It’s Not About Computer Processing — Here’s What I Mean
Rear View Trading
If there is one thing that looking at charts causes, it is a false sense of
one’s ability. Too often, we look at charts after the fact and wonder why we
were not part of that ‘big move’. As I have said in the past regarding this type
of situation, “What was going at the time?” “Was the trade really that
obvious?” I would be willing to bet that your conviction was not terribly
high. However, more importantly, what was the risk on that trade at that
particular time? I would be willing to bet it was not nearly as favorable as you
would have liked it to be and certainly not within the parameters of an approach
that has positive expectancy and minimal draw-down.
Trading, as we all know, is simply a game of probabilities. If the
probabilities are in your favor over a large enough sample size, and you have a
method which has a positive expectancy, you will make money. Get caught up in
the hype or trade for excitement rather than taking well thought-out, calculated
risks and you will never achieve anything close to consistency. It is
imperative to stick to your game plan.
With that in mind, let’s turn to the present market environment:
1. We are beginning the traditional summertime lull — volume is light and
range is limited (the exception being yesterday, FOMC meeting)
For those of you who are very familiar with my style of trading, you know
that 99% of the time I do not trade after the first hour and a half of the day.
For those of you who are wondering why, it simply boils down to the
probabilities of favorable trades declining. A 1-minute chart of the S&P futures
will illustrate this quite clearly.
Now, contrast that with this chart from the mid-morning session. Do you see
the difference? Where is your edge here?
The bottom line, don’t hang around thinking your going to stumble across some
‘big kill’ trade. Sure you might, but they will be few and far between and most
importantly only obvious, AFTER THE FACT.
Staying with the theme of consistency and low draw-downs, let’s turn to stock
selection. I get asked this all the time in my Trading Room and in emails from
readers. It is pretty simple. There are only about 15-20 stocks that qualify as
HVT candidates, so right away that narrows
your list and prevents you from trying to search for the stock du jour. However,
despite the fact that that reduces ones workload it also provides you with
something that the majority of traders overlook, specialization. If from those
15-20 stocks, I choose to focus on only 2-3 each and everyday, I think it is
safe to say that you will know the way these stocks trade better than 99.9% of
the traders out there who drift from issue to issue. Suddenly I have a “sixth
sense” at times about price action. In addition I have the knowledge of how the
specialist will handle order flow and be able to draw conclusions that a chart
will simply not tell you.
You need to remember that trading is a profession of contradictions to our
normal way of thinking:
1. Traders do not need to be trading all session long. Some of the best
traders are cherry pickers who have honed their skills through repetition and
patience.
2. As a trader you do not need to have your fingers in everything in order
to make money. You simply need to specialize.
3. A solid trading approach with positive expectancy will work in virtually
every market condition. Do not let quiet periods allow you to wander in search
of a holy grail.The answer to the current situation is likely to be found in
making minor adjustments so as to adapt to an ever changing marketplace.
I will give you another good example of why focusing on 2-3 issues is so
critical But first, let’s review the criteria for a long entry trade in
HVT
1. Stock and futures must be in an up-trend
2. Looking for a pull-back or at the very least consolidation in the price
action
3. Stochastics crossing back up, or on the verge of.
Look at the charts below:
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At this point, there is no valid entry on the long side. However, the next
chart offers a different perspective, albeit not readily recognizable by the
chart itself.
I pulled the trigger on this bar and got a great fill in
Citigroup (C).
You see, the trigger was combination of two things:
1. As has been the case in recent weeks, C is actually leading the market up
and down ever so slightly. In this instance he was heading toward the high of
the day. That was the tip off. A chart will not clue you in on that subtle but
incredibly important observation.
2. The crowd noise in the S&P pit was the other piece.
Meanwhile several traders were waiting for the breakout, you know, a fancy
way of saying, hand me the trade on a platter and I will take it. For them the
trade was not nearly as good. Once that momentum catches, a good fill on the
long side is tough to come by, there is simply no stock for sale.
The exit, was once again a combination of technicals and tape reading. The
price action on C was outside its’ upper Bollinger Band (not seen here) and it
hit a price level at 43.90 where regardless of how much stock traded on the
offer, it simply would not go away. My analysis, a good size seller that cannot
be taken out, why fight it? Send in a “Sell at Market”
order. Get the fill, move on.
The exit gave me a wonderful opportunity to highlight in the Trading Room
just how key it is. So, for those of you out there who are trying to automate
and develop a mechanical system, give the points in my column today some serious
thought. No amount of computer processing power can replicate what I outlined.
My good friend Todd Gordon said to me yesterday, “You cannot systematize several
hundred big, sweaty guys in a trading pit.” Secondly, if you do not see the
importance of focusing on one or two stocks each day you are missing the big
picture.
Meanwhile, I will continue to trade for roughly 4 hours each day, focus on a
handful of stocks and take home some money the vast majority of the days. Sure,
it may be a bit repetitive and and times boring, but it sure beats working for
someone.
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As always, feel free to send me your comments and questions.
Dave