Chapter 18: Tie Ribbons on Your Trading

Just when you know you have everything covered to start your trading career or to continue the one you already have started, you find you have a few more questions you would like to have answered. We will get Phantom's view on a few of those important questions yet unanswered. Questions like a few of the following are perhaps in your minds:

  • When you spill a soft drink on your mouse pad, why does it always soak in, but good trading methods take forever to soak into our brains?
  • What kind of system should I use to trade?
  • Should I buy a good system or come up with one of my own?
    How do I trade to not chase the market all the time?
  • Why do I always end up with the bad positions but seldom get the good positions and the big moves?

Other than your questions, we should ask Phantom some of the questions he first had and has now in trading. Answers are usually from different views. It helps to get other views for our questions. A good decision is one that can be made from having good choices.

Isn't trading a lot like picking out a Christmas tree? Do we just take the first one we see? Or does that apply only to the first house we buy? How about when we buy a different car: What approach or plan do we have? Do we buy the same car everyone else wants to buy? Or do we make the trade that no one wants?

There isn't really an end to questions we have in our trading careers. We'll try to touch upon some of the most important ones without writing a book about each one. These are Phantom's views and are not in keeping with everyone else's ideas at times.

Art Simpson (ALS): Phantom, since this was your idea after reading the Sunday paper, what questions do you think are important points that should be answered in trading?

Phantom of the Pits (POP): A point I would like to make is that sometimes the most brilliant minds cannot trade correctly. They don't always have all the answers. When they don't have the answers, we are disappointed. Many times the correct answers for someone else does not mean they are the correct answers for us.

It shows that, to be taught by someone else or by being self-taught, there is an important aspect of gathering the correct information. And then the remaining part of learning is the behavior modification after learning correct information. This conclusion has been stated previously.

The point I want to make is that, when we don't know the correct answer, so what? Admit it and use the channel required to find the answer. We can't know all the answers, and we can't be expert at all things. The smartest person doesn't know all the answers.

ALS: I've known some people who know it all!

POP: They don't trade long, do they? Having all the answers is still an incomplete process in trading. Often in trading we know the logical answer but don't know the intuition answer. There are situations in trading when we don't want to take the logical answer but the intuition answer. To know which answer to take is the most difficult decision for most traders.

I believe at least 90% of the traders lose money and that close to 80% of traders are logical in their trading and not intuitive. What do you now see about trading? Wouldn't you now look more at the intuition side of trading and do more research on intuition?

Do you remember that many times I say "second nature?" What I mean is intuition when I say that. Intuition can come from known logical reasoning but with the emotional part removed. It is a feeling we have. Sometimes we can't explain the feeling with reasoning or a logical plan.

Does this make trading seem more scary or open more thought in you mind? Many traders don't want to miss a move so they buy regardless of the intuition they may have. Other traders see a market move and refuse to jump on because intuition says they are buying a top. Who is right?

Is the intuitive trader a better trader than the logical one? How do you know? How would you prove it?

Those are questions I had when I began to trade. I found the correct answer for me, but it may not be the answer for others.

I guess you will want my point of view on the logical or intuitive trader answer. I don't expect all of you to agree with what I have found to be my case. There is one word I have dropped on you at times in these writings, and that word is a very important one in the answer to the logical or intuitive trader question.

I'll give you the word and let you use it to give some thought to the question. We'll answer that question as I see it along the way in this part. The word E X E C U T I O N is our key to the answer.

I saw an advertisement pointing out you would never have to worry about buying tops and selling bottoms again. There are times when you can make an exception about any statement, and you need a filter system in your trading program to help clue you in on these times.

There are, of course, times when you should buy tops and sell bottoms. I do it all the time when I expect a market to reverse. Why? Because I use a method I call the best of a bad position theory -- my theory being a learned one that my best trades are usually after correcting a bad position and getting correct in a market. This happens to me more at tops and bottoms than any other place.

Some of the biggest moves take off from a reversal, and if you miss the entry, it causes you to be hesitant to position as the move gets stronger because you missed the entry. A worse case is when you had a plan and didn't get filled. Why does it happen you got filled when it went against you but a good position never got hit? There are good reasons for that to happen.

I've always said to pick a range and not a price. The exact price cannot be done with consistency. A range is easier to pick and position when you have your signals. Most people think the position of getting out is the most important. You know what? It is important but the most important position is actually the entry. How many times have you put an order in at a price and got the price but not the fill? Many more than you think! It happens to most traders.

By knowing that most traders have put orders in the market and never gotten filled, what does that tell you? Inexperienced or uninformed traders are great market supporters and market resistance builders. Now, just why should I say that? The locals lean on the orders, as it is only natural. It works like this: You want to buy 10 December corn at 268 because that is where the support is. Sure enough, that is support. Tomorrow on the way to 275 you ask yourself why is it you only get filled if it continues to go down.

Do you have any clues? E X E C U T I O N! You must guarantee that you are filled with every signal you get. Any signal you get and you don't get your position is going to be your money position. The market never waits for you. If you trade millions of bushels a day, then you should worry about the extra quatrer-cent.

Even so, execution is still the most important step in your positioning. Your plan is the most important part of your trade, but execution is what validates your plan by giving you a position.

When you learn to use Rule 1 properly, you will never worry about or hesitate to take your signal and position with the utmost execution. You will see you must take all signals and make sure the market lets you in. How do you think the best way to enter a position is? The answer is based on how close you are to the market, how accurate and timely your quotes are and how quick your orders to the floor are.

You must guarantee you get all your positions on at all times! I can't stress that enough! The unfortunate thing about that statement is that it is completely true. The unfortunate part of positioning is that most trade programs or systems use price action, and positions are usually taken on strength or weakness. This causes buying tops and selling bottoms at the thinnest part of the trading day at times.

How are you going to make sure you have all your signaled positions in place? I could give you a way or you could come up with a plan of your own. Which would be the best plan? It has to be your plan. It is only my job to tell you what you must do!

You must position according to the market characteristics. Sometimes you will have to buy the high and sell the low. How do you know when to buy the high and sell the low? You must have two plans in place at all times. I would guess most traders have one plan, and when they miss their position, that is it for the day. You must be smarter than those who only support the market with their orders and never get filled. They can never make any money but you can. You see the market order support the orders waiting to get filled but never will be filled until they are wrong. Same thing on the topside! Why would you want to position this way, too?

One of your entry plans will always be a market order. The other order will be an intelligent order based on the nature of market you are trading. We know that each day there is a high and low and a range throughout the day. You seldom buy the low and sell the high so don't even consider it. Your second plan for entering positions will be based on the fact that better liquidity tends to migrate toward the middle of a day's range.

You don't want to chase the market if you can prevent yourself from doing so. This is the reason for your two plans. Your market order plan is your plan to execute upon failure of your first plan -- same as "get me a soda" but if no soda (sometimes they are out), then "get me a glass of water" (lots of water around). This is all pretty elementary to most traders.

What is not elementary is always having two entry plans. Some of your systems will ask you to enter a position on a stop. Okay, it is a market order. Throw out your other plan if the system is that accurate to expect you to enter on a stop. Other systems may ask you to enter on the close. Okay, execution is important and you have no choice but one plan at that point.

I usually know within the last hour of the market what I am going to do. This allows me more time than to just enter on the close. The reason most entries are poor is because the systems are based on how you get your market prices and information. It can't be a system that gets data that you don't have the possibility of obtaining. That is your big disadvantage.

As an example, if there are 1,000 day-traders in a market, you can almost be certain they have positioned by the last hour of the day. If the market is up, what do you think their position is most likely to be? Same if the market is down. What is their most probable position to be? Long or short?

Okay, you get my thoughts here. The point is that, when they offset, there will be some kind of wave action. You want to use wave action to your advantage when positioning.

You don't want to chase the market, but you don't want to miss it either. So your two plans cover all the bases with your input of market characteristics. If each day the market tends to give you a range of, say, 15 points, then you surely must be cautious when the market is already up 15 ticks. But only be cautious for a short period of time. Don't miss the move and use your "at the market" plan after a period of time. Sort of like a stop and I must say the best use of stops I know.

How does it work? Today at one hour into the trading session you get a buy signal. Your two entry plans are now valid to be used. The first one says to buy at the market, but you want to use that one last. Okay, so you hold that one because what you are doing is holding your own stop order to buy. The second plan is to buy as intelligently as your input allows for the particular market you are trading.

You know the signal to buy is going to be based on strength and stops are hit going up when it kicks in. More times than not, you will get several waves of buying, and this can be to your advantage. Sometimes you do just plateau but that is okay, too. Use your second plan for entry and price based on your criteria, but do one thing more! Add "MIT" (market if touched) to that order and add two ticks! It will be the best money you ever threw away. You must guarantee you are in your position but with intelligence. That is exactly what you are going to do.

After a short period of time, if your position is still not filled, you will use your first plan to go at the market to get filled. So be it! You still acknowledge that you guarantee you are filled and in the market at all signals.

Keep in mind if you don't get positioned, you are acting like you only want positions when you are guaranteed wrong immediately. This is one time the market can give you an emotional letdown if you didn't get positioned. It will always be the time the market takes off without you. Stop! Stop yourself into your entry signal at last resort but absolutely do it if necessary.

Take a survey! How many of you have missed your entry? Don't let it happen again!

Now we have your position established after you have a signal. Good and well so far, but what happens now that the position just isn't acting correctly? You have the old "oughta get out" signal. So what is so important about the bad position, now that it isn't correct?

What is important about a bad position -- one I consider not proven correct -- is that it gives you the greatest opportunity to get a correct position. This happens often at tops and bottoms. It must come from a trade program you develop that allows you to reverse your position at certain times but not all times.

Most of the time a good position, other than the bad position, is being out of that position. Other times the best position is to reverse the prior position. Your trade program should address this.

How do you know when to reverse? We watch effective ranges in bull markets. We expect a bull market to continue to build range during most up days as long as bull markets are strong. When markets are getting into topping action, you often see what is known as a large effective range.

Effective range is nothing more than a broker's dream. The market will go to a level, reverse, go to a level, reverse and so on until you have a very large number of price swings within a small range. Buying gets met with selling and selling gets met with buying which swings the market back and forth many times in compact ranges.

In bear markets your effective range may just go dead and not swing at all for lack of interest. A normal bear market will eventually have bottom-pickers cause upswings even though you are in a bear market. When all interest is lost in trading, you can look for a possible reverse of a bear market.

I find the positions that I reverse are usually the ones I have the intuition of not wanting to place in the first place. It works so well for me because I know my answer to what I disagree with in my positioning. This allows me to take all signals, even when I disagree with them, because I know that my true thoughts will allow me reverse if the first position isn't proven correct.

I saw some posts (on the Futures Talk forum) that the most difficult positions to place are usually correct. That is true in most traders' situations. That is why you must take all your signals and be prepared when you disagree with the signal to have a strong counter-plan due to your intuition. Intuition is your friend as it is your caution flag but not to the extent it takes you out of your plan.

Logical plans are usually what a system is developed around. Intuition is often left out. To me, the intuition side of trading is the surprise side of trading. You must always have your intuition plan along with your expected logical system.

You are starting to get my answer on the logical and intuition trade question. I did not prefer one to the other. They both have their place. What the true answer is to me is in the trading system or program I develop for my trading. Perhaps this is an answer for you also. I must have both covered in my trading plan. There are times the intuition plan comes out ahead, and these are usually at tops and bottoms. Be swift! The intuition part of my program is swift. It prevents large drawdown.

It's not exact but you see you must let intuition be your surprise side plan. How many times have you said, "I just knew it?" That is right! You did know it. Learn to use that intuition and when to use it. I cannot tell you because I am not you. I can only tell you how important it is. I know you have all felt it was important and have learned that it is important.

You know now how to put the good positions on and not just get stuck with the bad positions. EXECUTION when you get your signals is a must!

ALS: I thought you would go into more detail on how to enter with the two plans than you have. Would it help if you did?

POP: The point of execution has been made, and I think reflection of a person's trading is more important at this time. The positions must be entered to have a fairly good chance of having the good positions on as well as the positions that are never correct.

ALS: What kind of trading system should a trader start with for the early part of their careers?

POP: First, it must be one they totally understand. They cannot take a system they are not familiar with and expect to trade it correctly. There will be too many conflicts if the signals and how they are obtained is not fully understood. This can be a problem at times for some systems, which may not properly disclose the criteria on entry and exits of the trades.

The trader should error toward simplicity at all times unless they have a better understanding of a more complex system. With my rules, the system is going to be easier to judge, and simple systems can be just as effective as long as execution is never in doubt. The system they choose will be a tradeoff most of the time. I always want the system with the least drawdown and the maximum gain in the shortest period of time.

ALS: You don't want much, do you?

POP: I don't mean to be cavalier about it, but it's easier with my rules to look toward that goal. You will have to make sure you can use the rules successfully with the particular system you choose.

The other terms of a good system are the liquidity filters but with Rule 3, thanks to our traders, it won't be as critical as without the rule. To confirm the move, of course, the system should have some kind of volatility figured in and open interest.

On suggestions as to whether to purchase a commercial system or design your own, I would say your first purchase of importance is price data whether it is included in your system or outside of it. You need price data and chart data. Without those two elements, you have a very large handicap to overcome.

ALS: I've seen systems where they say "just 10 minutes each day." What about systems where you only need a short amount of time each day?

POP: I don't rule them out! I am saying you need the data to verify the validity of any system. Without it, you cannot be a good judge of any system.

ALS: What about long-term trade suggestions by various individuals or vendors?

POP: I don't know if you can remember my remark about not being able to carry a reputation. My reason for that feeling is that I know what has happened in the past is no guarantee of the future. I also know I change my mind more often than the experts. It is extremely difficult for expert traders to convey with confidence to their customers that they know what they are doing if they change their minds often. I like the luxury of changing my mind. They don't have that luxury.

I remember one day when I got at least six reversal signals in one day. How do you think a trader you are trying to help would understand your changing direction every time they saw you in a day?

That is another reason I say it is not an impossible road but a lonely one. It is out of necessity. You must have the courage to do what is correct at all times. A good advisor is perhaps good at advice. There is conflict between giving advice and also trading. I do not accept conflict. Some can but not me. Most new traders are better off without the conflict of advice.

I could tell you what I am doing every trade, and you would not trade the same way. You could never be at my point in time when I execute my trades. We must always have the latitude of changing our positions based on our systems. My rules allow this thought for doing the correct trading.

Good advisors are often trading funds instead of giving individual advice. Advisors have a harder job than I do. Think about how you explain to more than 80% of traders that they have lost and been wrong in their trading.

I am not saying anything against advisors, for I know the cards are stacked against them. You take the best advisor, and there will always be those who are upset with them for one reason or another. It's the adult-child thing in trading. I admire those who stick to the field and move beyond the difficulties of being leaders in their field.

The same also holds true of systems vendors. They are only as good as their data used for back-testing, and often it is past data being used for future prices. Any one event can change the entire picture. I guess that is why stops are so important in most systems.

I think to not overtrade is more important than a good stop system, but most traders don't have the discipline to trade small enough that stops won't much matter. Everyone is in this game to get rich. Why, it's the farthest thing from my mind. Can you imagine trying to get rich by trading? There is only one way to trade and get rich.

ALS: What way is that?

POP: Trade your program signal, protect it with Rule 1, add with Rule 2 when the program says to add and take profits or offset with Rule 1 or Rule 3 when required. And then do it all over again and again and again until you have the confidence you need. At that point you can think about getting bigger but not until you have complete confidence in your trading.

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