Trader’s Narrative

Trading is deceptively simple.

After all, there are only 3 kinds of trades, and thanks to today’s technology, anyone with even a small amount of money can open an account, be linked to the exchanges and start sending off orders in no time.

But that doesn’t mean making money through trading is easy. On the contrary. It is probably one of the most difficult, frustrating and challenging undertakings you can imagine.

So why is it so difficult?

Of course, there isn’t a pat answer for such a question. So I’m going to explore this in a series, of which this is the first.

One of the primary nature of trading is that it is a waiting game. Most people, especially those new to trading, imagine it is a frenetic exercise in yelling “Buy, buy” or “Sell Dammit!” into the phone or a flurry of keyboard presses and mouse clicks. I suppose they have this perception of trading from Hollywood.

In reality, trading consists of long bouts of (near) boredom, interspersed with spikes of adrenalin induced action. This makes trading extremely demanding, physically, emotionally and intellectually. Let me use an analogy.

A cheetah can instantly unleash an unbelievable amount of energy, reaching speeds of 100 km/h and more, faster than any of its prey. But such acceleration and speed requires restraint and responsibility.

A cheetah must stalk its prey, choose a specific one and then get as close as possible before initiating the case. In spite of its superior speed and agility, without these prerequisites, it faces failure.

Similarly, a trader can, with a click of a button, send an obscene amount of capital into a trade. But if s/he hasn’t done their homework, of what use is the instantaneous execution of their order?

So a trader must first watch, single out opportunity and then act. But this requires a special blend of patience and decisiveness. Most of us are good at one or the other. Some are very analytical and others very action oriented.

The ideal trader has a constitution that blends both harmoniously: they are patient and serene when scanning the market but when they spot an opportunity, they act quickly and decisively. They are able to stay alert and perform at their peak even during the “boring” parts.

Too much observation and analysis leads to missed opportunities. And on the other end of the spectrum, hyperactivity without forethought leads to taking too many trades and wasting your capital on unworthy ideas.

So how do you know when to be patient and when to take action? That depends on the type of trading you’re doing and what sort of trading plan you’ve set up for yourself.

You do have a trading plan, right?

Oops! You mistyped and made a fat finger trade

There is so much ink and pixels spilled on how to succeed in trading. So I thought, being a contrarian, I would zag instead of zig and outline how to fail as a trader. Without further ado, the 10 vital steps you must take in order to fail in trading:

1 Start out undercapitalized
Become enthralled with the romanticism of taking $500 to a $1 million - ignore any pesky thoughts about the improbability of such a Herculean task.

2 Ignore risk management
Always value conviction over discipline. Don’t worry when a trade goes against you, just put it aside and think of it as a long term investment. Or double down. It has to come back eventually.

3 Compare yourself to other traders, not yourself
Don’t use R or any of that weird stuff like MFE/MAE. Instead compare yourself to other traders using dollar amounts.

4 Look for the right system
Rather than gaining an understanding, search for the killer trading system - it is out there and it will make you rich beyond your wildest dreams! Take someone else’s system, seminar, etc. never waste your precious time in doing your own research. Don’t ask too many questions or push boundaries; crush your sense of wonderment and your natural thirst for learning.

5 Don’t keep a journal
Or in any way, try to learn from your previous trades.

6 Be secretive
If you stumble on an idea or insight, keep it to yourself. Never ever share it with other traders or ask their input on it.

7 Be casual
Don’t take it seriously, do it on the side, part time - don’t devote a lot of attention or resources to it. See #4

8 Fill your charts with as many indicators as possible
More information means more signals and money so make sure every chart is so complex that price action is hardly visible through all the indicators.

9 Trade with your emotions
If you’re feeling greedy, push your trades and buy more. If you’re fearful, stand aside or sell. If you don’t have strong emotions, go with the crowd. If they’re fearful, there must be a good reason, sell. If they are buying, join them. They must know something you don’t. And if you don’t know how to monitor the crowd, let a TV personality do it for you. Buy what and when he says.

10 Be inconsistent
Try to be completely random (that’s what markets are like after all, right?). One day trade based on news, the next day on candlestick patterns, the next day on fundamental analysis. Each day trade a different market: Monday: corn, Tuesday: the spoos, Wednesday: FX, Thursday: gold, etc.

If you’ve somehow managed to not learn about Mark D. Cook by now: he is a ‘Trading Wizard’ featured in Schwager’s series of books, a legendary futures trader and the winner of the 1992 U.S. Investment Championship (with a 563.8% return). His most famous contribution to trading and technical analysis is his self named, Cook Cumulative Tick Indicator.

This indicator is, as the name suggests, simply a cumulative count of tick throughout the trading day. The exact recipe is only known to Mark D. Cook but from what he has publicly divulged, we can try and estimate the Cumulative Tick Indicator to a pretty good degree.

First, separate the noise from the signal by ignoring any tick readings within the +/-400 range. We then record and aggregate those readings outside this range at a fixed time interval. We don’t know exactly what interval Mark uses so just pick a time interval: minute, hour, day, etc. The important thing is to be consistent. That’s it! Now you have the super secret Mark D. Cook, Cook Cumulative Tick Indicator. So what do you do with it? Watch the 95th and 5th percentile. If the Cumulative Tick Indicator is above the 95th percentile, sell; if below 5th percentile, buy.

Remember, this is a counter trend strategy so the more extreme the tick, the more vicious the snapback. As with all counter trend strategies, mind your protective stop loss! A trend can persist much longer than you can remain solvent. Never try and be a hero by playing chicken with the market.

But what if you don’t have access to such tick data? You can estimate the cumulative tick by calculating a simple moving average. This won’t be the same as Cook’s Cumulative Indicator, but it is still helpful:

The cool thing about this indicator is that it is quite accurate in pinpointing tops as well as bottoms (see how an oversold extreme in tick flagged the May 2006 bottom). After all, it is an almost real time snapshot of the market’s pulse, racing from greed to fear and back again.

Lets take a look a the recent action in this approximation of the Cumulative Cook Indicator. In early March 2007 it hit an extreme oversold level (-300). If you had any shorts or wanted to press the short side, this was telling you to both lighten up and to think about going long instead.

Then within just a few weeks in mid-March 2007 it reversed and went as high as +500! If you notice, it hit the overbought threshold (+400) when the Nasdaq reached 2450 and stalled. If you were long, it was telling you to lighten up and think about shorting. Remember that this indicator is quite hyper. Either adapt to such short term setups or use a longer moving average to get a more long-term perspective.

Mark Cook uses the NYSE tick, but personally, I think that the NYSE is so polluted with non-common share securities that the tick and any other indicator based on NYSE data has way too much noise to signal ratio to be useful. Thankfully we have the NASDAQ tick which is the same thing really - free of the ‘noise’ from bond funds, munis, preferreds, etc.

Cook has a few more tricks up his sleeve - would he be a Trading Wizard if he didn’t? There is the conjunction trade which relies on tick but is a bit different than the Cumulative Tick Indicator. First, you want a tick reading below -400 (the magical threshold). Second, you want the Dow Jones tick below -22. The ‘conjunction’ of these two gives you the signal (for the spoos). You give it a window of 21 minutes to work.

There are 3 possible outcomes:

• you run out of time (price meanders) and you exit
• you take a 3 pt profit
• you take a 6 pt stop loss

I’m not sure if it’s a great idea to have a 1:2 profit to stop loss ratio but I assume that Cook relies on the high probability nature of this setup to give him positive expectancy.

Finally, Mark D. Cook has a trading setup he calls a ‘tick buy’. This is the simplest one! The signal for a buy/sell is when the NYSE tick gets to -/+1000. That’s it. The thinking is, of course that you buy because market will snap back from such an oversold level. The wrinkle is that you watch and buy the index that cooperates or leads the most. Mutatis mutandis for an extreme overbought tick. So if the NDX is weak, and we get a sell signal (+1000 tick) we then sell NDX (not SPX or OEX which may be stronger).

If you’re interested to know What Mark thinks about the current market, you can read his most recent commentary here. But be aware that Mark tends to have a bias towards the bearish side

Would you be interested in peering over the shoulder of a profitable trader? one who has taken a $100,000 account and in less than three months grown it to $1.6 million? would you like to see and analyze every trade they made?

Just head over to Zack’s $100,000 Challenge and take a look at the current top contestant’s trades. He is hyper active… a scalper really. Whatever he’s doing is working! “Java J” is trouncing the rest with a current $1 million lead on second place!

You may not want to emulate his style (once you find it among the confetti that is his blotter) but you’ll definitely come away with atleast one or two insights. I’ve only glanced at a few of Java J’s trades. From those I see he only trades very volatile and active stocks: ACAD, BVSN, SPDE, and the like. From the sheer number of trades and their close proximity in time, he must be using a 1 minute or tick charts or maybe he’s not using charts at all but ‘reading the tape’ old school. The gains he has made are even more impressive when you notice that he pays on average $50 roundtrip! His must be a very high probability setup to achieve results above the transaction cost.

Unlike other trading contests, the prize in this one is not won by the highest equity but a combination of performance and blogging. So be sure to check out the top performers blog.

You might also be interested in this series posts by the Chairman, analyzing the trades of Charles Kirk, of The Kirk Report.

Yet another way to peer over the shoulder of a successful trader is to check out Tony Oz’s The Stock Trader: How I Make A Living Trading Stocks:

After having received an exciting challenge from the founders of the International Online Trading Expo, Tim Bourquin and Jim Sugarman, Tony planned to hold nothing back, providing all the decisive details of each trade, including the thoughts, strategies, surprises, and problems, and how he dealt with the momentby- moment challenges the Market presented him.

Such a book had never been attempted before. No trader has ever put their reputation on the line with this kind of honesty. It’s easy to search through past trades and present the best ones. But no trader has come forth in advance with the candor to say, “For the next four weeks, I will reveal my every move, for better or worse, entries and exits, winners and losers, with all my profits and losses.”