Trading Strategy #2: Inspired by Trading for a Living

Inspired by Trading for a Living by Dr. Alexander Elder. I recommend Elder's newer book, Come into my Trading Room, as a first read.

I want to start with swing trading. However, since my favorite simulator - TradingSim.com - focuses on day trading, my current strategy is based around day trading. Many of the fundamentals Elder discusses in his book show up as I practice day trading, so I don't feel to bad about this compromise.

Dr. Elder's Pillars of Trading:

1. Money Management - Risk

2. Trading System

3. Psychology

MONEY MANAGEMENT - RISK

The three steps of learning to trade:

1. Learn to break even and stay in the game. Learn how to manage risk. Develop a trading system.

2. Earn a small but consistent revenue.

3. Find big wins.

With that in mind, the first section is risk management:

The idea is to prevent big losses and protect profit.

1. Generally, my stop lies at a 0.50% loss of my capital, including commission fees.

----Although a 0.50% loss is a narrow stop, I prefer my trades go my way from the beginning. It's been working so far.

----I will trade with Sogo Trading, so an entry and exit willl cost me $6.00.

----I always use limits to eliminate slippage.

2. Once I hit 0.50% profit, I have to protect that 0.50%.

----If I enter and exit for a profit of about 0.50%, I am done for the day.

----If I gain more than 0.50%, I can enter again, but I can only risk the extra profit I've made.

TRADING SYSTEM

STAY OUT

1. I stay out when the price is in a range.

2. I also stay out if I am at all unsure. It is better to stay out and lose nothing than it is to over-trade or to trade without knowing exactly why you're entering and exactly when you will leave. With this in mind, every time I enter or exit, I write down my reasoning.

ENTRY

1. I enter the market only when price has been trending for two or more days.

2. If the price opens outside of the trend channel, I watch if the price returns to the channel.

----If the price is returning, I enter, but I prepare to bail quickly because price might be entering a range.

----Once the price returns, I watch volume closely to decide if the price gap predicts continuation or exhaustion. (Read Elder's book for more info.)

3. In an uptrend, I enter when the price is at the bottom of the trend channel.

EXIT

1. In an uptrend, I exit when the price is at the top of the trend channel.

2. When the price breaks the trend, I jump ship right away.

3. If my prediction is wrong or I'm not sure, I exit.

Trading Strategy #1

1. Enter when I feel I know the trend. Turn Bollinger on briefly before entering to ask his advice.

2. I will maintain 0.50% gain as soon as 0.75% is reached. A gain of 0.50% is the minimum daily goal.

3. When gain increases by 0.25%, the stop will tighten by 15%. For example, if gain increases from 0.75% to 1.00%, the stop loss will tighten from 0.50% to 0.65%. This way, I will always seal in more profit, but my tolerance gap will always increase.

Essentially, this stop loss puts losing profit in perspective. If I arrive at 3.00% profit, my greedy side will feel bad if my profit drops to 2.00%. Now, I won't feel so disturbed and will have the wherewithal to wait out larger rallies.

4. I can exit before being stopped out if I think the market is done giving profits.

TradingSim.com; SMAs; Bollinger Bands

I found TradingSim.com. It's awesome. They give you $50,000 paper money capital with $200,000 in margin. You can replay the past 25 trading days for stocks in NASDAQ, pause, fast-forward, use indicators. Sex on the beach.

On the first day, I did fine - came out to about $48,000, so that's a 10% loss. Okay. Relax.

On the second day, I ran the account into the ground. That sucked so much.

By the fifth day, I stopped losing altogether. Instead, I would routinely make 1.50-5.00%.

I've been playing around with some of the indicators on TradingSim.

Simple Moving Average (SMA)

I read a short article about SMAs on Wall Street Survivor. Apparently when the 50 and 200 periods intersect, you know what to do. Long-term, it looks fine. However, on the short-term, it's often far too late, far too early, or even suggests precisely the opposite of what you should do.

Bollinger Bands

I found a book called Bollinger on Bollinger Bands. I haven't read it yet, but I switched on his indicator and tried to figure out something from it. After a few theories, it hit me. I realized that often times when the price passes decisively above the top band, the stock will just keep rising. On the other hand, if the price just dances above the top band, a rise may come later. The reverse seems true for the bottom band. Pretty sweet.

Reading Trading to Win: The Psychology of Mastering the Markets by Kiev has helped me notice an interesting emotional phenomenon. I discovered this as I was killing my first $50,000:

Precisely after entering the market, the price would often move strongly against me. It became so predictable that I had an ingenious idea: Every time I would feel anxious to buy, I would sell and vice versa. Somehow, I found this method supremely satisfying - as if I was profiteering off my own emotional clumsiness. I became so good at doubting myself that I stopped losing. Thus began my current winning streak.

I have a creeping suspicion that there are cunning, well-funded groups which know exactly how the masses think and feel about the market at a given time. Just as the masses enter, these guys nudge the market in the other direction and make an killing.

Now, my strategy is a little less ridiculous. I wait until about 10:30 AM and enter just when I see a trend forming. If I do not see the trend, I don't enter. Sometimes I exit if the trend loses momentum or if I became unsure. Sometimes I leave my money in for the entire day. Also, I try to only trade on the half-hour. It prevents me getting caught up by my emotions. As much as I enjoy the "Let's do the opposite of what I want to do" Dance, I try to avoid it.

Right now, that's my trading strategy: up in the air - anchored only by novice intuition and the occasional Bollinger Band.

The Livermore Market Key

After reading How to Trade in Stocks by Livermore, I decided to make an honest effort with his system.

I found his explanation clumsy, so I haphazardly tried things out. I then went back to his explanation and it made more sense. It goes to show, learning with context is always easier.

Here's an overview of how it works:

(To get a closer view of the screenshots, press CTRL + "+" keys. To reverse effect you use the "-" key instead.)

You record prices in six columns. Which column a price goes in is determined by Livermore's rules. The columns suggest when trends begin and end as well as filter out unimportant price movement.

So far, I've tested the system with over a dozen stocks, each time over a period of a month. Except for once where I broke even, I have always made money. Usually, my monthly growth is between 10-25%. Several times, I had growth over 50%. I am sure in practice, the results will not be as spectacular. I am convinced, though, that this system is a sound trading strategy.

This second screenshot is the results from using only the Livermore Chart. No stock graphs were used. 31% in one month with four trades - not too shabby. And with practice, I am sure to find better results. Currently, I always try to be in the market, so I probably miss signs suggesting that the trend is unclear. That is probably why I was stopped out on the 19th of August, as you can see.

For those who know about the system, I made two changes:

-Livermore only changes columns when there is a big enough price change. He uses six points. He does this to filter out the noise. Myself, if the price changes direction, I always record it. It works fine for me.

-Livermore determined a trend by a change of three points. I use 5% of the initial price.

Perhaps this is why Livermore could use six points, yet I find it unreasonable.

It's nice to think that I can buy and sell stocks a few times a month and still make a profit. All I have to do is keep a record of mid- and end-day prices and watch for trends. If this is true, it's good news for me because I'll be in class most of the day. But then I feel like trading really ought to be more difficult...

I also have used Think or Swim's simulator to "day trade" using Prophet's historical charts. I would change the time period and scale so that every movement forward in time on the graph would expose another 15 minutes. Then, I would record my entry and exit prices in my datasheet. This is a difficult method, though. When the stock moves against you, it is easy to backtrack and change your entry/exit points - "Oh, I didn't mean that." However, day trading in this way, I make a lot more money than I do using Livermore Charts.

08-15: The Plan

A trader needs a plan. Without a plan, a trader is just gambling. And my daddy taught me not to gamble.

Current position:

I'm in university. My GPA must come first, so I am taking the slow road. I feel like I am lost in a forest of information - books, tutorials, forums - and cannot make heads or tails out of anything.

From the looks of things, stocks are my target. However, Forex (Foreign Exchange, meaning currency market) and Futures (commodities like wheat, coffee, and steel, as well as financial products...meaning?) also pique my interest. It'll be a while until I decide where to put my money, but for now, I will stick with stocks.

The plan:

1. Learn how to trade.

-Read books, forums, anything.

-Learn programming. One of my majors is Mathematics, so I might as well. I chose long ago to begin with the Python language.

-Learn how to use a trading platform. I am using the free platform from ThinkorSwim.

-Also, I use the trade simulator WallStreetSurvivor.

2. When I feel comfortable and time between studying permits, hopefully in a few months or a year, I will begin with $1000-5000. I consider this money tuition - it is not really mine and I do not expect to get rich with it.

3. After I am finished with university, I will begin my proper goal of turning $5000 into $1,000,000 in five years. My calculations show I need about 2.2% profit per week or 9.9% per month. This will put me to about 1,450,000, which gives me some wiggle room.

4. Before I begin intra-day trading, I want to have a year of successful end-day trading. Livermore himself suggests trading longterm is more profitable, so I will start there. I don't need to mention that I am a student, so I currently don't have the time for intra-day anyhow.