Michael Douglas's Mind over Market

Michael Douglas has this wonderful interview on YouTube. Watching the interview reminded me of the points from his all-time famous book "Trading in the Zone".

Thinking in probability

This is about not expecting to win every time. He mentioned that when we are trading with an edge, we swap positions to be the casino. We will win in the long run like how casinos work. Trend following strategies are known to have long periods of drawdowns. The key is to stay in the game, believe in yourself and your system.

In the zone

Someone says humans always look for comfort. Our behaviours change base on the outcome. We tend to take the easier path. That's how our brains are programmed to work, especially in times of duress. This concept of "in the zone" basically tells us to practise so hard that we subconsciously do what we have to do when we are in a trade, when we are experiencing the pressures from the market, to not let our conscious brain determine out next course of actions but instead leave the decision making to the subconscious part of our brain.

Scott Andrews shows that gaps can be traded!

I got to know about Scott Andrews (aka The Gap Guy) from Corey's blog.

In a presentation I gave to a group of over 140+, I talked about how I sieved out better quality trading resource. Traders who demonstrate success of their trading strategy/system with statistics always catch my attention. Scott Andrew is one such trader. Furthermore, he specializes in something close to my heart - GAPS. Yeap, I traded gaps for over a year before giving it up altogether.

During that time, I also did a fair amount of research on gaps. But I never thought of doing it Scott's way. Well, in the first place, I was taught to trade gaps in a unorthodox way. Scott fades gaps primarily. He has with him tons of statistical research on which gap patterns are risky and which gap patterns have a high probability of winning. His statistics are significant because of the large sample size. I am blown away.

Now, Scott shares some of his research at his blog - this is free :-) He also runs a paid service at MasterTheGap.com. But allow me to point you to the free Gap Trading Video section where videos related to gaps are posted up daily. A free great learning resource! You may also want to check out his presentation at the Traders' Expo 2009 that talked about 10 patterns that every trader should know. Also check out his trading results.

I am truly inspired.

Unconventional Trading Strategies

In our search for THE trading strategy, I guess many of us have come across dozens of more conventional trading strategies that made use of:

• technical indicators (ADX, MACD, Stochastics etc)


• price action


• support and resistance lines


• candlestick patterns (doji, harami, evening star etc)


• chart patterns (double top, flags, pendants, cup and handle etc)

As I got more acquainted with expert advisors (EA), I was exposed to some trading strategies, which I termed as "unconventional" trading strategies. Basically,  in unconventional trading strategies, they don't use any of the things listed above! So allow me to share some of the unconventional trading strategies that I have come across.

Correlation Trading

In correlation trading, people trade base on the relationship between the same or different trading instruments. I ever heard a course out there teaching people to buy a currency and sell another highly-correlated currency. Supposedly, this will cancel the effect of the currency price fluctuations and the profits will come from the swap. Not a bad idea...one don't have to care about which direction is the currency moving (aka non-directional trading) - provided the 2 currency pairs are REALLY moving in correlation, that is... But my this friend got a hell lot of problem...

Trading mean reversion

My encounter with the PID EA taught me the concept of mean reversion. The main idea is that there is a high chance that price will move back to the average price (more details at investopedia). Interestingly, Dr Brett has the statistics to show that "a disciplined trader can make a living simply trading this pattern".


Gambling and information theory applied to trading

A online buddy introduced this concept to me recently. I have not really dwell into this yet. Basically, some genius managed to represent gambling concepts mathematically such that the parameters can be manipulated and optimization can be done. Another genius applied this to trading. One such application is in Kelly Betting, that applies to money management.


Trading based on probability or other mathematical models

The Hedgecow EA trades base on a such a probability model. The high level concept is that it is highly unlikely to consistent lose for too many trades. So when there is a lose trade, we will increase lot size for the next trade. More details can be found here.

Disclaimer: I am not recommending any EA here. I am just illustrating some novel trading concepts that I have learnt from some of the EAs that I come across. In fact, PID caused many to get margin calls last year.

What Makes Learning Trading Truly Difficult

Rogue information

Some of our time are also sucked up by articles or teachers that teach rubbish.

Too many parameters to tune

I truly believe what's underlying that makes trading difficult is simply because there are too many parameters to tune. By parameters I am talking about:

• type of instrument - options, stocks (local or overseas) , futures, forex, CFD, warrants etc


• timeframe to trade - 5 min, 15 min, 30 min, hourly, 4 h, daily etc


• lot size - a couple of position sizing techniques are mentioned in Dr Van Tharpe's book


• entry strategy - which timeframe to enter, what and how many indicators to use, which candlestick/chart pattern to look out for?


• exit strategy - we have the same amount of choices as for entry strategy

If you were to mix and match the above, we have unlimited possibilities! Not to mention there are over hundred types of indicators and candlestick/chart patterns! Now, how much time do we really need?

Difficult to discuss

When aspiring traders come together, we usually talk about what work and what don't. However, because of the short acquaintance, traders usually don't spell out the entire context. For instance, a aspiring trader sharing with his friend may say: "The MACD indicator works for forex.". But... in what timeframe, what parameters, which currency pairs etc. I think you know what I mean. And those who are listening to him may take his "recommendation" and go back to do their own testing and wasting time as a result.

When something doesn't work it is normal

In my personal opinion, this is the most challenging issue to tackle. Let me illustrate with the following scenario:

I backtested a system, and it worked for historical data. And when I traded it live, things don't turn out as well. Explanation: Well, past performance don't gaurantee future result, market condition changes, anyway, best traders only have success rate of 60% at best, etc

If I come to think of it, we can't have a clue to what's working what not!?!?

Do you have any personal experience to share?

How much capital is needed to begin trade full time?

Well, I am a salaried-worker currently. As in, I receive a salary every month. I guess in trading, there has to be a paradigm shift. Trading profits may or may not come in every month on time! I did a quick search of the equity curves that I had come across (and still remember!):

• InfinityYield Forex - equity curve tells us that we may not make profits every week


• BK Forex Advisors - equity curve tells us that we may not make profits every month


• Ray Barros - equity curve tells us that we may not make profits every year

So what does this mean?

To live off trading, we need a good sum of starting capital

Let's use OptionPundit's equity curve as case study. Let's use his May 08 to Apr 09's results for discussion sake. That will be average of 5.5% gain monthly (which is quite good!).

Let's say I need US$5000 to maintain my family's and mine current lifestyle. I would require US$90909 in trading capital.

We also need to cater additional funds for our livelihood

We have seen from the above equity curves that no trading strategy can guarantee profits weekly, monthly nor yearly. So, in reality, we will have to set aside funds to tide over those months when the trading account suffers from losses. Even if we look at OptionPundit's equity curve, there was a month with 1.7% profit (not to mentioned -13% for Aug 08!) which will not give us the US$5000 to pay for our bills, mortgages, food etc.

So what is the GOOD SUM of capital to start with?

• Jorge from Investing Adventures feels that he will be comfortable to start with $200,000 


• Nerdyhomme estimates that USD$131,000 is the good amount


• Chris Perruna also suggests a six figure sum to start with

So our objective now as a part time trader should be accumulating that six figure amount so that we can trade full time. And...forget about starting with US$3000 capital and go full-time after demo trading for 6 months...

Trading Concepts That SHOCKED Me Recently

Seriously. I mean. Well, I have heard people mentioned some of the following concepts before. But you know, in another moment, we would hear others saying the opposite. This is how trading is like. Now, allow me to spark some new controversy:

Most, if not, all trading strategies don't work

Now we have strategies based on fundamentals, technical indicators, mere price action, or even magazine covers... Have you ever come across a trading strategy that has a success rate of 80% or more? Now, I have to qualify this. If it is a trading strategy based on daily charts, then it has got to have that success rate for more than 3 years. If it is a trading strategy based on 5-minute charts, then it has got to have that success rate for more than 3 months. Ok, the above values are fictitious, but you get what I mean. The period for judging the success rate of that strategy has to be significant enough. One hit wonders don't count.

If you subscribe to tradersinterview.com, you would hear that most of the successful traders trade with strategies that wins at most 60% of the time, and that is considered very good already!

Then came along a EXPERT expert advisor (EA) developer friend. Since he started EA development 2 years back, he had coded over 30 strategies into EAs (some from well-known forex educators too) and unfortunately, not many could even hit the 50% mark.

Most, if not, all technical indicators don't work

For the same EA developer friend, getting EAs to backtest with technical indicators is a simple task. And when he does backtesting with an EA, he is not merely looking at 6 months or 1 year or historical data. He can get his EA to run over 5 or 10 years worth of historical data in 1 night! From his very mouth: "INDICATORS DON'T WORK".

Trailing stops are not the most effective

This one is difficult to stomach. It seemed so profitable at first. You know, when you are profitable, keep on adjusting your stops as the price continues to move in your direction and capture as much profits as you can. This same EA developer friend (again!) has deduced from his EA that for the long term, trailing stops are not as effective as "soft stops" (This is proprietary, so don't ask me what is it).  Mainly because it is tough to determine the right value to trail behind with as the market changes and this limits profits.

It is difficult for humans to trade emotionlessly

This is from Ray Barros. He shared that even traders at his level can also be affected by emotional disturbances. In particular, he shared an instance of how he forgot to put a stop when he had to rush to the airport on hearing that a relative is critically ill. In the end, a winning position turned into a losing position. How true, certain circumstances is really inevitable.

Position sizing is the key

If you had attended our meetup back in Feb 09, you would have already be blown away by a pro EA developer friend's presentation. Here are his presentation slides (Registering for an account at Meetup.com and joining the Automated Forex Meetup group is required to download the slides). In essence, he showed the equity graph of trading a pivot strategy without and with proper position sizing. And the equity graph with proper position sizing applied is a up, up and away 45% equity graph!

Ebb and flow

This concept is up for discussion. Only 2 traders told me about this to date. Ray Barros discussed Ebb and Flow in his blog. Essentially, the concept behind is to take a larger position when things are going your way and vice versa.

Now, any other proven concepts that you would like to share?

7 Habits of Highly Effective Trading Groups

I believe most of us agree that trading can be quite a lonely activity. It is usually I... I... I... For instance, I won on the last trade, I lost on the last trade, I backtested, I read about etc... In fact, one would be fortunate if he/she could find someone to talk to about trading! This is where trading groups come in. Well, I have been in a couple of different trading groups so far. I've got to admit that most of the trading groups that I was a member of eventually dissolved or disbanded (Well, currently, there is this special one which is still full of steam!). So I thought I could share on my belief on how we can make trading groups effective (or even more lasting, for that matter :-P).

1. Look for members trading the same strategy/system - Well, most (if not, all) of the trading groups that I was involved in were formed after I attended some trading courses. Mainly because the students wish to form some sort of a support group to help each other and to learn from each other. It is crucial that members of a trading group are trading the same strategy or system. Actually, it is almost also important that they are trading the same timeframe. I have seen when members were not trading the same strategy/system, there would likely be no constructive comments and discussions and in certain cases resulting in some time-wasting disputes.


2. Have a projector around - When having a discussion on trading, it is almost inevitable that we would need to look at some charts, website etc. Can you imagine a group of 20 crowding in front of a 15" monitor while someone is sharing some information on his notebook?


3. Be seated in an effective manner - Most people don't really focus on the seating arrangement because usually finding a good location for group members to come together regularly is already as difficult as it is. We have to be aware that the larger the group, the more important is the seating arrangement, especially for effective communication flow and knowledge transfer. Personally, I feel the typical classroom style is good enough. But my most preferred seating arrangement is one in which everybody is seated in a circle and facing outside, with our notebooks of course.


4. Set an objective for each meeting - If not, most meetings would turn out to be casual chit-chat sessions. In general, when trading groups meet, it could be for live trading (provided the trading timeframe allows) or for discussion. Activities for meetings can include:
   
   
   
   • Sharing past trade results, charts and thought process before and after trade execution
   
   
   • Suggest improvements to strategy/system and get members to go back and backtest for each to verify if there really is an improvement
   
   
   • Suggest new strategy/system (proven)  and rally members to backtest/demo trade together
   
   
   • Watch training videos together, followed by discussion of the videos
   
   
   • Summarize and share concepts from a new trading book... etc


5. Decide on mode for trading together - This is for "live" trading sessions where group members come together to trade together. There are a few proposed modes for trade as a group:
   
   
   
   • Signal each other when there is a trade setup
   
   
   • Trade first, evaluate the outcome later
   
   
   • Trade a common pool of funds. At any one time, one person will be trading, the others will be analyzing and providing advice.


6. Develop good trading group culture and rules - One of the things I don't encourage is to say something is working when it is only based on one or two tries or based on hearsay.


7. Have fun! - Well, that's why we had the trading group in the first place right? Remember to organize activities that don't involve trading

Which Currency Pairs to Trade?

During the 1-day course by Ed Ponsi, he touched on the criteria to decide which currency pairs to trade. I thought I will just put things in perspective and provide some links as to where to look for the information that we need.

Spread

Spread is like the commission that we have to pay for our trades in forex. It is part of our business cost in trading. Different brokers offer different spreads for the various currency pairs. Let's take CMS Forex currency spreads as a guide (quite indicative for spread across different brokers). Spreads could range from as low as 2 pips for EUR/USD to 8 pips for GBP/JPY. As a rule of thumb, currency pairs with the smaller spreads is certainly more attractive. However, one should also look at the price movement range (the average true range or ATR is a good guide)  for his trading timeframe (if it could cover the spread easliy). Those trading daily timeframe charts can look at currency pairs with larger spreads because the spreads would be relatively small compared to the profit potential.

Correlation

Ed Ponsi suggested to not open positions in correlated currency pairs at the same time. For instance, EUR/USD and USD/CHF are known to have very strong negative correlation (ie, when EUR/USD moves up, there is almost 90% chance that USD/CHF will move down). So when one go long on EUR/USD and short USD/CHF at the same time, he is almost like having positions on a single currency pair! If the trade goes against him, it is almost certain that he will lose on both currency pairs.

Metaf.net provides a good tool for determine the correlation between the different currency pairs. The bigger the number in the table would mean the 2 currency pairs are highly correlated with each other. If there is a '-' sign in front of the number, it just means that the 2 currency pairs are negatively correlated, like the case for EUR/USD and USD/CHF.

From this data, I actually found 1 currency pair to be least correlated with the other major currency pairs (based on daily data). Want to know which one? Leave me a comment with your email :-P

Currency Strength

Ed Ponsi mentioned during the seminar that during this period, he will not trade with USD/JPY. During times of recession like this, USD and JPY are traditionally the strongest currencies. USD because traders are buying US treasury bonds as a safe haven. JPY because of traders no longer wish to be in carry trades. When 2 strong currencies are paired up together, it will be tough to determine who will win the tug-of-war. Ed Ponsi prefers to look at currency pairs that are made up of a strong currency and a weak currency so that there will be long periods of trends. Trends are forex traders' best friends! Ed Ponsi also mentioned his favourite currency pair to be GBP/JPY at this point in time.

ForexPeaceArmy offers a calculator that calculates the relative strengths of the major currencies based on their price movements. I find this is a good gauge to find out which currencies are stronger and which are weaker.

Rollover

Every currency has an interest rate tied to it (as dictated by the individual central banks). FX Street has a good table on worldwide interest rates.

The basics of rollover (aka swap) in forex trading can be best explained with an example:

AUD interest rate is at 4.25% and JPY interest rate is at 0.3% at the moment

Let's say we are long AUD/JPY. We will receive positive rollover as we are long the currency with the higher interest rate (ie, the AUD). The idea is we will receive money for the position that we are holding (for the duration of time that the position is opened). The amount that we will receive is broker-dependant however.

Do not underrestimate this rollover amount. We may be able to pay for the spread with that! Hence, alleviating the cost of opening and closing our trades!

Now we have a better idea of how to choose which currency pairs to trade 8-)

Trading Short Timeframes Vs Long Timeframes

In my last post, I discussed about how can one know that he/she is trading a unsuitable timeframe. And I found 2 other articles that supported my claim:

• Glen De Vadder wrote about how can one determine which chart timeframe is suitable. He broke down chart timeframes to 3 main types, namely, intraday, swing/position and long-term. In summary, aspiring traders will a job should go for swing/position or long-term timeframes - hourly charts and above.


• The team from PFX is more for trading long timeframes. They mentioned about the spread - yes, trading short timeframes incur more trading cost in terms of the spread because more trades are taken and of course, the emotional stress that comes along with short term trading.

One interesting point to note. Both articles mentioned about rollover, but from a different standpoint. In my interpretation, rollover is a double-edge sword. Whether you collect or is charged a rollover depends on the position and the currency pairs that you are trading. So we will have to take note of this if we are holding our positions overnight.

One point that is still not addressed any where is: whether trading short timeframes or  trading long timeframes is more profitable?

I would think they are equally profitable. Let's see if we can convince ourselves.

From the USD/JPY daily chart, the 60-day average true range (ATR) is around 90 pips to 200 pips

The 60-day ATR for a 5 min USD/JPY chart is around 15 pips to 5 pips.

So when trading the daily charts, my stop loss would have to be at least 200 pips while my stop loss for the 5 min charts would just have to be at least 15 pips.

Let's say I have a strategy that gives me 1:1 risk-reward ratio with a success rate of 60%. In addition, let's say the strategy, when applied on the daily chart, takes 3 days to close with a winner and makes 200 pips. In order for me to make 200 pips in 3 days on the 5 min chart, I would need to make 200/15 = 14 winners. But all in all I have to make 24 trades since 60% of my trades are usually winners.

So I would need roughly 8 trades per day on the 5 min charts to match a win on the daily charts. So which is more profitable? In my opinion, once I made 200 pips on the daily charts, it is a done deal. Imagine I have to make 24 trades on the 5 min charts to make that same profits...

Signs To Tell That You Are Trading A Unsuitable Timeframe

Trading 5 min charts has more money-making opportunities?

You can be trained to trade in any timeframe?

Think again. I also went through what most aspiring traders went through. I used to think trading the 5 min timeframe was suitable for me because of the adrenaline rush, as there were more entry opportunities. Most men like this type of adrenaline rush :-P However, I still feel that trading the shorter timeframe is good for brushing up trading skills. After trading the 5 min timeframe for a period of time, my observations tell me that the 5 min timeframe may not be suitable for me. Let me share my observations with you.

I have a full-time nine-to-five job. Most aspiring traders do (some own businesses of course). I realized I have been missing out on many good trade setups because they happen during the time when I am working! Good trades are hard to come by. Missing out on good trades really takes a  toll on my psychology.

I did try to force myself to trade while working. I adjusted my work schedule and tasks such that I would be able to monitor the charts as frequent as I can. You think this helped? NO! It made things worse. On one hand, I felt stress from my job. On the other hand, because it wasn't easy for me to find time to monitor the charts, somehow my brain started to see things. I saw trade setups that were not there! As a result, my trade quality took a hit.

You think I am able to trade after work? Ya, ya...forex is a 24-hour market right? Bad news. In my part of the world, by the time I reach home after work, it is almost close to the US market opening hours. Prior to the US market opening and even during the US market hours, there are often market-moving economic news announcement that cause the forex market to behave haphazardly. We are often taught not to trade around high impact economic news announcements right?

Well, I can trade into the wee hours of the night right? Sad to say, the forex 5 min charts typically quietens down after around 10:30 EST. There may be some movement around 12:00 EST when the London market closes. After which, I had to wait all the way till 16:00 EST (around 4 am local time) for possible movements on the 5 min charts. Imagine you are home after a tiring day at work and got to stare hard at the computer screen all the while. Stressful isn't it? Both physically and psychologically.

A fellow trading course mate also showed me the evidence that a suitable timeframe is crucial to one's trading success. We learnt the same 5 min chart trading strategies but he had much greater successes! Upon probing, I learnt that his working hours are totally opposite of mine! He works in the night only and has all morning and afternoon to trade.

Unfortunately, there is no one magic formula to determine which timeframe is the most suitable for you. The only way is to try trading the timeframe and evaluate yourself. Everyone's working hours is different, isn't it? :-P

Types of Expert Advisors

Based on my knowledge of experts advisors, I was trying to categorize them. It turns out that I cannot categorized them distinctly. Let's look at the various categories first:

Non-directional vs directional

Expert advisors that adopts non-directional strategies are usually based on hedging or non-directional trading models such as one based on the mean reversion theory. Directional expert advisors trade news, breakout, trend, range etc.

Indicator-based vs price action-based

Indicator-based expert advisors use one or more indicators in determining trade entries whereas price action-based expert advisors merely use price action, which can even be candlestick patterns or chart patterns.

Single currency vs multi currency

Some expert advisors trade with only 1 currency while others, especially hedging expert advisors, require trading with more than 1 currencies. The PID expert advisor (defunct now) needs to trade with 13 different currencies at a go!

Rule-based vs self learning

Rule-based expert advisors trade exactly in the manner that their programmers want them to trade. A breed of self learning expert advisors make use of machine learning techniques to learn about the market and adjust themselves to trade accordingly. An example of such an expert advisor is the Bogie. The Bogies uses neural networks to "improve perceptive intelligence on order entries".

Fully automated vs semi automated

There are some expert advisors that can (or they claim they can) run on their own 24-by-7 without human intervention. Of course that is the ideal case. Most fully automated expert advisors require optimization regularly so as to stay in tune with the current market conditions. Some expert advisors, on the other hand, are developed for the purpose of semi-automation. For some expert advisors, one may need to analyze the market and only deploy the expert advisor only if the conditions are right. In some cases,  the level of automation may just merely be to adjust stop loss to trail for profits.

Regular position sizing vs special position sizing

Position sizing is how an expert advisor determine how many lots to enter. Actually, I ran of ideas to term this properly. Let me describe what I mean and perhaps you can help to propose a good terminology :-P

Regular position sizing is determining how many lots to enter based on traditional position sizing techniques. For instance, the position sizing rule may be: the amount to risk for every trade is 5% of total account balance. And this is a hard and fast rule. The number of lots to enter only increases if the account balance increases.

Special position sizing adopts techniques such as Martingale or anti-Martingale (may or not may be on top of regular position sizing). For certain Martingale expert advisors, the number of lots to enter for the next trade doubles after every losing trade!

It is good to know more about your expert advisor and understand how your expert advisor works.

Help in Trading

I have to leverage on technology to make part-time trading work. Can you imagine reaching home after day job  and coaching the kids in their studies and after all that, got to work through 30 charts?

Time to tap on my long lost programming skills to help me with the charts. Ok now, there is that programming book?