Does the turtle trading rules still work in today’s market? Here’s a data driven answer and it’s not what you think…
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Bottom Fishing Trading – How To Find Reversals

The market you’ve been following just tanked. It’s hit a new low. But now, you see a glimpse of a potential rebound. It looks like a significant decline, but still, there’s no way to guarantee that it’s the bottom you’re looking for. As you know, one of the riskiest things to do is to predict bottoms and tops. Yet getting in on a position near a bottom (going long) or a top (going short) is the only way not to miss out on a significant portion of a trend reversal – or so they believe. In this case, thinking that this might be The Bottom, what might you do?

 

There’s Nothing Wrong with Bottom Fishing (just don’t get eaten by the fish)

“Bottom fishing” is a nice metaphor. And in a market context, the fish will devour you if you fall off the boat, proverbially speaking. Another metaphor describing this phenomenon is “catching a falling knife.” You don’t want to do that unless you’re a longer-term investor who doesn’t mind getting nicked here and there amid a dollar-cost-averaging strategy.

But as a trader, you want your long entries to be tight and precise. And that’s what “bottom fishing” is all about. So, that’s what we’ll cover–a sound method for catching a market when it appears to be bottoming out.

 

The Bottom Fishing Trading Method

The Bottom Fishing method is geared toward the long side of a trade. It works best when the longer-term trend is up, meaning that it can work exceptionally well after pullbacks or major corrections.

 

A Note on Stop Losses When Bottom Fishing

When bottom fishing, we’re looking for a certain type of Double Bottom.

• If you place your stop loss below the first bottom, you’re likely to sustain a deeper loss (so you compensate by taking on a smaller position size depending on you % risk). But your return rate may also be greater.
• If you place your stop loss below the second bottom (a higher level), your likelihood of getting stopped out may be greater and your performance numbers may not be as profitable as it might be with a deeper stop loss.

The Rationale

The rationale behind bottom fishing is that the lows in a declining market are failing to break lower. The second “retest” of the low is failing to match the level of the first swing low. So, you end up with a W in which the second low is higher. What it means is that sellers are beginning to drop out, and buyers may be entering the market, possibly reversing the trend.

A quick snapshot of what you’re looking for:

That’s the model. Here’s what it looks like in the live market. Note how reality can vary from the model. This example in the GBPJPY took several days between lows.

 

GPBJPY Daily August 15 to December 20, 2019

In the AUDCAD, the second low wasn’t very pronounced, and it falls between the categories of a V and W bottom. However, the second low gives you enough room to justify a trade setup.

 

AUDCAD Daily January to June 2020

 

CNYUSD Daily August 2019 to January 2020

The CNYUSD isn’t a very liquid currency pair to trade. But if you’ve been following the US-China trade tensions, the fundamentals might have given you enough confidence to trade this pattern. The technical setup would’ve made for a nice tactical setup.

Now that you know what to look for, the next thing you probably want to know is how to trade.

 

Setting Up Your Bottom Fishing Entry

Step 1: Find an ugly double bottom

We just covered a bunch of them. Let’s use our first example.

Ugly enough? We see one bottom followed by a second. In real-market cases, the bottoms can be closer or further apart. It doesn’t really matter, as long as you can identify two bottoms. The next part is critical with regard to this particular setup.

Step 2: The Second Bottom is Higher than the First

For the sake of the setup, we’re looking for a second bottom that’s 5% to around 20% than the first. Although the best test results come from this range, in some cases, the second high maybe even greater than 20%. You have to determine this using your own judgment–whether the reward is worth the risk.

What we’re looking for in this second low is an indication that selling pressure is being canceled out (or overpowered) by buying pressure.

Step 3: Calculate the height of the chart and determine your price target

• The first low [A], is the bottom of the pattern.
• The high after the first low [C], is the top of the pattern.
• The second low [B] indicates that buying pressure is more prevalent than selling pressure; it also serves as an alternate stop loss (for those that choose this level for a stop).

Calculate the height between A to C. You have to decide the multiple of this height (75%, 100%, or more) based on the technical or fundamental factors you see before you (resistance ahead, fundamental conditions, etc.) in order to decide which multiple you want to use. In other words, you have to use your discretion to customize your target.

Add your preferred multiple to C to get your price target for the completion of this candlestick pattern.

Step 4: Place your entry order, take-profit order, and stop-loss

• Trade entry should take place once the price action has closed above [C].
• Once you’ve entered your position, place an order to sell at your target.
• Place a stop loss at the bottom of your pattern [A].
• Alternatively, you can place a stop loss below [B], but be aware you may be stopped out more frequently than if you were to place a stop below [A] which, if violated, cancels out the pattern.

Step 5: Complete the Trade

The last part is pretty easy. Allow your trade to complete itself at a profit or loss. Hopefully, you’re allocated the right percentage of risk to your position, not more or less. If your target is 100% or more the height of the pattern, then you can consider either raising your stop loss to [B], or close to a breakeven point to limit your losses. At this point, you’re on your own, but at least you have several options for managing your trade.

Let’s look at this trade from a real market scenario, using some of our examples above.

 

Example – GBP/JPY Trade

 

The height of the pattern between [A] and [C] = 9.10 (or 910 pips). You would add this to the top of the pattern at [C], or 135.74, to get a target of 144.85.

You enter a long position at the close of the breakout candle at 137.11. Since your target is 100% of the pattern height, you exit your trade at 144.85 for a profit of 7.74 to 774 pips.

Example – AUDCAD Trade

Similar to the example above, you enter the trade at the close of the breakout candle at 0.8718. You exit at 100% of the pattern at 0.9315 for a profit of 597 pips.

Example – CNYUSD Trade

By now, you probably get the picture.

 

The Bottom Line

Bottom fishing trading is essentially an attempt to time the market. And once thing that’s certain is that most traders and investors are unsuccessful timing the markets. But what matters is not necessarily your win rate, but that your positive payoffs are greater than your losses. In other words, you can lose several times but make back your losses and hopefully more on fewer wins. And although there are many different ways to ‘bottom fish,” this technique is one sound way to keep your setup objective, measurable, and flexible enough for adjustment, should the situation (technical or fundamental) call for it.

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How to Grow a Small Trading Account

Discover practical trading tips you can use to grow your small trading account to 6-figures and beyond
How to Grow a Small Trading Account posted first on your-t1-blog-url

Risk Management: The Best Defense is a Good Offense

There’s this old saying, often applied to strategic games as well as warfare, that “the best defense is a good offense.” Another variation of this is that “the only good defense is an active defense.” Let’s transform it a bit: the best of “defensive strategies” has an effectively “aggressive (offensive) component.”

What we’re trying to say here is not that the two–defense and offense–are linked (which they are), but that one can easily shift to the other when the situation calls for it.

As it relates to trading, a “defensive” posture can be tweaked to take on an “aggressive” function. In other words, “risk management” is as much an aggressive concept as it is a defensive strategy. You manage risk to calibrate profit potential, not just to avoid losses. Here’s an example that explores this notion.

 

Risk Management Strategy Squeezes Profit From Losing Trades

Imagine two traders–Trader Joe and Trade Giuseppe.

Similarities

Both traders have a starting balance of $10,000. Both are trading the Dow Jones futures. Both are following the same trading signals.

Differences

Trader Joe trades a fixed position of one contract, which ticks at $5 per point. Trader Giuseppe uses a 2% risk strategy, so he trades both the YM and the MYM to fine-tune his position size.

 

The trades were losers but Trader Giuseppe ended the day with a profit

There were a total of five trades–all of which, when combined, ended in a loss of -130 points. Though Trader Joe ended the day down only -$650, Trader Giuseppe went home with +$1,068 profit.

How was that even possible?

How could two traders following the same signals for the same instrument have such a disparity in profit and loss? The answer, which you can guess, is risk management. It’s not that Trader Giuseppe lost less due to his risk management strategy, it’s that his strategy allowed him to win more. In short, risk management was not just a defensive strategy but an aggressive one as well. Let’s break it down to see how both traders ended up with their results.

 

Breaking Down the Trades

Position	Stop Loss	Profit Target	Point P/L
1 contract	-65	100	-65
1 contract	-75	100	-75
1 contract	-10	100	100
1 contract	-75	100	-75
1 contract	-15	100	-15
			-130

The total system loss amounted to -130 points. Quite a big loser.

The exit rules in this system are simple: close out at the maximum profit target or allow your position to get stopped out (at the stop loss).

Now, here’s where the interesting results begin–how Trader Joe ends up with a relatively sizable loss, when Trader Giotto generates a win. Let’s start with Trader Joe.

 

Trader Joe’s Losing Strategy

Position	Stop Loss	Profit Target	Point P/L	$ P/L
1 contract	-65	100	-65	-$325
1 contract	-75	100	-75	-$375
1 contract	-10	100	100	$500
1 contract	-75	100	-75	-$375
1 contract	-15	100	-15	-$75
			-130	-$650

Trading a fixed amount, in this case one contract, will give you a result that matches a systems PL once adjusted for value. In this case, Joe’s one contract has a $5 per tick value. So a loss of -130 points amounts to (-130*5 = -325) a -$650 loss.

How did Trader Giotto’s results end up so different and on the opposite side of the PL spectrum? All he did was use a simple 2% risk management strategy–namely, don’t risk more than 2% on any single trade. Let’s dig deeper into how this happened.

 

Trader Giotto’s Aggressive Risk Management Strategy

Note: at this point, we’re about to get very detailed. But when managing risk, position sizing can become a very detailed endeavor–one that requires you to constantly check your balance against % risk. So, let’s go over it blow by blow.

• To come up with 2% risk, Giotto multiplies his trading account size with 0.02 (Account x 2%).
• To come up with his max dollar-per-tick value, he divides his max risk by his stop loss (e.g. look at the first trade–$200 divided by 65 = $3.07 maximum dollar-per-tick value).
• He then selects the number of contracts to match the exact amount of his dollar-per-tick (or slightly below it).

 

Let’s walk through each trade.

Position	Balance	Stop Loss	Profit Target	Point P/L	$ P/L
6 MYM	10000	-65	100	-65	-$200
5MYM	$9,800	-75	100	-75	-$196
3 YM + 8 MYM	$9,604	-10	100	100	$1,921
6 MYM	11525	-75	100	-75	-$230
3 YM	11294	-15	100	-15	-$225
				-130	$1,069

 

Trade 1

Balance: Giotto begins the day with $10,000.

2% Risk: Amounts to $200.

Stop loss: 65 points.

Maximum dollar-per-tick: He can’t risk more than $3.00 per tick ($3 x -65 = -$200).

Contract size: To match the ideal dollar-per-tick value, Giotto needs to trade no more than 6 Micro Emini Dow Jones contracts (MYM) each with a tick value of $0.50.

Result: He got stopped out with a -$200 loss (-65 x $0.50 = -$200).

 

Trade 2

Balance: $9,800 left.

2% Risk: $196.00

Stop loss: 75 points

Maximum dollar-per-tick: Risk no more than $2.61 per tick (round that down to $2.50).

Contract size: 5 MYM contracts maximum (5 contracts x $0.50 = $2.50 per tick).

Result: PL of -$196.00

 

Trade 3

Balance: Now, Giotto’s account is down to $9,604.

2% Risk: $192 is his two percent loss limit.

Stop loss: This stop loss is 10 points away–meaning he can have a much larger position.

Maximum dollar-per-tick: He can risk as much as $19.21 per tick ($192 divided by 10 = $19.20)

Contract size: 3 YM + 8 MYM contracts ($15 + $4 – $19 per tick).

Result: A winner, this one yielded a return of $1,921–a big winner. Note that Joe, in the previous trade, only made $500.

 

Trade 4

Balance: Giotto’s account is now up to $11,525.

2% Risk: Maximum risk has increased to $230.

Stop loss: 75 points.

Maximum dollar-per-tick: $3.07 (rounded to $3.00).

Contract size: 6 MYM contracts.

Result: Stopped out with a loss of -$230.

 

Trade 5

Balance: Giotto’s account value is down to $11,294.

2% Risk:$226.

Stop loss: This one is 15 points away.

Maximum dollar-per-tick: Because of the small stop loss, to lose 2%, he would have to risk $15.00 per tick.

Contract size: 3 YM contracts.

Result: Another loser, this ended with a return of -$225.

 

In the end, Trader Giotto gained $1,069, or a 10.7% profit, as compared with Trader Joe’s -6.5% loss. But what a world of a difference.

 

Same Win Rate, Different Profit Factor

In a previous post, we discussed the concept of win rate vs profit factor. Win rate is the frequency of wins, often expressed as a percentage. The profit factor is the ratio of wins to losses.

The System:

• The system’s win rate for these last five trades was poor–a 20% win rate, and 80% rate of loss. Granted, these were just five trades. But still, it was a loser.
• The system’s profit factor was poor–0.43-to-1, or inversely, -2.31-to-1 (loss factor).

Trader Joe:

• Joe’s win rate and profit factor mirrored the system’s, as he used a fixed allocation for each trade.

Trader Giotto:

• Giotto’s win rate was the same as the system’s and the same as Joe’s.
• But his profit factor was a surprising 2.25-to-1. For every one unit lost, he gained 2.25 units in profit–the exact opposite of Joe’s.

To reiterate, the difference between Joe’s loss and Giotto’s win was that the latter used a risk management strategy to guide his position sizing. And the difference turned out to be night and day.

Since we’re discussing win rate and profit factor, let’s talk about both for a moment.

In our previous post, we mentioned that a system with a high win rate can still be a losing system, especially if its negative returns dwarf its profits. Similarly, a system with a high profit factor can still end up a loser, if it loses frequently enough to begin generating negative returns.

 

At What Point Will Win Rate Interfere With Profit Factor and Vice Versa?

Let’s imagine a trading system that had a win rate of only 30% but it made double what it lost.

• If its average win was $100, it’s average loss was $50, can you expect it to generate positive returns? The answer is no, you can’t.
• But what if it made an average of $120 and an average loss of $50. Does it have a positive trading expectancy? Yes, it does.

Let’s play with this idea some more. Let’s take the first example, wherein a system has an average gain of $100 and an average loss of $50.

• At its current 30% win rate, it’s a loser.
• What if its win rate were 32% instead? It’s still a loser.
• What if its win rate was slightly higher, at 35%?. In this case, it’s potentially a big winner.

How did we just figure this out? Simple, we calculated the trading expectancy.

 

Introducing Trading Expectancy

Trading expectancy is a calculation you can use to theoretically predict the favorability of a trading system–whether winning or losing–based on its win rate and its average wins and losses (almost like profit factor).

It can help answer the following questions: “How low can the win rate go before the system begins losing; and how low can the profit factor go before it begins losing?”.  Likewise, it inversely tells you how high the win rate or profit factor must be for a system to be profitable.

Trading expectancy sets a limit at zero. If a system’s trading expectancy is below zero, it’s a loser. If it’s above zero, it’s a potential winner.

Here’s how to calculate it:

(Win % x Average Win) – (Loss % x Average Loss) = Trading Expectancy

With this calculation, you no longer need to worry whether you’re focusing too much on a system’s win rate or profit factor. All you have to do is plug in the numbers, and you’ll be able to forecast whether a system will likely “make” or “take” your money.

Let’s illustrate this concept with a simple example of a coin toss.

 

Trading Expectancy of a Coin Toss and a Weighted Coin Toss

Someone presents you with a coin toss bet. If the coin shows heads, you win a dollar; tails, you lose a dollar. You know right off the bat, it’s a 50/50 bet. How might it look in terms of trading expectancy?

Win rate = 50%; Loss rate = 50%

Average win = $1.00; Average loss = -$1.00.

Plug in the numbers: (0.50 x 1) – (0.50 x 1) = 0 trading expectancy. Over time, it’s neither a winning nor a losing bet. You do, however, lose time, effort, and you pay an opportunity cost; missing out on a more favorable gambit.

 

But what if that same person presented a slight variation–a weighted coin toss:

• The coin is weighted so that it tends to land “heads” 75% of the time…however…
• A heads win will return $1 and a loss of $2.50
• A tails win will return $2.50 and a loss of $1.

Would you bet heads or tails?

The winning bet would still be heads, with a trading expectancy of 0.125–not the biggest winner, it’s still the only bet that won’t lose over time.

 

Using Trading Expectancy to Analyze Trades

If you understood the examples above, you can easily transfer this to the domain of trading performance.

Here are three systems, each presented with their Win Rates and average wins and losses:

 

System 1 wins only 20% of the time, returns an average of $425, loses an average of $100.

System 2 wins 95% of the time, returns an average of $50, loses an average of $975.

System 3 wins 65% of the time, returns $200 on average, loses $375 on average.

 

Which systems can you expect to win and lose over time? Without calculating its trading expectancy, it would be difficult (if not nearly impossible) to objectively determine that system 1 is the only winner, as you can see below.

System	Win %	Av Win	Loss %	Av Loss	Expectancy
1	0.2	425	0.8	100	5
2	0.95	50	0.05	975	-1.25
3	0.65	200	0.35	375	-1.25

The important takeaway here is that win rate and profit factor, despite being important metrics, can’t give you a big picture view of a system’s performance. Trading expectancy helps complete the picture, unless the underlying conditions of the market change.

Although there are many factors that go into “risk management,” we’re hopefully covering a few important and practical ideas that can help your trading. There’s one other that we’d like to go over. We touched upon this in our previous post, but let’s expound upon it now, since many traders don’t always get the big picture behind this very basic concept.

 

The Single and Largest Risk That Most Traders Miss

Let’s imagine three really-bad traders who aimed to make upwards of 200% return in the markets–this is a hypothetical figure.

Instead, they all lost 100% of their trading account. Let’s say this amounted to $100,000. That’s quite a dismal performance.

That’s where the similarities end. There’s a big difference between the three.

• Regarding the first trader, $100k was his entire life savings, all distributed to other market participants. A tragic story indeed, as he truly faced financial ruin (or more years in the workforce to make up for what he had lost).
• Regarding the second trader, $100k was only 20% of his $500k total investable capital. He kept the rest in cash. Not a “loser,” but not quite a winner either. He put his money to work for him, and it came back empty-handed. The rest of it just slowly lost purchasing power due to inflation.
• Regarding the third trader, the $100k lost was also 20% of her total capital, but she invested the rest in stocks, bonds, real estate, and other ventures. She’s the only “bad” trader among the three who ended up with more than just her starting capital.

The moral of the story: often, your biggest risk as a trader is “you.” There may be no “safe” trades or investments, but there are certainly “safer” trading and investment practices.

Let’s step back and take a closer look at the third trader, the one who ended up a “winner” despite losing big in her trading endeavors.

She didn’t have great trading skills, apparently. Perhaps, she didn’t have very sophisticated investment skills either. But she held true to a couple of principles:

Her trading expectations had a reward-to-risk scenario of 2-to-1. The potential payoff was much greater than the loss. But because the risk was high, she allocated only 20% of her investable funds, nothing more. Most importantly, she knew that she had very little in the way of “sophisticated” market knowledge, making it impossible for her to “predict” market and economic trends. So, what did she do? She allocated her capital evenly across the board, diversifying and expanding her “return sources” while hedging one economic sector against another. All this while attempting to trade the markets.

The idea of positive vs negative payoff is an important one here when it comes to managing risk. Ideally, you’d speculate on opportunities whose positive payoff outweighs the negative payoffs. That’s a simple principle that doesn’t take sophisticated knowledge to put into practice.

To demonstrate this further, and its importance to risk management, let’s talk about a very ancient story about risk–about NOT having sophisticated knowledge, but having solid knowledge on scanning and assessing the odds. This is a story about Thales, one of the Seven Sages of Greece, and to whom Aristotle referred as the first “philosopher,” who not only made a killing in the olive oil market but was one of the first recorded “monopolists” as a direct result of his speculations.

 

How to Make a Killing in a Market You Don’t Fully Understand Using Only Basic Risk Management Principles

The story goes like this. One harvest season, Thales speculated that the olive harvest was going to be bountiful. So, he rented all of the olive oil presses in his area and surrounding areas at a discount. The weather later that season turned out to be a real boon for the harvest. As Thales owned all of the presses, he rented them out to farmers, became wealthy, and proved to his fellow citizens that he could be a very good businessman should he choose to continue as one.

So, what does this story have to do with risk management? It’s subtle, but it underlies every aspect of the story.

 

Success Attributable to Knowledge?

Aristotle attributes Thales’ fortune to the latter’s knowledge of astronomy. Since Thales was skilled in reading the stars, he was able to predict a good harvest. Thales’ success, according to Aristotle, was based on “knowing” things (astronomy) that most others didn’t understand. Do you buy his explanation? Such knowledge can help, but it’s no surefire guarantee of success–as nobody can predict the future.

 

Success Attributable to Risk Management?

But what if Thales’ astronomical knowledge wasn’t advanced enough to predict the outcome of an entire harvest season? In other words, what if Thales had far less knowledge than Aristotle claimed? What if given the discount in press rentals, Thales knew that the potential return far surpassed the potential loss? And what if Thales was able to afford that loss, should he be wrong? In that case, Thales made a fortune by simply managing his risk-taking a “bet” on an opportunity that presented a much higher upside (outcome unknown) than downside (outcome known and fixed…the cost of the rental).

The takeaway here is that by sticking to this rule of thumb–exploiting opportunities with significantly higher upside than downside–you can gain the upper hand on most speculative endeavors, never approaching the risk of ruin.

 

The Bottom Line

Risk management is more than just a defensive strategy; it can be used to aggressively pursue opportunities while (secondarily) keeping risks under control. It can also help you better identify the conditions in which trading opportunities or systems may prove more or less favorable in terms of profit potential. Last but not least, we hopefully demonstrated how risk management principles can either enhance or “best” trading knowledge no matter how simple or sophisticated. When you engage the markets, keep in mind the saying we opened with “the best defense is a good offense.” No successful pursuit is sound without a risk management plan that adequately supports it. Remember, you can trade aggressively and safely at the same time.

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Mastering Technical Analysis and Price Action – Part I: Macro Analysis

The technical analysis approach revolves around evaluating and capturing mass psychology and sentiments of market participants. Regardless of which technical indicator or other tools we use, mastering this technique, for the most part, involves analyzing price trends and chart patterns.

Most beginner traders look at a chart and use the combination of technical analysis tools to make trading decisions based on a single dimension, often on a single timeframe, without paying attention to the big picture. As a result, when broader trends change or the market enter a consolidation phase, the systems they use cease to generate the accurate entry and exit signal. At this point, the beginner traders scratch their heads and do not understand how a profitable strategy suddenly stopped working.

 

Big Picture Analysis

In this two-part article, we will discuss how to identify and conduct macro analysis without using any special indicators, simply by looking at a chart. We will further explore how to formulate a trading decision by boiling the process down to micro factors that can help us enter a trade.

We will start by discussing momentum and how can we use it to understand the macro trends. Then, we will learn the significance of chart phases how it dictates the outcome we can expect from different trading systems. Last but not least, we will try to establish a connection between chart phases to wave analysis that will help us time our trades and complete the trinity of mastering technical analysis based macro analysis.

 

Momentum

The best way to identify the comprehensive trend in any market would be beginning with finding out the state of momentum in the market. Once you learn to identify momentum, we can confirm the existence of a price trend in either direction, up or down. It will also help you find out if the market lacks any momentum and it is in a consolidation period.

To put it bluntly, momentum is the measurement of the trend strength. While there are several technical indicators that we can use to measure volatility and momentum, such as standard deviation based Bollinger Bands and expanding price range value-based Average Directional Movement Index (ADX). However, here, we will discuss about mastering the measurement of trend strength, the momentum, by simply looking at a Candlestick chart.

Figure 1: EURUSD Candlesticks on Daily Timeframe Indicates Bullish Momentum

 

If you observe any candlestick chart carefully, you will find that during a trend, the length or size of the candlesticks starts to gradually increase compared to the timeframe when it was in the consolidation phase. During an uptrend, like the example chart in figure 1, we can see the size of the Candlesticks remains relatively small during the consolidation phase on the EURUSD’s daily timeframe. However, as soon as it breaks above the resistance and the uptrend resumes, the length of the bullish (Green) Candlesticks starts to increase.

On the other hand, during this uptrend, the size of the bearish Candlesticks  (Red) started to become shorter. The key to identifying momentum is thinking in terms of ratios. For example, if the bullish Candlesticks during the previous consolidation were on average 50 pips (on the Daily timeframe) in length and after the breakout, these bullish ones start to form with a length of only 25 pips, you can be certain that there is a lack of bullish momentum. But, if you see bullish candles forming with the length of 80+ or 100+ pips after a breakout, you can be pretty sure that there is a presence of strong bullish momentum in the market.

By simply observing the price action and paying attention to the size of the Candlesticks, we can easily determine in figure 1 that the buyers are dominating the market, and sellers are having a hard time pushing prices down or create any sustainable consolidation phase.

Using a similar rationale, you can also read a Candlestick chart and find divergence without any special technical indicators. For identifying divergence, you have to look at the ratio of the length of the Candlesticks, but also how long it takes the market to create new highs, during an uptrend, or new lows, during a downtrend.

Figure 2: Identifying Divergences by Observing Price Action and Time

 

It may sound tricky at first glance, but let’s take a look at figure 2. In the first instance, we see some large bearish bars forming and breaking below the uptrend line. Subsequently, we see two bullish Candlesticks and a few neutral looking Candlesticks. But what is important here to observe is the size of the Candlesticks and how many Candlesticks it took to form the downtrend and the subsequent retracement. You see, the first series of bearish Candlesticks recorded a 180 pips movement. But, the next series of five bullish and neutral Candlesticks only recorded a move of only 88 pips, less than half. Since it took longer to register an up move and it failed to go more than the previous down move, we can easily conclude that there is a bearish divergence in the market.

Similarly, in the second instance, we can see the three bearish Candlesticks could not even penetrate below the of the previous two bullish Candlesticks, which signaled a bullish divergence.

 

Chart Phase

The concept of identifying the chart phase is pretty simple to understand. If you come to think about it, there are only three types of markets. Price is either going up or going down, and consolidating within a range. But, if we refine these three phases, we can see that there’s more to this than meets the eye.

After the initial impulse move that started an uptrend, prices can go down or retrace for a prolonged period of time. Then, once it breaks out of the consolidation range, the market can show strong bullish momentum and trend strongly. By the end of the uptrend, we see new higher highs are made but it is taking much longer time to reach a new high, which signals that the prevailing trend is entering exhaustion or end of trend phase.

Figure 3: Identifying Different Chart Phases is an Important Factor for Long-Term Success as a Trader

 

As we can see in figure 3, the EUR/ZAR broke out of a bearish contracting range then swiftly pulled back to the pivot zone, where the resistance turned into support. Once it resumed the uptrend, it entered into a mature trend, which ultimately culminated in an exhaustion phase. In the end, there was a major breakout on the downside that triggered a bearish trend.

The reason for having a sound understanding of how to identify the chart phase is it basically helps you identify what type of trader you are and how your trading system should be applied. If you have a breakout trading strategy but you are trying to trade during a range-bound market with a lack of strong momentum, you will have a hard time finding entries or may enter the market at the wrong time. Similarly, if you are a pullback trader trying to enter during an up-trending market that just broke lower after finishing the exhaustion phase at the top, you will get caught in a trap and end up losing money on the trade.

Hence, knowing what type of trader you are and which chart phase your trading system is suited for is an important factor that separates the traders who are consistently profitable from the rest.

 

Wave Analysis

The whole business of wave analysis started with the development of the Dow theory, which was later refined by Ralph Nelson Elliott with the introduction of his Elliott Wave Theory in the 1930s.

Figure 4: Example of an Elliott Wave Theory Plotted on the EUR/CAD Daily Candlestick Chart

 

In the nutshell, the Elliott Wave Theory dictates that prices move in financial markets in fractal wave patterns. He argued that trends start with five impulse waves, as seen in figure 4, then three corrective waves, A to C, on the opposite of the larger trend occur to complete a wave cycle.

Beginner traders may find it difficult to identify exactly which wave is currently happening in the market. Because a corrective move in the daily timeframe may appear to be an impulsive trend on the hourly timeframe. But with ample practice, and sticking to one timeframe at a time, you can easily figure out exactly which wave the market might be in.

 

Takeaway

The key mistake novice traders end up making is they try to trade everything and look for opportunities to enter the market all the time. Once you master the concept of macro or big picture analysis, you will start looking at price charts very differently.

While beginner traders may try to catch the first wave that breaks a trend line, once you know how to identify the second wave, you will see that entering at the start of the third wave, from 2nd to 3rd point, is often more profitable. After all, you are entering the market knowing the previous trend has already changed. Furthermore, the stop-loss would be much smaller if you put it behind the high or low of the second wave, depending on whether you are trading a downtrend or an uptrend.

Nonetheless, there are ways to trade the first impulse wave as well as at the end of the exhaustion phase, giving you a much better entry opportunity. But it is important to remember that if you have a strategy to trade the first or third impulse wave, it will likely not work if you are trying to catch a corrective move and vice-versa. Hence, having an appropriate trading system for the right wave is crucial.

In the next installment of this two-part series, we will discuss the micro concepts in trading, including how to identify the key levels in the market and exactly what signals you should look out for to time your market entries.

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How Long Does It Take to Become a Consistently Profitable Trader?

Discover how long it’ll take you to become a profitable trader and it’s not what you think.
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How do hedge fund traders get better? – Trading Podcast with Steven Goldstein and Mark Randall

In our latest interview podcast, we had the privilege of speaking to Steven Goldstein and Mark Randall from Alpha Mind.

 

Even the best traders will have moments where they go on tilt, but they get out of those slumps by breaking the negative loops in their minds. To catch it and to realize that you are in those negative cycles, is the first step of breaking out.

 

Self-compassion is something we don’t always have, but we all deserve it.

 

The ego and your confidence can go both ways. Lacking confidence leads to fear, missing opportunities, doubting decisions, cutting winning trades short. Too much of it takes you to hubris.

 

Moritz’s “biggest losing months are always after his winning months”. This is the quintessential example of how being overly confident can drive you over the edge as well.

 

So much more topics we discussed in this episode, and lessons we can all learn from. What would be your most memorable story from it? And why?

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Pullback Trading: 5 Things to Look for Before You Place a Trade

Discover pullback trading secrets that work you so you can better time your entries and improve your winning rate.
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9 Lessons from trading coach Mandi Rafsendjani – Trading Podcast

In our latest podcast (click for all episodes) we talked to Mandi Rafsendjani and we went really deep into trading psychology, the mindset and how traders can become successful.

Below the video, I compiled the 9 most insightful take-away messages that I got from talking to Mandi.

1. Fill all your buckets

The best traders lead a balanced life and do not derive their self-worth from trading alone. This will help you push through hard times when your trading results are not what you imagine them to be.

Make sure that you have a supportive social environment, look after your family, surround yourself with people that add positivity to your life. Take care of your health, do sports and fuel your body with good food. Have hobbies, try out new things and explore your interests. Feed your mind with good books, inspiring conversations or challenge your world-view to broaden your horizon.

 

2. The importance of feedback

The best traders can take feedback. The market will humble you and will give you harsh feedback on a weekly basis. Your coach will have to point out flaws and critique the way you do things.

The average losing trader will usually not be open to feedback and close themselves off.

Pay attention to how you deal with feedback and how it makes you feel when someone/something challenges your way of thinking/doing. You will learn a lot about yourself.

 

3. Understand your trading method in the market context

Most traders have no connection to their trading strategy and they just view it as a set of abstract rules that they need to follow.

The best traders understand what their trading strategy is trying to accomplish and under which circumstances it works best.

 

4. Your programming will influence your trading

Our values and beliefs shape the way we engage with the world, how we deal with setbacks, how we think and what drives us.

Our families and the inner social circle is what shaped our beliefs and values and, thus, it’s so important to look back at where we are coming from. Understanding the past, the motives, worries, goals and ideals of our parents/family will help you understand why you have been raised in that specific way. This will also help you understand yourself on a much deeper level once you understand why/how you react to specific circumstances the way you do.

 

5. Just because you read it in a book, it doesn’t mean you will be able to execute it

Reading books is important but without applying the knowledge, it’s pointless.

You can read about the importance of cutting losses and letting winners run all day long but if you do not experience it in your own trading, it won’t matter. And it won’t become a part of you.

 

6. Successful traders think strategically / solution-focused

When faced with a problem or an obstacle, do you complain or blame someone/something else? Or do you roll up your sleeves and look for solutions?

When confronted with a problem, the best traders ask themselves: how do I fix this? 

The average trader says: Why does this happen to me? 

Always look for a solution instead of trying to put the blame on someone/something else. The problem won’t just go away.

 

7. The best traders can recover quickly

The best traders are not trading without emotions and they experience all emotions. But what’s different is that they will pick themselves up quickly and (as we discussed in point 6), look for a solution right away.

Thus, don’t be too hard on yourself when you screw up – it will happen. But recognize that it’s up to you to turn things around.

Take full responsibility for everything that happens.

 

8. Know your strengths/weaknesses and leverage it

What are you good at and what are you not so good at?

Are you creative and like to test new ideas and explore how you can tweak your strategy in different ways to improve your edge?

Or are you an analytical person and work best with rigid rules, frameworks and a fixed routine?

Don’t try to blindly copy another person just because you see some level of success. Every person is unique.

 

9. The importance of the growth mindset

In our podcast with Dr. Steenbarger, he said that the number one predictor for success is curiosity.

And as Mandi rightfully pointed out, curiosity and the growth mindset go hand in hand.

Try out new things, get back into the beginner mindset and experience how you can get better at a new skill.

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Day Trading vs Swing Trading – What’s The Difference?

Day trading and swing trading are two strategies worlds apart. Know the difference, and don’t assume it’s just a matter of trading frequency and time.

Every trade or investment is based on the same precept: buy low and sell high. That’s the one thing that ties together day trading, swing trading, and long-term position trading. But aside from this one precept, each style has enough differences that a trader specializing in one might find himself completely unfamiliar with the other.

But how different can it be, really? Isn’t it just a matter of ramping up your trading frequency, going for shorter profit targets, and limiting or expanding your trading duration? Yes, it is. And by virtue of those three things, day trading is a completely different practice from swing trading.

If you’ve tried both, you probably know that day trading isn’t swing trading sped up, and swing trading isn’t day trading slowed down. If you switch domains without changing your approach, you might fail to maximize your opportunities. If you’re not familiar with the differences, then read on–that’s what we’re going to cover here.

So let’s dive in, starting with the first, and often overlooked, factor: volatility.

 

The Smaller the Scope, the Greater the Volatility

If you’re a high-frequency day trader aiming for small profit targets, say five to 10 ticks, you often have to take larger positions to make your ticks worthwhile. How large a position you should take depends on many factors, but let’s save that for another discussion.

Suppose you’re trading anywhere toward the end of the rectangle at [1]. You go long. Suddenly, at [2], the YM spikes. You were shooting for a 10-tick profit, but the spike measured at 138 ticks!

In just one bar, the average volatility jumped up from an average of 12 ticks to 138 ticks–in short, a 1,050% spike! In short time frames (in this case, the 5 minute chart), such percentage jumps in volatility are common, and you have to be ready to handle them.

 

YM August 7, 2020 – 5 Minute Chart

In daily bars, a 1,050% volatility increase is very rare. But it’s common in the smallest time frames. So, if you had a fairly sizable position, and if you were “short” instead of long, such a spike can take a big chunk from your trading account, if not wipe you out altogether.

Remember, in short time frames, volatility and noise can be much more significant than in larger time frames, for which you probably would hold smaller positions in a more “stable” volatility environment.

Let’s take a look at the same day but from a swing trader’s perspective:

 

The day we observed using the 5 minute chart is designated by the red arrow in the chart above. It was a relatively uneventful day from a swing traders perspective.

The context as shown in the daily chart appears much less noisy, allowing the swing trader to execute a “cleaner” trade. The setup is quite simple:

1. As YM continued to trend upward, you might have expected a “measured move,” calculating the top and bottom of the first swing at [1], a total of 1,770 points.
2. Let’s suppose you entered at the breakout of the swing low at [2].
3. Taking a measured move approach, you would have added 1770 points to the bottom of the swing low, setting your profit target at [3] which is at the price of 27651. Simple and easy, right?

But can’t you lose money swing trading in the same way that you can day trading? Of course. But at least you don’t have to deal with frequent swings upwards of 1,000% on a regular basis.

In fact, such volatility is rare, as you can see below. The chart illustrates the March COVID-19 crash. It was a deep plunge, but it also took several weeks to happen; it didn’t happen in a single day.

 

The Cost of Missed Trading Opportunities

One of the most obvious key differences between day trading and swing trading is trading frequency. Day traders can trade multiple times intraday, while swing traders can keep positions open for one to multiple days.

The cost of missing a trade can be substantial–either missing out on a big winning trade, thus lowering your overall returns, or missing out on a big losing trade. But since we do our best to limit our downside by placing trades with favorable reward-to-risk ratios, adequately sizing our positions, and using stop losses in addition to loss limits, we’re more worried about missing a winning trade that might have significantly raised our overall profitability, rather than a losing trade whose negative return could have been capped by virtue of a stop loss or loss limit (risk management strategy).

The more you trade on an intraday basis, the easier it is to miss a trade (think: bathroom break, phone calls, kids, meals throughout the day, etc.).

Here is a simple scenario. Imagine four trades on a given day, two are winners and two are losers. Your losses are capped at -50 points, while your profits, though uncapped, are aimed at double your loss amount, or 100 points.

What might happen if you miss one trade, given this 2-to-1 risk/reward scenario?

• Take all trades, you finish the day up +70 points.
• Miss trade 1 (a winner), you are down -30 points.
• Miss trade 2 (a winner), you are up only 20 points.
• Miss trade 3 (a loser), you end the day +120 points.
• Miss trade 4 (a loser), you walk away with +100 points.

With your losses capped in the scenario above, you can see that the most negative consequences occur when you miss the winning trades. You can’t predict which trades are going to end up winners or losers. So if you have a strong system, and if your reward-to-risk ratio is favorable, it’s best not to miss any trades at all.

Now, this is a very simplistic example, but it does a clear job explaining our main point.

What about missing a swing trade? The cost of missing a swing trade can be equally harmful. However, the chances of missing a swing trade can also be less likely. If your swing trade has a longer trade span, say a day or more, it’s harder to miss simply because you might have plenty of opportunities to enter the trade even if you missed the initial entry point (time is even more forgiving for long-term positions which last weeks to months). This may shave off points from your potential profit (or loss), but since your profit target may be days away, you might still have a chance to enter the trade relatively early on. In contrast, day trades can have a much shorter trade span, from seconds to minutes–miss your entry, and you may miss a large chunk of your profits or losses.

The main point here is that the cost of missing trades can be significant and that the likelihood of missing trades is greater for intraday trades than it is for swing trades that span multiple days.

 

Converting Demo Performance to Live Performance

Here’s a quick note on converting demo to live performance, as this is typically what beginning traders do to measure their readiness for a live market. Let’s try a simple thought experiment (though you’ve probably already done this yourself using a demo and live account).

• You make 100 demo scalp trades, all aiming for short profit targets of a few ticks, and you succeed in most of them, yielding profitable results.
• You “demo” trade (on pen and paper), 100 long-term position trades, say in the stock market, yielding profitable results at the end of the year.

Which profitable “demo” scenario is likely to have produced similar results in a “live” market? The second one, of course. Since demo trades can’t accurately simulate the supply/demand forces of a live market, the shorter your time frame for trades in a simulated environment, the less accurate your results. For instance, you may not get filled in an ultra-short term scalp; your slippage may be horrendous; and compounding trading costs can quickly erode your profits or add to your losses.

In contrast, when demo-trading a longer-term position, the forces of intraday supply/demand are less of an issue, making your simulated results more aligned with your live results.

The main point is that if you’re looking to jump from a simulated market to a live trading scenario, the longer your trade span, or the larger your profit target and stop-loss, the closer your simulated results may be to reality. Scalpers who attempt to convert demo to live often get burned right away; only then do they realize how different the live market is from a simulation.

 

A Tactical Versus Strategic Environment

The narrower your trading timeframe, the more “market noise” you have to deal with. If you’re scalping the market, chances are you’re trading a lot of noise, looking for quick “tactical” setups to exploit near-term supply and demand which may or may not have a meaningful connection to the larger fundamental forces shaping the market.

Whether it does or not, your primary concern would be tactical rather than big-picture “strategic.” For instance, take the Emini Dow Jones (YM) on August 27, 2020. Below is a 1-minute chart that presented us with two scalping opportunities before the market started trading sideways in the late morning.

Let’s annotate these hypothetical trades blow by blow. In each example, you’re trading one contract:

[1] You go long on an upside breakout from a rectangle formation.

[2] The breakout appears to be false, as you get stopped out (-58 points)

[3] Another breakout occurs, and you go long again.

[4] Following a traditional tactic, you take profit (+93 points) at 100% of your formation (as measured by the top and bottom of your rectangle).

[5] A broadening top occurs and you go long again at the breakout.

[6] You take profit (+69 points) at the distance equivalent from the top and bottom trendline.

You end the morning with a total market profit of 104 points, or $520–not bad for one day.

 

Now, how might you have approached this scenario from a swing trading perspective?

Let’s suppose you were using a 1-hour chart for swing trading, Here’s what a more strategic scenario might have looked like:

You noticed that both the S&P 500 and Nasdaq have been reaching record highs throughout the week. The YM has not, but it’s correlated with the other two indexes, driven by bullish sentiment.

The upward trend leading up to the first trade is a small technical indication, yet it sets up a clear context for the trade, for which your directional bias is upward.

[1] The Jobless Claims report is positive but muted–not quite meeting consensus but showing fewer jobs lost than last week. You buy one contract, expecting the Dow to advance.

[2] For safety, you set a stop loss below the trend line. You are waiting for the opening of Federal Reserve Chairman Jerome Powell’s speech at 9:10 am ET, which the market expects to be supportive of sustaining low-interest rates.

[3] Powell’s speech calls for sustained easing, with a goal to “overshoot” the Fed’s inflation target of 2%. This is bullish for the market as low-interest rates usually are..

[4] The US home sales report delivers a blowout; also positive news.

[5] The market responds by selling off, but over the near-term, the two reports are generally positive, so you expect markets to recover, as it subsequently does. You move your stop loss to below the most recent swing low.

[6] It’s now the next day, and the YM has been hovering above your last stop loss. The personal income report was muted but favorable. But it’s also Friday, and you’re not sure you want to hold the positive over the weekend, so you close and take profit upon failure for the price to match its day highs.

 

You end the swing trading session with a profit of 341 points of $1,705.

 

Do you see the difference not only in the length of trade and points gained (or lost) but also in approaching the markets tactically vs strategically?

 

Differences in Trading Time

Can you handle sitting in front of your computer waiting for trading opportunities day in and day out? It’s one thing to sit at your desk working on a project, say for work. It’s quite another thing staring at your trading screen paying attention to most, if not all, of the nuances in market movement.

Day trading not only requires more focus, it’s arguably much more exhausting than swing trading. Many swing traders work off the daily charts. This gives you plenty of time to analyze and execute your trades. It can also be less stressful–you set your risk and profit scenario, and you let it play out. If you swing trade the one-hour charts, then yes, it’ll take more time. But it’s still relatively less stressful than watching your screen for hours on end, every single day, hoping not to miss a trading opportunity.

Since swing traders are focused on the bigger picture, they’re less burdened by second-to-second changes in the market. They’re able to use technical and fundamental tools to identify potential opportunities in a timely yet less-rushed manner. Day traders who often and willingly engage supply and demand at a “noise” level can’t afford to miss a trading opportunity, whether it has lasting significance in shaping the market or not. It’s a “be quick or be dead” mentality. It takes lots of more time, lots of more focus, and the price of your time and energy investment ought to be worth it, otherwise, you’re taking on more risk, more frequently, for a payoff that may or may not be worth the cost. So think long and hard about this and try both before dedicating your focus to either one.

Listen to our podcast: What is the best timeframe?

 

Focus, Research, and Experience

As we said early in this article (and it should be evident by now), day trading is NOT swing trading slowed down, and vice versa. For example, just because you’re trading the same chart pattern (say, a symmetrical triangle) in either scenario doesn’t mean that the difference between the two is in scale or frequency. There are major differences in the market’s “time” environment which require a difference in approach. Let’s go deeper and look at both approaches as something of a “discipline”–one requiring its own unique level of focus, research, and experience.

Remember that successful day trading or swing trading requires time, repetition, and the experience of both success and failure. Developing an “edge” in either case requires dedication; something you can’t achieve unless you master one or the other (at least in the early stages of your trading career).

For instance, there’s a certain level of tactical flexibility and time in-flexibility that day trading requires. If you’re trading a scenario that’s noisy, you might have to switch your setups because, after all, the event you’re trading–ultra short-term supply and demand imbalances–may be occurring at the noise level. This differs in swing trading, where your trade setup may be based on a larger supply and demand scenario, or on fundamental data or expectations.

There’s an inflexibility with regard to day trading–namely, you can’t afford to leave your screen for too long, as you may miss a trade. In swing trading, you don’t necessarily have to be at your screen once your trade has been planned or executed.

Swing trading may require near-term fundamental analysis in order to get a strategic view of the context. Day traders just have to know when big events are happening (i.e. FOMC announcement, GDP report, etc.). But beyond that, day traders are masters of minutiae–and the more skillful ones can make a living trading small and sometimes insignificant market fluctuations.

In short, the difference between day trading and swing trading goes much deeper than just timeframe alone. Both are completely separate disciplines that have their own requirements and their own rules of engagement.

Ultimately, deciding between the two depends on your own personal tendencies with regard to physical and mental stamina, reflexes, risk tolerance, capital resources, and emotional inclination–in short, your personality.

 

Capital Requirements May Vary

There are varying requirements for different asset classes and markets. For instance, if you’re interested in day trading stocks, you’ll need a minimum of $25,000 to be a “pattern day trader” without being penalized. In the case of equities, swing trading may be more suitable, especially if you don’t have an extra $25k to add to your account.

This isn’t necessarily the case in the futures market, though you have other funding challenges to consider. Competitive day trading margins can allow people to day trade contracts such as the emini S&P 500 (ES) for as low as $400 per contract, but to hold a position beyond market close, as swing traders often do, you may need upwards of $12,000. Not many traders can afford that. Fortunately, the CME now offers “micro” emini contracts–a tenth of the exposure to the standard eminis–so that an equivalent contract (MES) would require only, say, $100 to day trade and $1,200 to hold “overnight.”

In addition to capital requirements, another thing to think about is whether you can afford to trade at the frequency at which you plan to trade. For instance, we know that trading costs (commissions and slippage) can eat away at your profits and add more to your losses. In light of this fact, can you afford to day trade, say, five times, ten times, or twenty times or more a day without depleting your trading account? Something to think about.

 

The Bottom Line

Day trading and swing trading are two separate disciplines whose differences are to be found not only in their respective markets and time frames but also outside of the trading window (stamina, research, capital requirements, and everything else we discussed above).

Before you decide on one and the other, be sure to give it plenty of thought, and perhaps try your hand at both in a live market (simulations don’t really count at this stage of the game). Ultimately, it boils down to your personality and which style resonates with you the most. Be honest with yourself and capitalize on your strengths first before buffering up your weakness. In time, you’ll find what’s more natural to you, and once you do, that’ll be the start of your path toward successful trading.

In our Masterclass, you get immediate access to both – one swing trading and one day trading strategy. We provide the exact rules and the framework and you can test which one fits your personality and thinking.

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