11.Traders Virtual Mag OTA July 2011 Web

Interview: Thomas Kahdemann – Elliott Wave Is No Hocus-Pocus

July 2011

»»

Finding Your Feet in Forex The Biggest Market – the Biggest Chances

»»

The Future of System Development Rank and Filter to Adjust Position Size

Be a

Free-lance Hedge Fund Manager

»»

Effective Swing Trading Buying the Dips and Selling the Rallies

»»

Trading Templates Generic Solutions to Trading Problems

TRADERS´ EDITORIAL

2

On a different note: TRADERS´ comes to you free of charge. This is possible because of the support of our sponsors and advertisers. So please take a good look at their messages and help them develop their business. Moreover, we are looking forward to your feedback. This is the only way for us to constantly improve our magazine. Please write to: feedback@ tradersonline-mag.com.

To Trade or Not to Trade There is at least one thing about the stock market you can always rely on: twenty-twenty hindsight. With hindsight it is always easy to draw the best trading ideas on your chart and calculate your profits. But what really counts are the decisions we make in real time. Unfortunately, there is a catch, i.e. we are not half as smart in advance as we would like to appear in retrospect. Looking back, the past basically seems to be much clearer to us than events were at the time they happened. So we tend to distort our earlier predictions in the direction of the later outcome of events. Scientists call this phenomenon hindsight bias. Examples of this are legion in the stock market. When looking at charts, we are ultimately subject to this skewed perception all the time. It is all very well for people to say today that the disaster in Japan was a first-class entr y opportunity, but at the time the Fukushima gap was causing stocks to crash, none of us surely were tak ing things so lightly. A t such points in time, there is a great deal of 07/2011

www.tradersonline-mag.com

uncertainty that makes it difficult for us to actually carry out a trade that is “logical” in hindsight. You can only understand the markets in hindsight but you need to do your trading going forward. That is why the psychological aspect is far more important than it seems to be when looking at the chart in retrospect. Using a model, we can easily understand and calculate risks such as there are when throwing a dice with the numbers one to six. However, it is much more difficult to cope with uncertainty since the model itself may change here: If the dice suddenly has the numbers 2, 2, 3, 4, 5 and 7 (!), that is going to have a major impact on the results. After a while, we can understand such structural breaks in the stock market, but by then the “dice” of the market may have been cast again – or maybe not, we just do not know. So uncertainty is our constant companion. The good news is that such uncertainty only makes it possible for major profits to be made. At the same time, we sometimes find it hard to press the buttons and make the trade: We

keep waiting for the ultimate confirmation that the trade is “correct”. However, this absolute certainty will always elude us unless we look at the situation in hindsig ht – but by then the opportunity has already passed. What can we do then? We need to accept uncertainty and treat it as an “ally”, trading consciously once our setup has been met. At the same time, our risk management must always be of a conservative nature in order to ensure longterm survival in an uncertain stock-market universe. If you combine the two, only one question really remains in the end: “To trade or not to trade”.

Good Trading

Lothar Albert

TRADERS´ CONTENT

3

07/2011 July

COVERSTORY Be a Free-lance Hedge Fund Manager In our current cover story, we show how you as a private trader can take hedge funds as an example to improve your own results. Why should you do this? Quite simply: Who could be a more shining example than the best in their trade?

23

INSIGHTS

INSIGHTS FLOOR-istic

Momentum Trading An Intraday Style of Trading Rank and Filter to Adjust Position Size The Future of System Development – Part 2

COVERSTORY Be a Free-lance Hedge Fund Manager

FLOOR-istic Interview with Ben Lichtenstein

41

TOOLS

STRATEGIES Trading Templates New Products Softwarereview Webreview

STRATEGIES Option to Buy Pullbacks More Effectively Using Short-term Collar Adjustments f or Intermediate Bullish Profits Buying the Dips and Selling the Rallies Effective Swing Trading Trading Templates Generic Solutions to Trading Problems The Inverse Correlation Trade EUR vs. USD

BASICS Finding Your Feet in Forex An Introduction to Currency Trading Industrial Advantages Why It Pays to Understand the Unique Attractions of the Stockmarket Sectors Building and Applying Your Trade Plan Trigger, Order Management, Filter

PEOPLE Thomas Kahdemann Elliott Wave Is No Hocus-Pocus

59

PEOPLE Thomas Kahdemann

07/2011 www.tradersonline-mag.com

18

INSIGHTS System Development – Part 2

50

BASICS Industrial Advantages

TRADERS´ INFO

4

Address

TRADERS´ media GmbH Barbarastrasse 31, D-97074 Wuerzburg +49 (0) 9 31 4 52 26-0 +49 (0) 9 31 4 52 26-13 [email protected]

Phone Fax E-mail

TRADERS’ media GmbH is a financial markets publisher specialising in education and continuing education in the field of trading and securities markets. TRADERS’ media was founded in April 2004. It publishes the trading magazine TRADERS´ in the German (print), English (digital), Russian (digital), and Arabic (digital) languages every month. TRADERS´ magazine was founded in 2001 by market mavericks Lothar Albert and Allison Ellis. Lothar Albert is CEO of TR ADERS´ media GmbH a nd chief editor of T RADERS´ magazine. Fu rther TRADER S´ editions will follow focusing on Asia (Singapore), India and Russia and coming soon in the very near future, an edition for Latin America in Spanish. TRADERS´ was awarded the title of World’s Best Magazine for Traders by Trade2Win, an international community of traders for four years in a row, from 2004 through 2007. TRADERS´ is unique because we do not give any advice or recommendations on what to trade. This makes our content very different from any other market magazines. We are not interested in giving people certain buy and sell recommendations, but rather in teaching the basics of trading from the beginner to the professional level. Our magazine has established itself as a source for information and communication for elite traders in Germany, Europe and around the world. Current information about technical, mathematical and psychological aspects of the markets is discussed in professional articles and interviews. Each issue contains articles about trading strategies (for basic, intermediate, and advanced traders), risk management, technology for traders, business issues for traders, book and website reviews, and much more! Still today, the trader-elite are interested in professional and current trading knowledge and experience. Dedicated traders have no need for buy and sell recommendations. Trading pros make their decisions with self-confidence and are self-sufficient. These people know that trading can be profitable in both bull and bear markets. The question is: what are the markets,tools and strategies that lead to success? TRADERS´ magazine addresses this question every month in multiple languages.

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www.traders-mag.com; www.tradersonline-mag.com [email protected] Tel: +49 (0) 931 45226-15

Address of Editorial and Advertising Department

Barbarastrasse 31, 97074 Wuerzburg

Editor-in-Chief

Lothar Albert

Editors

Prof. Dr. Guenther Dahlmann-Resing, Johann Gorol, Marko Graenitz, Theresa Hussenoeder, Sandra Kahle, Nadine von Malek, Rodman Moore, Stefan Rauch, Tina Wagemann, Sarina Wiederer

Articles

Tillie Allison, Mustapha Azeez, Jessica Furseth, Gavin Knoesen, Tony Loton, Thomas Stridsman, William Thompson, Brandon Tristan, Chris Tyler, Dan Valcu, Peter Webb

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TRADERS´ COVERSTORY

6

How to Trade in a Professional Way

Be a Free-lance Hedge Fund Manager In TRADERS´ May 2011 we ran a cover story which dealt with the topic of reality and myth of hedge funds. These professional traders employ the smartest people in the financial industry aiming jointly at hammering out sophisticated trading strategies with well thought-out risk management. Basically hedge funds are the usual suspects when it comes to cashing in high risk-adjusted profits. Building on the findings of the first hedge fund cover story we want to show how you, as a private trader can take these pros as an example to improve your own results. Why should you do this? Quite simply: Who could be a more shining example than the best in their trade? 05/2011



7

As some ti me has ela psed since our first cover story about hedge funds, let us start by recalling the gist of it. A hallmark of alternative investments like hedge funds is the fact that profits accumulate mainly independently of other markets such as stocks or bonds. In other words: When you are building up a long-term portfolio which is supposed to develop in a stable manner, a few hedge funds are added along with stocks, bonds and real estate. Thus the risk is spread more broadly and overall performance is more solid. Hedge funds are of interest both as an individual investment (for institutional investors) and as a structured product, or fund of funds (for private investors) because many substrategies have very attractive

is open to private traders– but margin. For clarification,Figure 1 shows the risk/return analysis of this does not mean they cannot take clues from them. Quite several markets and hedge fund strategies, which were published in the opposite: Traders should absolutely take advantage of the last hedge funds cover story. every available edge and who better a role model to have than The Best in Their Trade the best in the trade? It is worth acknowledging that hedge funds act in an absolutely professional way Our Strategy Example which dwarfs small private With so many fund strategies traders. As a rule, the success out there, in this article we want to concentrate on a concrete of these professionals is based on decades-long experience in strategy which is relatively easy to understand: Equity long/short. international financial markets. Often, the founders and CEOs In other words, we are betting on a portfolio of shares equally of hedge funds worked with big banks or funds where they divided between short and gained the necessary experience. long positions. The purchase of stocks for the long positions is Good connections with potential investors and long-standing essentially financed by means made available by selling short. client trading relationships were established and these managers The means freed up by selling

risk/return profilescategories that surpass other investment for example, stocks, by a wide

found it a alucrative prospect to establish hedge fund of their own. This is not really a path that

Sharpe Ratio The basic idea of the Sharpe Ratio is a comparison between return and risk. As an example for it we use our long/short example strategy with an annual return of twelve per cent and an annual standard deviation of the returns (= risk) of nine per cent. First, the excess return is determined by subtracting the risk-free interest rate from the return. Suppose, the risk-free interest rate amounts to one per cent then we arrive at an excess return of eleven per cent. This figure is subsequently divided by the risk (nine per cent) which makes a Sharpe Ratio of around 1.22. Sharpe Ratio = Return - risk-free interest rate = 12 - 1 divided by Standard deviation 9 = 1.22


short will essentially finance the purchase of stocks for the long positions. The actual capital required is therefore small – the systematical risk inherent in the stock market equals zero or next to zero. The aim of the strategy is an adequate positive absolute annual return in the high singledigit or low double-digit zone – we are talking about returns of between eight and 15 per cent. At the same time the volati lity of the capital curve needs to be low. In practice the annual standard deviation of the returns (i.e. the risk) should hover between five and ten per cent, that is to say

F1) Risk/Return Analysis

Since 1994 the highest returns have been generated with Global Macro Strategies followed by Event Driven and Equity Long/Short. These strategies boast a higher return compared with the S&P 500 and simultaneously (!) lower return volatility. The latter is called annualised volatility and corresponds with the risk of the respective investment form. In addition to the three strategies mentioned there are many further hedge fund styles which have well beaten a classic stock investment in terms of risk/return ratio. Exceptions are the pure short strategies (Dedicated Short) which, however, improve the performance of a portfolio as an add-on in weak stock market periods. Source: Dow Jones Credit Suisse H1 2010 Hedge Fund Industry Review, July 2010


below the corresponding annual return. This ratio between return and risk constitutes an important measure in institutional trading, known as the Sharpe Ratio (see info box). Running yield is used as the benchmark for our strategy – with the proper choice being a matter of taste. Hedge Fund Manager = Risk Manager As can be s een in this strategy example, most strategies are conservatively oriented. Basically, successful hedge funds operate as risk-aversely as possible. Private traders should take a page out of the professional traders‘ book in this regard. Despite a predominantly lowrisk attitude, the media and politicians have jointly succeeded in denouncing funds as an especiallyhedge risky form of investment and as the bain of all our economic ills. You might wonder why our equity long/short strategy is aiming at a relatively low annual return of 15 per cent at most. On the one hand this is due to the fact that major investors do not like to lose a lot of money. As hedge fun ds often have onl y a few major individual investors, capital preservation is the prime target. And it would behoove you to behave likewise. However, astronomical returns are rendered impossible and, you will not be 07/2011 www.tradersonline-mag.com

8 able to get on the gravy train. On the other hand, the fund bets on a market-neutral strategy and will therefore lose money on one side in many market periods and only cash in on the relative difference in performance of the long and short positions – unless the very stocks on the short strategy are falling on average while those stocks on the long strategy are rising on average. Indispensable: The Statistical Advantage Let us now deal with the approach professional traders use to hammer out their strategies. Perhaps you have wondered how an equity long/ short fund can earn money over a long period. After all, there is a balance between long and short positions which should, a longer period result in anover average profit of zero minus transaction costs. Or maybe not? To assume this would clearly be a mistake. Traditional efficient market theory has long been superseded. Today we assume that price formation in markets can be distorted by both rational and irrational behaviour. Without going too far into this theory, it is obvious that such patterns can be identified and exploited. However, this makes it necessary for you to statistically evaluate your trading ideas and to test them for relevance. It is exactly

here, however, where the pundits have a falling-out. Private traders tend to pay insufficient attention to this crucial point or they even skip it altogether – arguing ‘It will work all right or ‘I want to trade discretionarily anyway and do not need any testing‘. Without a clear statistical advantage, however, you will be hardpressed to be consistently successful – whether or not you trade discretionarily. You do not need to guess much to get an idea of which traders have been conducting thorough tests for a long time and have been constantly improving them: It is the hedge funds that strive to gain a statistical advantage and make money using it. As a private trader, without comprehensive testing you place yourself in a situation where the odds are unfavourable over the long haul. So stop gambling and start testing. Ranking Strategy A popular way to test a strate gy for significance is ranking-tables. Here, all stocks included in the strategy are ranked by number according to the criteria chosen. Suppose you analyse a universe of 100 stocks. Then the stock which fulfils the purchasing criteria best is ranked No. 1 and the stock which fulfils your short selling criteria best is ranked

No. 100. Depending on the size of your trading capital and how much time you want to spend on your analyses you may now: a) automatically buy a certain number of the best and/or short sell a certain number of the worst stocks or

b) trade according to discretionary criteria. Let us take a closer look at the top and bottom ten per cent of our ranking order from the universe of 100 stocks. The stocks on ranks Nos. 1 through 10 are buys and the stocks on

T1) Performance Ranking Rank 1

ID 878372

N ame ELECTRONIC A RTS

2

121092

DELL

3

882807

VERTEXPHARMA

46.67

19.63%

53,575,119

4

886391

WHOLE F OODS

58.56

16.10%

49,220,444

17.37

15.19%

354,456,752

NEWSCORP.

Pr i ce 18.8

Ch a n ge 25.33%

15.83

20.38%

V ol u m e 187,375,835 502,953,481

5

A0DLJU

6

779633

JOYGLOBAL

7

901626

QIAGEN

8

A0F5DE

9

888903

URBANOUTFITTER

10

157484

COMCAST

25.76

12.78%

319,203,129

91

875272

EXPEDITORS

47.8

-5.57%

32,105,832

BAIDU

97.38 20.63 121.16 38.38

14.09% 13.79% 13.72% 13.48%

54,707,503 34,433,168 151,180,828 44,770,945

92

889328

MILLICOM

87.6

-6.96%

11,658,952

93

913684

BROADCOM

41.22

-6.99%

247,265,479

94

867900

AMGEN

51.33

-7.16%

95

A1C08F

SEAGATE

96

861114

PACCAR

97

883035

98

878841

99

A0F41M

100

928906

TEVA P HARMA CISCOSYSTEMS EXPEDIA AKAMAI

12.7 50.13 50.1

-7.98% -8.56% -8.58%

128,904,679 183,020,153 65,224,863 168,006,840

18.56

-11.32%

2,064,458,955

19.86

-20.50%

164,239,665

37.53

-21.40%

168,891,619

The performance ranking is very easy to conduct. Simply arrange all stocks of your analysis universe (in this case NASDAQ-1 00) in descending order according to your 1-month-performance (done here on 28th February, 2011). The strongest ten per cent of the stocks (ranks 1 to 10) are possible buys and the weakest ten per cent (ranks 91 to 100) are possible short sales. Such criteria can be simulated for past periods with the help of appropriate (statistics) software. As an alternative you may adjust the strategy to your own requirements by, for instance, discretionarily selecting the best three long and short positions with the highest risk/return ratio or by including different criteria such as volume or technical/c hart technical aspects.


9

ranks Nos. 91 through 100 are short sales. We are no longer interested in the remaining stocks. Discretionary traders can markedly improve their results with the help of such methods because no boring, mediocre stocks are being analysed whose prices randomly go to and fro. Using the ranking, we zero in on stocks which best meet the criteria you have chosen at the moment – and where the best prospects should arise accordingly. The mediocre rest can simply be ignored. Table 1 shows what a simple ranking based on performance for one month might look like for a private trader. Basically, there are different ranking criteria which can be selected as an alternative to past performance. Here, only

to a unfavourable risk/return ratio. Discretionary traders could wait for a temporary recovery to short sell the stock. The disbursement profile for this strategy results from the difference of the average weighted price rise of all long positions plus the average weighted drop of all short positions.

the strongest and the weakestare stocks from the NASDAQ-100 being looked at on a 1-monthbasis (as of the end of February 2011). For example, the strongest stock on a monthly basis, Electronic Arts, is represented in Figure 2. As a pro-cyclical momentum trader, a good entry into a strong upward movement within a pullback could be had here. Our second example, Akamai Technologies (Figure 3) shows the weakest stock in the ranking. Admittedly, the set-up is not exactly at an optimum right now. Due to the recent slump, a short sale right away would lead

2) programming expertise.


Implementation of the Tests If the ranking idea sounds plausible, the next question is how to test the ranking method in the best possible way. In other words: How to back-test the whole thing with a historical dataset? Here, two things are vital, and not surprisingly, professional traders like hedge funds have the best access to them: 1) comprehensive historical data At first gl ance, the comprehensive back-testing of a ranking strategy retracing many years hardly seems viable for a private trader. On the one hand, reliable historical data is hard and expensive to come by. Then, suitable software is needed which is also not cheap and requires a not insignificant investment of time to learn how to use it. At this juncture, it becomes clear how high the bar is set in trading. Anyone can open a brokerage account and start gambling but professional trading on the basis

of statistical evaluation requires skill and money. The “Light” Trading Alternative The has been a lot of development in open source programmes which may be of help in testing. This might save some money but not all costs can be avoided. Not many traders have sufficiently learned the neccessary statics and programming skills or have been familised with them in their vocatonal training or college courses. A few basic ideas concer ning your ranking method can be run on Microsoft Excel for instance. A free open source alter native to Microsoft products is Open Office programmes. Tests can be performed much more comprehensively a more customisable wayand withinVisual Basic for Applications (VBA) in Excel – depending on the scope of your analyses. Special statistics programmes like GNU R (open source software, therefore highly recommended), S-Plus or MATLAB are suitable for professional testing. Learning the respective programming language, however, is required. Hedge funds hire special staff to do this but as a private trader you will have to shoulder this yourself. Besides software you need data, which, nowadays, is in part, freely available on a daily basis,

F2) Electronic Arts

The strongest stock of our ranking on a monthly basis, Electronic Arts, is depicted. As a pro-cyclical momentum trader a good entry into the strong upward movement within a pullback could be had here. Source: www.tradesignalonline.com

F3) Akamai Technologies

The chart of the weakest stock of our ranking, Akamai Technologies. Because of the recent slump an immediate short sale would lead to an unfavourable risk/return ratio. Discretionary traders could wait for a temporary recovery, then shorting the stock. Source: www.tradesignalonline.com


for instance on the web pages of Google Finance and Yahoo! Some software providers even co-operate with data providers and make available part or even all daily data on a free basis. A recent example was Ninja Trader providing daily data of KineTick on its platform. As you can see, searching for free data may be an alternative to paying through the nose for overpriced data. As a rule, check all data carefully for mistakes to avoid grossly distorted results. Your Own Approach If backtesting – be it in the classic way or with the ranking method described here – brings forth a promising approach, you may adjust it according to your own risk evaluation. For instance, you may adjust the here long/short strategy put forth according to the current market phase. You may halve the short positions in comparison to the long positions (in an upward

10 trend) or even outstrip the long positions (in a downward trend). It is worth noting that in practice not every stock can be shorted, which means that part of the short positions hav e to be realised by short-ETFs or the like. Alternatively, you may couple the long/short strategy with a long-term buy and hold index investment thus obtaining additional profits with respect to the index movement as well as cushioning temporary lulls. The variations are many and success ultimately is based on comprehensive testing because without significant statistical evidence that your approach has worked reliably in the past, you are just fumbling in the dark. Take the pros as an example: without a sound and extensively tested

with countless professionals in the financial markets? After all, statistics show that only a singledigit percentage of all trading newbies become consistently profitable and hold their own in the market. But you do have advantages over the pros. They are the minimum trading volume as well as a ma ximum of independence. Institutional investors do not make money out of their performance directly but indirectly from fees. They manage large amounts of money but this money belongs to their investors. As a rule (a nd the exception proves the rule), little or no proprietary capital is managed. Therefore the rules to be heeded and the restrictions are often considerable. The really large funds especially cannot

strategy would never show up at thethey starting line!

decide to dumpnotice their in trading at a moment‘s order plan to manage a position discretionarily if the business plan does not provide for it. The managers are normally salaried and have to play by the rules – which is often an advantage and helps to avoid mistakes, especially in turbulent times. What is more: Large investment firms in particular manage so much money that trades can be opened or closed only step by step (over several hours or days). As a private tr ader you are “free”. The main drawback for you is the possibility of botching up

What Is Your Edge? Life as a trader is hard. Why on earth should you ever compete

Sortino Ratio While the Sharpe Ratio was long considered the measure of all things, today more sophisticated indices like the Sortino Ratio are applied. It is calculated in the numerator like the Sharpe Ratio but in the denominator instead of the “normal” standard deviation of the returns only the downward movements are taken into account. This is conceptually more sensible because upward returns are considered beneficially thus representing no risk in the strictest sense. The Sortino Ratio, especially with hedge funds, has been broadly adopted because the aim is to generate positive absolute returns.


F4) Electronic Arts as of 30 May 2011

Here you can see how Electronic Arts performed since 28 Feb. Source: www.tradesignalonline.com

F5) Akamai Technologies as of 30 May 2011

Here you can see how Akamai Technologies performed since 28 Feb. Source: www.tradesignalonline.com


everything. So you have to first think of your risk management and subordinate everything else! You trade with your own capital, as a rule leveraged by futures, options, contracts for difference (CFDs), Spread Betting, leveraged structured products or warrants. You are your own boss. You are not subject to regulations or transparency requirements towards your investors. Of course, you have to adhere to the rules of your business and trading plans but these are your own rules. You have the freedom to change your mind if there is a discretionary component in your trading. You are small and nimble

07/2011www.tradersonline-mag.com

11 and are almost always able to get in and out immediately. Consequently, you may profit from the patterns of the big players in the market who clear their orders over longer periods of time thus driving the market in either direction (Market Impact) and boosting trends. Not least, you have the freedom to trade on all available markets and to combine them. Always pick only the best set-ups. Unlike the flagships of the industry you are not restricted to the biggest and most liquid world markets but are able to trade minor stocks whose price formation tends to go off more inefficiently and

which may provide appropriate opportunities. An Incont rovertib le Truth

If you have decided to implement your market strategy after testing and confirming it, you should, after vitally important risk management, keep one thing in mind: it is a fact that the active managed dollar/pound comes off worse in terms of cost than does the passively managed one. You can easily deduce that even in the most outstanding market environment it will not be easy to attain an excess return over the long haul. There are traders and hedge fund managers, of

course, who pull off a return far above average over many years. But you have to be aware that there automatically have to be people who permanently perform below average or who leave the market altogether. So tackle your trading as professionally and as cautiously as possible. Look at risk first and use your freedom as a private trader to your advantage. Conclusion

Take your cues from the best of the industry. Forget about threedigit returns and concentrate on risk management. Watch the pros – be they hedge funds, insurance

companies, banks or the like: They manage risk! Returns are a spin-off of this process – provided your underlying strategy works which means you have tested it extensively and judged it sound. This path is not exactly the most simple one – but if you are honest to yourself then you know that the professional approach is the only promising one over the long haul. Aspire to “become your own hedge fund manager”.

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TRADERS´ NEWS

13

Commission-free Trading of ETFs

RTS to Acquire First Futures Software in India

Interactive Brokers is now offering commission-free trading of the first five exchange traded funds launched by Factor Advisors to clients using its award-winning Trader Workstation platform. Commission-free trading currently applies to the first five FactorShares 2x products: S&P500 Bull/TBond Bear, TBond Bull/S&P500 Bear, S&P500 Bull/USD Bear, Oil Bull/S&P500 Bear, and Gold Bull/S&P500 Bear. Interactive Brokers has agreed to waive the flat-rate and cost-plus brokerage commissions for transactions in FactorShares ETFs and will not impose short-term trading fees. Source: http://www.interactivebrokers.com/factorshares

RTS Realtime Systems Group (RTS) announced that it has signed a letter of intent and entered into exclusive negotiations to acquire First Futures Software Engineering (FFS), a high-end technology solutions provider in Pune, India. The transaction marks RTS’ first acquisition of another company since its founding in 1992. The move follows the RTS announcement in April of plans to open the firm’s first office in India to service a growing client base in the country. The acquisition enables RTS to gain a highly skilled and experienced development team in India and a complementary, state-of-the-art global product suite, while substantially increasing the distribution

potential of FFS products and services globally. RTS offers Indian trading and brokerage firms the ability to connect to India’s major exchanges, including the Multi Commodity Exchange of India Ltd. (MCX), the National Commodity & Derivatives Exchange Limited (NCDEX), the National Stock Exchange of India Limited (NSE), the Bombay Stock Exchange Ltd. (BSE) and the recently launched United Stock Exchange of India Ltd. (USE). The firm’s algorithmic trading solutions, RTD Tango and RTD Tango Trader, help market participants trade in multiple asset classes as well as capture trading opportunities and manage their risk. Source: www.rtsgroup.net

SEC too Bogged down to Act on “Flash” and Other Options Proposals The Securities and Exchange Commission (SEC) is unlikely to take action anytime soon on two of the most important outstanding rule proposals effecting the options industry. According to Heather Seidel, an associate director in the SEC‘s Division of Trading and Markets, the regulator is scrutinising proposals that would ban so-called „flash“ orders and cap exchange fees. However, the agency is not even close to ruling on them, she said. The official, who spoke at this year‘s Options Industry Conference, cited the regulator‘s workload as the reason for the holdup. “The Commission and the staff have a lot on our plates now and in the foreseeable future”, Seidel said. “I do not know that there will be any action on those proposals in the near future.” Both the SEC and the Commodity Futures Trading Commission (CTFC) are struggling under the weight of converting the historic Dodd-Frank legislation into rulemaking. Flash orders are unexecuted orders that exchanges „flash“ to anonymous traders in hopes of a fill before routing them on to competitor exchanges. The SEC first proposed a ban on the practice in September 2009. In July 2010, still undecided, the regulator asked the public for more input, especially regarding the effect of a ban on the options industry. The comment period ended in August 2010, but the SEC never ruled. While the practice has largely faded away in the stock market, flashing still occurs at options exchanges. Inextricably linked to the flash order debate is another SEC rule proposal that would cap exchange access fees in the options market. In April 2010, the SEC proposed capping the fees exchanges charge to trade in their markets at 30 cents per contract. Such a cap could make a ban on flash orders more acceptable to some brokers. Currently, flashing saves them money over routing if the destination is a more expensive exchange. A fee cap could reduce any such routing expenses. Source: www.tradersmagazine.com, by Peter Chapman

07/2011


TRADERS´ NEWS

14 Crude Oil Sets Record as Volume Rises at CME As cru de oil prices hurdl ed above $100, the Chicago Mercantile Exchange (CME) announced its benchmark NYMEX crude oil futures (CL) set a new open interest record in March. Total open interest (the number of open trade positions) hit 1,605,830 contracts on Friday, March 11, the third consecutive day above the previous record of 1,579,109 contracts from July 16, 2007. The CME also announced the exchange’s average daily trading volume for February volume was 14.7 million contracts, up 17 per cent from February 2010, and up 19 per cent from January 2011. T otal February volume was 279 million contracts. Source: www.activetradermag.com

CQG Associates with Tokyo Commodity Exchange CQG has connected to the Tokyo Commodity Exchange (Tocom), the largest of Japan’s commodity futures exchanges. CQG’s high-speed connectivity follows their hosted direct market access to the Ose. Tocom is part of its efforts to provide traders with broad coverage of Japanese exchanges. CQG’s connections gives customers the ability to execute strategies on a range of Japanese markets. Source: www.cqg.com

HKEx Considers After-hours Futures Trading

Efficiency Grows for OTC Derivatives

Hong Kong Exchanges and Clearing Limited (HKEx) published a consultation paper to seek views on its proposal to introduce afterhours futures trading (AHFT) to strengthen Hong Kong’s derivatives market. HKEx is proposing trading of three futures contracts, Hang Seng Index (HSI) futures, H-shares Index (HHI) futures and gold futures, from 30 minutes after the current market close (from 4:45 pm for the index futures and 5:30 pm for the gold futures) until 11:15 pm (the proposal’s main points are in the appendix). In addition to aligning HKEx’s futures market with other leading markets, AHFT would allow investors in HKEx’s HSI, HHI and gold futures to trade during most of Europe’s business day and part of the business day in the US. It would also provide additional business opportunities for FEPs and position Hong Kong’s derivatives market for future growth. Source: www.hkex.com.hk

The International Swaps and Derivatives Association, Inc. (ISDA) announced the publication of its 2011 Operations Benchmarking Survey. This publication includes results from G14 respondents as of year-end 2010, and follows the release of survey highlights at ISDA‘s 26th Annual General meeting in April. The survey reflects the increased automation in the OTC derivatives market over the past several years. 100 per cent of eligible credit default swaps and 83 per cent of eligible interest rate derivatives are now confirmed electronically. The ISDA Operations Benchmarking Survey identifies and tracks operations processing trends in privately-negotiated OTC derivatives. The results provide individual firms with a benchmark against which to measure the promptness and accuracy of their trade data capture, confirmation, and settlement procedures, as well as the level of automation of their operational processes. ISDA first conducted the Survey in 2000 and has done so annually since then. Source: ww w.isda.org

07/2011


An Intraday Style of Trading

Momentum Trading Momentum Trading is a popular style of Intraday Trading. The study of momentum is an analysis of price changes and the faster prices change, the faster traders make money. Taking advantage of momentum when trading increases the probability that the trader is trading in the direction of the primary trend with the momentum and reduces the risk associated with countertrend trading. Momentum trading is also called trend trading. Among chart technicians and analysts, momentum is studied to determine the rate of ascent or descent of price change. In terms of Newton’s Second Law, momentum can be described as, “prices tend to remain in motion.” Strong momentum indicates that the trend will continue and weak momentum indicates that the trend will not continue. Anticipating a change in momentum will prepare a trader for changes before they occur and the trader can plan to trade in the direction of the momentum in advance.

TRADERS´ INSIGHTS

16 Momentum Indicates the Rate of Change of Price There are a variety of momentum indicators designed to measure the strength of momentum. As the range of price increases, momentum is increasing and as the range of prices decreases, momentum is decreasing. Imagine a car speeding up as it approaches a green light (increasing momentum ) and a car slowing down as it approaches a red light (decreasing momentum). Intraday traders need a tool to identify when momentum is likely to change like a driver anticipates the intersection before actually arriving at the intersection to avoid slamming on the brakes. Identifying

Anticipating Mo mentum Anticipating a downtrend before it actually happens, prepares the intraday trader and enables the

Momentum on aisChart Depth Perception the eye’s ability to perceive surroundings in three dimensions and to judge distanc e. This bec omes increasingly difficult as prices change quickly intraday. The decision making process also becomes increasingly difficult as prices change frequently on charts with streaming data. In addition, news creates additional volatility and emotional reactions. As the news a nnouncement of the Libya oil crisis surfaced following the US public holiday, Presidents Day on February 21, 2011, traders prepared for the

intraday trader to better the momentum. The trendmanage line break on February 22, 2011 (see Figure 1) warned traders that the uptrend was weakening just as the media reported the two year anniversary of the bull market. Active traders were on gua rd because overbought markets react violently to bad news and the Libya Crisis occurred as the stock market returns recorded gains. As the uptrend weakens and breaks below the trendline, traders start planning to sell short at supply levels in anticipation of more momentum selling pressure

Tillie Allison As an instructor for Online Trading Academy, Tillie began teaching following the financial disruption of 2007. Her goal is to educate students on the realities of the markets and to teach students how to develop a skill set to successfully trade the markets. She is a member of The Market Technicians Association, The Certified Financial Planning Board of Standards, has an Associates Degree in the Applied Science of Real Estate, and a Bachelors Degree in Business Administration.


momentum associated with the news as a negative catalyst. In Figure 1, the NASDAQ Futures declined more than 3% off the highs of 2400 on the 60 minute chart. This 3% change indicates selling pressure and gives the short-term intraday trader information to plan to sell at supply levels, planning to trade in the direction of the momentum (strong downtrend). The traders’ ability to properly identify the momentum change on the chart enables the trader to plan to sell short and to plan the trade in advance.

F1) Momentum Trend Line Breakdown

Figure 1 shows a momentum trend line breakdown out of the supply zone in the NASDAQ Futures on February 22, 2011. Source: www.tradestation.com

TRADERS´ INSIGHTS

17

as price moves to the downside. In addition to the trend line break, intraday traders utilise a variety of other indicators to prepare for momentum. Increasing selling pressure is confirmed in the volume indicator displayed in the studies window below the price chart in Figure 1. The increase in volume confirms the strength of the downtrend.

downtrend, the trader can post a pending sell limit order in the supply zone. The protective stop loss is placed above the supply zone and the profit target is in the

Planning the Trade

Just like planning to apply the brakes before entering the intersection before a red light, the intraday trader plans to sell short at supply zones before the market actually trades into the supply zone. After identifying a supply

demand zone (see Figure 2). For this particular trade, the entry was 2371, the stop loss was 2391 and the profit target 2291. Risk tolerance will determine if the trade meets the risk to reward ratio criteria. Risking 20 points to earn 80 points is a 4:1 risk to

zonethe (see Figure 1) on February 22, active intraday trader may target intraday highs to sell short. On March 03, 2011 the NASDAQ Futures were making intraday highs near 2371 near the supply zone (see Figure 2). In anticipation of the continuation of the

reward ratio and the was identified intraday ontrade a 60 minute chart of the NASDAQ Futures (symbol NQH11). The tr ade was executed intraday and was held overnight as a momentum trade. Momentum trades may trend for a few days and intraday traders

anticipate trading in the direction of the momentum as the market trades between the supply and demand zone on the 60 minute chart. Many intraday traders close all trades before the session ends and trade in the direction of the momentum when the market reopens. The market tends to gap in the direction of momentum and trading a 24 hour market reduces the risks associated with overnight gaps.

If you like driving fast cars, then you will like momentum trading.

T1) Trades List Entered

Filled/ Cancelled

03/13/11 07:18:01 PM 03/03/11 03:59:51 PM

03/13/11 07:Ö47:28 PM 03/03/11 03:59:51 PM

Sy m b ol

Ty p e

Limit

Filled Price

Order Status

NQH11

Buy

Market

2291.58

Filled

NQH11

Sell

2371.75

2371.75

Filled


Managing Risks

With proper planning, momentum trading cannot only be profitable but very rewarding for those traders that enjoy planning.

F2) Short Trade in NASDAQ Futures

Momentum traders trading as being likedescribe driving fast cars. If you like driving fast cars, then you will probably like momentum trading. Safe drivers always wear a seat belt and check for danger before entering an intersection. Successful traders use a stop loss and confirm that they are buying in demand zones and selling in supply zones before taking the trade. So buckle up and get ready to momentum trade! We enter a short position in the supply zone on March 03, 2011. The stop is above the supply zone, the profit target is in the demand zone. Source: www.tradestation.com

The Future of System Development – Part 2

Rank and Filter to Adjust Position Size The higher the likelihood for a trade to go your way the more contracts you would like to buy. By ranking and filtering all trade signals for a portfolio on any given trading day you can achieve this. For this to work your system needs to keep track of all markets simultaneously. For a broad futures-markets portfolio measuring and ranking the most recent trends strength is one way to do it.

TRADERS´ INSIGHTS

Thomas Stridsman Mr Thomas Stridsman is a partner of Alfakraft Fonder, where he manages two funds (Alfa Commodity and Alfa Energy). He has been developing strategies for model-based investing since the early 1990s. Prior to joining Alfakraft Fonder, Mr Stridsman managed client money in the FX markets. He also is a freelance analyst and author of the two books Trading Systems That Work (2000) and Trading Systems and Money Management (2003).


19

One feature that has been lacking for many years in most tradingsystem platforms is the possibility to test a system incorporating ranking and filtering functions. Sure, many testing and trading platforms offer these possibilities as stand-alone features, but very few if any offer the possibility to incorporate them into a system. This is because old tradingsystem platforms operate under the old paradigm of testing one market at a time from the start of the data to the end of the data, before they combine the performance for each market tested into a portfolio report. With the old-school way of testing there is no way to compare the

The markets tested are listed at the end of this article. Figure 1 shows the performance for this system since 1990. An average of $5 and $10 was deducted for commission and slippage for all contracts traded. The risk per trade was set to 0.2 per cent of total equity. You can see that the average annual return comes out to 19.08 per cent with a maximum drawdown of 22 per cent, over 8869 trades.

markets and their respective indicator values mid-test. Newer platforms, on the other hand, offer this feature, because their way of testing things are not one market at a time, but rather one day (bar) at a time, simultaneously across all markets in the portfolio. One of the platforms offering ranking and filtering for systems is Trading Blox, which is used in this article on a portfolio of 49 commodity futures markets in an effort to improve a basic volatilitybreakout system. The system is a standard Bollinger-band type system with a 40-day lookback period for its calculations.

days Range ago) and theindicator. Average For True (ATR) the momentum ranking, a high positive value means the market has been trending higher and is expected to continue to do so. A high negative value means the market has been trending lower. For the ATR ranking a high value means low intraday volatility, which is considered a good thing for both long and short trades. Using the ranking and filtering techniques you can test the performance of all markets based on their relative strength in the portfolio for each day, provided that they also signaled a trade

The Ranking Functions

Two different ranking and filter functions are added to the above system. They are based on a simple momentum calculation (Close today minus Close n

F1) Original 40-day Volatility Breakout System

The performance of the srcinal system indicates the system works well over time. A steady equity growth generates an annual return of more than 19% over 8869 trades. Source: TradingBlox

F2) Filtering out the Worst Trades

Reducing the number of trades based on a filtering function would be a bad idea for this system. Getting rid of potentially profitable trades is seldom a good idea. Source: TradingBlox

TRADERS´ INSIGHTS

20

that day in accordance with the srcinal breakout rules. Table 1 shows the performance of each percentile, using the momentum filter. For example, the row for the top-10 percentile shows those markets that were among the highest ranked markets according to the momentum filter, and also signaled a trade that day which produced 2068 trades for a total annual return of 3.13 per cent. Now, not knowing any better, we could just add all the percentile returns together and might conclude something like, “Trading only the top-60 percentile markets will produce a return of close to 35 per cent, so let us settle for that”. However, this the wrong conclusion as both the sum of all returns and trades are

much higher for the sum of all percentiles than they are for the unconstrained system in Figure 1. This is because a filter like this can in fact, offer more trading opportunities per market over a longer test period, the narrower the ranking bins are. Figure 2, which shows the performance of trading only the top-60 percent trades, confirms that this would be a bad conclusion. Filtering out positive trades always lead to lower performance. Testing Money Management So, in this case filtering out trades is not the way to do it. But is there another way? How about altering the positions size based on the ranking so that those markets that are ranked the highest according to the ATR filter

T1) Percentile Performance Per cent ile 10 -

Re tur n 3.13

S har p e 0.62

20-10

5.40

0.72 0.80

Tr a d e s 2068 3299

30-20

6.23

40-30

7.82

0.96

3462

50-40

5.53

0.81

2926

60-50

6.20

0.98

2314

70-60

2.72

0.54

3688

1772

80-70

1.00

0.28

1331

90-80

0.75

0.07

893

100 -90

0.45

0.22

426

Here we see the performance of each percentile, using the momentum filter. For example, the row for the top-10 percentile shows those markets that were among the highest ranked markets according to the momentum filter and also signaled a trade that day produced 2068 trades for a total annual return of 3.13%.


trade more contracts while those that rank the lowest trade as few contracts as possible? In this case we will alter the srcinal 0.2 per cent risked per trade with the following simple formula: New Risk = Original Risk * ((1 Rank / 49 - 0.5) * 2 + 1), with the number 49 representing the total number of markets. This way we double the risk for the highest ranked markets while decreasing the risk for the lowest ranked markets all the way down to zero. For all trades, the average risk per trade will still be 0.2 per cent or close to it. Figures 3 and 4 show the performance of such tests with our filters.Figure 3 shows the performance for the momentum filter. With this filter, the annual return came out to 23.62 per cent, an increase of approximately four percentage points. The modified Sharpe ratio (not including the interest rate) also increased somewhat, but the bad news is that both the magnitude and the length of the maximum drawdown are also increased. Figure 4 shows the performance for the ATR filter. Now the annual return comes out to 21.38, an increase of 2.3 percentage points. Again, the modified Sharpe ratio also increased somewhat, which is an improvement. Again, though, the bad news is that both the magnitude and the length of

F3) Ranking the Momentum

Ranking the markets in the portfolio according to their relative market momentum before modifying the position sizing algorithm incorporating the ranking, generates higher returns, but also higher drawdowns. Source: TradingBlox

F4) Ranking the Average True Range (ATR)

In this case, ranking the markets in the portfolio according to their relative ATR before modifying the position sizing algorithm based on the ranking turned out not as profitable as the momentum-based ranking. Source: TradingBlox

TRADERS´ INSIGHTS

the maximum drawdown also increased considerably. Overall, the momentum filter did a slightly better job than the ATR filter. Analysing th e Results The reason why we were not able to increase the performance more than this can be deducted from Table 1. First, take look at the values for each percentile’s Sharpe ratio. Notice that there is little order to how the values change from one percentile to the next. Sometimes it is higher, sometimes it is lower. This means the filter is doing a poor job in sorting out risk-adjusted trading opportunities. For the system to do a good job we would have liked for the Sharpe ratio to be consistently lower. (A consistently higher Sharpe ratio would also havein been a good thing, although that case our reasoning for how the filter was supposed to work would have been completely backwards.) Second, if we divide the annual return for each percentile with the number of trades for that percentile we come to a number indicating the performance per trade for that percentile. Again, for the system to do a good job we would have liked for this ratio to be consistently lower or higher. Figure 5 shows this ratio for our two filters, with the momentum filter in blue and the ATR filter in 07/2011 www.tradersonline-mag.com

21 red. As you can see, both lines are rather unstructured with no clear trend from high to low or vice versa. This indicates that the trades for each percentile are producing profits similar to the trades for all other percentiles, which makes the use of these two ranking techniques for adjusting the position size for this particular system fruitless. Another Exa mple As is likely to be pointed ou t more with some frequency in this article series: The purpose of this article is not to provide you with any turn-key trading systems, but rather to present, state-ofthe-art research concepts while inspiring you to conduct your own research. Therefore, so that you do not feel left in the dark

system after the ranking process. Notice how both the Sharpe ratio and the profit ratio become increasingly lower for each percentile. This is exactly what we want to see for the ranking based money management to work the most effectively. If we base the position sizing of each trade on the ranking, the annual return increases by close to nine percentage points, which is very good; the modified Sharpe ratio increases by 0.27 points, which is phenomenally good; the drawdown increases by close to seven percentage points, which is bad. The most important point here is the large increase for the modified Sharpe ratio, while the drawdown increases less than the annual return. This is super good news, because now what we can

thinking wasleta us badtake trading idea andthis article a look at another system with an accompanying ranking function which considers adjusting the position size. Figure 6 shows the performance of a basic volatilitybreakout system, also tested on the same portfolio of markets, risking 0.2 per cent of equity per trade. This system has an annual return of 20.27 per cent, a modified Sharpe ratio of 1.2 and a maximum drawdown of 22.9 per cent. Figure 7 shows the Sharpe ratio (in blue) and the profit ratio (in red) for each percentile for this

do is to lower the average amount risked per trade from 0.2 per cent to look for a target return close to the srcinal 20 per cent which will lower the drawdown even more while maintaining a very competitive Sharpe ratio. Figure 8 shows what happens with the performance, if we keep the ranking based money management, while lowering the average risk per trade to 0.14 per cent. With both the return and the drawdown back to their srcinal readings, the modified Sharpe ratio remains at 1.47, which indicates that the day-to-day and month-to-month volatility of the

F5) Profit per Trade for Each Percentile of Trades

The profit per trade for each percentile of trades for the ranking functions. There really are no distinct trends from high to low values for either of the two ranking functions. The momentum function in blue and the ATR function in red. Source: TradingBlox

F6) Performance of a Proprietary Breakout System

The performance of a short-term volatility breakout system without any filtering or ranking. Note that the annual return is accompanied by a modified Sharpe ratio of 1.2. Source: TradingBlox

TRADERS´ INSIGHTS

account equity has decreased significantly, making this version of the system both safer and more enjoyable to trade than the srcinal version.

22

Conclusion Both ranking and filtering has been around for many years, but not as features to be added into a trading system. Being able to do so, represents a huge leap forward in the systems development process, which opens up the doors for a completely new set of automatised trading strategies and completely new ways of thinking. The sky is truly the limit in this area. For this article we looked at two very simple ranking and filtering techniques, using nothing

builders and technical traders. First we tried using them as filters, filtering away the least profitable trades, which did not work that well in our case. This, however, has more to do with the underlying system than the filters themselves. Because if the system is good, generating profitable trades even during most circumstances, then the filters do nothing but lower the profit. Had the system itself been better, then even these simple filters would have done a good job. When the filtering process did not work we tried to rank only the systems and then adjust the money management function based on the ranking so that the highest ranked markets at each day were allowed to take

markets were then allowed only a small risk per trade, all the way down to no risk (= no contracts traded) at all. This way of doing things turned out much better, and in one case we increased the average annual return by more than four percentage points from 19.08 per cent to 23.62 per cent. This in itself is very good, but we also took a closer look at why we did not manage to increase the profit even more. To maximise the total profit increase, the ranking process needs to be constructed so that the average profit per trade and/ or the Sharpe ratio decreases at a steady pace, the worse the upcoming trades are expected to perform. That is, in a backtest, the highest ranked markets

but the simple momentum and ATR indicators. Both techni ques are well known to most systems

on a larger position than the srcinal 0.2 per cent per trade. Consequently, the worst ranked

should have much higher average profita per trade than the worst ranked markets. To show this, a final example with a proprietary breakout system and a proprietary ranking managed to increase the annual return by close to nine percentage points, from 20.27 per cent to 29.06 per cent, indicating that a wellfunctioning ranking and filtering function will increase a system’s performance significantly.

Markets used in these tests Currencies:

Australian dollar, British pound, Canadian dollar, Euro, Japanese yen, Mexican peso, Swiss franc EUA emission rights, Crude oil, Heating oil, Brent oil, Gas oil, Natural gas, Gasoline Equity indices: SP 400, CAC 40, Dax, FTSE 100, Hang seng, Nikkei, Russell 2000 Grains: Corn, Rice, Soybeans, Soybean meal, Soybean oil, Wheat, Kansas wheat Interest rates: Australian bonds, British long gilt, Canadian bonds, German bund, Japanese bonds, US 10-year notes, US 30-year bonds Metals: Aluminum, Copper, Gold, Nickel, Palladium, Platinum, Silver Misc: Feeder cattle, Live cattle, Lean hogs, Coffee, Lumber, Orange juice, Sugar Energies:

F7) Profit per Trade and Sharpe Ratios

Both the profit per trade and the Sharpe ratio trends nicely from high to low values for this system with the modified filtering function in place. This indicates that the performance could increase significantly with the position sizing altered by the ranking. Source: TradingBlox

F8) Ranking Increases Performance

The performance of a short-term volatility breakout system with a proprietary ranking function affecting the position size. Note especially the large increase in the modified Sharpe ratio, from 1.2 to 1.47, even after the average risk per trade has been reduced from 0.2% to 0.14% per trade. Source: TradingBlox


23

Interview with Ben Lichtenstein

FLOOR-istic We are delighted to present to our readers an interview with Ben Lichtenstein. He works on the trading floor of the Chicago Board of Trade (CBOT), running the Squawk Box service from there known as Traders Audio (www.tradersaudio.com). One of his best-known recordings – from the memorable day of the Flash Crash on 6th May 2010 – can be watched free of charge on Youtube at http://www.youtube.com/user/adamglatt.

07/2011


TRADERS´: First off, can you tell us something about your career? When did you start at CBOT and what do you do today? Ben Lichtenstein: I started out about 20 years ago as a young runner on the floor and then worked my way up over the years. This is called the “classic” career. After some time I had gained enough experience to open an account of my own, which allowed me to do my own trading. That was about 15 years ago.

nature and so does not make any sense.

TRADERS´: you trade? Which markets do Ben Lichtenstein: Primarily, I trade the S&P 500 futures as well as currencies and crude oil.

there was a huge levelfelt of energy thatonce was very clearly by everybody and immediately rubbed off on observers. During hectic periods of time, of course, this was always associated with a healthy dose of organised chaos. On the screen, however, things proceeded more transparent ly – especially so as far as the execution of an order was concerned.

TRADERS´: What are the most important things you have learned in your own trading? Ben Lichtenstein: You always need to be sufficiently in control of yourself to avoid any so-called random trading. Time and again, many traders arbitrarily enter some trade or other where they basically do not have an edge at all. Without such an edge, though, trading is of a random

TRADERS´: And what is your edge? Ben Lichtenstein: To me, setups with an optimum risk /return ratio are key. I only enter a trade when I can derive it from the situation in a given future or currency pair and when that trade offers a high potential at low risk. TRADERS´: What changed when trading increasingly moved to the screen? Ben Lichtenstein: On the floor

TRADERS´: Did you trade on the floor yourself? Ben Lichtenstein: I have never actually traded in the pit. When I started to trade, the switch

TRADERS´ INSIGHTS

from floor to screen trading had only just begun. Initially, I traded floor contracts for a while, but only entered these trades at the direction of the machine on the floor and never did any trading by show of hands or acclamation. Even today, I trade electronically from the floor.

24 to have a squawk box which continuously passes on the most important information from the trading floor to your own trading space. This brings the human element back into trading, as it were.

it, experienced considerable difficulties.

TRADERS´: What are the advantages of trading on the floor? Does it really matter in electronic trading where you sit? Ben Lichtenstein: On the floor practically everything is different from the trading floor of a commercial office or an investment bank. Many screen traders now have the problem that they need to make their decisions while being isolated

TRADERS´: What advantage do pit traders actually have today? Ben Lichtenstein: Traders in the pit use different trading opportunities than screen traders and, in my TRADERS´: So listening in can judgment, can therefore continue be another useful perception in to hold their own. Of course, trading? a great deal of the business of Ben Lichtenstein: Exactly. The previous pit traders has been potential of this additional taken over by screen traders, but channel of perception is great, also by machines and algorithms but so far only few traders use of high-frequency trading. Yet this option. You just need to try it even today there are advantages out and develop some confidence to the trading floor. For example, in the combination of what is the locals here in the pit still have heard with the visual perception the lowest transaction fees and of the charts. the highest speed of execution in some contracts. TRADERS´: Can you estimate how many traders have TRADERS´: So floor t rading will

from outside world, which is notthe exactly an advantage. To combine the best of the two worlds of pit and screen trading, it is therefore best in my view

successfully moved from the pit to the screen? Ben Lichtenstein: No, not really – unfortunately. But I think that most of those who have tried

not disappear Ben Lichtenstein:anytime Definitelysoon? not. To a degree, the whole thing can be compared to a game of poker: It is nowhere near the same whether you play poker on the screen or in a tournament with other players sitting right next to you at the table. Surely, the one without the other would be pretty one-sided.

Squawk Box A squawk box reproduces the atmosphere and the activity on th e trading floor via a resident announcer. This information cannot be derived from charts or fundamental data, and can therefore be an important support in daily trading. The announcer says, for example, who is buying or selling what and what the volume is of orders being processed. They may also reflect the mood on the floo r by the way they speak, either quietly or fast or in a hectic man ner. Especially during less hectic periods of time, traders who constantly think they might miss a movement, can be kept from over-trading by a calm voice. Since the announcer sits right on the floor and watches the traders, they pick up this information visually and immediately verbalise it so that practically everything reaches users of the service in real time.


F1) Flash Crash on 6th May 2010

Interview conducted by Marko Gränitz Through the link http://www.youtube.com/user/adamglatt you can access the video by Adam Glatt, which is Ben Lichtenstein’s live recording of the day of the Flash Crash. All the while there is the tick chart of the S&P 500 futures in the background, and the whole thing is really well worth watching. Source: www.youtube.com

TRADERS´ TOOLS

Macroaxishas launched a product upgrade with features that make personal investment management easier. Improvements include enhanced portfolio optimisation and backtesting, better correlation and volatility introspection, larger position coverage, and more categorised asset allocation options. Users will be able to track portfolio asset allocation by sector, equity type, and market cap, utilise larger historical horizons, verify new optimised portfolios against a backtesting tool, rebalance portfolios manually with immediate optimisation and feedback, and srcinate new portfolios via one screen interface to execute multiple transactions. Please visitwww. macroaxis.com Impulse Accelerated Technologies™has announced the addition of GigE (Gigabit Ethernet) and 10GigE Fieldprogrammable Gate Array (FPGA) development kits for financial traders. The kits are for firms that develop proof of concept and full production FPGA Auto Trading systems. Included with the kits are a working reference


25

design, training, and available engineering services to increase first hardware project success rates. Auto traders are already using Impulse 10GigE User Datagram Protocol (UDP) Ping, GigE ITCH pre-parsing and GigE UDP-to-host production systems. Now Impulse adds a 10GigE ITCH/OUCH protocol and a GigE Macroaxis

IP gives teams a foundation for efficient customisation and further development. More accelerated trading kits will be announced in 2011. In addition to this building block system, Impulse builds and services pre-trade filtering solutions, pretrade risk analysis appliances and normalization appliances. For more information, please go to the website www. highfrequencytraders.com

TraderMadehas introduced news and commodity technical strategies into its Maverick platform to enable more accurate markets study and analysis. The FX News service, Market News International (MNI), and the existing FX Market Commentary service are delivered directly into the platform via an intraday IPC

Ipc Systemshas launched Unigy, a unified trading communications and applications platform. Unigy can help trading firms transform their trading workflow, making a firm’s

low latency to host user space IP kit. In this kit the reference design works with a range of off the shelf FPGA boards. The optimised UDP ping solution includes an Impulse Partner reference design with sub-2 microsecond latency from fiber to fiber. This enables software developers to migrate strategies to hardware in half the time, such that Impulse partners have created full trading systems in 120 days. The reference design

trading teams more productive and their operations more profitable. The platform speeds collaboration between traders and the entire trade support team and has the ability for firms and partners to develop their own applications. Ipc is offering a suite of hard and soft devices for collaboration, a new compact turret, and out-ofthe-box Unigy-enabled trader applications built on the new Blue Wave Application Development platform. For more information, please visit www.ipc.com

model and order management. Global changes are quickly implemented, while ensuring taxable and tax-deferred accounts are assigned the appropriate securities. Seamless integration with Portfolio Center is another feature where users can now access an efficient solution for portfolio rebalancing and trading, complete with integrated account details, tax lot information, security details, and also existing models. For further information, please visit www.blazeportfolio.com CQG has completed a software licensing agreement

chronological newslist and ticker. TraderMade will increase the news in the coming months and users will be able to add their own RSS to the platform. For further information, please visitwww. tradermade.com is BlazePortfolio Systems offering Atom Align 1.3, which introduces several ways to streamline portfolio rebalancing and trading, establishing a straight-through process for

with HSBC to make CQG’s advanced trading front ends available to HSBC’s customers. This addition connects traders to futures in a range of asset classes. Exchange access via HSBC Futures extends from the Asia-Pacific region to European and North American markets. Through CQG, HSBC’s customers and internal trading desks can now route orders to these exchanges using CQG Trader and CQG Integrated Client. Additional details can be found at www.cqg.com

TRADERS´ TOOLS

W E I V E R E R A W T F O S 07/2011www.tradersonline-mag.com

26

A Smorgasbord for Traders and Investors

TeleChart Are you hungry for and want to enjoy the exciting oppor tunities offered in th e US and Canadian markets? With 22 successful years behind it, a list of accolades, and a very large global customer base, TeleChart software is the choice for those searching to better navigate these markets. Along with its newest members, TC2000 v11 and the mobile-enabled versions, this product family offers solutions that cover everything a normal-profile trader or investor needs: charting, technical and fundamental data, technical analysis (standard and own indicators), commentaries/chat room, access to social media, and many other features.

annual or monthly payments are made. After the login the dashboard appears as shown in

two proprietary tools, Time Segmented Value (TSV) and Money Stream (MS), can be

provides a range of fundamental data such as

TeleChart 2007, most commonly known as TC2007, can considered the pillar ofbe the charting software developed by Worden Inc. The package is downloadable to your computer from www.worden.com together with a US markets historical database that can be quickly updated anytime during or at the end of the trading session. Two levels of membership are available: Gold and Platinum, the last one offering access to a live chat room where members can discuss and get trading ideas in real-time. The customer can use the software immediately, once

Figure 1. TC2007 well designed and offers optionsisto define templates for each financial instrument chosen (i.e., stock, index, ETF, mutual fund, Worden indicator, Morningstar industry (sub)group). Each template adds technical indicators to the price chart and can be customised according to each trader’s own needs. Traders and investors are already familiar with indicators that can be added to each chart template: volume, averages, RSI, ROC, OBV, Bollinger bands, Stochastics, ADX, Relative Strength. Additionally,

also attached and are often mentioned in Worden’s chat room, commentaries, and daily reports. If the users have enough technical skills to write their own indicators, the software offers a simple language to code custom indicators similarly to the definition of a Personal Criteria Formula (PCF) (see Figure 2). A growing numb er of people started trading and investing using both technical and fundamental data. TC2007 is a highly-sought and appreciated product for this purpose. For each financial instrument and where applicable, the software

• • • • •

TeleChart 2007 – the Older Chef

• • • • • •

P/E Ratio Current Book Value per Share Earnings/Share Debt-to-Equity Ratio Diluted EPS from Total Operations Dividend Growth 5-Yr EPS Latest Quarter Earnings Gro wth rate 5-yr Gross Margin Gross Operatin g profit and many other useful ratios

In addition, technical data such as Beta, Capitalisation, Trending/ Consolidation (25 day), Up five days in a row, Volume Surge today, New High, New Low

TRADERS´ TOOLS

27

offer additional input to further filtering. The historical database contains approximately 7700 instruments, and even more for those focused on mutual funds. This collection is sufficient for anyone keen to trade and invest in the US markets. Worden’s software package also offers the option to organise data through the creation of watch lists. For example, if you follow US-listed companies involved in extraction and processing of gold, you can define a watch list named ‘My Gold Companies’ and include symbols of companies involved in this business. If you want to export data to another software package, the option is also there. One of the strong features of the software is the ability to

the Daily Worden Report with a summary of the US markets and valuable personal insight.

writepersonal and immediately test your own criteria formulas (PCF). The example illustrated in Figure 2 uses basic language commands to build a True/ False alert for a crossing of the 10-day moving average above or below the 200-day average. The trader can combine several of the PCFs written in an EasyScan procedure, where the objective is to scan a watch list or a bigger exchange group for specific requirements (price, volume, fundamental ratios, technical signals, and others). At the end of each trading day, subscribers gain access to

web platform offers userstheir some extras that can improve trading experience:


TeleChart2000 – the New Chef TC2000 version 11 is the latest important addition to the Worden charting product suite and is provided free of charge when a customer subscribes to TC2007 Gold or Platinum services. In terms of functionality, it is similar to TC2007 but with one fundamental difference: It is a web-based application which stores the historical price and volume database outside the user’s computer, running on both PC and Mac. Figure 3 shows the application’s main screen that resembles the TC2007 dashboard. Running TeleChart 2000 on the

• Over 3700 Canadian common stocks (TSX and TSX Venture), indexes, and market indicators. • 24 FX pairs. • Access to NASDAQ Bulletin Boards and Pink Sheets. Along with technical indi cators, TC2000 offers a wide range of visual tools such as Fibonacci arcs, fans, price and time retracements, regression line and channels, speed lines, Tirone levels, etc. In case you choose to

make annotations directly on the chart, text and graphic symbols are available to facilitate this task. This new platform strives to keep pace with the digital era as social media is present in the toolbar with Twitter and Facebook gateways. This functionality allows a user to make notes on a chart they like, and share it via an active Twitter or Facebook account. Adding to this communicative functionality is the ability to open a link to TD Ameritrade brokers. Another useful feature is the data and indicator values export; at a click of a button you can export data to process it with third-party statistical or technical analysis software.

F1) TC2007 Workplace

www.freestock charts.com – the those Free Meal For interested in only the basics of TeleChart software functionality, www. freestockcharts.com is a logical alternative and it requires Microsoft Silverlight installed on your computer. It offers streaming real-time US data from the BATS exchange and Canadian quotes (15-min delayed) ranging from 1-minute to 4-hour bars. For longer time horizons (up to yearly bars), the switch is available with a click of the mouse. Social media access is allowed only for users with a valid TC200x paid Gold or

All main fun ctionality is avail able on this scre en at a click of a but ton. Source: TC2007

F2) Personal Criteria Formula (PCF)

Example of a PCF to alert for 10-day/200-day crossings. The commands are available and can be inserted easily into the PCF. Source: TC2007

TRADERS´ TOOLS

Platinum account. This is a cutdown version of TC2000 v11 with marketing connotations. TeleChart Mobile

This new charting platform is the ideal feature for people on the move, and is free for Gold and Platinum customers. Customers are able to watch developments in real-time as the iOS- and Android-enabled software synchronises watch lists, EasyScans, and chart templates with their existent TC2000 v11 installation. This cross-platform effort from Worden will certainly bring more enhancements to the overall usability and experience of this product.

28 alongside specialists. If customers live in other parts of the world, the forum on their site offers advice on product and market strategies. Webinars are a great addition to Worden’s after-sales support. Although they run very ear ly in the morning for European users, they discuss trading strategies and techniques implemented with the software. In case you miss any of these presentations, an archive is available at kb.worden. com to keep you up-to-date. Pricing TC2000 Gold:

Free 14-day trial, @29.99 monthly, $299.90 for one year, $589.32 for two years.

The Kitchen

TC2000 Platinum:

Newcomers and existing users

$89.99 monthly, $899.90 for one

may occasionally more information about need the product range and its capabilities. Luckily, finding answers to your questions should not be a problem since Worden offers multiple response channels, ranging from traditional technical support to functional webinars. Overall, customer service and offered support are excellent – replies are very often received within hours from submitting the request. Additionally, the Company regularly offers free training and workshops across the US where you can explore the product and its capabilities

year, $1619.82 for two years. TC2000 Mobile:


Free for Gold and Platinum customers. FreeStockCharts.com:

Free at www.freestockchart.com. Wish List

As with any meal, product, or service, customers always want something more and TC200x is no exception. In this case, three main improvements come to mind: 1. The European markets are not negligible in terms of capitalisation and product

offerings; therefore, making a version of either TC2007 or TC2000 featuring European markets may result in an attractive product for European traders and investors. 2. There is a tendency with technical analysis software to expand into backtesting strategies. This addition would be a nice present to those interested in this subject. 3. The ability to include future access to recursive calls when writing PCFs and unique indicators would be highly appreciated by users.

F3) TC2000 v11 Workplace

This is a very dynamic environment with streaming quotes, real-time prices, and all functionality existent in TC2007. Source: TC2000

Next Step?

Now you can get to the TC200x buffet and taste what is out there. On Worden’s web site (www.worden.com) you c an

F4) TeleChart Mobile

get comprehensive information about individual software and download the desktop version of TC2007 as well as the newer, web-based product TC2000 v11. Although there are some usag e limitations during the free trial, you can easily appreciate the great offering and functionality of these products. Whether you are home, in the office, or travelling, Worden’s suite of products keeps you in synch with the US and Canadian financial markets. TeleChart Mobile keeps customers synched with the markets. The iPhone application can be downloaded from their e-store and markets are at your fingertips. Source: TC2000 Mobile

TRADERS´ TOOLS

29

W E I V E R B E

Free Guidance for Professional Traders

Mode of Operation NetDania provides knowledge, professional tools and competitive transaction fees for professional traders. It maintains high quality standards for real time quotes and updated news

a 15 minutes delay. To access NetStation, the user has to click on the NetStation icon on the left side of NetDania’s homepage. A page then l oads which clearly displays the delayed data for any Java enabled platform.

W

and results financial markets. NetDania is for a completely Java based platform. The system offers various tools for the analysis of various markets such as stock, forex and commodity. At its core is the tradin g software NetStation which provides a real time interbank FX feed from top brokers, as well as complete currency and money market data feeds, selected commodities inclusiving precious metals and RSS news from reputable financial sources. The real time version costs 2,400 euro for up to 20 users per month. The free version provides data with

Professional Trading On the complete Java based platform NetStation, there are menues on the upper side of the window for workspaces, plug-ins, chart type, time scale, edit, lines, view, studies, alerts, settings, window and help by selecting the appropriate chart window. Figure 1 shows a extracted Java window from the website and its comphrensive professional information for the trader. Users find streaming quotes of Dollar, Euro, Pound Sterling with major currencies, USD forwards, world markets including major equity


www.netdania.com

F1) NetStation

There are various websites available on the internet for traders and investors which provides various technical tools and news updates at high costs. Some of them are equipped with delayed data feed at high costs for professional traders which is worthless to momentum traders. www.netdania.com provides a real time web based Java platform for professional traders and hence momentum trades can be decided very quickly with perfect news and strong professional technical analysis tools like Fibonacci parameters, upper and lower indicators with changeable parameters and various comparisons between stocks and indices.

Figure 1 shows NetStation Java enabled window which provides quotes of commodities, currencies and world markets. Source: www.netdania.com

F2) Economic Calendar

Figure 2 shows a live economic calendar which is very useful for curr ency traders and while taking quick major momentum trade decision. Source: www.netdania.com

TRADERS´ TOOLS

indices, Dow Jones and NASDAQ stocks. On the right side, you will find gold and silver spot prices with bid/ask spreads and much more important information . Another three windows at bottom of NetStation can be seen such as live, three tick by tick selected charts, updated news and information, and market depth of selected stocks. The Java based NetStation provides all chart types such as OLHC, candle stick, line, bar etc., timeframe with tick, (1, 5, 10, 15, 30, and 60) minutes, daily, weekly, and monthly. Professional technical analysis tools such as arrows, annotations, Fibonacci

30 (time zone, retracements, arcs, extensions, fans), Andrews pitchforks are found in the edit and lines tabs. Whereas most lower technical indicators like Moving Average Convergence/ Divergence (MACD), Relative Strength Index, Stochastic (fast, full, slow, RSI, momentum index), William %R, Trix, Commodity Channel Index etc., and major upper technical indicators such as Moving Averages (simple, exponential, triangle, weighted), Ichimoku Cloud, Pivot Points specifications, Parabolic SAR, time series forecast, Zig Zag Bollinger bands etc. are found by clicking on the studies tab.



The user can set alerts on any particular movement and any news and updates by using the alerts tab and is also able to optimise the view. This customised work station can be saved and accessed on any computer system to which it was saved. Precious Information

NetDania provides mobile applications for Blackberry and Windows phones. It has also launched a mobile site for traders on the go with streaming technology at www.mobile. netdania.com where traders can find live quotes of major

currencies and commodities. Moreover, NetDania provides an economic calendar with real time data feed for previous information, forecasted data, analysis and up to date information with the level of impact or importance to the major currencies and commodities like precious metals, base metals and energy commodities as well. Specific information regarding a particular currency symbol is indicated on the left side of the web page with adjustable date and time zones for major countries. The economic calendar is shown for the week, starting with Sunday. The impact and basic analysis of data from information is also shown on the right side which is listed under the heading of

data from major exchanges in Europe, North America and Asia Pacific. Information regarding over the counter and interbank prices, money markets, forwards and derivatives etc. from major international banks and brokerage firms situated in Europe, North America and the Mi ddle East is available. Services are provided as Premium feeds, usually for closed user groups and/or ‚Light‘ feeds, typical of public web sites. The user has access to major country and industry specific news in several languages provided by major financial news services such as Bridge News, Future World News, Direkt from Denmark and Sweden, TDN from Norway, Market Guide from UK, Russian news, Imerisia, Six Market Estimated from Nordic

commentary. Users see and analyse the can nextalso or any particular date or time information data by searching and clicking on the link for Today, This week, Previous week and Next week. Figure 2 shows an economic calendar for currencies, commodities and major news updates. Various news and information for example, crude oil inventories, US natural gas storage, US unemployment claims etc. NetDania provides real time and delayed equity, warrant, fund, bond, futures, indices and option

etc. all quickly accessible from NetStation. Conclusion

NetDania is a professional trading information guide and analysis tool for traders and investors. The professional trading software NetStation provides real time information and updated news about equities, commodities and currencies which are quickly updated and very useful.

Accumulatin g Headache s? For active traders who maintain longer-term stock commitments, a drop in share price is supposed to be a welcome event as you have the opportunity to act as a value investor and pick up shares at a hypothesised discount. But what if your value bet gets even cheaper after adding shares once or worse yet, twice? Unfortunately, the financial strain and mental limitations of pursuing value investing, is often easier said than done in actual practice. Even if you do have the financial wherewithal to purchase shares during a corrective m ove, your mental state to act according to plan could be severely challenged and cause a missed opportunity nonetheless. Enter the married put, or collar strategy.

Using Short-term Collar Adjustments for Intermediate Bullish Profits

Option to Buy Pullbacks More Effectively Many traders realise a married put or collar strategy can prevent the sometimes devastating losses endured by a naked long shareholder during a correction in the underlying. But a second and often overlooked feature to these positions, as Chris Tyler will demonstrate, can help traders buy on weakness more effectively without busting the bank and getting in real trouble.

Smarter Options Traders familiar with the married put or collar realise these limited risk spreads define a trader’s downside risk by maintaining a protective put as part of those positions. This form of insurance can, on occasion, drastically reduce exposure compared to a naked long shareholder. What many traders using these two protective strategies fail to consider is how that same advantage can be used, if a trader is so willing, to accumulate stock on weakness without having to tap outside resources.

TRADERS´ STRATEGIES

33 A stock tra der who wishes to buy more shares on weakness ultimately needs to ante up additional funds to add to his or her stock position. In the same situation, having used one of these option strategies in advance of the bearish move, you can acquire additional stock by closing out profits realised on the long put and/or short call. You can then adjust by rolling down and restructuring the spread to accommodate the additional shares without increasing the cost of the entire position. This is not to say the adjustment process of adding shares on weakness is not without risk. As a trader using this technique, you

share price than not. If you are more bullish about the near term price action in shares, you can consider loosening up the spread to a certain point. Regardless, short-term premiums will, as desired, be Trading Criteria Aside from a trader nee ding to quick to react strongly to bearish moves. Your short call will have maintain a bullish longer-term a better opportunity to drop outlook on a stock, there are a couple more important conditions towards $0.00 and zero deltas while the long put can move to consider before venturing into these position types. Liquidity, as towards -100 deltas, deep in-thewith any option strategy, is a lways money and act as a profitable a consideration. In that regard, short stock equivalent. This combination, upon closing the your attitude should be one of “the more, the merrier” as there is contracts, will provide you with no drawback to tight markets and the necessary profits used to accumulate shares when a quick fills due to strong trader participation. stock corrects within what you anticipate is a larger bullish cycle. Secondly, higher volatility stocks tend to work better than low volatility issues. With either Other Important

outlook for a stock, as (and if) shares be gin to move back up, you can and should exploit strong rallies to rebalance the position. As shares move up and beyond your positioned strikes, you will find scaling out of your accumulated shares, rolling up, out and possibly tightening your options will allow you to effectively reduce risk, increase your reward potential and/or lock in gains. In the end and with either of these dynamic strategies, a stagnant stock will be your worst enemy. Such an environment will create little opportunity to make meaningful adjustments to profit for collars. Worse yet, if you are positioned with a married put, it can be downright costly. In the worst of situations for

will have a losstoonincrease paper and also be willing yourmust risk exposure compared to the srcinal position. However, relative to the shareholder, paper losses, if executed judiciously, will continue to be much smaller and without the compounded mistake of buying additional shares from monies not initially involved in the position. Remember or realise this, this more “dynamic” means of trading a married put or collar rests on using the profitable proceeds of the long put and/or short call without increasing (or maybe only slightly) your initial account debit or actual dollar exposure. The

of these two strategies the trader will be looking to make quick adjustments to take advantage of sufficiently large percentage movement. What previously was unnerving price action as a correction occurred, can now be viewed as a well-structured, limited risk opportunity to add to your holdings with much greater confidence. In deciding which options to use, short-term front or near front month puts and calls work best. In setting up the position initially, a more protective collar would use strikes placed closer together and the put closer to the

a marriedcan put,be thelost purchased premium in its entirety while the stock shows

Dynamic Risks to Consider

Chris Tyler Chris Tyler is a former equity market maker on the floors of the American and Pacific exchanges.


same cannot be said for dollar cost averaging, double dipping or whatever name is given to the continued buying of shares on persistent weakness.

Considerations Conversely, though you are

bullish on the longer-term

Info A marriedput is the synthetic equivalent of a long call pos ition using a 1:1 ratio of long stock and purchased put. A bull verticalcombines a purchased lower strike and sold higher strike using all calls or all puts. The spread allows a bullish trader to position with defined risk below the lower protective strike but also caps the trader’s profit potential above the shorted strike. A collar is a synthetic vertical which for longer-term traders may hold tax and dividend advantages. A married put is combined with a short call at a higher strike to establish this position.


continued losses down to the protective strike. If this type of lower volatility bearish environment persists and you continue using the married put strategy versus a collar (whose bearish operation is financed with the short call p remium), you will defeat the objective of having a profitable hedge in place for those opportunities when buying on strong weakness in the stock presents itself.

34 Simple yet Effective

Let us now illustrate how you can use these strategies to accumulate stock with less risk and capitalise more effectively on those efforts as bullish opportunities to adjust and neutralise emerge. In Figure 1, we are looking at a volatile and mostly bearish period in F5 Networks (FFIV) daily price chart. The network communications outfit was a growth favourite of traders throughout 2010 but has

Strategy Snapshot Strategy name: Strategy type:

Time horizon: Setup: Entry:

Stop-Loss:

Take Profit: Trailing-Stop: Exit: Risk and Money Management: Average number of signals:

Adjusted/Dynamic Collar Strategy Long-term b ullish with f ocus o n accumulating s hares on substantial corrective weakness, while scaling out, tightening risk and maximising profits on significant rallies Weekly i n conjunction with eye on d aily c hart for volatile adjustment opportunities which might occur Bullish orientation Discretionary.Tradersc anusevolatility/standardd eviation formula to find strike placement or technical analysis for initial design None, as this is considered a longer-term accumulation strategy. If trader‘s bullish view on the underlying changes, exiting to close the position might be considered Trader adjusts collar as shares move through sold strike which allows for the locking in of gains None, unless bullish prognosis changes See above Scaling in/accumulating with limited risk and reversing those actions with bullish adjustments by rolling strikes up and scaling out of shares Not applicable, but more volatile bullish stocks should provide greater opportunities to adjust collar overall and increase profit potential


been decidedly less so in early 2011. In January and denoted by “A” a bullish trader establishes a collar on ten contracts. With shares breaking out on a closing basis above consolidation highs, the trader purchases 1000 shares of FFIV at 143.90, buys ten February 135 puts for $5.00 and sells ten February 150 calls for $6.20. In front of relatively rich earnings and option premiums, the collar’s protection is fully financed by the call and even receives a credit of $1.20. As much, the collar is viewed as more appropriate to the circumstances than the married put. At “B” traders react poorly to disappointing guidance from FFIV with shares tanking a bit more than -21 per cent. This price

F1) F5 Networks (FFIV) Daily Chart

action is at disastrous short-term. Looking the “mid quote” data, we see the approximate loss of -$7530 is near the collar’s max risk of about -$7750. At the same time though, a trader long shares from the same levels would be down nearly -$35,000 on paper. Dynamic Opportunities

What traders do not see or may not consider is how the drop of -21 per cent might allow for the accumulation of 200 shares or a 20 per cent increase in collar position size. In adding shares the trader’s risk will increase. But the maximum exposure i.e.

This volatile bar chart of FFIV details the timeline of an initiated collar strategy and opportunistic adjustment points thereafter, as shares correct during a bearish gap and then rally strongly to enable a profitable roll of the collar to further contain risk and increase the trader’s profit potential. Source: www.profitsource.com


35

the cost/“entry debit” inFigure 2 is not increased as the trader is able to finance the accumulation effort through the profits earned on closing out the short call and long put. Waiting for a bit of daily confirmation, on January 25 (“C”) and sha res near $107.50, the trader closes out the srcinal contracts for a credit of about $27,000 (closing mid market). With those proceeds the trader buys an additional 200 shares, purchases twelve February 100 puts for $1.70 and sells twelve February 115 calls for $2.10. Looking at the mid quote data in Figure 3, we can see our open loss of -$7660 is approximately what it had been three sessions prior. Of more interest, the total dollars or “entry debit” at risk has

trader simply long 1000 shares is showing a much larger paper loss, now roughly -$36,500 with shares of FFIV at 107.50. And if the trader considere d buying more shares on this price weakness it would only add to his or her overall risk exposure.

actually adding dropped byshares. about $6000 despite 200 What is more, the accumulation and collar adjustment allows the trader to drop the breakeven level on the position from around $143 down to about $113.50. If the share s rally, above 115 the trader will be profitable by a bit more than $1850. The risk of this adjustment is the trader has increased the “max risk” of the position to a round -$16,150. That is more than double the existing paper loss. Yet as we can see, the absolute dollar exposure has dropp ed to $136,146 from $142,750. As mentioned, a

shares falter against the 50 (Simple Moving Average) andSMA the February contract coming off the board in just three days; there are three very good reasons to take action. Shown in Figure 4 and at a time when the long shareholder is still out roughly -$17,600 with the stock near 126.35, our collar trader is already profitable by roughly $2000. This position adjustment sold out the 200 accumulated shares after gaining about 20 per cent and rolled up the remaining shares into a “surrounding money” ten contract collar using +10 March 120 puts


Dynamic Adjustment

Keeping this illustration simple yet more powerful without even having to show an idealised adjustment, refer back to “D” from Figure 1. Less than three weeks after accumulating shares, FFIV has moved forcefully higher by 20 per cent and in keeping with the trader’s continued bullish longerterm outlook. But given the size of the rally now well above our positioned strikes, maybe a bit of technical concern as

and five lot sales on the March 130 and 135 calls. Also depicted, we see this improved position has room to more than triple the current profits to about $8500 without further adjustments required. Remember too, that profit potential could be increased if shares did proceed to rally and the trader initiated a fresh roll. It should also be noted this collar maintains “max risk” of less than one-half the max profit potential and has less than $124,000 invested in the position. Those factors are two fresh “lows” that should make this trader happy as well and relative to a bull in the stock. Conclusion

In conclusion, the married put and collarinitially can bemeets much more powerful than the eye if traders use a stock’s volatility and these strategies inherent risk controls to their advantage when planning to accumulate shares. Hopefully, we have shed some light on or allowed for a better understanding of those mechanics so the next time you are drawn to buying a longer-term commitment, you will remember to pay equal attention to those other important investment options.

F2) F5 (FFIV) 10 x Feb 135/150 Collar Risk

The risk matrix details the collar’s dollar cost, current paper loss, maximum risk exposure, profit potential using “natural” or nonnegotiated call and put quotes and a mid quote which values the collar’s market P&L by splitting the option market’s bid/ask in half. Source: www.optionetics.com/platinum

F3) F5 (FFIV) 12 x Feb 100/115 Collar Risk

Figure 3 shows the risk matrix details of 12 x Feb 100/115 Collar. Source: www.optionetics.com/platinum

F4) 10 x March 120P/(130/135C) Collar Risk

Here you can see the risk matrix details of 10 x March 120P/(130/135C) Collar. Source: www.optionetics.com/platinum

Effective Swing Trading

Buying the Dips and Selling the Rallies One of the time-tested secrets of successful trading is to buy at a wholesale price and sell at a retail price. Buying into a supply zone and selling into a demand zone are some of the reasons why novice traders often get sliced up. You would not want to buy a particular item at $800 when it could be bought at $400. The best way to buy the dips and sell the rallies is to do that in the context, and of course, in the direction of the overall trend. This prevents us from trying to pick tops and bottoms in the currency markets (which is a recipe for pecuniary ruin). This article of fers a proper way to buy cheaper and sell dearer; and do that alongside the ongoing trend. It also suggests a safe position sizing rule that goes with the strategy; something that can help you meet your trading objective.


Mustapha Azeez Mr Mustapha Azeez is a

37

Swing Trading the Smart Way A novice trader can be lured into buying a pair like the GBP/USD when immediately she/he sees that its price skyrockets, only to be stopped out by a pullback before the market continues going in the forecasted direction. Pairs and crosses whose prices shoot up or nose-dive and later change direction are no longer a curiosity. Bulls or bears can gain upper hands for many weeks or months, yet prices do not go in straight lines. Every experienced trader knows that there are pullbacks in bull markets and there are rallies

“A Breakdown of the Trading Method.“ When a market is trending downwards, then sell and sell short; and vice versa in a market that is trending upwards. Nevertheless, you would have a much better edge if you sell higher in a bearish market and buy lower in a bullish market. For this swing strategy, the instruments with comparably lower spreads have been chosen. These instruments seem to be more suitable for this strategy than the instruments with higher spreads – which appear to trend without many instances of

in bear markets. When a currency market is trending strongly to the upside, an oscillator can be in an overbought region for a very long time. The same is possible when a market is caught in a serious bearish move: an oscillator would be in an oversold region for a long period. A smart swing trader would therefore not trade against the trend because she/he thinks the price seems to have gone too far.

retracement. The potential risk per trade stands at 0.5 per cent and the potential reward per trade stands at 1.5 per cent; something that helps you remain unperturbed in a possible event of a few losses in a row. It is better to gain small than to lose big, but if you can stomach bigger risk, you could risk one per cent per trade to target a potential gain of three per cent. The long-term hit rate is roughly 50 per cent, whereas your survival is quite possible even with approximately 33.3 per cent hit rate. If you hit only three trades out of ten, you are a winner.

professional Forex trader, Forex signals strategist, funds manager, and researcher.


How You Can Take Advantage of the S trategy For the details of the strategy, please check the section titled

F1) USD/CHF Bearish on the 4-hour Chart

The EMA 50 in the 4-hour chart shows a very strong bearish bias on the USD/CHF. The Swiss Franc had been rising against the Greenback for several months in a row. The key then was to sell short whenever there was a rally in the price. This was best done on a shorter timeframe. Source: www.metaquotes.net


38

Figure 1 shows a bearish USD/ CHF on the 4-hour chart. Figure 2 confirms the same bearish USD/CHF on the hourly chart, including where you could have entered the market, on the formation of a bearish candle, which followed the move of the %R into an overbought zone. This happened around the middle of April 2011, which m ade me ente r the market at the right time and enjoy protracted price movement in my favour. You should make a strategic decision on the 4-hour chart and a tactical decision on the hourly chart. The EMA 50 (Exponential Moving Average) must confirm a bull market on both timeframes. You would then wait for the %R (Williams’ Percentage Range) on the hourly chart to go into oversold region

of the AUD/USD was at 1.0744 at the time a ‘buy’ signal was generated, you might do well to set a ‘Buy Limit’ order at 1.0700. If the price of the USD/JPY was at 81.25 when a ‘sell’ signal was generated, you might set a ‘Sell Limit’ order at 81.50. Doing this can cause you enter the market at a better price, the downside being that your order may not be filled before the market turns in the direction you anticipated. Remember to include your stop loss and take profit levels in the pending order.

before youway think of buying, and the other round for a bull market. Please bear in mind that you should never buy if the %R does not go into oversold region: a trade missed is better than a trade lost. You would only need to do the exact opposite of the above in a bear market. You would then open an instant position after the formation of a bearish candle, i.e., if you want to go short, or a bullish candle, provided you want to go long. You also might sometimes set a pending order around the nearest important price or psychological level. For examples, if the price

been placed, should be allowed to the playmarket itself out since the price might sometimes reverse against you by several tens of pips before going in your direction. Simply put, either the stop or the target would be hit, but some trade management must be put in place so that trading results can be optimised. As soon as a trade moves i n your favour by up to 50 pips or above, you may move your stop to breakeven. Moving your stop when the price has moved by only a few pips would usually result in premature exits (tighter trailing stops would often get


Managing an Open Position This strategy is designed in a way that can make you spend minimal time trading, and looking for new signals and managing open trades. Once a trade has

you stopped out by negligibly transitory fluctuatio ns in price before continuing in your favour). Then the position should be left until it gains up to 180 pips before 100 pips are locked by moving you stop. A favourable trade may or may not hit the target, or it may hit the trailing stop within the 2-week duration of the trade. Once an open trade is up to two weeks old, it must be smoothed regardless of the profit or loss status. The stop must never be widened under any circumstances. Why? This is because no-one can predict the future with certainty. If I thought I had a knack for predicting the future, I would abandon trading and buy some lotto tickets. I would then enter my lucky numbers and begin to smile all the way to my bank even before the results were announced. But this is only wishful thinking. Trade Examples In Figures 3 and 4, the red vertical line on the left shows where a trade was entered and the red vertical line on the right shows where it was exited. Example 1: In Figure 3, an oversold region was capitalised on when the %R went below the -80 level on the hourly chart. The EMA had confirmed a strong uptrend on

F2) USD/CHF Bearish on the Hourly Chart

The same EMA on the 4-hour chart shows a bearish bias on the USD/ CHF hourly chart. What was to be done here was to identify a selling opportunity when the price went to the overbought region. Source: www.metaquotes.net

F3) A Nice Bullish Ride on the GBP/JPY

An over sold regio n was ca pitalised on when th e %R wen t below the -80 level on the hourly chart. The EMA had confirmed a strong uptrend on both the 4-hour and the hourly charts prior to this. The target was hit in less than two days. Source: www.metaquotes.net

F4) Selling a Rally on the USD/JPY

A vivid downtrend was verified on the 4-hour and th e hou rly ch arts. Then a rally was sold on the hourly chart. The position was closed after two weeks. There was a need to stick to the maximum trade duration. Source: www.metaquotes.net


both the 4-hour and the hourly charts prior to this. The market went up with alarming ferocity and the target was hit in less than 30 hours. Instrument: GBP/JPY Order: Buy Entry date: April 4, 2011 Entry price: 135.40 Stop loss: 134.40 Trailing stop: 136.90 Take profit: 138.40 Exit date: Apr il 6, 2011 Exit price: 138.40 Profit/loss: 300 pips

39 Example 2:

Please see Figure 4. After confirming a vivid downtrend on the 4-hour and the hourly charts, a rally was sold on the hourly chart. The position was closed after two weeks. If you checked your chart further on the 4-hour horizon, you would note that the market was trying to rally at the time of the smoothing of the position, which reduced the profit to 150 pips. The target would have been hit some days later if the position had been left

Strategy Snapshot Strategy name: Strategy type: Time frame:

Currency Swings Monitor Swing trading 4-hour charts and hourly charts

Indicators:

Exponential Moving Average (EMA) and Williams’ Percentage Range (%R) EMA 50 and %R 20, levels -20 and -80 In a downtrend, sell short when the %R goes above -20 (overbought region) on the hourly chart. In an uptrend, go long when the %R goes below -80 (oversold region) on the hourly chart. Orders type: Instant executions and pending orders Position sizing: 0.01 for each $2000 (thus making it 0.05 for $10000) Stop loss: 100 pips Take profit: 300 pips Risk-to-reward: 1:3 Trailing stop: Please see the section titled ‘Managing an Open Position’ Potential risk per trade: 0.5% Names of pairs and crosses: EUR/USD, GBP/USD, USD/CHF, USD/CAD, EUR/GBP, EUR/ CHF, USD/JPY, EUR/JPY, GBP/JPY, AUD/USD and NZD/USD Maximum duration per trade: Two weeks Note on hit rate: Long-term survival assured with only 33.3% hit rate Indicators parameters: Entry Signals:


open. However, there was a need to stick to the maximum trade duration. Instrument: USD/JPY Order: Sell Entry date: A pril 15, 2011 Entry price: 83.60 Stop loss: 84.60 Trailing stop: 82.10 Take profit: 80.60 Exit date: April 27, 2011 Exit price: 82.60 Profit/loss: 150 pips Conclusion

This article corroborates the hard fact that a simple strategy can lead to consistent survival if you let your profits run and give your open positions enough leeway. Your chart need not look like a Michelangelo painting before you can make better trades.is A simple trading approach what you really need to play the market, provided you want your trading life to be easier. Selling rallies in a southbound market and buying dips in a northbound market ought to be done with a clear-cut trading plan. Then more importantly, it is through sound position sizing and risk management that you can meet your strategic objectives.

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41 Generic Solutions to Trading Problems

Trading Templates Do you know how to use trading platform order types in combination to solve common trading problems like BUY LOW/SELL HIGH and BUY ON UP-TREND/SELL ON DOWN-TREND? Trading Templates might help you apply the right combinations of orders in each situation.

What Are Trading Templates? The computer software industry utilises the concept of “design patterns”: generic solutions to software design problems, which can be configured for specific applications by adjusting various parameters. We can adapt this idea in order to devise generic solutions to common trading problems like “buy low, sell high” and “buy high, sell higher”. However, the trading domain presents us with a dilemma if we adopt the term “trading patterns” because the word “patterns” already has connotations for traders; so in this article we will adopt the alliterative term “trading templates” instead. “What is the difference?” you may well ask. Whereas a financial “pattern” generally refers to observable we can use theprice term behaviour, “trading template” for descriptions of trading actions. Trading templates do not tell us what to look for; they tell us what to do to achieve a specific trading objective. Continuing to borrow from the software engineering discipline of design patterns, the idea is to present each “trading template” in a standardised form that includes the following: Name: A name that uniquely identifies this trading template. Objective:A description of the trading problem for which this


Tony Loton Tony Loton is a prolific trading and investment writer, and author of the book “Stop Orders” published by Harriman House. You can reach him via his Position Trading web site at www. lotontech.com/positiontrading.


42 template provides a solution. Used by: An indication of the type of trader who might use this template. Tools:The trading platform order types that this template utilises. A Stylistic Representati on: descriptive and pictorial idealised success scenario showing how the template should be applied. Failure Scenario:A descriptive and/or pictorial representation of the conditions that will cause the trading template to fail. Contingencies:Contingent measures that can be put in place to limit the adverse effects of failure. Variations:Ways in which this pattern may be adapted or enhanced. Now let us see a couple of example trading templates.

Failure Scenario:This trading template will fail when the price breaks out of the trading range and begins a sustained trend either upwards or downwards. Contingencies:When applying this template, the trader would typically position a stop order to sell just below the trading range and a stop order to buy just above the trading range, to guard against a price breakout. Variations:The basic template implies a long-only implementation in which the limit order to sell matches the limit order to buy pound-for-pound thereby closing the long position at the top of the cycle and waiting for the next cycle. A variation would be to limit buy at £1-perpoint and then limit sell at £2-perpoint thus establishing a net

The Limit Buy, Limit Sell Template Name: Limit Buy, Limit Sell Objective:Buy low and sell high. Used by: Swing Traders. Tools:“Limit Order to Buy” and “Limit Order to Sell”. Figure Stylistic Representati on: 1 shows a stylistic representation in which a swing trader places a limit order to buy at the bottom of a trading range and (at the same time) a limit order to sell at the top of the trading range. The trader banks the profit indicated by the arrow and then repeats the exercise.

short position at the top of long the cycle (switch directly from to short). A subsequent limit buy at £2-per-point would establish a net long position at the start of the next cycle, and so on. The Trailing Stop Buy, Trailing Stop Sell Template Name: Trailing Stop Buy, Trailing Stop Sell. Objective:To buy into a new up-trend, and to sell out when the trend comes to an end. Used by:Position Traders and Trend Followers. Tools:“Trailing Stop Order to Buy” and “Trailing Stop Order to Sell”.

F1) Limit Buy, Limit Sell Template

Figure 1 shows a stylistic representation of the Limit Buy, Limit Sell Trading Template. Source: TRADERS´ graphic


43

Figure Stylistic Representati on: 2 shows a stylistic representation in which a position trader uses a ‘trailing stop order to buy’ to chase down a falling price until it turns upwards, and then uses a ‘trailing stop order to sell’ to lock in an increasing amount of profit as the price trends upwards; until, as is inevitable, the trend comes to an end. Failure Scenario: This trading template will fail when the price does not trend and instead moves sideways within a range that extends just beyond the stop placements. The stop orders to buy and sell will be triggered repeatedly, causing whipsaw losses.

consider pyramiding into a continuing up-trend using risk capital that is freed up by the trailing stop order to sell locking in an increasing amount of profit. An interesting feature of this pattern is that our fixed trailing stop distances will automatically become tighter as the price goes higher. With the price at 50 our

In the case Contingencies: of stopping-out shortly after stopping-in, we should be careful not to be too eager to re-enter the position out of fear of ‘missing out’. It may be wise to wait for the price to fall even further such that a new trailing stop order to buy would execute below our last selling price. If the price rebounds upwards immediately after our stop-out, we simply accept this as a missed opportunity. We do not over-trade, and we avoid whipsaw losses. Variations:This pattern may be varied by altering the trailing stop distances. We might also

the price reaches thewould same trailing stop order 100 to sell stop out on a fall of only 10 per cent. Some traders will see this as a good thing – because the stop gets tighter as the price gets more “toppy” – and some will want to adjust the trailing stop distance periodically in order to preserve the percentage distance.

a financial security’s price will oscillate within a trading range (the Limit Buy, Limit Sell template) and when you think it may embark on a sustained trend (the Trailing Stop Buy, Trailing Stop Sell template). These templates are in fact composites of simpler templates – Limit Buy (alone), Limit Sell (alone), Trailing Stop Buy (alone) and Trailing Stop Sell (alone) that solve simpler trading problems like simply “buy low”. We might combine the Limit Buy, Limit Sell template with the Trailing Stop Sell template as follows; if the price breaks upwards out of the trading

Trading templates give ready-made answers to what you should do.


trailing stop order to sell at -10 (for example) would stop out on a fall of 20 per cent. When

More Trading Templates The trading templates presented here provide ready-made answers to what you should do, in terms of the trading orders you should place, when you think

range of the Buy, Limit template ourLimit protective stop Sell order actually takes us net long so that we can ride the newlyestablished up-trend (until it ends) using the Trailing Stop Sell pattern. Taking this to its logical conclusion we might imagine a complete catalogue of simple and composite trading templates that document the optimal arrangements of trading orders for all trading scenarios.

F2) Trailing Stop Buy, Trailing Stop Sell Template

Figure 2 shows a stylistic representation of the Trailing Stop Buy, Trailing Stop Sell Trading Template. Source: TRADERS´ graphic

EUR vs. USD

The Inverse Correlation Trade On May 5th European Central Bank President Jean-Claude Trichet suggested that Euro zone interest rates were unlikely to rise. The results were Euro futures tanked and the US Dollar bounced. Therefore, a strategy that takes advantage of news or events about currencies of strongly capitalist countries is a need which traders have. The Euro future is an excellent product to trade against the USD because it is inversely correlated by -97 per cent. The stronger the percentage the better this strategy works.


45 F1) USD 60 Minute Chart

Confirmation Tools and Euro Characteristics

Brandon Tristan Brandon has ten years energy trading analytical experience, working on the energy trading floors in Houston. He decided become an independent professional trader, so in 2007 he graduated from Online Trading Academy’s Professional Trader Course and continued his education in their Extended Learning Track Program (XLT). Since September 2009, he has exclusively traded the futures and the Forex markets.


Price action is most important to all traders. A great compliment to confirm this price action is the Commodity Channel Index (CCI). It is used primarily to identify beginning and ending of cycles in futures markets and is commonly used to indentify buy and sell opportunities. Before trade execution, the CCI confirms the price action. The CCI helps us manage the trade from stop, entry, and exit. A trend line will be used in combination with CCI confirmation. A trend line is a line drawn on support and resistance price points. It is a line at the top or bottom of the wick. Another item forAverage our risk parameters will used be the True Range (ATR). Most chart packages provide this study. This is an average over the last 14 one hour candles of the range of the product. If it were a 5 minute ATR this would be the range of the last 14, 5 minute candles. The Euro is a very nice vehicle that may produce excellent results for day trading. But we must understand the product that is used in the trade. The Euro price movement is per pip. Ten pips would be 0.0010. The Euro’s leverage is $12.50 per pip. A move of ten pips is $125 ($12.50

x 10 pips). It is very important to understand your risk parameters before taking any trade. Platform

Four charts are needed on your platform: A real time 60 minute USD, 60 minute Euro, 5 minute USD, and a 5 minute Euro. Set Up

Before entry, support and resistance must be determined. Shortly after determining support and resistance, the risk parameters will be calculated. Thus, the position used may be calculated as well. Step 1: Scanning the USD on

Step 1: A CCI reading between +250 and +300 for the pierce is required. Step 3: The CCI cross below +100 on the USD signifies a setup for a trade on the Euro. Step 8: Target is the CCI cross below the -100 on the 60 minute of the USD. Exit the position on the Euro. Step 9: If you have more than one contract exit half at the first cross below the -100 (Step 8) and move stop to breakeven, where tra de entry occurred. The last exit for the Euro trade shall be the next time the CCI crosses below the -100. Source: www.tradestation.com

F2) EUR 60 Minute Chart

a 60 minute chart, look for powerful pierce through thea +100. A CCI reading between +250 and above for the pierce is required. The CCI reading for this trade is +293.74. It meets these requirements (Figure 1, Step 1). Step 2: Next flip over to a

Euro 60 minute and look for a powerful pierce below -100 in the CCI. The CCI reading for this piercing is -269.43. It meets the requirements (Figure 2, Step 2). Step 3: The CCI cross back

below +100 on the USD signifies for a trade on the Euro (Figure 1,

Step 2: The CCI reading for this piercing is -269.43. Step 5: When the CCI crosses above the -100, put a trend line on the lowest 60 minute candlewick. The stop for the Euro will be the support less a 5 minute ATR. Step 8: Target is the CCI cross above the +100. Exit the position. Step 9: If you have more than one contract exit half at the cross and move stop to breakeven or where trade entry occurred. The last exit shall be the next time the CCI crosses above the +100. Source: www.tradestation.com


46

Step 3). With the USD CCI cross below +100, a resistance level has been established. Step 4: A trend line will be placed

on the highest candlewick that was formed after the CCI +293.74. The stop will be placed above the 60 minute resistance plus a 5 minute ATR (Figure 1). Place the stop and resistance trendline on the 5 minute USD as well (Figure 3, Step 4).

Entry Step 7:On the pierce of the CCI

above -100 on the Euro 5 minute enter trade on the open of the next 5 minute candle (Figure 4, Step 7).

Euro 60 minute CCI crosses above, then exit the Euro on the 5 minute with a pierce above the +100 on the second 5 minute candle after the pierce (Figure 4, Step 8). Move stop to entry after exit of 1st target. If you have more than one contract exit half at the cross and move stop to trade entry.

F3) USD 5 Minute Chart

Price action is most important to all traders.

Step 5: On the Euro 60 minute

chart when the CCI cross above the -100, put a trendline under the lowest candlewick on the 60 minute after the pierce. The stop for the Euro will be the support less a the 5 minute (Figure 2).on Place trend ATR line and stop the 5 minute Euro chart (Figure 4, Step 5). This was the last stage of the set up. In summary, the trendlines for resistance and support are now known for the USD and the Euro. More importantly the stops have been established. Now wait for entry. Pre-Entry Step 6: In order for entry to

occur, the CCI has to have dropped below -100 on the Euro 5 minute (Figure 4, Step 6). 07/2011 www.tradersonline-mag.com

Step 9: The last exit Risk Management

Manage the risk on the Euro by watching the price action on Figure 3. The price action of the 5 minute must not have a 5 minute close with strength above the Stop. If this occurs the Euro long trade will not succeed. Weakness on the USD needs for the Euro long tradetotoprevail work out. The risk on this specific trade is 30 pips. That is 30 * 12.50 = $375 for one Euro contract. Thus, the risk on this trade is for seasoned traders. Target Step 8:The Target is the CCI

cross above the +100 on the 60 minute of the Euro (Figure 2, Step 8). On the 5 minute Euro chart (Figure 4, Step 8), your first exit is the next candle after the cross above +100. If the USD (Figure 1) on a 60 minute chart crosse s below the -100 CCI before the

shall be the next time the CCI crosses above the +100 on the Euro 60 minute chart (Figure 2, Step 9).

Step 4: For Confirmation as the 60 minute USD CCI crosses the +100, it should also cross on the USD 5 minute. Place the stop and resistance trend lines on the USD 5 minute. Risk manage the entry on the Euro by watching the price action on the USD chart. The price action of the 5 minute shall not have a 5 minute close with strength above the stop. If this occurs the Euro long trade will not succeed.

Review

Price action observance and execution skills are very important in seeking this low risk and high reward trade. Focus and keep your on your relaxed so hand that you may mouse take advantage of this trading strategy. It is strictly for day trading only. Other products and indices that work inversely with the USD support and resistance are the E-Mini’s (S&P, NASDAQ, Russell), Gold, Crude Oil, the Euro, and the pound. Make sure you first examine the correlation of these other products against the USD and test this strategy before executing it with real money.

Source: www.tradestation.com

F4) EUR 5 Minute Chart

Step 5: Place support and trend lines (from the Euro 60 minute chart). Step 6: The CCI has to have dropped below -100. Step 7: On the pierce of the CCI above -100, enter trade on the open of the next 5 minute candle. Step 8: Target i s the CCI cross a bove the +100. Exit the position. Step 9: If you have more than one contract exit half at the first cross and move stop to breakeven or where trade entry occurred. The last exit shall be the next time the CCI crosses above the +100. Source: www.tradestation.com

47

An Introduction to Currency Trading

Finding Your Feet in Forex Your decision to enter the world of Fo rex trading will elicit an array of reactions from those nearest to you. Your mother may look to your father, shake her head and ask “Where did we go wrong?”; your colleagues may ask “Is that no t just gambling” or “Wow that is a risky business, can you really make a l iving from it?”; others will have no scruples in predicting your demise before you have even begun. It is often due to these myths that many do not venture any further into the Forex market and those that do often become overwhelmed by the magnitude and apparent complexity of the currency markets, resulting in a certain degree of desperation. It need not be so – believe it or not the Forex markets, but more specifically the major pairs, move quite ration ally and should you make the decision to commit time and resources, you can begin to read and anticipate price moves with a considerable degree of accuracy.


outset of every trading day. When economic data is released volatility increases. As a trader your immediate objective is not to understand the implication of the data but rather to interpret the price action after the release of the data and to look for low risk entries. A rule of thumb is to avoid trading in a currency in the 60 minutes preceding an announcement. As technical currency traders we have to appreciate that the fundamentals create the conditions for longerterm trends in the market and we utilise technical methods to enter those trends.

Fundamentals vs. Technicals As a technica l trader your job is not to predict but rather to anticipate market moves. When

the daily Forex market turnover), New York (respons ible for 17.9 per cent) and Tokyo (6.2 per cent). These hours translate to 8am local time at each location. Try to ensure you are in front of your charts at least an hour before each open. The two hours following the open generally offer the optimum opportunities for placing trades. Also be aware that holding positions through the weekend can expose you to unmanageable risk should an event, geo-political or other, unfold whilst the markets are closed. Long stretches in front of the charts do not generally result Trading Hours and Overtrading in higher profits. The opposite One of the most appealing factors is in fact true, especially for of the Forex market is the fact newcomers to this market. that it is open for 24 hours a day, Understand when conditions

you first you encounter technical analysis will probably be taught that all known information is priced in the market. Whilst this is true to a degree, a blinkered technical only approach is a sure route to losing money. Every Forex trader should have a basic understanding of global money flow caused by interest rate differentia ls and geo-political events, for example the status of the Swiss Franc as a safe haven asset and the Japanese Yen as a funding currency are important characteristics to understand. It is imperative that you consult an economic calendar at the

five and those a half days a week enables interested in which Forex to trade in the evenings when they have finished their day job. However this may not be the best approach depending on your geographical location. As a trader you need to optimise your market trading conditions as best you can. There are some key times of day to be trading due to the volume of participants present in the market. As a retail trader you need the larger players to be moving the market so you can effectively trade in their slipstream. The key opens are London (responsible for 36.7 per cent of

The Strategy You will come across a wide range of strategies when you begin to look for an approach or methodology in the Forex market. Beware not to be drawn to the over elaborate setups consisting of a plethora of indicators as this can often be quite intimidating to a new trader. When developing your methodology you will come to realise that a cleaner and simpler display of your charts will result in more concise trade planning and execution. Remember price action is the purest indicator you can use – learn it, listen to it and master it.

are optimum andtimes execute strategy at those – asyour you become fatigued your concentration and discipline may begin to wane and you could take impulsive, poorly planned trades. Stay fresh and hydrated, if opportunities do not arise in those approximate time windows, walk away and come back for the next session. Which Pairs? Probably one of the best pieces of advice I was given was to specialise in one currency, namely the US Dollar. The USD accounted for 84.9 per cent of

TRADERS´ BASICS

Gavin Knoesen Gavin Knoesen began trading futures on the South African Futures Exchange in 2003 initially in stocks. In 2007 he relocated to the United Kingdom where he moved on to trading spot Forex exclusively. His approach is technical with a high regard for fundamental factors and an extremely vigilant approach to managing and mitigating risk. He regularly reviews trades on his blog www.thetradersview.com.


48 the market turnover in 2010 and is still the world’s reserve currency. Make sure you are studying your chart of the USD Index. You will very soon learn the value of this. Once you have established your directional bias on the USD you will be able to conduct a relative strength exercise to determine which major currency to trade against the USD. Trading in the major pairs is a risk management tool as the majors have the highest liquidity and thus the tightest spreads. The chances of your stop being jumped are almost non-existent (unless you have held a position through the weekend or enter trades around a news release). The major pairs are EUR/USD, GBP/USD, USD/ JPY, USD/AUD and USD/CHF.

your trade plans converging on numerous intraday timeframes will become apparent. Daily Pivot Points are invaluable leading indicators. Pivot Points are calculated using the previous day’s price range. They have been used for many years srcinally by pit traders to mark significant price levels in the market and thus have a strong following. The basic premise of Pivot Points is that the Central Pivot Point (CPP) when acting as support will “propel” the price back toward Resistance 1 (R1) and then possibly onto Resistance 2 (R2). The converse is true when the CPP acts as resistance and the price will then fall towards Support 1 (S1) and Support 2 (S2). These areas between R1 to R2 and S1 to S2 are exit zones and therefore

Key of Tools One the most common mistakes new traders make is to choose a timeframe to describe their trading approa ch – “I am a 15 minute trader” or “I am a 60 minute trader”. This mistake of viewing a timeframe as a separate entity is a costly one and is often a difficult one to overcome. When planning an intraday trade be sure to analyse the charts from the daily timeframe down to the timeframe on which you intend to trade – on Mondays start on the weekly chart. Once you realise the market is dynamic on all levels, the importance of

should not be in the trade, act as ayou warning indicating thatwill the move is reaching an extreme and that new positions in the direction of the market should not be entered. Learn to use Fibonacci retracements – another accurate leading indicator. The key levels of 38.2 per cent, 50 per cent, 61.8 per cent and 78.6 per cent are the most commonly used in the Forex market, thus making them highly significant. Fibonacci will assist you in creating high probability trade plans at areas of support where other factors converge, such as support and

F1) Daily Forex Volume 2010

Figure 1 shows the daily Forex volume in 2010. The EUR/USD is the most liquid currency pair, followed by the GBP/USD and the USD/JPY. Source: www.bankofengland.co.uk

TRADERS´ BASICS

resistance lines, moving average and/or Pivot Points.

49

indicators start with material on building and maintaining a positive and disciplined mindset. Mark Mind Games Douglas’s “Trading in the Zone” Perhaps the most exciting and yet is a near compulsory read on this daunting fact is that on this journey subject. to becoming a successful Forex trader you will eventually realise Beware the Guru that success and consistency There is no shortage of statistics have very little to do with which illustrating the Forex market to be indicators you decide to use and both profitable and/or dangerous. more to do with your mindset. What is interesting h owever, is This is not exclusive to Forex that these stats generally form trading and I am sure you have part of some or other sales pitch read many articles on the subject by many self proclaimed “Guru’s”. of trading psychology. I would Strangely enough the attrition however recommend that before rate of new traders reported by immersing yourself in reading brokers is significantly less than material focused on strategy and those claimed by these salesmen.

The lofty promises made in much of their marketing material is purely emotive and whilst there are traders who have grown small accounts into significant six figure sums it would be naïve to believe that these traders would need to, or even desire to sell their system for $99. These black box systems are often constructed on the use of historic data that has been optimised to produce maximum returns and thus in real time the system will not produce the same results. I find it interesting that on many of the model portfolio screenshots that appear in the marketing material “demo-

account” will appear at the top of the screen. There is no quickfix or get-rich-quick approach in Forex. These advertised high rates of return are often an indication of over leverage and/or a system with a skewed expectancy ratio. As a Forex trader your objective is to build a sustainable business. Every business person needs to understand their industry and tools so as to posses an edge in order to profit, and this business is no different. Persevere

Forex trading is one of the most rewarding and challenging

Chart Junkie I trade daily, and I always want to have complete control over my charts. At Tradesignal Online, I can find the international price information and professional tools that I need for charting. And it's all done through my browser – free of charge. My charts, my analysis, Tradesignal Online!


journeys that you will embark on. The truth is if you treat it with due respect and give it the time it deserves it will reward you generously. The early days will be tough, be under no illusion of that, and will require discipline, patience and hard work. You will learn many things about yourself and your character, but be assured that when you summit that initial mountain, the view is beautiful, the satisfaction sweet and the lessons learnt are absolutely invaluable.

TRADERS´ BASICS

50

As a stock market investor, understanding the company you are putting your money behind is a key rule – what is their product, and how good are they at selling it? While the questions are simple, the answers can be complicated, meaning investors may be forgiven for sticking to companies belonging to the same industry. After all, each sector has its own set of rules, and it is a lot easier to assess a new company if it fits into a structure with which you are already familiar. However, it is crucial to be aware how the different industries encompassing the market-listed companies can be vastly different

Why It Pays to Understand the Unique Attractions of the Stockmarket Sectors

Industrial Advantages Each of the stock market’s industry sectors brings with it a unique set of promises for the investor. Learning more about them will ensure you get what you are looking for. A little knowledge of the industry food chain will go a long way, whether it is coming to grips with components and logistics, or a bet on which sector will be the next key beneficiary of macroeconomic movements.

from each other. A personal interest may mean you prefer investing in companies in the retail market, but you would be well advised to consider whether this industry’s characteristics are compatible with your investment needs. For example, if you are a pensioner investing on behalf of your grandchild, you can afford to take a long view, and this means higher-growth sectors such as technology or media may be better choices. Investing for kids means plenty of time to ride out shorter-term value fluctuations. On the other hand, if you, as a pensioner investing

TRADERS´ BASICS

51 on behalf of yourself, you are looking at a shorter timescale and may want to consider more stable areas such as utilities or telecommuni cations, where the risk of short-term losses are lower. Reassuringly Boring Utilities, telecommunications, food retailers and pharmaceuticals are all defensive sectors, which performed well during the recession due to their stable customer markets. Limited risk does, however, mean modest scope for share price growth, and what is reassuringly boring in hard times may start to look just plain boring when the market is doing well. Many investors may still choose to stick to the defensive sectors, where

Jessica Furseth Jessica Furseth is a Londonbased investment journalist specialising in the technology, telecommunications and renewable energy sectors. For contact details, see: www.jessicafurseth.wordpress.com


the risk oflow losing money is relatively andyour the companies compensate for the lack of growth by offering something equally attractive: dividends. The utility sector is the classic dividend play, consisting of water and power groups operating under regulated conditions. While not subjected to the same level of regulatory pressures, telecommunications groups may have similarly limited scope for growth because the market is saturated and highly competitive. Also on the list of defensive industries are healthcare equipment groups

and manufactures of household goods such as diapers and laundry detergent. Dividend Control Investors should bear in mind that while these investments should remain quite predictable, even these companies may become derailed due to changes to regulation, new competition or lack of innovation. For example, the UK water sector is subjected to a regulatory review every five years, an event that never fails to rattle the stocks. Following what was considered by the industry to be a harsh review in 2009, several of the UK’s water companies were forced to significantly reduce their dividends, most of all United Utilities (UU:LSE), which cut its payments by 21.2 per cent

F1) Emis

in Companies the year to March 2010. may start paying out dividends once they reach a certain level of earnings, and this will usually boost the stock’s stability. Even if earnings are high, it is more rare for companies belonging to typical growth sectors to pay dividends, and if they do it will be small. Companies in sectors such as oil exploration and technology will usually channel their earnings back into the company to accelerate growth. One notable exception to this rule is hazard detection technology group Halma (HLMA:LSE), which is one

Figure 1 shows the share price performance for Emis (EMIS:AIM) from its stockmarket flotation on 29 March 2010 to 31 December 2010. Source: www.advfn.com

TRADERS´ BASICS

52

of the UK market’s most stable dividend payers. The company has raised their full-year payouts by over five per cent each year over the past 30 years. The group is however conscious of driving growth, and will ramp up investment when its profit margin closes in on its 20 per cent target. Fast and Furious Risk-tolerant investors looking for a blue-sky punt may also find it useful to educate themselves about the merits of the various stockmarket sectors. Biotechnology is an example of a notoriously tricky sector, where companies spend years

May 2010, peaking at 508p in September the same year. A more stable commodity play is gold, not just as the pure metal but also the listed miners. As investors seek refuge in the precious metal as a hedge against uncertainty, one shining example is how shares in Randgold Resources (RRS:LSE) have risen by 2,712 per cent in the past decade.

Wincanton (WIN:LSE) and ACM Shipping (ACMG:LSE) also boast notable dividend yields, at 6.6 per cent and 5.3 per cent last year respectively. This will protect the stock on the downside when times are tougher. Following the food chain will also reveal how electronic component manufacturers slot into end products. For instance, ARM Holdings (ARM:LSE) i s the designer of the brain in 98 per cent of the world’s mobile phones, collecting royalties with each sale. The semiconductor industry is notoriously cutthroat, however, so things can change quickly. On the other hand,

Biotechnology is an example of a notoriously tricky sector.

developing drugs andthe where a lot can gonew wrong. Back right one, however, and you will be telling the story for years to come. Technology and cleantech startups fall into this category also, and so do the smaller oil and gas explorers. The oil minnows will often be sitting on nothing but the extraction rights to an unexplored area, where they may or may not find resources. For example, oil driller Rockhopper Exploration (RKH:AIM) saw the shares shoot up by 1,273 per cent after the company made an oil discovery in the Falkland Islands area in 07/2011 www.tradersonline-mag.com

Moving up the Food Chain The market is not home to a host of companies visible when walking down the high street, but still playing a crucial role in our daily lives. Industrial transportation is one example here, encompassing companies operating across areas such as ship broking, aviation services and logistics. While it may not sound like the most exciting bunch, these shares may be of interest due to their sensitivity to overall economic growth; the volume of goods moved correlates closely to the health of the economy. At the same time, companies such as distributor

F2) Rockhopper Exploration

product development new gadgets run over cycles severalfor years, meaning a contract signed today will continue to bear fruits in many years to come. Back to School The large chemicals companies also have their fingers in many pies, but similarly to the components groups, the operations can look complicated. Take leading materials technology group Johnson Matthey (JMAT:LSE), which broadly speaking, trades and processes platinum and it also manufactures catalytic converters for cars.

The share price performance for Rockhopper Exploration (RKH:AIM) between 1 January and 31 December 2010. Source: www.advfn.com

TRADERS´ BASICS

Companies should try and make it as easy as possible for investors to understand what they do, but this can be tricky for the most scientifically advanced players and investors can find themselves facing hours of homework. With large companies, investors can look to factors such as year-on-year earnings growth to see whether their methods are successful, even if they do not fully understand how it works. This is not possible when dealing with a company that is yet to be profitable, however, as the market value is simply a reflection of unproven potential. While understanding the company’s operations is always important, it

53 is especially crucial when dealing with a start-up. Last year’s share price movements at Oxford Catalysts (OCG:AIM) were testament to the group’s progress with an intriguing new catalyst for clean energy generation. In cases like these, investors should pay extra attention to the company details, as Oxford Catalysts was years away from profitability with an unproven technology. Even an investor with a sound understanding of the chemicals industry may have found themselves in deep water with Oxford Catalysts, as its business plan hinged on attracting the interest of companies in neighbouring industries such as oil and gas exploration.

Case Study: An Alternative Approach Most of the time, a company’s sector allocation is self-explanatory, but there are times you may be excused for feeling bewildered. Take Emis (EMIS:AIM), which is classified by the London Stock Exchange as a constituent of the Software and Computer Services sector, and within that, in the Computer Services sub-sector. During the recession, the computer services companies underperformed the other sub-sector, called Software. Emis was a notable exception to this. Part of this can be explained by the fact that Emis was a new market listing in a time of slim pickings. Even so, much of this reputation for quality stemmed from the fact that Emis operates exclusively in the healthcare market, servicing solid customer groups such as doctors’ offices and health clinics. Companies providing traditional computer services, such as delivering and running information technology systems, were struggling through a period of slow customer sales in 2010, but Emis managed to escape this fate by having a foot in the healthcare sector. The stock reflected the much more stable ordering pattern of this industry, boosted by the fact that the UK healthcare industry had long been under-invested in technology such as that sold by Emis. For those investors who understood the drivers of both these sectors, the logic was clear.


Old Adages and New Disruptions A quirk of the market is how excitement surrounding a stock market sector will benefit all its constituents, not just those who deserve it. It was investment guru Warren Buffett who coined the phrase, ‘it is only when the tide goes out that you learn who’s been swimming naked.’ While seemingly similar, each company comes with a unique set of circumstanc es that become clear once the hype passes. In the same vein, a big company’s share will behave differently than a smallcap, even if the companies belong to the same sector. This was demonstrated during the recession, when a reluctance to back less secure companies

insecurity in the past years are the media and publishing industries. Their business models are being disrupted by technological advances; such as illegal music downloading and the availability of free news on the internet. At the same time, social media groups are starting to sniff at the potential of m arket listings, although few have yet to develop any semblance of solid revenue generation. Investors interested in this dynamic but uncertain area, need to check their appetite for risk before digging in.

meantmar constituents of London’s junior ket AIM were s avagely sold off. As confidence returned, AIM investors we re rewarded by a stronger recovery; compared to its lowest level in March 2009, AIM had ris en by 140 per cent by the end of 2010, compared a 65 per cent gain for the constituents of the FTSE 350 in the same period. While we can learn a lot by looking at how sectors have behaved in the past, do bear in mind that the future can throw up a few surprises to disrupt old adages. Two sectors having experienced a fair amount of

macro-economic This means that if you climate. can identify where we are in the economic cycle, you can take advantage of the somewhat predictable nature of sector rotations and trade depending on where we are in the economic cycle. For example, the tobacco industry performed well during the recession, as this is an industry with stable demand and is hence seen as a ‘safe haven’ in times of hardship. However, as we entered the recovery, investors were eager to collect on growth and moved their money into sectors such as automotive,

Economic Cycles: the Latest Fashions Which sector happens to be in vogue at any given time is largely dependent on the

travel and leisure. These sold off heavily in the recession and were due for recovery. A bit of com mon sense goes a long way to understand where a sector fits into the economic cycle, but a look back at longterm share price patterns will also provide some information about how stable a share can be expected to be in the future. This is called ‘beta’. Essentially, if a sector’s beta is less than 1.0 the investment will be more stable than the market, and if the beta is higher than 1.0 it will be more volatile. If you invest in high beta sectors such as airlines or biotechnology, you can expect the stocks’ values to fluctuate, but there is also the potential of more return. A pharmaceutical company or a utility, on the other hand, will likely have a nearneutral beta, reflecting the high stability. It is unlikely you will lose money, but you pay for this by also being unlikely to see any extra gains. Most interactive investment software will let you look up a company’s historical beta, but be aware that these numbers will change should any significant new information enter the mix. As with any statistic, it should not be viewed in isolation.

55

Trigger, Order Management, Filter

Building and Applying Your Trade Plan What is the trigger? Just have the right trade trigger and you will make millions in the markets – right? We all have seen many traders come and go – and yes, as everyone knows 80 to 90 per cent of traders are in fact losers. If the MACD crosses up, Stochastic rises above 81.54, the lunar bands widen to the point it intersects with the polar ice caps – then go long – with a two tick stop. Or maybe I got that Stochast ic parameter wrong, was it 81.53? T his may be amusing but often this describes how many traders think. Traders either have such a complicated Trade Plan or none at all, leaving many traders with trading approaches marginally better than throwing a dart. So does having a well defined Trade Plan really work or is trading just about having the right feeling in the market? In this article we will explore one approach to building and applying your own Trade Plan.


The three parts of the Trade Plan design theory are: the trigger, order management and the filter. So many traders only focus on just the trigger, that they completely forget about the other aspects of the Trade Plan. If we were to break down the percentage of importance of these three parts, we would break it down as follows; the trigger is 40 per cent, order management is 40 per cent and the filter is 20 per cent. Remember, trading is a

correct, relative to the size of your account. First are you over leveraged? A common error for many traders. One should try to maintain 50% liquidity with in a given trading account. Also set realistic profit objectives and draw-down limit percentages. A good rule of thumb is to have around a 10 per cent monthly trading profit target with a 10 epr cent to 20 per cent draw-down limit. Too many traders lever up so much, that its almost a

trigger set-up conditions are limitless. Your Trade Plan can have multiple strategies in order to have a toolbox of potential Trade Plan types, to take advantage of all types of market conditions. However, it is good to understand the basic trade Trade Plan types in order to look for specific trade indicators that support the type you are trying to trade. One can break down most trade triggers into three basic types of trades. The counter

percentage traders only have a game. slight Often percentage advantage over breakeven to be profitable. So leave any one part out of this Trade Plan approach, and you could become a loser. Before we go into detail of these Trade Plan aspects, a quick word on risk management. Risk management for a trader is always job one, but it is the framework to which your Trade Plan fits, it is not the Trade Plan.

guarantee that they Show will eventually blow their account. me a trader that says I make 20 per cent to 40 per cent per month or leverages 100 per cent of their account consistently and I will show you most likely a losing trader. Analyse well your account leverage parameters with your typical profit/loss ratios, if it falls outside these parameters you may want to reconsider your Trade Plan strategy.

Risk Management Risk management guidelines are to ensure that your risk percentage parameters are

The Trigger The trigger is the actual technical set-up conditions that cause you to enter a trade.The potential

trend trade trade, and the breakout forward trend the continuation forward trend trade (i.e. enter on the pull back). Most triggers can be placed into one of these basic types of trades. Trade indicators line up into three types as well; support-resistance-t rend lines, price derived indicators (i.e. MACD, moving averages, Stochastics, etc...) and time and price patterns (i.e. candle stick hammers, flags, head and shoulders, etc). The idea when designing your trigger is to use the trade indicators that will identify the entry point of the trade type you

TRADERS´ BASICS

56 wish to trade. In addition, having several trade indicators that line up to validate the trigger of the trade type, on multiple time or period basis, will give the trigger a higher percentage success rate. Each trigger will have a different order management and filter strategy and cannot be looked at in isolation to the other parts of the Trade Plan approach. The error most traders make is that either they have no trigger or the trigger is too complicated. Remember this is only 40 per cent of the Trade Plan design and only eight per cent of the overall building and applying approach effort, so do not place too much focus on this. Order Management

William Thompson William Thompson is the Managing Director of Blue Point Trading, a boutique proprietary trading firm. If you would like more information about this article, trader opportunities or Blue Point Trading, please feel free to contact us at www.blue-point-trading.com.


There aresecret two aspects and a trader‘s that one must consider in order management. The two aspects are knowing the projected win/loss ratio and properly applying it to a correct profit target/stop loss ratio. These ratios must correlate to the type of trigger of your Trade Plan. If you have a two tick stop and a 100 tick profit target – what you are saying is that you can call market tops and bottoms – most likely a losing Trade Plan. A two tick profit targ et and 100 tick stop loss ratio with a win/ loss ratio of even 80 per cent, is a losing Trade Plan. There

must be reasonable symmetry in these ratios in order to be profitable. Many traders have not considered this simple math. In addition, they often have too tight of stops and too tight of profit targets. Which brings us to the trader‘s secret. Where most experienced traders make money is in their ability to trade a fade in and fade out order entry and exit strategy. This is the real secret in trading – not so much the trigger, though it is important as well. Fading a trade allows the trader to change their entry and exit position when they discover that in fact the initial trade set up was not quite exact. It is very difficult to see how anyone trading can be a winner over time if one does not understand and implement this order management concept. The Filter After you get th e trigger an d order management right, the filter is the last concept that is extremely important to put you over the top from being a losing to a winning trader. The idea of the filter is to put a cautionary thought in your head before you push the buy or sell button on your computer. There are two parts of the filter. The first is the obvious news event or a planned report that comes out to the market. Each trading day you need to be watching for these planned

F1) Building and Applying Your Trade Plan – Overview

This figure shows the process of building and applying your trade plan. Source: www.blue-point-trading.com

TRADERS´ BASICS

and unplanned events to filter out potential bad trades that can cause sudden reversals that invalidate your Trade Plan. The other part of the filter that is important is to understand that the market is made up of humans that do very predictable human things. They eat, sleep and play at set times of the day. You may have noticed that there are natural daily cycles that need to be respected in your Trade Plan. For example, the London and New York morning sessions tend to have continuation moves followed by retracements during their lunch periods as traders take off their positions and go

57 eat. These filter concepts need to be incorporated into your Trade Plan. A practical interactive coachi ng approach is the next step in the building and application of your Trade Plan. You may feel that you understand the Trade Plan principles and have designed a good Trade Plan, but this means that you are only 20 per cent on your way. The other 80 per cent is about the application of your Trade Plan into actual trading. One should strongly consider having a trading coach to help the trader with a systematic approach. Traders often struggle equally with Trade Plan definition

and its application, but the application is by far the most time consuming. A good t rading co aching approach should consist of three parts: design, trade and refine. The thrust of this coaching starts by your coach validating that you are defining your Trade Plan theory adequately. Then during the Trade Plan application period, the trader should keep a Trade Journal. Regular follow ups with the trading coach should occur, by together matching the Trade Journal with the Trade Plan. Deviations from the Trade Plan will need to be explained and corrected in future trading.

Often you will need to refine the Trade Plan by returning to the design phase and make adjustments to the Trade Plan from actual market lessons learned. This process never ends as one must repeat this process continually as market conditions warrant. The trader then begins to progressively augment their capital base as the trader proves their capabilities. This is just one Trade Plan approach, perhaps you have your own, but experienced traders know, having a detailed Trade Plan is not only useful, but required to be a successful trader. Trading the markets is not

Trading System Arti st I trade by my own rules with my own system. Tradesignal Online gives me over 500 ready-made trading systems and a complete code editor. Then there's a professional charting tool with back-testing and a large community with whom to exchange strategies. My idea, my strategy, Tradesignal Online!

07/2011


about just having the right feeling. The feeling part comes when you have successfully executed your Trade Plan repetitively enough, to the point it becomes so ingrained in your mind, that one may call it a feeling. However this feeling is based upon a specific set of rules that is quantifiable. For the truly motivated, having a good Trade Plan and the right coaching approach to help apply its implementation, you too can become the consistent profitable winning trader.

59

Thomas Kahdemann Elliott Wave Is No Hocus-Pocus Thomas Kahdemann (45) was a securities advisor at a German retail bank from 1987 to 1995 and later an asset manager and derivatives specialist. In 1995, while working for REFCO INC in Chicago, he completed his derivatives training at CME and CBoT and subsequently worked for a major bank in Switzerland as a proprietary trader (bonds, stocks, derivatives). From 1997 to 2007, he was an asset manager for wealthy individual clients, and then in 2007 became a managing partner of the KBG consulting firm and KBG Asset Management GmbH. Together with his colleagues Sven Benniss and Juergen Gindner he manages the asset-management UI Fund of the KBG Athene portfolio (Securities Identification Number: A0YJF7). Technical analysis constitutes an essential component in a company’s fund management. During his time in the US, Thomas Kahdemann was able to enhance his knowledge of Elliott Wave, Gann, Fibonacci and market psychology, and uses it now actively on a daily basis. Marko Graenitz went to see Thomas Kahdemann in his trading office for a day and interviewed him exclusively for TRADERS´. Look forward to an exciting interview.

04/2011 05/2010


TRADERS´: When did you first undiminished motivation and come into contact with trading kept providing encouragement, for which I obviously continue and the stock market?

still organised traditionally and was not as standardised as it is today. For example, we said “buy

Kahdemann: That was at the age of 14. I was fascinated by the stock market from the very beginning. I read everything about it that I could get my hands on. At 18, I went on to make my own first few trades while completing my training programme at a bank. I can still remember vividly that my first trade was a call on Hoesch, which promptly ended in a profit. At that time I traded under the supervision of my superior at work, who was also my role model in trading for a long time. He and other supervisors recognised my

a call and not “long Theoption” new terminology and call”. standardisation only came with the launch of the German Futures Exchange (DTB) in 1990. What many people today cannot even imagine any more is the fact that in my early days, we did not constantly receive new quotes – although we did our trading in a bank. On the contrary: Every day at lunch time – around 1 pm – the update reached us by telex. As can be gathered from that, the whole financial market and the technology that goes with it have since made tremendous strides.

to be“stumbled” very grateful. This I then into theway assetmanagement department, which enabled me to establish myself there. TRADERS´: How successful were your early days? Kahdemann: Actually, things were going well from the very beginning – even though I initially tried out many different trading techniques. As instruments, I almost exclusively used options on individual stocks such as Mannesmann, Volkswagen or – as before – Hoesch. At that time the entire options business was

TRADERS´ PEOPLE

TRADERS´: Let us stay with the “old days”. How did you experience the big stockmarket crash in 1987? Kahdemann: That was really a remarkable experience in my career. Throughout that year I had built up several positions in various put options with a ninemonth maturity. Initially, they were not doing very well since markets rose significantly longer than I had expected. At this point I had already written off these positions, because their value was virtually zero, and a sale would not have been worth it any more. In the second half of 1987, I was completing part of my military service and for long periods of time only learned from press reports about what was happening in the economy and on theexactly stock market. remember becauseI Istill was sitting in the barracks office on the day after the crash and came across a newspaper there, from which I learned about the whole thing for the first time. At a stroke, my options were really worth something and I went on to smooth my trades. Overall, I made a decent profit from this extreme event.

60 the New Market because I was suspicious of the whole thing. I had bought none of these preposterously high-priced shares, although with the right timing it was, of course, possible to achieve incredible returns. However, it turned out to be not too bad that I was not in on this rally because things went very well for me in the bear market from 2000 to 2003. There are certainly not many people out there who can say the same thing for this period. TRADERS´: So you have developed a forte for the short side in the market? Kahdemann: I think so. Time and again, I have managed to achieve a decent return during periods of falling prices. For example, my

“apprenticeship” the Eurex market fell into a on period when the stock market was in a markedly downward trend. That was at the time of the First Gulf War in 1990/91, when many shares recorded heavy losses. It is important to recognise that you can make money much faster on the short side than with positions on rising prices. This is not only the case with extreme events such as the TRADERS´: How did you 1987 crash, but is a general experience the other extreme, phenomenon. When prices fall, the price bubble during the this will happen much faster than New Economy? is the case with a price rise by the Kahdemann: I completely missed same amount. 07/2011 www.tradersonline-mag.com

In addition, falling prices tend to overshoot, since some market participants have to liquidate, sometimes causing fear and panic to spread. It is important to know that most of the time markets do not tend to clearly move up or down, but sideways. For this reason, I believe that many traders and investors lose a great deal of money in lateral movements when they are trying to pro-cyclically buy into strength and sell weakness. TRADERS´: So sideways markets will be “bought into”? Where are errors being made? Kahdemann: Of course, there will always be those market participants who “buy into” upward or downward trends. I think the basic problem is that there are many people with really good analyses who can nevertheless gain no added value from that analyses. In other words, many experts are essentially right on what they conclude from their analyses – but they are often right at the wrong time or they are using the wrong instruments. This is one of the biggest problems in the whole trading business since the assessments made mostly turn into reality – but unfortunately at the wrong time. There are many examples of good and correct scenarios where users have “starved” along the way,

F1) Much Ado about Nothing

The 15-minute chart of the DAX future of early April 2011. On balance, the market has not moved during this period, but there is no doubt that many market participants have lost a great deal of money at the same time. Source: www.tradesignalonline.com

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because the markets at that time just did not want to play along. So we have to try not only to be right, but also to identify opportunities at the right time and to trade accordingly. To make that happen, you need a method of analysis that you can trust and that makes the right timing possible for you. And for that, you certainly need a lot of experience.

downward trend, the impulse wave 1 is the start of the upward trend, which continues to wave 5. This is followed first by three corrective downward waves a, b, and c, and then by a new cycle. This describes the Elliott Wave in general terms. It is important that each and every wave can in turn be subdivided into the cycles 1-2-3-4-5-a-b-c. The reason for that is that the markets are of TRADERS´: The word “method a fractal nature, i.e. the same of analysis” makes us wonder. patterns are shown again and You use a very special method again – no matter how far we of analysis: the Elliott Wave. We“zoom in”. have already heard and read a lot about it, but on this issue TRADERS´: Elliott Wave is there is a lot of beating around ridiculed by some market the bush. Can you explain to us participants or described as simply and intelligibly how the “hocus-pocus”. What can you whole thing works? say in its defence? Kahdemann: During my time in Kahdemann: That is exactly

based on my conviction of the underlying wave theory, I believe in the functioning of the method, and that is good enough for me.

Chicago at REFCO, I developed a comprehensive understanding of the Elliott Wave and obtained background information on it. There is a great deal of literature that is sometimes not entirely clear since it is open to different interpretations. The classic authors are Alfred J. Frost and Robert R. Prechter, whose publications I can fully recommend to everybody. However, the Elliott Wave principle is quite simple. The basic assumption is that markets move in waves, in a pattern of the 1-2-3-4-5-a-b-c sequence (Figure 2). Based on a previous

analysis and charting quite generally. Where exactly do you see the added value of these analyses? Kahdemann: Well, charting in particular may be a self-fulfilling prophecy. This idea is widely known. However, it only works if as many market participants as possible take part and there is a clear mainstream that dictates the direction. Such a mass of people – let us call it a “herd” for pragmatic purposes – will make certain mistakes over and over again – even if some individuals know that it is wrong. Charting and technical analysis rely on


the beautydoes of the stock market: Everyone what they want to and what they think is right. And in the end success will vindicate us – or it will not, as the case may be. In my estimation, Elliott Wave is no hocus-pocus at all. However, technology is not rigid and there are different interpretations, so that the whole thing is impossible or only extremely difficult to squeeze into a mathematical description, by means of which objective retrograde calculations of the strategy are possible. From personal experience of the application of the Elliott Wave and

TRADERS´: What exactly is the difference between the Elliott Wave and Gann? Kahdemann: The Gann technique is essentially a gradient system, which divides the chart into different clusters or regions based on a distinctive high/low range. The whole thing is based on the relationship between price and time and can only be represented superficially by conventional chart programs since the subtleties require a real logarithmic scale representation.

F2) Elliott Wave Pattern

TRADERS´: You also use instruments of technical

Here is an ideal 1-2-3-4-5-a-b-c-model of the Elliott Wave basic theory for an overall upward trend. The impulse wave is composed of five waves, of which three are pointing up (1-3-5) and two are pointing down (2-4) in the overall upward trend. The corrective wave consists of three waves, of which two are directed downwards (a-c) and one is directed upwards (b). Impulse waves always run in the direction of the overall trend and for orientation purposes are usually labelled with numbers while corrective waves are labelled with letters. Within each sub-cycle the same pattern again occurs in miniature (fractal nature of the markets). Based on this pattern, there can be further divisions into more subtle qualities. One example is that a simple wave 2 is often met later by a complex wave 4 and, conversely, a complex wave 2 is met by a simple wave 4. Sources: R N Elliott, “The Basis of the Wave Principle”, October 1940; Wikipedia (posted by user “Masur”).

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just such re curring pat terns of behaviour, and for this reason, these forms of analysis can work well when used correctly.

TRADERS´: You have to then try to take advantage of mass movements for yourself? Kahdemann: Yes, but that is not exactly easy either. After TRADERS´: What exactly do all, you usually are not sitting you mean by “used correctly”? in a helicopter, but are rather a Kahdemann: What I mean by that sheep in the flock. I am trying, is that during the first third of a metaphorically speaking, to movement I want to be there – position myself well in the crowd, to and need to, since it is otherwise be sensitive to changes and then no longer worth beginning to be flexible enough to anticipate build up my positions. In using the new direction as early as this one-third strategy, I want possible. Of course, this does not to make sure that the majority always work but when it does, I of market participants will enter am followed by the greater part of after me and drive prices in my the mass, which then drives prices direction. further in my direction. So I try to use the delay that TRADERS´: Can you elaborate occurs between the faintly discernible change in the on this? Kahdemann: Try seeing the direction of the bellwether and market as a mere mass of the last apparent directional push

the case, or else any other information would always be worthless. But when it comes to making good trading decisions, I actually do find all the necessary information on the chart. Of course, you must be prepared to let go of the stream of news and emotions on the market, take a step back and look unemotionally at the whole thing from a certain distance. From this perspective, you can then apply a proven strategy that takes advantage of certain constellations and patterns in the market. It is important that things do not get too complicated here. So keep your strategy as simple as possible and avoid overly complex interpretations since this can exert unnecessary pressure on you while trading in real time.

individual playersThis flowing in best a certain direction. works from the helicopter perspective from which you look down in your imagination on that mass of people as you would on a large herd of animals. Now if the “bellwether” at the front of the herd changes direction and the first few animals begin to follow him, then what is the back of the herd going to do? Right, they have not noticed the change in direction yet and first continue to run in the wrong direction. As they say, the devil – or in stockmarket terms – the prices take the hindmost.

TRADERS´: Do you use fundamentals as well? Kahdemann: Knowing a few rough fundamentals is certainly not a mistake. However, eventually multiples, such as the price/ earnings ratio (PER), invariably are nothing but relative ratios, causing them to be too vague for decisionmaking purposes. E.g. it is possible for a stock with a PER of 15 to be a clear candidate for sale in a bear market, but to be considered a hot buy candidate in a bull market. In between those two phases, however, the assessment of the stock may be anything but clear.


on the part the stragglers the herd. If Iofenter in the first of third of the movement and can predict the last third reasonably well, this tactic will, on average, stand me in good stead. TRADERS´: In order to properly assess the herd, the way in which you deal with information is key. What does your approach look like? Kahdemann: We live in an age of vast information overload. I therefore simply assume that all the information can be found in the chart. Of course, I know that in reality this is not always

F3) Elliott Wave Extension with Silver

A fin e exampl e of how a final wave can extend upwards. Within the upward wave from Point 4 to Point 5, a brief correction is formed, after which the movement continues dynamically, causing the wave to be “stretched”. Within the extension the sub-waves 1 to 5 (marked green) can in turn be detected. Source: www.tradesignalonline.com

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So to be able to assess the stock, you need to know or appreciate many other factors, which means that it is a) complex and b) in need of interpretation. How much easier it is to leave all the ratios to the analysts and get the information for your trading decision from the chart.

components. Can you explain this to us in more detail? Kahdemann: We use Eurex strategies and my trading model as well as a traditional asset allocation with Exchange Traded Funds (ETFs) and individual securities (stocks, bonds, commodities ) with me basically trying to hedge currency risks. TRADERS´: What other insights From a trading perspective, of gained in your trading career course, the Eurex strategies and, are crucial for your success? above all, the trading model are Kahdemann: There are essentially the most interesting components. two things: First, I would say that While the latter is based on the you should not take advantage previously described techniques of every movement down to the such as Elliott Wave, the Eurex last euro in profit. In other words, strategies involve using other, do not touch your last euro. It but also discretionary items. I am is impossible anyway to catch using the full range of strategies. the exact highs and lows, so we One possibility is marketshould not even try. I would rather neutral strategies which involve be on the early side with my my building up long and short

Kahdemann: Yes, because it always depends on what I get offered and where. And as we all know, conditions are constantly changing. For example, the relative performance of different asset classes is important. If I can get high interest rates at low to moderate inflation – i.e. an attractive real rate of interest – I will increase my fixed-interest investments. There were, for example, very high real interest rates during the reunification of Germany. But if, as is the case now, money is “cheap” and on par with inflation, this would be unprofitable or even lead to a loss of value. I therefore increase the trading component, i.e. the weight of my Eurex strategies and my trading model. By the way, the whole thing can be seen as a kind

entries and exits opportunity in thethan end.miss the The second insight, which I fortunately gained long ago with the help of my mentors is that the stock market and in particular trading is a huge shark tank, where there is only one goal: survival. This in turn implies that it is all primarily about risk management and only secondarily about the maximisation of profit. Those who choose to ignore this will very quickly be“eaten”.

of “trade”, albeit of a strategic nature.

TRADERS´: Your trading strategy includes three 07/2011 www.tradersonline-mag.com

positions in different securities that throughindividual their movement relative to each other move into the profit zone (and sometimes into the loss zone), but do so regardless of the overall market. Another example is options strategies that target the time value or volatility. Sometimes I also bet on call options instead of buying the shares directly, or write covered calls on stocks I hold in the portfolio (covered call). TRADERS´: So trading is an activity providing added value to traditional portfolio management?

TRADERS´: Why has this dynamic approach to portfolio management developed only in recent years? Kahdemann: In the bull market until the year 2000, the average investor did not mind performing worse with the typical fund than did the index – or rather he did not know about it at all since he was happy to achieve (seemingly) good returns anyway. The reason for this was that there were gains for everybody, even after costs. Since 2000, this perception

F4) Trades of 11th April 2011

The 15-minute chart of the DAX future of 11th April 2011, the date of the interview. In the chart, the Bollinger bands are shown and below the chart the Stochastics indicator. I was prepared to be bearish that day since there had been an aftershock with still unknown damage in Japan and the previous day had ended weaker as well. I built my short position in three stages at 7236, 7225 and 7215 points (see red arrows).The strong upward candle at noon caused these positions to be quickly stopped out at 7204, 7208 and 7215 points (see green arrows). My speculation was ultimately wrong, but I made money anyway. In the afternoon it can clearly be seen that on some days it is also good to just do nothing – the market swung listlessly along the moving average of the Bollinger Bands. Source: www.tradesignalonline.com

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has changed significantly. Now investors watch the relative performance much more as well as costs such as front load and management fee.

money. As a matter of principle, have been set as a matter of I only take small risks here. For principle. Do you think that all option-speculation purposes, I the stock-market action can be very much like using part of the compressed in a formula? “money of the market”, which I Kahdemann: I understand the earned in a futures trade. This stock market as a kind of world TRADERS´: Coming back again opens up the opportunity to risk formula that has an evolutionary to your trading strategies, can only a portion of my profits again, and a random component. you explain your technique by but to win far more than what I This means that none of the giving us some examples? had invested. This year, one very developments are completely Kahdemann: I make a distinction successful example of this is my predictable. By analysing mass between the long-term and short- long position in calls on the stock psychological behaviour, however, term horizon. For the former, I use of Deutsche Telekom (Figure 5). you can anticipate what is more weekly charts to get an overall likely and what is less likely to picture and identify the overall TRADERS´: Many of your optionhappen. There are also laws such market direction. At this time trades get nowhere and you as the Elliott Wave principle which level, we make the decisions on bet on just a few large winning individual market participants, traditional asset allocation. For however, find impossible or trades? my futures trading I use a much Kahdemann: Exactly. The whole difficult to detect. Such laws exist shorter timeframe, the 15-minute thing is, of course, dependent everywhere in nature. chart. This means that I trade on volatility. I like entering into The best example is Fibonacci – mainly intraday and largely avoid my long call and long put option it is found in all sorts of areas of our holding positions overnight or contracts at low volatility and everyday life. Since it is especially even for several days. Anonexample of a differentiated trade 11th April 2011 (the date on which this interview was conducted; interviewer’s note) is shown in Figure 4. As supporting indicato rs I like using the Bollinger bands and the stochastic.

choose “harakiri“ base prices. As a result, options, relati ve to a stock, often only cost a few cents. If one of the speculations is successful, high returns are possible. But if volatility is very high – and hence option premiums particularly steep –, I write options. In doing so, I often trade according to the aboveTRADERS´: Can you also describe your option strategies mentioned covered-call strategy, in more detail? where I write a call option (short Kahdemann: Sure. My option call), on which I hold the relevant trading is very different from my shares in the port folio. futures trading. With options, I would like to participate in a TRADERS´: So your strategies larger movement and I therefore are largely discretionary, invest in warrants far out of the but follow certain rules that 07/2011 www.tradersonline-mag.com

in extreme that people keep fallingsituations back on simple – i.e. natural – patterns of behaviour, the natural Fibonacci ratio ultimately is also reflected in the stock market. And since patterns of behaviour repeat themselves, this results in similar patterns occurring in the stock market. TRADERS´: Why do so many people act irrationally in extreme situations? Kahdemann: When we are in an extraordinary – either positive or negative – situation, our body releases hormones that block our rational thinking. As a result,

F5) Long Call on Deutsche Telekom

At Deutsche Telekom I really had a stroke of luck. At low volatility levels, I incrementally bought out-of- the-money call options with a strike price of ten euros (green arrows). My entry price on 21st December 2010 was €0.29 and my 19th January 2011 purchase was made for €0.21. These options then saw a dramatic rise in value upon the price jump of the Telekom stock, en abling me to smooth my posi tion on 4th April 2011 with high p rofits at €1.00 (red a rrow). Source: www.tradesignalonline.com

F6) Long Call on SAP

With SAP, I have bet on call options that are far out of the money. On 28th October 2010 I bought calls with a strike price of €44 for €0.40 and sold them on 28th January 2011 for €1.00. Source: www.tradesignalonline.com

TRADERS´ PEOPLE

we switch to attack mode (greed) or escape mode (fear) while our emotions gain the upper hand over logical thinking. Later, we sometimes regret the rash decisions we have made in such a situation. TRADERS´: What does this mean for pricing in the stock market? Kahdemann: Basically, it has become apparent that emotions will run higher the stronger the trend is in one direction or another. Mental blocks are therefore most severe in boom and bust times while in sideways phases the level of emotional stress is correspondingly lowest. This means that in sideways phases there is a rational search for the “right” stock. For this reason,sideways dynamic periods breakouts longer arefrom often of a sustained nature since they are rationally and fundamentally justified.

65 The one depends on the other. Nevertheless, everyone is looking for the “perfect trading strategy”. For all practical purposes, the stock market’s survival is ensured by the fact that there are people who believe in the Holy Grail, which reminds me of a good story. When I was at the very beginning of my career, working in a bank’s small branch office, I always thought that people at the Frankfurt headquarters were better than everybody else and knew “how the stock market really works”. When I later worked at headquarters, I quickly realised that that was not the case. There was the same uncertainty there as in the branch office. Then I thought that at least the traders in the trading departments, for example in Zurich, should

and would like to stay with it permanently? Kahdemann: To be honest – I do not think that the trading business is suitable for the average private investor. In the long run, almost all of them either lose their money or are disillusioned and give up. To all those who are still ready to meet the challenge, I can give some classic advice: 1) Risk management always comes first. 2) Only trade with money you could do without in an emergency. 3) Do not trade instinctively, but according to clear rules. 4) If you do find something that works well, then go through with it, too. 5) Always remember this: your competitors are professionals

know. When I worked there who are always present. proprietary trading, there wasin no trace of omniscience either. TRADERS´: There are typical “But the top traders in the US trading errors that are made are bound to know how it works”, again and again. What should I thought. Yet again, I was particular attention be paid to TRADERS´: So if there is no disappointed when I worked in in your opinion? predictable market formula but Chicago and was looking for the Kahdemann: You always need only a vague description with Holy Grail. No one knows with to let the market breathe. Many an evolutionary and random absolute certainty how to achieve traders set such tight stops that component, will the search continuous gains. As a trader, the position is too confined and for the “Holy Grail” of trading you have to accept that and a minor random movement is then be meaningless from the learn to cope with the inevitable enough to stop out the position. outset? uncertainty. This is tactically unwise. Just Kahdemann: Exactly, and so it imagine the opposite: If your must be, otherwise there would TRADERS´: What qualities profit target is close to the current be no uncertainty and hence should traders have who wish price, you do expect it to be no excess returns by trading. to face the challenge of trading achieved frequently. There is a 07/2011


connection between that mistake and stops not being adjusted to volatility. Take a look at the shortterm price history and adjust the distance of the stop on the basis of the range of movement. That way, you can often avoid an unwanted exit. Another mistake is to constantly look only at the hypothetical trades which would have caused you to achieve profits had you not been stopped out before. So far, nobody has died of lost profits yet. The first loss is always the smallest, and since risk management always comes first, it is irrelevant whether or not the position later turns.

information. The advantage – but also the risk – for private traders is in the great freedom of choice and the ability to quickly switch back and forth between positions without you yourself influencing the price in the process. TRADERS´: Do you think that successful trading can be learnt? Kahdemann: Yes, I do. But it is obviously not easy. Once you have worked your way to a professional level, it is also important not to want to optimise everything excessively. The KISS rule (Keep It Simple, Stupid) has proven to be a reliable guideline for professionals.

TRADERS´: What are the advantages and disadvantages TRADERS´: Following this institutional market technical discussion, we participants have, and where do you see advantages for private traders? Kahdemann: As a professional market participant you have a professional infrastructure, but this in turn will ultimately have to be funded by your trading. In addition, professionals enjoy direct support from the trading department of their broker – whenever an order was executed, I would get a call with a brief confirmation of the trade. Otherwise, private traders now are largely on par with the professionals in terms of trading costs and the availability of

would also be interested to know how you find a change of pace in your spare time as a counterbalance to your trading – how do you manage to clear your mind of all thoughts of trading? Kahdemann: You need to know that money and the stock market are not everything in life. I have three children and enjoy going on trips. I also have a motorcycle and enjoy taking it for a spin now and then.

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67 To the legendary Harvard professor John Kenneth Galbraith, who died in 2006, the whole thing was crystal clear: Each wave of speculation on the stock markets ends with deadly accuracy in a crash and then leaves a shambles to the mass of small savers. Galbraith identified as the cause of speculative bubbles the sheer ignorance of a new generation of investors who allow themselves to

be blinded by the system and then succumb to the promise of new ideas. Free market economies tend to

theory makes entrepreneurship the strongest driving force of economic development and the typical innovative entrepreneur the principal player who, resisting the ruling classes, introduces new technologies and revolutionises the structure of production at regular intervals. The ascent of new entrepreneurs and their technologies is the cause of everrecurring upswings, changing the economic system from within, as well as everrecurring downturns that occur whenever old economic structures are removed and the entrepreneur‘s profit evaporates. The capitalist economy is inherently subject to constant change. Companies with new products and new methods never

Capitalism can make the most of its creative impact when innovative entrepreneurs are quickly allocated all necessary resources to implement their ideas. And it is precisely this reallocation of production factors that occurs in bubble-like phases of the stock market. During the Internet euphoria during the turn of the millennium countless small Internet companies were able to raise venture capital and use innovative ideas to join the competitive battle for the best business models. The money raised in large IPOs caused the rules in the business world to be changed instantly. Brandnew companies can compete with established companies for the best talent and people with an entrepreneurial mindset give up their existing work to seize

developments can clearly be identified as such at the time of their occurrence. Looking back on Google‘s IPO may confirm this intuitively. As early as the time when the Google share was quoted at $100, the majority of financial analysts warned against exaggerated valuations. And we all know how well things developed later. How hard it is to assess the potential of new technologies and business concepts is also revealed by the controversy surrounding the high valuations that Internet companies like LinkedIn or Tencent were readily given shortly after their IPOs. According to Pastor and Veronesi, such bubblelike price movements follow quite a rational pattern because there are new business concepts involved, whose profit potential can hardly

experience speculative at regular intervals. Is this bubbles trend really a weakness of the system or do speculative bubbles assume an important role in the functioning of the economy? It is only recently that economists have begun to understand the paramount importance of stock market speculation for economic growth and technological progress. The new findings are based largely on the research done by Joseph A. Schumpeter, who lent his name to an entire branch of research in macroeconomics known as “Schumpeterian Growth“. Schumpeter‘s economic-cycle

cease to make their way into the world of business, threaten the existence of established businesses and force them to defend themselves. Horse-drawn carriages were first superseded by railways and then by motor cars. The mechanisation of industry by the steam engine caused a spike in productivity. Electrical appliances were moving into the flats of people and computers revolutionised office work. For this process of constant overall renewal of economic structures Schumpeter fittingly coined the term “creative destruction”.

the opportunityrevolution. of being part of a technological Through this mechanism generated by the very stock-market euphoria, new technologies can change the entire economy within short periods of time. Examples are Google, Amazon and eBay. In their much-acclaimed 2009 article “Technological Revolutions and Stock Prices”, Pastor and Veronesi show that speculative bubbles almost always occurred in the context of technological revolutions. The results of their research contradict the opinion expressed by Galbraith that bubble-like stock-price

be estimated but which are capable ofyet, revolutionising economic life.

Creative Speculation

Simon Betschinger Simon Betschinger, born in 1980, is an economist with a master’s degree from the University of Constance, Germany. He is an entrepreneur who is involved in several businesses. Projects of his relevant to the stock market include TraderFox. de and MasterTraders.de. TraderFox is a real-time stockmarket software program for systematically trading according to chart patterns. M asterTraders is a trading community, where traders do some advance trading with real money.


Conclusion

Stock market speculation has its merits in considerably accelerating the dissemination of new innovations and technologies. A speculator with a nose for future developments supports the process of creative destruction, which is ultimately the engine of economic growth.

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