"In day-trading when the last trade is made, you expect to be out of your positions. You are letting the clock decide if you win or lose. That, to me, is a restriction." - Phantom of the Pits
Art Simpson (ALS): Just by the title of this chapter I can see a picture being painted by an artist. All these traders standing with notebooks, bow and arrows, alarms ready to sound and no bids in the pit as quiet sets in.
Phantom of the Pits (POP): Yeah, and I can tell you the artist.
ALS: Who would it be?
POP: Leroy Neiman! I'm impressed with his work. It is something he would paint. I can't help but put him in the class with Oprah, MJ, Don Gibson, LeAnn Rimes and . . .
ALS: . . . and Phantom of the Pits!
POP: Phantom of the Opera maybe but not the Phantom of the Pits! You must remember that no one knows who the Phantom of the Pits is. In fact, I can argue that there will be but this one book! Only this one!
ALS: Now wait a minute. You said it depends on the reception of the traders when we started this project six months ago. Are you backing out?
POP: That is something I want to discuss with you. There is no big profit in writing unless you can really write. I can't and don't want to write except for my own keeping. You can make more money trading than writing.
This brings me to my point of insight in trading. I wouldn't do this insight on my own for it would be a waste of my time. In fact, I am sure this reason is the primary cause of lack of knowledge presented to traders based on experience. Theory is great but not a learned behavior. Behavior is the key.
ALS: Phantom, you forget easily as it was YOU who came to me about giving back by helping other traders. You were as sincere as Michael Jordan is on the court. You don't fool me! I know what your plan is!
POP: Yeah, perhaps, but I know you won't tell anyone unless I let you.
ALS: I am going to tell without your permission right now! You are going to cut your losses, if any, in this project, and you certainly will press your gain, if any, from this insight give-back.
POP: That's good. Wish I had thought of that.
ALS: I would like to know in day-trading if you should use the same rules as in longer term trading. Are there times when you shouldn't use Rule 1 for day-trading or any trading, for that matter?
POP: Never, in trading forward from now. Looking back, you could say there are certainly times when you would have been far better off to forget the rules. But that is looking back and that is not how you trade. You must plan for what will eliminate you from trading in the long run and protect yourself.
ALS: There are going to be lines of traders lined up to tell you why you are wrong!
POP: Let me point some things out here. Many years ago when I first started to use computers and their speed was slow, I had so much to do that I had to get outside help. I had this one program that I could have written but it would have taken too long. I didn't want to write it in assembly language because I needed to see every step work before I could use the program. I contacted newly established programmers and some not so new to help me.
It was sort of an experiment within itself. I narrowed my choice down to about four or five possible candidates. I asked each one of them to solve a problem for me and gave them access to a computer and a basic programming language. The question I asked first was what is the answer to every number from 1 to 100 added up.
Think about how you would solve that problem for a minute before you see the final conclusion to it. One programmer used the computer and came up with the correct answer. It took him all of three minutes plus. One candidate put down his paper and computer and said the answer is 5,050 within 10 seconds.
I asked the individual who only took 10 seconds how he came up with that answer. His remark was, "I don't see or do things the way everyone else does. I take and split the numbers into pairs such as 1 and 99, 2 and 98, 3 and 97. When I am done, I have 49 pairs that make 100 ,with two numbers of 100 and 50 left over. If you multiply the 49 pair times 100 , you get 4,900. Then add the 100 and 50 you get 5,050 as the answer.
Well, that made an impression on me I still remember.
Now, I want you to understand about day-trading the same way. WE DON"T ALL SEE OR DO THINGS THE SAME WAY! We are all after the correct answer. My answer is to keep you in the game for the longest possible time.
ALS: Who gave you the quick answer?
POP: You know very well who it was! I didn't say I wouldn't give you credit in these insights, just that I wouldn't take any. And wipe that big smile off your face.
That impression was a start, but I wasn't done with my experiment. Next, I asked each of them to write me a computer program to give me the correct answer for all numbers added from 1 to 10,000. They were all able to give me a program to do what I asked of them in Basic language. I judged their success on how quick the computer would give the answer and not by looking at the program. I used 1 to 10,000 because I knew it would take longer.
All of the programs came up with the correct answer but at different speeds. Because we were using Basic language, it was slower than I wanted for my particular program, but I was pretty well decided I wanted to understand the program for my own protection. The ranges of speeds were from 48 seconds to 3 minutes for all but one.
The last one took less than a second done in Basic. That surprised me so I took the fastest two programs and called in the programmers. The 48-second program ended up with a loop: N=0, for NN=1 to 10,000, N=N + 1, next NN. Print N.
The time of 48 seconds was still slow as far as what I wanted. The fastest program was: N=N squared + N divided by 2. Print N.
Just as each programmer came up with a different style and program, not everyone was correct for what I wanted. It is the same in trading. The common ground here is that we are all after the ability to not ever having to stop trading, and we are all after the ability to make more than we lose.
You see, there are variables in all of our trading styles. It is just that my Rules 1 and 2 are designed to give you the longest answer when it comes to trading longevity (Rule 1) and the shortest time to get to your goal of return (Rule 2). You need them both.
ALS: You've made a good point!
POP: Let the debate continue for we all benefit from knowledge brought forth with each different situation. The only time I have a closed mind is when there is total lack of understanding of what is required of a trader. That part of a program is not a control from a program but the required execution by the trader.
ALS: Day-trading. Where do we begin?
POP: We'll start with the reason for day-trading by most traders. It is a function of my Rule 1. And it is a function of my Rule 2.
ALS: You mean you are going to take credit for day-trading? I thought you said you didn't want any credit!
POP: It is the traders desire to be able to trade and not worry overnight about their positions, risk and exposure of positions beyond a short period of time while expecting the maximum possible gain in the quickest possible time. Actually, the desire to have Rules 1 and 2 in a short time frame is a perfect prelude to day-trading.
ALS: Okay, we'll buy that. A day-trader often is doing just what your rules imply.
POP: There are advantages in day-trading but not many because restrictions come into play. In day-trading you are more apt to lose than win due to the time limit being a restriction that creates a situation of whoever is ahead at the buzzer wins.
In basketball, when time runs out in the fourth quarter, the game is over. The high score wins. In day-trading, when the last trade is made, you expect to be out of your positions. You are letting the clock decide if you win or lose. That, to me, is a restriction.
I did a study on day-trading and came up with some very interesting findings. The first thing I learned in the study was that you could use the day-traders to your advantage in trading by knowing that they would have to get out by the close.
Second, I learned that day-traders actually do a better job of keeping ranges smaller than do scalpers whose purpose is to fade small moves for quick profits.
Third, I learned that day-trading did afford traders a way of keeping risk smaller and allow them to work larger positions in the short run as opposed to large positions in the long run.
Without going into the next 10 learned points, we will concentrate on the first three. The first three are probably the most important, but they all have merits.
Day-trading is good for some traders, as this is the only way they know to keep risk smaller because of shorter time frames. There are those traders who do not want to put up the margin to carry overnight positions and have the risk (better known as under-funded traders who don't have the money in the first place and should not be trading such size). Whatever the reason for day-trading, it is a valid method of expressing my Rule 1. The only exception is that they usually expect their position to be right.
A scalper is quicker to take a loss but tends to let profits run a little less than a day-trader's ability to take losses. In other words, a day-trader tends to lose on a trade more than a scalper makes. This leaves a margin of loss in losing trades. Believe it or not, guess who picks up that extra loss that day-traders make? It is usually the position trader.
So that, to me, is the edge. You must know when you have the edge and just what it is. It is not an exact thing, but I feel it is because day-traders are not as good or don't have the ability to execute as scalpers. A day-trader would do better if execution became a market order on exits -- especially on taking losers.
ALS: You're going to discourage a lot of day-traders.
POP: Not at all, as the day-trader is a more disciplined trader. It you take Rule 1, which is the assumption of being wrong until proven correct, you will have the other side of the coin for most day-traders. They could become better traders if they were to use Rule 1. Day-trader's odds are lower because of their limitations on overnight carries.
Another big drawback is delayed reactions on what the market prices have done. If they use criteria such as opening range breakouts, they will have to be fast at getting the orders into the pits. On that type of trade they are better to take a position on the open and protect it than to take the opening range breakout. But they want the position proven before they take the position and wait until the breakout.
As a day-trader, they would do better if their trades were within criteria, executed and protected by Rule 1 instead of the delayed trade due to the lag in information. They must pick the points almost exact. This is another drawback for them. You put yourself at the mercy of how the orders enter into the pits as a day-trader. It is almost impossible to be exact in your estimate of price. A better situation is to be able to pick a range instead of a price on execution.
Same with exits. This all reduces your potential profit from day-trading.
So what is the answer? A day-trader can do better by averaging, but you never want to average in an established trend. The trend will tease you into bad entry positions if you don't do your research on market characteristics. Countertrends will do the same thing, mainly because there will always be those weak positions that turn into profit-taking. This is a day-trader's nightmare in day-trading.
ALS: How can you be so certain on day-trading?
POP: The best traders will take what I have to say, study it, research it and decide how exact it is. They will judge accordingly and make their own trades based on improved judgment of day-trading.
That is what we want them to do. It is too easy to think day-trading is everyone's game and a good one. It is a good one for some but not most. It can be improved by understanding the drawbacks. All trading has drawbacks so it is critical as to how they view their trading probabilities.
ALS: You said day-trading could also be compared with your Rule 2. How so?
POP: A day-trader tends to take bigger positions because they know they will exit quicker than most position traders. This will give less risk long term and affords them a way to over-trade . . . or I guess I should say gives them a way to trader bigger.
In Rule 2, the idea is to be bigger after proven correct, and I suppose that is what the day-trader is thinking in trading bigger as a day-trader. Right or wrong, it is correct in being bigger within correct criteria. The bad side is they tend to be wrong as often as right. This keeps it more of a 50/50 game than an advantage they would have if only being larger on correct moves.
Being larger on correct moves as a day-trader is difficult, at best, due to limitations of the day's range requiring the adds to come quicker after the initial position. Often, day-trading will not allow more than one add, if any add at all. Often, too, the profit side gets taken off sooner, restricting the range even more.
ALS: Is there a better way to day-trade?
POP: You bet there is! Now I have every day-trader's attention. For a price I will be glad to give that information out.
I am just kidding, of course. The answer lies in their research. Look at what causes the most losses in day-trading. Now study your own entry and exit criteria and decide what doesn't work. Look at the other side and assume a day-trading criteria does not work and expect it to be wrong. Next, devise a way of removing positions until they prove correct. There you have the answer.
Can you incorporate it? Not in all situations, such as we said previously. Trends and countertrends tend to do a number on day-traders due to their not caring what a trend does.
Next, set up a criteria for removing your positions. You must not allow the clock to dictate when you get out.
Most important in day-trading, you must never play everyone else's game. Say, for example, you play the opening range breakout. Everyone does that. You will wash in the long run, even though you just want to day-trade.
You set your criteria differently. Let us say you trade the third move through the opening range. Why? The market tends to be a trading market if you get the third move through. That is what you are, a day-trader. You can now expect the market to be on your terms as a day-trader. You expect it to come back, but what if you are wrong? Well, then you will make your profit instead of being prepared to break even on a swing trade.
As a day-trader without an existing trend, you can also fade the market. Let us say the last 10 days' range averages 8 cents in onions (never heard of them). Your criteria could be the old Fibonacci number of 5. Wait for a 5-cent setback to buy or a 5-cent rally to sell. I am not saying this works in your particular market, but you can study it and establish your criteria in a non-trending market.
I know some day-traders who take the day off until they have had two days in a row of a non-trending market in the same direction. The next day is theirs, as they will wait until it looks like the reversal is about to take place and then counter the two-day move.
Day-trading is a psychology study of the last few days. If you use Rule 1, you stand a better chance of being up in the long run. It is not exact, and as long as that is understood and losses are kept low, it is a possible moneymaker in the long run. If you like the odds, you can be satisfied if you do everything correctly, regardless of the outcome.
A critical point in day-trading is not to just use the prior day's high, low, range and close as inputs to your criteria of signals to use. Point-and-figure charts are closer to the market as P & F charts don't restrict prices to within a day's range.
Remember, you are staying away from the same methods used by most day-traders in order to get the edge on them, as well as the position traders who most likely only use bar charts.
Last of all, don't just take someone's word on day-trading. Check out your particular market and see the characteristics in action during the day. What you think is a good trade might not even be possible when you try to place the position. Use market orders to make sure you have a position but do it with intelligence. A non-position is a wash.
ALS: Phantom, I have a question and sort of a remark from a successful day-trader. Using a volatility breakout system and using a stop after a series of consecutive losing trades, can you use Rules 1 and 2 correctly?
POP: I can tell you whose idea that is and what course it is in, but I don't want to disclaim or endorse the data. There are some markets in which this is an excellent method for day-trading. Not all markets will be good markets for this method. I am sure traders who use this method know which markets to shy away from by experience.
Yes, you can use Rule 1 correctly, as it is saying that you assume your position is wrong until proven correct and, by taking a position after a series of losses, you are certainly aware that you are going for probabilities of a turnaround. If there is no turnaround, you certainly were expecting to get out. Naturally, the market will have to prove you correct after your entry within your established criteria.
On one of our examples of an onion trade earlier, we used end-of-day criteria as an example of what some would consider the last resort criteria for day-trading. It is the end-of-day criteria to get out. Day-traders tend to be or get out by the close. To watch a market go against you all day and not get out until the close is certainly a challenge in trading criteria, but sometimes your criteria will require this situation to be set up. You just know you will be out on the close if all does not prove out. This alone keeps you from carrying a loser overnight.
On using Rule 2 in your question, would you say the odds of increasing the position after a series of indicator losses allows you a better opportunity to add if the initial position is taken after those losses? Only if the position was to prove to be correct.
The swift would be able to determine if the position had proved itself and at that time adding or removal should take place without the fade to enter. I would agree that, with this plan, if your data feed is quick and your line to the floor is quick, you would certainly be in a position to improve your payout. The part I like in this style is that you are required to do either one of two things at a certain point -- either add or remove.
Keep in mind that Rules 1 and 2 do not negate a successful trading system at any time. They are to keep you from a huge drawdown from which you would never recover. This could be additional protection outside the plan or could be incorporated within the plan itself. I appreciate that question and understand where that trader is in his career. It sounds like proper research for the proper criteria in his style of trading is paying off. It's good to hear when that happens. It proves that trading is not easy but is behavior modification and knowledge.
You can learn from other traders, but you never learn to be them. Just the other day on a business channel I heard the announcer indicate that a particular trader was selling all day, and the question was why they would sell now. One of the answers was correct: He was offsetting his positions.
I remember one day when I bought all day and at the end of the day when the market was down on the close, one trader asked me why I went long all day. He didn't know I had orders twice as large selling after every buy I made.
My point is that you don't know what a trader did; you only know what you have seen him do at the time. You see, my plan was to establish what the market was going to do that day. Every time I bought, I had a broker with my exit double the other way. I would try to offset my new short position and getting out was wrong so we doubled it the other way again. At the end of the day I had a position twice as large as I had intended and the opposite way I intended to go. I only knew that it was the day I had to be swift.
Sometimes your criteria may be that you must be swift to take any possible loss -- especially when a certain Fed chairman speaks.
ALS: Is there a way to plan for such surprises?
POP: Yes, there is . . . by not ever over-trading at any time.