
I first performed this exercise in my 1989 book, The Dow Jones-Irwin Guide to Trading Systems. The testing period there was the five-year period ending June 30, 1987. Some time ago, I thought it would be instructive to bring that research up to date.
The procedure is to create four simple trend filter indicators. Each will use different price components. To test their effectiveness, I created for each a simple trading system. When the trend filter is pointing up, the system goes long. It holds the position until the trend filter reverses to down. At that point the system closes out the long position and establishes a short position. The system continues to trade that way. It is always in the market and always positioned in the direction of the trend filter. In order to make the system test as realistic as possible, I deducted $100 from each trade to cover slippage and commission. Theoretically, the filter that is most effective in determining trend should yield the highest profits as a trading system.
I tested each filter in ten diversified markets over a ten- year period. The ten markets were the same I used in my book: Cattle (LC), Sugar (S), Soybeans (SB), Swiss Francs (SF), Comex Gold (GC), T-Bonds (US), Japanese Yen (JY), Heating Oil (HO), Eurodollars (ED) and the S&P 500 (SP).
I used a similar approach to measure historical market trendiness in my book, Trendiness in the Futures Markets. Because the time period is so crucial in measuring trend and because I did not want to make a subjective choice, for purposes of that book I tested every time period between 5 and 85 days. I update the research every year, so the book is constantly up to date.
For this limited project, I chose to use 34 days as a constant time period. From my research I have found this area to be an excellent overall trend-measuring period for all markets. It did yield profitable results for the average of all ten markets, even after deducting $100 per trade for slippage and commission.
Momentum
Momentum is perhaps the simplest form of trend indicator, but it is theoretically sound and ought to be psychologically pleasing. It looks at the direction of the closing price. It uses only the closing price in its calculation.
To calculate Momentum, first determine the time period over which you will measure trend. Then compare today's close with the close at the beginning of your chosen time period. In this case you would compare today's close with the close 34 days ago. If today's close is lower, the trend is down. If today's close is higher, the trend is up. If today's close is the same, the trend is the same as it was the previous day.
This comports with common sense. If the 34-day trend is up in the market, wouldn't you expect today's close to be higher than that of 34 days ago? Isn't that what trend means? This is a simple indicator to use while eyeballing charts. Pick your time frame and become an instant trend expert.
Using the Momentum-based trading system, half the markets were profitable, and the overall average trade was $42.
Directional Movement
This method of identifying trend was created by Welles Wilder and described in his 1978 book,New Concepts in Technical Trading Systems. Unlike Momentum, which uses only the closing price, Directional Movement uses only the high and the low price. It is fairly complicated mathematically, and therefore, you cannot eyeball it on charts.
Directional movement compares the portion of today's price bar that moves beyond yesterday's. If today's high and low are greater than yesterday's, the portion of the today's bar that extends above yesterday's is the up directional movement. If today's high and low are less than yesterday's, the portion of the today's bar that extends below yesterday's is the down directional movement. For an inside day (where today's high is lower and today's low is higher than yesterday's), there is no directional movement. For an outside day (where today's high is higher and today's low is lower than yesterday's), the day's directional movement is the larger of the up or down directional movement as defined above. Up directional movement is positive; down directional movement is negative.
To calculate the indicator, you find the total directional movement over the time period you selected for measurement. If it is positive, the trend is up. If negative, the trend is down. Just as with Momentum, the concept makes intuitive sense. If price is trending up, you would expect the preponderance of daily bars to have higher highs than the day before, and vice versa.
Using the Directional Movement-based trading system, half the markets were profitable, and the overall average trade was $54.
Open/Close Indicator
This is an alternate trend indicator I created about nine years ago. It looks at the relationship between the opening price and the closing price on the same day. Thus, it has the advantage for our purposes of incorporating the opening price in the trend calculation. It is the only trend indicator I know of that uses the opening price.
In an uptrending market, you will find that the close is most often higher than the open. In a downtrending market, the close tends to fall below the open. By comparing the sum of the closes with the sum of the opens over the trend time period you have selected, you get a good indication of the trend based on the relationship of the opens and closes.
Using the Open/Close Indicator-based trading system, half the markets were profitable and one broke even. The overall average trade was $31.
Combination Indicator
The last test attempts to use all four available data points (open, high, low and close) to determine trend. Its indicator is the combination of Momentum, Directional Movement and Open/Close. When all three indicators (measured over 34 days) point up at once, the Combination trend is up. It stays up until all three indicators point down at once. At that point, the trend changes to down.
Using the Combination Indicator-based trading system, again, half the markets were profitable, but the profits were considerably larger. The overall average trade was $185.
The results of these tests indicate that the best trend indicator was the Combination. Next best was Directional Movement. Momentum was third best. Open/Close was the least effective.
That such simple trend-following trading systems were profitable on average over ten diversified markets for a ten-year period shows that there is an exploitable trend component in market price action. By using a more sophisticated trading system and trading it in a more carefully chosen selection of markets, you can improve results substantially. That is precisely the way a diversified, trend-following program, such as I use in my personal trading, works.

The Best Way to Trade with Limited Capital

The Best Way to Trade with Limited Capital One of the biggest swindles unscrupulous commodity vendors are pulling is to suggest that you can be a successful commodity trader with minimum capital. In order to sell their trading courses, they claim you can make a fortune starting with whatever amount you currently have available. Most thoughtful experts agree that there is a minimum below which success is determined by luck. I set that amount at $10,000. Below that, it is nearly impossible to apply proper risk management principles. Studies have shown that success is directly proportional to the amount of capital you have. To maximize your chances of success, it is best to have at least $75,000. My best mechanical system for small traders requires at minimum $15,000 for a conservative approach involving a five-market portfolio. Without a little luck, trading that system with limited capital may require extraordinary patience to wait for the system's statistical advantage to assert itself. If I had to trade with less than $15,000, how would I do it in a way that would maximize my statistical advantage? My suggestion is to pick a few classical chart patterns and specialize in trading with them. You must have discipline and patience to wait for the patterns to develop correctly using only markets suitable for small accounts. Additionally, you must apply strict risk management and have great tenacity to let your profits run on the good trades. Mid-America Exchange mini-contracts are a viable alternative for small accounts and highly recommended. Full-size contracts would occasionally be all right in such markets as Gold, Cotton, Soybean Meal, Soybean Oil and Oats. The best book on chart pattern trading in futures is Peter Brandt's Trading Commodity Futures with Classical Chart Patterns [available from Reality Based Trading Company]. Peter has been earning his living trading this way for over 25 years. His entry approach is to identify clearly defined chart patterns as described in the Edwards and Magee classic, Technical Analysis of Stock Trends, with a "measured move" representing a profit potential of at least $2,000 per contract and a reward/risk ratio of at least 3 to 1. There are some further requirements described in his book. For those who want to follow and learn from Peter's trading, he publishes a newsletter called The Factor (719-471-6898). Another successful expert who uses chart patterns for entry is Steve Briese, publisher of theBullish Review (612-423-4900). This excellent newsletter reports on and analyzes the CFTC Commitments of Traders reports. Steve's personal trading approach is to concentrate on only two kinds of patterns. Here's how he described his method in an extensive, exclusive interview available from Reality Based Trading Company. II continue to believe that using standard chart patterns is a very lucrative way to trade. I've gone back to look at what has worked and tried to reduce the chart patterns down to a manageable few. The first is a failure swing top or bottom, which may be a double top or bottom or the last part of a head and shoulders or triple top or bottom. These are reversal-type patterns. The other one is a coil. That would include any type of triangle which is a consolidation. It is typically a continuation pattern, but it can also be a reversal pattern. The problem with these patterns is that to trade a breakout and put your stop on the other side of the pattern usually creates more risk than I want to take and that most traders should take based on their account size. The typical approach to this would be to trade the breakout when it comes, but to put your stop at a money risk distance from the entry. I take the opposite approach. First, I determine where my stop-loss should be based on the pattern. I want to put my stop at the point where the pattern fails. Then I determine how much I'm willing to risk on the trade. In my case I never risk more then $500 per contract on any trade. I don't trade the S&P, where that would be difficult. After I've established my stop, I know what the exit point will be. Now I have to find the entry point that will keep my risk within the required amount. This will usually be at a point before a breakout verifies the pattern, still within the pattern. I use the Commitments of Traders data to forecast which way a pattern is going to complete.
					I continue to believe that using standard chart patterns is a very lucrative way to trade. I've gone back to look at what has worked and tried to reduce the chart patterns down to a manageable few. The first is a failure swing top or bottom, which may be a double top or bottom or the last part of a head and shoulders or triple top or bottom. These are reversal-type patterns. The other one is a coil. That would include any type of triangle which is a consolidation. It is typically a continuation pattern, but it can also be a reversal pattern. The problem with these patterns is that to trade a breakout and put your stop on the other side of the pattern usually creates more risk than I want to take and that most traders should take based on their account size. The typical approach to this would be to trade the breakout when it comes, but to put your stop at a money risk distance from the entry. I take the opposite approach. First, I determine where my stop-loss should be based on the pattern. I want to put my stop at the point where the pattern fails. Then I determine how much I'm willing to risk on the trade. In my case I never risk more then $500 per contract on any trade. I don't trade the S&P, where that would be difficult. After I've established my stop, I know what the exit point will be. Now I have to find the entry point that will keep my risk within the required amount. This will usually be at a point before a breakout verifies the pattern, still within the pattern. I use the Commitments of Traders data to forecast which way a pattern is going to complete.
				The biggest problem in trading with a small account is finding reasonable stop-loss points and still keeping risk to an appropriate level in relation to your account size. Since strings of losses are inevitable regardless of your approach, you must control risk so you are not wiped out by consecutive losers. Experts agree that for proper risk management, you should limit risk to no more than about one percent of your account equity. This is impossible with a small account. Steve Briese has been successful with stops under $500. Peter Brandt's average loss is generally under $400. You must be patient to wait for entries that qualify under your rules where you can place an intelligent stop at a point which will limit risk to less than $400-500. If the current volatility is too large to accomplish this, you must pass the trade. While novice traders spend all their time working on entries, seasoned traders know that the really difficult decisions in trading involve exiting profitable positions. Letting profits run on good trades is absolutely essential to long-term success. I believe that judicious trailing stops are the best way to let profits run. On multiple contract positions Steve Briese uses a combination of trailing stops and volatility. Peter Brandt prefers exiting at pattern objectives. While successfully trading commodities with limited capital presents the highest challenge in trading, you can do it if you recognize the problems and construct a trading plan to accommodate the realities.

How To Trade With The Trend

How To Trade With The Trend
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. You should make sure your strategy includes each of these requirements for success.
Trade with the trend relates to the decision of how to initiate trades. It means you should always trade in the direction of recent price movement.
Mathematical analysis of commodity price data has shown that these price changes are primarily random with a small trend component. This scientific fact is extremely important to those desiring to pursue commodity trading in a rational, scientific manner. It means that any attempt to trade short-term patterns and methods not based on trend are doomed to failure.
A good example of such a doomed method is Japanese Candlestick patterns. This theoretical conclusion is consistent with my previous research. Many years ago, just as Candlesticks came into vogue, I attempted to create a profitable trading system incorporating Candlesticks. I tried many patterns and many types of systems, all without success. I have never seen anyone else demonstrate the effectiveness of Candlesticks using objective rules either. Successful traders use a method that gives them a statistical edge. This edge must come from the tendency of commodity prices to trend. In the long term you can make money only by trading in synch with these trends. Thus, when prices are trending up, you should only buy. When prices are trending down, you should only sell.
While this important principle is well-known, traders violate it surprisingly often. They are looking for bargains so they prefer to try to buy at the very bottom or sell at the very top before new trends become established. Winning traders have learned to wait until a trend is confirmed before taking a position consistent with that trend.
Here's what consummate market expert Jake Bernstein said in my book, The Four Cardinal Principles of Trading: "Of all the common market principles, I put 'Trade With The Trend' at the very top. It's a lesson I've had to learn and relearn practically every year. All traders have the tools to find trends. That's what makes it especially frustrating when we go contrary to the trend or when we try to pick tops and bottoms."
The alternative to trend following is predicting. This is a trap that nearly all traders fall into. They look at the commodity trading problem and conclude that the way to be successful is to learn how to predict where markets will go in the future. There is no shortage of people willing to sell you their latest prediction mechanism. We all want to believe that predicting is possible because it's so darn much fun to make a prediction and be right.
Here's Jake Bernstein again with a little dose of reality: "It took me over nine years to realize that, although it may be a romantic and ego-satisfying goal, forecasting is not necessarily synonymous with profit. To anticipate trends is a difficult and often haphazard task, and it tends to lead to losses more often than profits."
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. 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.
Here's what Russell Sands said in an interview with Commodity Traders Consumer Report. Russell was an original member of Richard Dennis' Turtles group and has built a successful career as a money manager and advisor generally using the Turtle methodology.
"The best approach is to be a long-term trend follower. Trend following is statistically valid in the sense that everybody has tested it for years and years, and it works. "I acknowledge that the market trends maybe 20 percent of the time and chops back and forth in consolidation 80 percent of the time. The trick is how to define where the trend starts and where it stops. If when a market does trend, you get in at the right time, ride that trend and then get out at the right time, you'll make enough money to more than offset the losses you take during non-trending periods.
"Another part of the basic philosophy is that we don't know when the market's going to trend and when it's not. In fact, we don't know what the market's going to do at all. We can't predict anything it does. We don't believe in predictions. Instead, we react to the market."
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. If you can develop the discipline to measure trends using intermediate to long-term time frames and always trade in the direction of the trend, you will make a giant step in the direction of profitable trading.

The Seven Habits of Highly Effective Futures Traders

The Seven Habits of Highly Effective Futures Traders
Stephen Covey's The Seven Habits of Highly Effective People has been on the national best-seller lists for years--first as a hardback and then as a paperback. I wondered how its list might relate to commodity futures trading.
My interpretation of Covey's agenda is as follows: 1) Take responsibility for yourself and your life, 2) Act in light of your vision of success in life, 3) Act with proper attention to the correct priorities, 4) Act in a way that maximizes benefits for everyone, 5) Try to understand the other person before putting your point of view across, 6) Exploit the potential for cooperation among the people in your life, 7) Pay attention to maintaining and refining your physical, mental, social and spiritual dimensions.
While there does not appear to be any direct relationship between my commodity trading list and Covey's overall life experience list, there are some definite similarities and differences. It is well known that normally successful approaches do not work in trading. Additionally, life in general requires involvement and interrelating with other people, while trading is a more solitary endeavor. Here is my list of successful habits for traders.
ONE. Understand the true realities of the markets. Understand how money is made and what is possible. The markets are what is called chaotic systems. Chaos theory is the mathematics of analyzing such non-linear, dynamic systems. According to Edgar Peters, author of Chaos and Order in The Capital Markets, mathematicians have conclusively shown the to be non-linear, dynamic systems. Among other things chaotic systems can produce results that look random, but are not. A chaotic market is not efficient, and long-term forecasting is impossible. Market price movement is highly random with a trend component.
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 want to believe 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. They have been falling for crackpot methods and systems since the markets started trading.
The truth is that the markets are not predictable except in the most general way. Luckily, successful trading does not require effective prediction mechanisms. Successful trading involves following trends in whatever time frame you choose. The trend is your edge. If you follow trends with proper money management methods and good market selection, you will make money in the long run. Good market selection refers to selecting good trending markets generally rather than selecting a particular situation likely to result in an immediate trend.
There are two related problems for traders. The first is following a good method with enough consistency to have a statistical edge. The second is following the method long enough for the edge to manifest itself.
TWO. Be responsible for your own trading destiny. Analyze your trading behavior. Understand your own motivations. Traders come into commodity trading with a view to making money. After awhile they find the trading process to be fascinating, entertaining and intellectually challenging. Pretty soon the motivation to make money becomes subordinated to the desire to have fun and meet the challenge. The more you trade to have fun and massage your ego, the more likely you are to lose. The kinds of trading behaviors that are the most entertaining are also the least effective. The more you can emphasize making money over having a good time, the more likely it is you will be successful.
Be wary of depending on others for your success. Most of the people you are likely to trust are probably not effective traders. For instance: brokers, gurus, advisors, system vendors, friends. There are exceptions, but not many. Depend on others only for clerical help or to support your own decision-making process.
Don't blame others for your failures. This is an easy trap to fall into. No matter what happens, you put yourself into the situation. Therefore, you are responsible for the ultimate result. Until you accept responsibility for everything, you will not be able to change your incorrect behaviors.
THREE. Trade only with proven methods. Test before you trade. When applied consistently, most trading methods don't work. The conventional wisdom that you read in books is mostly ineffective.
Notice that commodity authors never demonstrate the effectiveness of their methods. The best you can hope for is a few, well-chosen examples. The reasons for this is that they are lazy and their methods mostly do not work when tested rigorously.
You must be skeptical of everything you read. You must somehow acquire the ability to test any trading method you intend to use. The reliability of non-computerized testing is highly suspect. You must, therefore, use software that tests a particular approach or a variety of approaches. You must learn the correct way to test and evaluate trading approaches.
Have a good approach. Follow the four cardinal rules of trading. 1) Trade with the trend. 2) Cut losses short. 3) Let profits run. 4) Manage risk. These are well known cliches. Yet virtually all losing traders violate these rules consistently. Trading with the trend means buying strength and selling weakness. Most traders are more comfortable buying weakness and selling strength, the essence of top and bottom picking.
Trade good markets. Trend is your only edge. You must emphasize those markets which trend the best. This will maximize your statistical edge over time. I wrote a huge book (which I update every year) ranking the markets in historical trendiness.
FOUR. Trade in correct proportion to your capital. Have realistic expectations. Don't overtrade your account. One of the most pernicious roadblocks to success is a manifestation of greed. Commodity trading is attractive precisely because it is possible to make big money in a short period of time. Paradoxically, the more you try to fulfill that expectation, the less likely you are to achieve anything.
The pervasive hype that permeates the industry leads people to believe that they can achieve spectacular returns if only they try hard enough. However, risk is always commensurate with reward. The bigger the return you pursue, the bigger the risk you must take. Even assuming you are using a method that gives you a statistical edge, which almost nobody is, you must still suffer through agonizing drawdowns on your way to eventual success.
The larger the return you attempt, the larger your drawdowns will be. A good rule of thumb is to expect an equity drawdown of about half the percentage of your annual profit expectation. Thus, if you shoot for annual returns of 100 percent, you should be ready for drawdowns of 50 percent of your equity. Almost no one can keep trading their method through 50 percent drawdowns.
It is better to shoot for smaller returns to begin with until you get the hang of staying with your system through the tough periods that everyone encounters. An experienced money management executive has stated that professional money managers should be satisfied with consistent annual returns of 20 percent. If talented professionals should be satisfied with that, what should you be satisfied with? Personally, I believe it is realistic for a good mechanical system diversified in good markets to expect annual returns in the 30-50 percent range. This kind of trading would still result in occasional drawdowns up to 25 percent of equity.
FIVE. Manage risk. Manage the risk of ruin when you create your trading plan or system. Manage the risk of trading when you select a market to trade. Manage the risk of unusual events. Manage the risk of each individual trade.
The risk of ruin is a statistical concept that expresses the probability that a bad run of luck will wipe you out. On average, if you flip a coin 1,024 times, you will have ten heads in a row at least once. Thus, if you are risking ten percent of your account on each trade, chances are you will be completely wiped out before long. If your trading method is 55 percent accurate (and whose is?), you still have a 12 percent chance of being wiped out before doubling your capital if you risk 10 percent of capital per trade. For the mathematicians out there, this assumes that you win or lose the same amount on each trade. That is unrealistic, but I'm just trying to explain the risk of ruin problem. The point is that in order to reduce the harm caused by unavoidable strings of losses, you must keep the amount you risk on each trade to about one or two percent of capital. This makes trading with small accounts difficult. Two percent of $5,000 is only $100. That means with a $5,000, you should be trading with $100 stops. If you trade with $500 stops, your chances of avoiding meltdown from a bad series of trade are not good. Trading with small stops is usually ineffective because they are within the market's "random noise."
Another element of risk is the market you trade. Some markets are more volatile and more risky than others. Some markets are comparatively tame. Some markets, such as currencies, have a greater chance of overnight gaps which increases risk. Some markets have lower liquidity and poorer fills which increases risk. If you have a small account, don't trade big money, wild-swinging contracts like the S&P. Don't be above using the smaller-sized Mid-America contracts to keep risk in proportion to your capital. Don't feel you have to trade any market that might make a move. Emphasize risk control over achieving big profits.
The commodity markets are notorious for making locked-limit moves where the trader is stuck in his losing position. The market can go against him for days while he must helplessly watch his capital disappearing. This is certainly a reality, but the trader is not helpless to decrease the risk of it happening to him. Pay attention to the risk of surprise events such as crop reports, freezes, floods, currency interventions and wars. Most of the time there is some manifestation of the potential. Don't overtrade in markets where these kinds of events are possible.
The most important element of risk control is simply to keep the risk small on each trade. Always use stops. Always have your stop in the market. Never give in to fear or hope when it comes to keeping losses small. Never risk more than one or two percent of capital. Preventing large individual losses is one of the easiest things a trade can do to maximize his chance of long-term success.
SIX. Stay long-term oriented. Don't adjust your approach based solely on short-term performance. Our entire society emphasizes instant gratification. We are consuming are long-term capital. Eventually, this will lead to a decline in our standard of living over what it could have been with more attention to the future.
Most traders have such an ego investment in their trading that they cannot handle losses. Several losses in a row are devastating. This causes them to evaluate trading methods and systems based on very-short-term performance. Statisticians tell us that there is no statistical reliability to a test unless you have 30 events to measure. Short of a reasonable number of events, the outcome is wholly dependent on luck. As we saw in the risk of ruin discussion above, strings of losses are as certain as government inefficiency. Thus, the trader who chucks his system after four losses in a row is doomed to spend his trading career changing from one system to another. Don't start trading a system based on only a few trades, and don't lose confidence in one after only a few losses. Evaluate your performance based on many trades and multi-year results.
SEVEN. Keep trading in correct perspective and as part of a balanced life. Trading is emotionally intensive no matter whether you are doing well or going in the tank. It is easy to let the emotions of the moment lead you into strategic and tactical blunders.
Don't become too elated during successful periods. One of the biggest mistakes traders make is to increase their trading after an especially successful period. This is the worst thing you can do because good periods are invariably followed by awful periods. If you increase your trading just before the awful periods, you will lose money twice as fast as you made it. Knowing how to increase trading in a growing account is perhaps the most difficult problem for successful traders. Be cautious in adding to your trading. The best times to add are after losses or equity drawdowns. Don't become too depressed during drawdowns. Trading is a lot like golf. All golfers, regardless of their ability, have cycles of good play and poor play. When a golfer is playing well, he assumes he has found some secret in his swing and will never play poorly again. When he is hitting it sideways, he despairs he will never coming out of his slump.
Trading is much the same. When you are making money, you are thinking about how wonderful trading is and how to expand your trading to achieve immense wealth. When you are losing, you often think about giving up trading completely. With a little practice, you can control both emotional extremes. You'll probably never control them completely, but at least don't let elation and despair cause you to make unwarranted changes in your approach.
Since correct trading is boring, don't depend on trading as your primary stimulation in life. Unfortunately, the exciting aspects of trading, such as easy analysis and trade selection, are counterproductive. Good trading is repetitive and pretty dull. Thus, if you depend on trading for the major excitement, pursuit of fun will probably cause you to lose. If you can afford it, fine. If not, seek your entertainment elsewhere.
Here's a summary of my seven habits of successful traders. 1) Understand the true realities of the markets. 2) Be responsible for your own trading destiny. 3) Trade only with proven methods. 4) Trade in correct proportion to your capital. 5) Manage risk. 6) Stay long-term oriented. 7) Keep trading in correct perspective and as part of a balanced life. The common theme is self-control. As I've often said, if you can master yourself, you can master the markets

Ideas For New or Unsuccessful Traders

Ideas For New or Unsuccessful Traders
Don't be too eager to trade in the beginning. Watch how the markets work for at least three to six months. Subscribe to a chart service and start watching market action from day to day. Pick a small universe of markets and update those charts by hand every day.
If you would rather follow price charts on your computer than subscribe to a published, weekly chart book, I suggest Omega Research's SuperCharts (800-556-2022). It is inexpensive yet extremely powerful. It has a wonderful tutorial feature that will analyze any chart and explain the important technical aspects. At the end of every day you can update your price data (futures, indexes and stocks) via modem for a very modest monthly fee.
I am constantly amazed at how many people try to trade without charts. They are the best way to understand market price action. You should pay special attention to trend. Of course, trend is only relevant in a particular time frame. On a daily chart I recommend picking a time frame between 15 and 25 days. Use the same one for all markets.
One important thing to notice as you watch price action unfold is how unpredictable the markets are. Mathematical analysis of historical market price action has shown that price changes are primarily random. There is a small trend component in most futures price action, however. It is this trend ingredient that allows traders to make money . . . but only if they follow trends.
Those who try to anticipate changes in trend rather than follow establish trends are doomed to failure. In addition, with only a few exceptions, trying to find bargains by buying weakness and selling strength is likewise a prescription for eventual disaster.
Frustrated traders are constantly looking for some secret that successful traders use to make money. The only secret is that there is no secret. Those who are successful in the long run all follow the four cardinal principles of trading. They are: (1) Trade with the trend, (2) Cut losses short, (3) Let profits run, and (4) Manage risk.
There are many ways to implement each of those four principles. The important thing is that you have the discipline to adhere to each of them all the time without exception. You can read about how a wide variety of experts execute each of those principles in my book, The Four Cardinal Principles of Trading.
By the way, books are your best value in commodity trading information. You get more ideas for your money from books. But don't assume that just because someone famous has written a book, all the ideas in it actually work. One of the unknown reasons why so many traders lose is that most of what you read in books, what I call "the conventional wisdom of trading," doesn't work. You must be extremely skeptical about everything you read. Insist on a rigorous demonstration that when the ideas are applied continuously for many years, they lead to profits. You almost never find this kind of proof in books.
Since most trading methods you will come across don't work over time, you must be careful not to trade with any approach you haven't tested rigorously on historical data. Notice that to test something, there must be objective rules. If you insist on trading with a subjective, seat-of-the-pants approach, don't be surprised if you eventually lose money. Your method probably has a negative statistical advantage. Just like a casino gambler, you will eventually lose.
Don't blindly assume that a system which appears to be profitable in historical testing will necessarily work in the future. The testing must be rigorous enough to weed out those curve-fitted systems that only work in hindsight. Most commercially-sold systems are of this variety. It is quite easy to create a system with a fabulous hypothetical historical record simply by creating the rules to conform to known historical price action. Computer-aided optimization is good for this. That's why you should be suspicious of complex systems and all optimization.
Determining whether a system is over-curve-fitted is not an exact science. A good clue is whether the system trades multiple markets profitably over a five-to-ten year period using the same trading rules. Those systems designed to trade only one or two markets or those that use different rules for different markets are not likely to be profitable in the future.
If you aren't going to use a system that comes with its own testing software, you will have to test your prospective approach yourself. This may involve hand-testing on charts, which is not especially reliable. There are computer programs with generic system testing ability. The previously-mentioned SuperCharts is a good example. Newsletters can be valuable in exposing you to various potential trading styles. A subscription to Commodity Traders Consumer Report(800-832-6065) can give you lots of information about newsletters, books and other sources of educational assistance. Published since 1983, it is the only objective source of performance information on advisory services. This information is invaluable if you intend to follow the trading recommendations of any advisory service. Be extremely wary about expensive products. There is no relationship between price and quality in futures trading information. While it is generally true in life that you get what you pay for, commodity product vendors prey on this assumption by pricing their mediocre wares at outrageous prices. People then buy them with the idea that one could not sell something for so much money if it wasn't good. Do not assume that whatever a system or seminar may cost, you will quickly earn it back from profitable trading. It seldom works that way.
One important reason 95 percent of traders eventually lose is that they are too lazy to do the work it takes to be successful. Another reason is that they have no plan or method. They are guessing, gambling and hoping. That just isn't going to cut it in speculation, which is one of the most difficult endeavors there is. However, if you work hard and work smart, you can be part of the 5 percent who are wildly successful.

Q: Do trading systems really work?

Q: Do trading systems really work?

A: Yes. Good systems that have not been over-optimized market-by-market do work. You must be careful to distinguish systems that work in hindsight testing from those that work in real-time trading. People assume that anything that worked over a long historical period will almost certainly continue to work in the future. That depends on the system and the test. There is no absolute relationship between historical performance and real-time future performance.

Q: Do I need a computer to trade?

Q: Do I need a computer to trade?

A: You cannot beat the markets by outsmarting them or other traders. Computers can make your analytical life easier, but successful methods are simple enough to apply without using a computer. Computers' real value, in my opinion, is their ability to help you test trading ideas historically. Most trading methods, even popular ones, do not work when put to a rigorous test. This is one of the great unspoken reasons why so many traders fail.

Q: How about day trading?

Q: How about day trading?

A: Find one person who has made a long-term career from day trading. Short-term price data is too random to exploit. This has been demonstrated mathematically. The only way to trade successfully is to follow trends. The trends you follow must be large enough so that the average trade result is greater than the costs of trading. Day trading does not permit you to do this on a consistent basis. Long-term trading is much easier. 

Q: What kind of returns should I expect from trading?

Q: What kind of returns should I expect from trading?

A: Risk is always commensurate with reward. If you are trying to "get rich quick," the high risks you will have to assume will probably break you. Commodity trading is not inherently risky. It is only as risky as you want to make it. Most people bust out because they can't control themselves and the urge to gamble. A disciplined person trading a solid, trend-following system with sufficient capital to diversify can reasonably expect consistent returns of 25 to 50 percent a year with drawdowns of 15 to 30 percent.

Q: Can I make a living trading?

Q: Can I make a living trading?

A: If you are an exceptional person, maybe you can after several years learning and studying markets. Just as you can't learn to drive a racing car by reading a book, you will need a certain amount of trading experience to learn about markets and trading psychology. You will also need sufficient capital so that you are not trading with "scared money.