Do Popular Indicators Really Work for Day Traders?

Traders today have access to highly sophisticated computerized trading software at reasonable prices. With just a click of the mouse, most trading packages allow you to overlay numerous technical studies, adjust default settings and change timeframes. The novice trader normally is both awed and overwhelmed with these choices and can spend hours creating complex charts in exotic colors.

However, what many traders may not know is that most, if not all, of the available technical indicators were developed years ago on end-of-day data. Many were designed using only a hand-held calculator! The input was obtained from daily, weekly and monthly data. Traders would spend the evening if they had access to end-of-day data – or the weekends if they only had access to the weekly “chart books” – making these calculations and then applying the results to the next day’s or week’s trading plan.

Like many other things in our society today, the computer changed all of that. Indeed end-of-day data can be analyzed in countless different ways. First with satellites and then with the growth of the Internet, data now is accessed in real time, as well. This allows traders to apply these same technical indictors to data in timeframes that are as fast as the data can be released. And this is precisely what many traders do. However, this is exactly why many traders fail.

In this article, we’ll cover three of the most common technical tools: moving average convergence divergence (MACD), stochastics and relative strength (RSI). This includes review of the concepts underlying the indicators and then an illustration of a typical trading day, showing how these indicators would have fared in real time. This article does not address the idea that technical indictors may be programmed in real time for the purpose of computer-generated signals, instead assuming that these tools are in the hands of a discretionary trader.

Tick Tock, Tick Tock
One of the hardest concepts for day traders to understand is time. Most traders find their way to day trading through the stock market. Usually they’ve invested money in mutual funds or stocks. Perhaps they’ve learned the important ideas of P/E ratios, dividend growth over time and valuation. Maybe they’ve even dabbled in more exciting growth stocks and have learned about relative strength as it applies to stock picking. Then they discover day trading and have the mistaken belief that it can’t be too different from what they’ve already learned – only just a bit faster. That’s the first big mistake.

Here’s where the computer-trading package is purchased and the high speed Internet connection arranged. This is where the trader starts madly clicking his way through the dozens of technical analysis modules, and that’s where the problems really begin.

The second fallacy is that those same tried and true technical indicators developed on daily and weekly data will work on one-minute data. They don’t. Stop and think about what the trading day is really like. Even if you are alert and fresh, the complexity of the information and the speed with which it is delivered is overwhelming. Face it – even the sharpest person out there is only capable of synthesizing a limited amount of data in any given moment.

Once the data is obtained, analyzed and viewed graphically, the trader still needs to compare the information to price points and trading rules he may have developed, make an informed decision and then enter a trade. All the while, time is ticking by and money is on the line, offering even greater emotional factors with which to contend. But all this time, the data keeps flowing; the charts keep updating; and you are faced with yet more information to synthesize.

Without even touching on the various indicators, it should already be clear how difficult, if not impossible, this challenge is. Most intelligent humans are hard-pressed to remember a seven-digit phone number, a grocery list or the name of a new acquaintance. Before you shrug this off, remember – it’s a completely different matter to calculate relative strength, MACD and stochastics and then draw trend lines when the market is closed.

Relative Strength
For the purpose of this article, I decided to examine the results using the “default” settings for all three indicators. First off, relative strength as a technical tool was developed by J. Welles Wilder, Jr. (New Concepts in Technical Trading Systems, 1978). Although one of the most commonly followed indicators, it is misunderstood. In stock trading, the term relative strength implies a ratio or comparison of stock to stock or stocks to various industry groups. Similar use is made in classic commodity analysis, such as comparing various delivery months or markets to benchmarks like the CRB commodity index.

In day trading, though, relative strength is an altogether different construct. The original idea was to smooth out the fluctuations in momentum indicators that result from “drop off” of distant extreme price data and to provide for a more constant band for comparison of momentum over time. The formula is based on a ratio of the average of up closes to the average of down closes over a certain number of days (14 is the default). That product is then applied to a simple formula, which allows the result to oscillate between zero and 100. Typically, a number greater than 70 is considered “overbought” while a number less than 30 is “oversold.”

Simple enough? Traders use this information to take a buy signal on a cross back up over 30 and a sell signal on a cross back below 70. Others use the “50” line to generate or confirm a signal. Still others use divergence from price as the key to pulling the trigger. The RSI is an invaluable tool for analyzing end-of-day or end-of-week data, and when extreme levels are reached and divergences set up, it is one of the best. However, as an intraday tool it leaves much to be desired.

Next Up: MACD
In 1977 Gerald Appel devised the moving average convergence divergence, or MACD, the popular technical indicator that determines the direction of a trend in an individual security or an entire index. It remains at the core of his analysis. Again his work was based on daily and weekly data, not one-minute data. The idea behind this tool is to generate a value, which is the difference between two exponential moving averages, and compare that to a nine-period exponential average of that value to generate a signal. The default values of the two moving averages are 12 and 26. The result is an excellent moving average crossover system combined with an oscillator. In this way, a trader can see not only a crossover, but also how it occurs in the context of an oversold or overbought environment.

As an end-of-day or end-of-week tool, it is an excellent performer. However, as an intraday tool using one-minute data, it will generate multiple confusing signals. As with RSI, there are many ways to interpret the MACD including overbought and oversold crossovers and crossing of a zero line, but the best results come from spotting divergence from price. This is easy to do with end-of-day data and a ruler or chart tool in hand. On the fly it is a challenge, if not impossible.

Stochastics
Our last oscillator was developed by George Lane and was built on the idea that as a market goes up, prices should close at the upper end of the range, and when prices decline, they should be nearer the lower end of their range. Thus, stochastics tries to determine where price is relative to its price range over a given period of time. A trader once again can see how this will work well if one is able to spot divergence between stochastics and price.

Calculation of stochastics involves a ratio of the closing value and the 14-period low to the difference between the 14-period high and the 14-period low. The results, as in the RSI, use a zero to 100 scale. Lane suggested a second line which is a three-period moving average of the first result, which allows for a “signal” to be generated, much like the nine-period signal-generator for MACD. Volumes have been written about the nuances of the various crossover signals. Suffice it to say that like the other indicators already discussed, overbought and oversold crossovers generate signals. In general, a cross down through the 80 line indicates a sell, and a cross up through the 20 line indicates a buy. Traders will also look for a divergence from price to generate signals. Stochastics has become an extremely popular day trading indicator, yet conventional wisdom holds that 90 percent of all traders lose money. Is there a connection?

A Typical Day…
The following charts are taken from August 16, 2004. The day was chosen randomly and is an excellent example, as it turned out to be a fairly typical day. Remember what we are tying to show are the problems a trader might face by relying on what are supposed to be standard indicators. Default settings were used and the time frame is a one-minute chart. Time shown is Central time. First, we’ll show the indicators separately and then see if the indicators would have worked better when employed together as most traders use them. See how you would have interpreted the charts.

As illustrated in Figure 1, the market opened very strong, leaping higher from the opening bell. We’ll assume that the trader was unable to act until after 9:00 a.m. According to MACD interpretation, a long trade is entered at 1071.50 at 9:08 a.m. with an exit at 1075. So far, so good. However, look at the chart and see if you can figure out what you would have done next – in real time, not in hindsight. Would you go short? Short at 10:15? Break even. Short at 10:58? Break even. Long at 12:13? Break even. If a trader were dutifully trying to trade the MACD signals as they appeared live on his screen, each of these trades would have been taken and would have led to whipsaw and frustration.

Relying on RSI in Figure 2 would not have allowed us to enter the early profitable MACD trade. Instead, we would have entered short at 9:20 a.m. as the signal crossed below 70 from overbought, and we would have stopped out. We enter short again just before 9:30 only to see RSI move lower and prices move steadily higher! Even if we had used price divergence as our tool, it would have led to a couple of points on the short at 10:20 as we broke below 50. But ask yourself if you would have stayed short at 10:45 as RSI rose back above 50, or if you would have held on until 11:00. Why? The rest of the day shows a series of unclear waves, unless you can figure out a trading rule that would cover the short at 12:20. I can’t.This indicator, stochastics, seen in Figure 3, is the most useless of them all in my opinion. Remember, we never know ahead of time what kind of trading day it’s going to be.

We want a reliable system where we can turn on the computer and begin generating effective signals in real time. Would you go short at 9:10 or 9:25 a.m.? Would you go long from 9:40 to 9:45 and then miss the bulk of the subsequent move? After that, I see more than 15 “typical” sell signals. Which one would you have taken? I see around seven buy signals. Which ones would you have taken? Which ones would have worked?

Combining the Indicators
Most traders who come to me for help are routinely watching more than three charts at a time. See Figure 4 to see what August 16 looks like when all three of these indicators are placed together. Around 10:20 a.m., there may be a sell signal, but what criteria would you have used to exit? By 10:20, the stochastic was already oversold and the MACD was turning up. If you had the conviction to stay short through the RSI drop, you would have made two points.

There might be a good sell signal at 1:15 p.m. following the spike in the RSI and confirmed by the MACD while the stochastic may have already been in a sell. It’s a lousy trade. At about 2:00, one would have been confused by the uptick in MACD. Would you have covered and gone long at 2:30? It’s hard for my eyes to move up and down through the price bars and the indicators simultaneously in an end-of-the-day chart! Imagine trying to synthesize this on a computer screen in real time!

Frustrated yet? The real kicker is that the Dow was up around 120 points that day, and there was a 12-point move in the S&P 500. Not one of these famous indicators would have captured any meaningful piece of that move. While not impossible to use, (and I am sure there is someone who has a “system”) the point is if you have not been able to make money trading off of one-minute charts, the problem is not that you don’t know how to read the charts right yet. The problem is that they don’t work.

This review does not intend to take away from these excellent technical indicators. The point is that it is naïve to think a trader can simply switch to an intraday timeframe and obtain the same benefits from indicators that were designed for something
altogether different.

What’s a Day Trader to Do?
So how do we trade? That’s a topic for another time, but stop and think about all the successful traders who never look at a computer screen. What about all the floor traders? Surely there is other information we can use. We use all of these indicators on end-of-day data as they were meant to be used, giving us a good feel for the market trend and strength. Using that data, a trading plan can be developed for each day, including price support and resistance. In addition, we use supporting indicators during the day – such as breadth, volatility and volume – to assist with trading decisions.

Don’t be fooled by the allure of sophisticated trading software. Traders who choose to use intraday technical analysis should make sure to understand how the indicators are calculated and what the output represents. It’s easy to forget that even with sideways price movement, these oscillators will continue to move between zero and 100! During periods of low volatility they will still generate buy and sell signals that can churn your account and fray your nerves. Some of the most successful S&P day traders I know follow price, Tick, Trin, VIX and volume and never look at a chart during the day. There is a place for technical analysis: at night and away from the action.

Inside the Counterintuitive World of Trend Followers: It's Not What You Think. It's What You Know.

In his book, Trend Following, Michael Covel states that trend followers have a philosophy that informs their trading. What is all too easy to miss is that these philosophies aren’t after-dinner digressions. When trend followers say they have a philosophy, they are talking about how they know the world around them, and this knowledge is not from books. It is won from the world and is quite empirical.

The trend-following philosophy can be summarized in seven statements – taken in part from actual utterances of trend followers (and the rest used with poetic license as regards their principles). Each will be covered in detail in the ensuing paragraphs. They are:

• No one can predict the future;
• If you can take the would-be, could-be, should-be out of life and look at what actually is, you have a big advantage over most human beings;
• What matters can be measured, so keep refining your measurements;
• You don’t need to know when something will happen to know that it will;
• Prices can only move up, down or sideways;
• Losses are a part of life; and
• There is only now.

The difference between trend followers and other types of traders isn’t one of style. What trend followers do is outside the scope of normal human reactions. Frankly, their deeply counterintuitive strategy should alert other traders that something very different is going on.

SIDEBAR
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Ed Seykota’s Trading Tribe

Trend followers tend to be careful observers who notice trends everywhere; those observations include their own emotions while trading. Ed Seykota’s investigations of how trends in emotions affect trading first appeared in his now-famous interview in the original Market Wizards book. “Win or lose, everybody gets what they want from the market. Some people seem to like to lose, so they win by losing money.”

Over the last decade, Seykota has extended these apparently paradoxical insights into trading and life with another set of assertions; that we need to feel our feelings – those we like and especially those we don’t like. If we resist our feelings, we wind up creating “dramas” in our lives and in our trading so that we have to feel these feelings. As he puts it, “The feelings you are unwilling to feel are your real trading system.”

In many emotionally charged situations, like trading, a full expression of our feelings is stifled by an inner judgment about these feelings. Seykota calls this a “k-not.” Avoiding these k-nots becomes more important than any stated goal. The way to untie these k-nots is to experience the feelings, but because these are the feelings we are unwilling to feel, we need the support and acknowledgement of others. Seykota insists that traders need to band together in “Trading Tribes” where they can encourage each other to face, embrace and celebrate these feelings through a process known as the Trading Tribe Process (TTP®).

In TTP, a trader voluntarily takes the “hot seat” and other Tribe members encourage him. According to participants, when a trader feels his feelings fully, he often experiences an “a-ha” along with spontaneous insights and revisions of previously problematic trading behaviors.

Whether this sounds offbeat or on the money may depend on your attitude toward men’s groups, warrior training or something similar. You can find out for yourself through Seykota’s website www.tradingtribe.com.
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Take the adage every trader knows: “Cut your losses, let your profits run.” Clearly, every trader will agree that it is the hardest thing to do. Why? Is it because “a bird in the hand is worth two in the bush” (or in the account)? Or is it because when your dog runs away from home, he is usually back by dinner? Trend followers know about these experiences, and they know something else: They know that all of these examples are anecdotal. They are just personal experiences and beliefs that will bias their judgement. Trend followers know that these instances are not reliable guides to the nature of markets. All right then, what is?

No One Can Predict the Future
“There is no predicting anything,” the very successful trend follower, John W. Henry, tells us. What this means is that all of your hunches, intuitions and beliefs about how the world works are steeped in self-deception. Thus, despite pronouncements of a bunch of experts on television or elsewhere, tech stocks are not trading because of anything; gold is not moving for anybody. The Fed rate is not changing for a particular reason. It’s not that there are not market influences or market makers or reasons that markets change. There are. It’s just that there are so many of them. But to quantify them and to make a judgment about their relative weights and influences is beyond the possibility of anyone.

Trend follower and president of Dunn Capital, Bill Dunn, has a doctorate in theoretical physics. No one gets a doctorate in that discipline without understanding, in a deep way, the “three-body” problem. In the celestial version, Sir Isaac Newton found a way to mathematically describe the interaction of two bodies – the earth and the moon. To do this, he ignored all the other influences in the heavens. Enough for a start, he assumed his two-body solution would lead to solutions being found for the interaction of three, four and more. Two centuries later, they hadn’t. Finally, to speed things along, a prize was offered by the king of Sweden. It was won in 1889 by Henri Poincare, but not for solving it. He demonstrated that it could not be solved.

Professor Poincare found that with just three bodies, the behavior of each one affecting the other made it impossible to calculate directly what was going on, and therefore, how the bodies would affect each other. The same is true of the relationships between stocks, bonds and futures. Approximations are possible, but counterintuitively the more accurate that market participants try to make their models, the more these models cease to describe what is going on in the world.

The conclusion is, quite simply, that the world is much richer and more detailed than any model, and every model of complex behavior (starting with only three bodies) will fall short of a description that allows prediction. Was that too much detail? It turns out that trend followers are fascinated with the details of what is in the world and how it works. They live and work in the world of what is.

Look at What Is
If you can take the would-be, could-be and should-be out of life and look at what actually is, you have a big advantage over most human beings. Take these remarks by John W. Henry when asked how he created and maintains his discipline: “Well, you create discipline by having a strategy you really believe in. If you haven’t done your homework properly and haven’t made assumptions that you can really live with when you’re faced with difficult periods, then it won’t work. It really doesn’t take much discipline if you have tremendous confidence in what you’re doing.”

What are these assumptions? Henry is clear about them – “No one consistently can predict anything, especially investors…” and “…other investors are convinced that they can predict the future, and I believe that’s where our profits come from.”

Notice that Henry’s assumptions are not social givens such as, “I assume you are joining us for dinner,” or “I assume I’m going to be rich.” They are not even beliefs in the psychological sense, that is, a feeling of certainty about something that cannot be determined for sure. Many traders and trading coaches will read Henry’s statement and conclude that what they need is tremendous self-confidence, an indomitable belief in the likelihood their success. They will want to instill beliefs like, “I will be a great trader,” or “I deserve to be rich.” But these “success beliefs” miss the point when it comes to trend following. It isn’t what trend followers think of themselves that matters, it’s what they know about the world.

[Editor’s note: For more information on John W. Henry’s trading philosophy, please see his feature interview in July 2004 SFO.]

What Matters Can Be Measured
What kind of assumptions do you make if “there is no predicting anything?” If there is no predicting anything, what do trend followers do when they do their research? If they have already taken the would-be, could-be and should-be out of the scenario in order to look at what is, then what is?

All traders know that there are vast quantities of price data available. What trend followers measure is the likelihood of price patterns recurring – in other words, probabilities. With probabilities, the human feeling for a market, intuitions about price movements and the gratifying feedback of getting it right disappear.

Jerry Parker, top trend follower and president of Chesapeake Capital, reminds us that trend-following metrics and measurements are “…not intuitive, not natural, too long term, not exciting enough.” They are experienced as counterintuitive.

Market wizard Richard Dennis (whose hobbies include studying baseball statistics) is attributed with saying, “If your system makes a little money all year and loses a lot of money twice a year, reverse your system.” This sounds crazy, but Dennis has run the numbers, and the couple of wins will outstrip all the losses the rest of the year by a wide margin.

Trend follower trader Ed Seykota adds, “If you can’t measure it, you probably can’t manage it.” This certainly applies to Dennis’ example.

“When” Doesn’t Matter
You don’t need to know when something will happen to know that it will. Trend followers know there is a statistically significant likelihood that a big payoff trade is coming, but they do not know in what market and they do not know when, so they must take every trade their systems generate. They know the vast majority of the trades the systems generate will result in a loss or a small gain. Richard Dennis is reported to have had an extraordinary number of winning trades for a trend trader, 55 percent, and it is said that he still made all of his “real money” on less than five percent of his trades.

To do this, trend followers must live at least part of life in this larger, abstract and statistical scope of time. For trend followers, the everyday moments of trading participate inside a “campaign” in a certain market or instrument where traders see each moment as the possibility of a statistical opportunity. This tends to reduce the importance of individual trades. The price will move – that’s what is. There is a statistical probability for each outcome. One of the actual outcomes will happen.

Prices Only Move Up, Down or Sideways
Computerized trading software is so prevalent that traders can quickly create a trading system so complex that is it quite beyond their understanding. Meanwhile, clarity of thought and simplicity of design are the hallmarks of a good trend-following system. Trend followers know that however deep or complex their thinking is about trading, the input to their system is limited to one of three possible states – price increase, decrease or no change – and the final output of their system must be one of three actions, buy, sell or do nothing. This allows for fast heuristics.

Losses Are a Part of Life
In his classic, The Battle for Investment Survival, Gerald Loeb writes, “Accepting losses is the most important single investment device to insure safety of capital. It is also the action people know the least about and that which they are least liable to execute.” Though this statement should resonate with all traders, it has a special meaning for trend followers.

Trend followers tend to be more aware of the relationship between losses and gains than other types of traders. They realize that a large loss affects their trading gains over the lifetime of their portfolio. They realize that trading less frequently reduces the number of their losses as well as transaction costs and, so, is another effective means of preserving their capital.

According to Ed Seykota, elements of good trading include, “(1) cutting losses, (2) cutting losses and (3) cutting losses. If you can follow these three rules, you may have a chance.” Few non-trend-following traders realize that Seykota is talking about three different kinds of losses. The first two of them are offered above – reducing the largest loss by strictly limiting position size and reducing the overall number of trades. Only trend followers know about the third. To quote John W. Henry again, “The desire to have close stops to preserve open trade equity has tremendous costs over decades.” In essence, he is referring to cutting the exit stops that would turn trades into losses in volatile markets and greatly reduce eventual gains. This once again draws attention to the fact that trend followers, while trading in the same markets as everyone else, are living and working in profoundly different and more detailed worlds.

Does this make taking a loss easier? Yes and no. Yes, trend followers know they can’t know the future, that there are statistical opportunities for those who know how to exploit them, that they must respond to every opportunity, and that they must preserve capital to continue trading. They backtest this until they are convinced it’s the case. Then they set up their systems and take the trades that the system calls.

And no, trend followers are human and hate to part with something of value. The need for the adage “Cut your losses, let your profits run,” is much like the need for the Ten Commandments. We do not have to be told what is in our nature. In going against our nature, instinct and a lifetime of cultural conditioning, trend followers really earn their money.

What About the Rest of Us?
Some people call economics the dismal science. But those people haven’t talked to cognitive neuroscientists. According to their research, we humans have limited perceptual as well as information-processing abilities. When faced with decisions, whenever possible we tend to use simple rules and short-cuts, and we apply a criterion of sufficiency (good enough for now) – with little review of possible consequences and in a way that requires the least possible effort.

So, clearly, most of us will not measure up to the stiff requirements of successful trend following. On the other hand, these differences are due to the encouragement of some innate attitudes like curiosity about the world and some life-changing experiences like studying physics or learning about probabilities.

For example, Bill Dunn and Ed Seykota are graduates in physics and engineering. John W. Henry became convinced of his assumptions as a student when he collaborated with his college instructor on a strategy for beating the odds at blackjack. As any reader of Edward O. Thorp’s famous book, Beat the Dealer, can tell you, it’s all about the probabilities. In fact, the number of outstanding traders mentioned in Jack Schwager’s two Market Wizards books, some of whom started as gamblers, could fill a suit in a deck of cards. This makes sense. A trader who directly experiences the results of probabilities over and over again will become convinced that he doesn’t need to know the future to win. He will recognize that the odds/probabilities shift over time. If this sounds like an encouragement to join the current poker craze, it’s not. But if you do, keep in mind you are “at the table” to practice these odds-watching skills. The stakes need to be small enough that you are learning from your experience, not adding more traumas to your trading.

Another way to get started is to get more curious about the world of what is. Your children can help you with this, and even if you don’t have any, you can still take a walk in the woods and notice that the shape of the leaves, branches and the trees are similar each other. Or go shopping and notice how you respond to closeouts and one-of-a-kind items. Or how people decide on what to order in a restaurant. Fractal market analysis, behavioral finance and heuristics all started with people noticing these kinds of things about the world everybody else thought they already knew. So do many trading ideas.

Trend followers can’t trust their senses or their intuition or their better judgment. They deal in quantities and probabilities with bodies and minds designed for instincts and feelings. To paraphrase Woody Allen, their experience of the world may be untrustworthy, but it’s the only place they can get a great steak. Us too.

Is the Trend Really Your Friend? A Professional Trader Flips a Coin 10,000 Times to Find Out

Often when I am instructing a novice in the esoterica of the active trader’s thought process, I will begin by presenting a coin-flipping scenario: You have a dollar and can double or lose it on the flip of a coin.

Alternatively, you can choose to win two cents or lose a penny with every flip. Which is a better bet? I have yet to encounter anyone who wants to argue that risking their entire stake on a single bet is preferable. Yet once many begin trading they completely ignore what they have told me, apparently believing that making big bets, irrespective of the risk involved, is the quickest way to riches. In fact, it is the quickest way to a margin call.

Some extremely complicated risk management models rely on this basic principle, namely that a large potential reward does not justify the assumption of excessive risk; that the law of averages guarantees that the more flips (trades) you are able to make, the better the chances for a successful outcome. And we learn this from a simple coin toss.

With the theme of this month’s issue revolving around trends, I thought it would be interesting to consider what we can learn from coin flipping about the basic chart pattern that traders believe is their friend.

It occurred to me that, while I have studied probability in school, read many academic papers on the subject and deal with the underlying concepts every time I make a trade, I have never actually conducted my own research. So late one night, I decided to write a stream-of-consciousness piece focusing on important principles of probability relating to trends, while actually flipping a coin 10,000 times. It seemed like a clever idea at the moment I conceived it, but at one point during my college days, I also thought it was a good idea to try to catch a major league baseball thrown off of the top of a tall building; what seems clever after 1 a.m. is not always easily explained to the attending physician in the emergency room. So I commenced my experiment, but did not appreciate that the human thumb is perfectly constructed to hitch a ride, indicate approval or disapproval, wipe away a stray tear from the corner of an eye, but not to flip a coin 10,000 times.

After the first 100 tosses, I was ready to call the pharmacist and beg for some needed Vicodin, but then my young son, Joshua, walked into the room. Luckily, his only goal in life is to please me. I am not proud of myself, but thanks to Joshua, I was able to complete this article. Let me tell you, it’s not easy to watch your children suffer, but there is a silver lining to every cloud, and I am happy to report that my son won’t be sucking his thumb anymore.

Heads: 5,209; Tails: 4,721; Buy Heads, Sell Tails?
First, some statistics (Table 1). Heads beat tails by 418 flips. Throughout the experiment there were numerous series of at least five consecutive flips in favor of heads or tails. There were five series of 10 consecutive flips in favor of one or the other; four of those series were in favor of heads. The longest consecutive series was 12, near the end of the contest, in favor of tails. There were only four occasions when the tally stood even: on the first, third, ninth and seventeenth flips. After flip #17, heads took the lead with a run of seven consecutive flips, a lead it never relinquished.

Even if one doesn’t know a standard deviation from a regression to the mean, results such as these might be surprising. The casual observer might ask, if each flip of the coin, by definition, has an equal chance of coming up heads or tails, how can heads hold such a commanding lead after 10,000 flips? And why did heads spend so much time in the lead? These are good questions, but what our casual observer really wants to understand is how a random series of events can appear to indicate a trend.

John Allen Paulos, in his wonderful book, A Mathematician Plays the Stock Market, explains this phenomenon in the following way: “One odd and little-known fact about coin flips concerns the proportion of time that the number of heads [in our case] exceeds the number of tails. It’s seldom close to 50 percent!... it’s considerably more probable [when there are a large number of coin flips] that heads has been ahead more than, say, 96 percent of the time than that either has been ahead between 48 and 52 percent of the time.” The shocking principle here is that there is no “probabilistic rubber band,” as Paulos calls it, snapping the tally back into its rightful 50/50 proportion. Yet at the same time, there remains an equal chance that each flip will be either heads or tails.

Therefore, it is only natural that “patterns” favoring the winning side develop. When these patterns are graphed, they look remarkably like the charts traders use to make their trading decisions, with head and shoulders formations, double tops and bottoms and trend lines that practically beg you to place an order to buy or sell. And yet, because these chart patterns were generated by completely random events, no rational person would assume that the past performance as expressed on the chart could predict the outcome of the next toss. Or would they?

Consider the following: If we took 10,000 traders rather than coin flips, we can theorize that some percentage of them – let’s say 50 percent – might be profitable from year to year simply by chance. After year one, there would be 5,000 winners, year two, 2,500, year three, 1,250, and so on, until by year 10 there would remain three traders that were profitable for ten consecutive years, solely by chance. Nonetheless, it is likely that these individuals would be very well regarded in the investment community; they probably would be inundated with offers to manage other people’s money.

Another way to think about this scenario is suggested by Nassim Nicholas Taleb, the author of Fooled By Randomness: The Hidden Role of Chance in the Markets and in Life, a brilliant book that every trader should read before even thinking about making his next trade. The author poses the following scenario: An eccentric billionaire offers $10 million to anyone who wins at a game of Russian roulette. One has to agree that the odds, strictly speaking, are favorable. A participant has a 5/6 chance of walking away rich, and only a 1/6 chance of, let’s just say, suffering the consequences of an extremely bad risk/reward ratio. The successful risk-takers in this “market” likely would be revered by the public, whose view tends to be that the attainment of riches is worthwhile irrespective of how the riches are attained. Were one to start playing this game at age 25 and commit to playing it every year, it is more likely than not that the individual would win before losing, yet it also is probable that he or she would not die of old age.

Now imagine that we have hundreds of thousands of 25-year-old players in the game. A few of these individuals will survive to old age, and in the process become very wealthy simply by chance (remember, even tails, which trailed badly in our experiment, had a winning streak of 12 tosses). Perhaps you think the analogy flippant: the market is the market, not Russian roulette (although it would explain the origin of the ubiquitous trader’s phrase, “pulling the trigger”). Maybe so. But how then are we to explain the relatively small number of successful traders out of all of the hundreds of thousands of individuals who test their skills in the market? Perhaps some traders know how to pull the trigger better than others.

It’s a Beautiful Day in the Market. Would You Like to Take a Random Walk?
One cannot discuss this subject without acknowledging that the market may be a random walk, that is, completely unpredictable. And if the market is unpredictable, what does that mean for those of us who treat trend lines as if they were drawn by the finger of God? Burton Malkiel, author of one of the most famous and important books about the market,
A Random Walk Down Wall Street, would say we are delusional and that past market information reveals no more about the future than the “wallpaper behind the mirror” can predict the pattern of wallpaper above the mirror. He scoffs at the notion that prices moving in a particular direction are like a “fullback, who once having gained some momentum, is expected to carry on for a long gain.” He states, unequivocally, that the patterns suggesting trends are nothing more than a “statistical illusion.”

If reading Malkiel doesn’t make you want to cancel your subscription to your charting service, consider the words of Warren Buffett. While Buffett, the great value investor, does not buy into the random walk theory – after all, there can be no such thing as a “value” investment in a truly efficient market – he has no patience for technical analysis and nothing but contempt for those who use it to make investment decisions.

In a 1984 speech delivered at Columbia University in honor of the 50th anniversary of the publication of The Intelligent Investor (one of whose co-authors, Benjamin Graham, was Buffett’s mentor), he said, “I find it extraordinary that so many studies are made of price and volume behavior, the stuff of chartists. Can you imagine buying… simply because the price… had been marked up substantially last week and the week before?... It isn’t necessarily because such studies have any utility; it’s simply that the data are there and the academicians have worked hard to learn the mathematical skills needed to manipulate them. Once these skills are acquired, it seems sinful not to use them, even if the usage has no utility. As a friend said, to a man with a hammer, ‘everything looks like a nail.’”

If anyone has the right to scoff at the way I make my living it is Buffett. His strategy is to “buy a dollar for 40 cents,” and no one has ever done it better than he does. Yet to be dismissed so summarily hurts a bit. My only consolation is that with his haughty attitude Buffett probably got beat up a lot when he was a youth, whereas I had a very nice childhood, even if I did grow up to be a hopeless trend follower.

A Comforting Message to All Hopeless Trend Followers
Probability can explain a lot, but it can’t explain everything. If an operation with a one-percent mortality rate has been performed 99 times successfully, and I am about to be rolled into the operating room for the 100th operation, it would hardly concern me that I had a 100-percent chance of dying, although statistically speaking this could be said. I would rely on my belief in the skill of the doctors and nurses to get me through the operation notwithstanding the odds against survival. In other words, my chances of survival could not be said to be random.

Similarly with chart patterns, and specifically trends, I expect that there is more to rely on than simply an arbitrary line connecting some points on a graph. Something significant is happening when a trend is forming. For whatever reason, discernible or not, people are deciding to play follow the leader to a destination unknown. That it often is impossible to figure out who the leader is or why they are leading the way is largely immaterial; the fact is that something palpable is occurring, and it is not in your best interest to get in the way of the crowd. Usually, if you are paying close enough attention, you can join the group as it makes its way toward its objective. You can befriend the trend. Sometimes the trend will betray you, but this happens in life. If we are smart, we learn from our mistakes, and if not, we suffer the same disappointments again and again.

Among other things, George Soros is famous for admonishing his traders that they – and he – are a bunch of “mistake-prone idiots, who know nothing, but are endowed with the rare privilege of knowing it.” This is one of those statements that is so simple, it must be profound, and most traders could use an occasional profundity amidst the nonsense that normally clutters their brains.

But how can we know if a market move is real? Nassim Taleb offers some excellent perspective on this. He asks you to consider you are in a bicycle race across Siberia. If a month later you have beaten your opponent by one second, it isn’t particularly meaningful to say you are a faster rider. Perhaps #2 went over a pothole at some crucial point, or some other random event influenced the outcome. But if you beat him by three days, it would remove any doubt that random causes influenced the outcome of the race. Applying this approach to the markets, Taleb suggests that while it can be very complex to perceive what he calls “causality,” it can be found if you know how and where to look for it.

In his case, he knows “if something is real” by the magnitude of the move. As he watches the markets, he reacts only when the percentage move is large enough to ensure that the move could not have taken place as a result of random events. How does he measure the “realness” of a move? He does not divulge his proprietary models, except to say something extraordinarily important: “The interpretation is not linear; a two-percent move is not twice as significant an event as one percent; it is rather like four times. A move of 1.3 points in the Dow has less than one-millionth of the significance of the serious seven-percent drop of October 1997.

People might ask, “Why do I want everyone to learn statistics?” The answer is that we cannot instinctively understand the non-linear aspect of probability.

For me, as well, the significance of the move is tied to its scale, and I learned this as a young trader in one of the currency pits of the Chicago Mercantile Exchange. I stood next to an order-filling group that each day entrusted one of its members with its stack of customer sell orders and another with the stack of buys (this was in the not-too-distant past when orders were transcribed to paper). On days when the market was moving up, the stack of buy orders would grow so large that clerks would have to hold some of it in their pockets lest it spill onto the trading floor, and the order filler with the deck of sales stood mostly idle, having few orders to execute in a rising market. The mirror opposite occurred on days when the market was plummeting. If the market is truly random, this should not have been the case; one would expect that at least on some of those days the order filler with the smaller deck should have been doing some business. Yet in 17 years on the trading floor, this is the reality I knew – a market that did not seem random, and I used that knowledge to my advantage. In today’s electronic world, the cues are different but no less palpable. Like Taleb, when a move of significance is underway, I usually can spot it.

I have been thinking and talking about coin flips since the beginning of my career 24 years ago. To this day, I struggle with the subject of randomness, which is far too complex to deal with adequately in an article such as this. This is not, after all, some obscure area of market analysis. The vast number of studies that have been performed is only exceeded by the number of traders who utterly ignore the findings. The random walk debate preceded me and likely will continue long after I have pulled the trigger on my final trade.

So what do I really believe? My intellect tells me that the academics are right, that the numbers don’t lie. But at the gut level, where for better or worse most of my trading decisions are made, I continue to think that there is a chance that not all is governed by chance. So I draw my trend lines and make my trades. While I am not as successful as Warren Buffett, there’s food on the table every night, a roof overhead, and I can afford to pay for the physical therapy that Joshua so desperately needs to regain the use of his thumbs.

Trading Rules

Different Types of Buy Orders

Entering a stock properly is responsible for 85% of all successful trades, so knowing the different types of orders, which can be used to enter a stock, is obviously crucial. And while this is neither the time nor the proper format in which to review this matter in detail, I will quickly list the primary order types that are most frequently used in the strategies outlined in The Pristine Day Trader.

    1) The Market Order is simply an instruction that informs your broker that you want to buy or sell a stock at the best possible price that can be currently obtained. This is the most widely used order type which is precisely why it isn't overly used by astute market players who have the luxury of watching their stocks closely. This is not to say that the market order has no place in a traders program, but rather that it should be utilized sparingly, and only after the market and the playable stock has already begun trading. Rule: Traders should never place a market order on any stock before the market opens. This is an error typically made by inexperienced stock market players who get over-zealous in their desire to buy or sell a particular stock. Professionals simply don't buy or sell stocks without any regard for what price they are going to open. They would prefer to run the risk of missing the entire play, comforting themselves in the irrefutable fact that "missed money is much better than lost money." Market orders should be used primarily in quiet trading climates, and only then after the overall market and the underlying stock has opened. Market orders used any other way are nothing more than dangerous, shoot-from-the-hip, gambling bets that will wreak havoc with your trading career. How many times have you bought at, or before the open, only to find out later that you purchased at the highest price of the day? Want to dramatically reduce the odds of this ever happening again? Just have the patience to wait a few extra minutes, and I guarantee that those extra moments will often mean the difference betwen latching onto a winner at the right price, and getting caught in a dud.

    2) The Buy Stop Order is by far our most frequently used order type and should be thoroughly understood by all of our traders. This order instructs your broker to buy a stock once (and only if) a specific price objective has been met. For instance, we may instruct you to place a buy stop order for XYZ Company at $20.50, which is well above XYZ's current price of $19.75. If XYZ displays enough strength to trade up to $20.50, you will be filled at the best price obtainable at that time. If XYZ fails to reach the buy stop price of $20.50, because of inherent weakness or overall market softness, you (fortunately) will not be executed. Whenever we advise you to use a buy stop order, you should observe the following cardinal rule, unless otherwise instructed. Rule: Place all your "buy stop" orders after the underlying stock has opened for trading. Just like the rule above, this will virtually eliminate the chance of you being caught into an issue that gaps open several points higher at the opening bell. Tip: You will be frequently instructed to buy a stock once it trades above a certain price level. It is this recommended strategy that is ideal for the "buy stop" order. If we are advising that you buy ABC Company, once it trades above $30, you will want to place a "buy stop" order at $30 1/16, providing that you are dealing with a stock on which you can place such an order. Unfortunately, stop orders cannot be placed on all stocks. The stocks on which you cannot use buy or sell stops must obviously be watched closely in order for the appropriate action to be taken. This is commonly referred to as using a "mental stop."

ON Selling

Selling is largely the most difficult part of the overall investment/ trading equation, and if a market player does not have a firm handle on a few sell guidelines which aid in making proper sell decisions, profits will be hard to keep, if they are ever come by at all. Below, I have listed a few guidelines that will help limit the number of errors which can too easily occur in this most delicate of all trading areas.

    Rule 1: Consider selling any short term stock recommendation that languishes for 10 consecutive trading days without ever achieving its upside target or violating its downside stop loss. We are in the business of moving in and out quickly (in most cases 2 to 5 trading days), and in order to maintain a certain degree of liquidity, we must eliminate any stock which attempts to tie up our much needed capital. We refer to this as a "time stop," and it is an excellent tool to incorporate into any short-term oriented trading program. Tip: In most cases, if a good part of the expected move has not occurred during the first 5 trading days, the chances are good that the stock will be "timed out" or even stopped out. You will find that most of our winning plays do produce a large part of their move in the beginning. This is not to say that one should not go the full distance with each short- term stock pick (max. 10 days). I just felt this point was worth being aware of.

    Rule 2: Consider selling only 1/2 of any stock that catapults over 25% within 3 trading days. While we are primarily short-term traders, as mentioned above, we are intelligent enough to realize the importance of capitalizing on longer-term opportunities that offer the chance of truly spectacular price gains. And our studies suggest that those stocks which rocket 25% or more in less than 3 trading days are the ones that will typically go on to be the market's big winners. Tip: We usually sell 1/2 of our position in these quick 25% cases, and keep the remaining half as long as the stock stays above its break even point and/or its 50 Day Moving Average (50 MA).

    Rule 3: On short term trades, consider always selling 1/2 of your current position whenever you can lock in a $1.50 to $2 profit, even if we state that we're looking for a larger gain. While it is true that many of our stock picks go on to score very large price gains, locking in a part of your profits by selling 1/2 gives the trader an opportunity to profit in two ways. The smaller "trading" profit will undoubtedly satisfy that insatiable urge to take home some bacon for the kids NOW. While letting the remaining half ride will satisfy the natural urge to really go for the gusto, just in case you happened to have purchased a "Pristine Rocket." Tip: This is a strategy that will largely appeal to those who trade in larger lot sizes, but we have found that it can work wonders for those who initially buy as little as 200 shares. Just remember, should you decide to put this strategy into practice, never allow your remaining portion (1/2) to slip back into negative territory. The beauty of this approach is that it is virtually a no lose situation. Locking in the initial profit makes part of the "paper gain" real, while the rest of your money either makes more money, or breaks even at the very worst. This is a very important point. Remember it.

    Rule 4: Do not lose more than 8% (10% max.) on any stock that is above $15. You will automatically adhered to this rule if our suggested stop losses are strictly administered. The "stop loss" is the the tool that we will always use as insurance against disaster. As a short term trader who utilizes the stop loss, you will frequently experience being stopped out of a stock, only to watch it quickly rise again. Unfortunately, this is a reality we traders must face and learn to live with. Why? Because this scenario is here to stay. When playing stocks over longer time frames, you can afford to give a stock a greater degree of latitude, because time becomes more of a positive factor. However, when you're playing stocks over several days (typically 2-10 days), you cannot be as generous with your risk parameters. This is why The Pristine Day Trader places such a great degree of significance on stops, even if it means occasionally selling our stocks near the low of the day. When you're primarily trying to capture $2.50 to $3 gains per trade, your average loss must obviously be significantly smaller than that. So a tight stop loss, just as those detailed in The Pristine Day Trader, is a must. Tip: At times, we will feel quite strongly that a stock which is about to be stopped out is still an excellent hold over a slightly longer period of time. And if we are willing to extend our holding period a bit, we will decide to sell only 1/2 of our current position at our suggested stop loss. The remaining half will be given a wider risk parameter. This partial sell technique typically accomplishes two things. First of all, it lightens the burden of our loss by exactly 1/2. At that point we are dealing with only a portion of your original problem. And a portion, as you well know, is a lot easier to deal with than the whole. Secondly, it gives the stock an opportunity to come back, as many of our stocks often do. While we don't want to minimize the importance of taking your lumps quickly and moving on, initially selling only 1/2 of a very strong stock on the downside can prove to be a wise choice. Just remember. Everything has its price, and this revised stop loss technique is no exception.

    Rule 5: Never let a $2.00 gain in any stock turn into a loss. This should be self-explanatory. It is hard enough finding issues that go in the desired direction, without allowing those that do to turn into wicked losers. Once you have a $2.00 gain or greater, consider yourself free from the possibility of loss. At that point you can either adhere to rule number 3 above, or even sell it all. But whatever you decide to do, never ever let a $2.00 profit go sour. It's simply not smart, my friends.

Gap Openings

Gaps openings are those frustrating occurrences when a stock (which we what to buy) starts the day trading significantly higher than the price at which it closed the previous day. Knowing how to deal with them in the context of our strategies can mean the difference between staying out of trouble and losing money very quickly. Below you will find a few helpful trading rules to aid you in coping with these frequent occurrences.

    Rule 1: Do not buy any stock that gaps open more than $0.50 above the previous day's close or our recommended buy price, whichever is higher. For example, if we state that we will look to buy once it trades above $35.00, i.e., entering at $35 1/16, and the stock then opens at $35.62 (over $0.50 above our recommended entry price of $35 1/16), it becomes invalid and should not be entered. Gap openings are typically caused by a euphoric morning rush of buy orders that dramatically overwhelms the number of shares currently being sold. As mentioned in the Market Order section of this report (see part one; page one), professional traders don't indiscriminately place buy orders at the market open, without any regard for where the stock is going to open. So, your job as a professional short-term trader is to refrain from getting caught in these amateur driven stampedes. And you can accomplish that by waiting to see where the stock begins trading, before you decide to act. Tip: As mentioned in part one of this report, you must never place a market order on a stock before it opens for trading. This one single rule should virtually eliminate the possibility of being caught in a morning gap. Also, I'd like to point out the fact that we personally use a more precise version of this rule, and strongly suggest that you consider incorporating it into your trading plan. Note: For stocks under $15.00, we will allow only a $0.37 gap above the previous day's close or our recommended buy price, whichever is higher, instead of the full $0.50 as stated above.

    Rule 2: Consider all trades that gap open more than $.50 (as stated above) INVALID, even if they subsequently fall back into our suggested buy range. This is by far one of our most important "gap" rules. Once a stock has opened for trading beyond the point we are willing to pay for it, the recommended trade becomes permanently invalid. Very often, a stock will start the day off very strong, only to meet with major selling that takes the issue back down to our originally desired buy range. When this happens, there is a strong tendency for those who feel that they've missed the first run up to gleefully buy it on the decline. Generally, this practice will produce more losers than winners. When a stock fails to maintain its initial strength, it is a strong indication that either professional traders who already own some are using the strength to take profits or that they're simply "fading" the issue. Note: Fading refers to a trading technique that involves going against the herd or crowd. If a stock jumps up too abruptly, some market makers or professional traders will sell into the rise with the idea that the herd mentality that caused the advance will quikly die out. Of course this applies to the reverse scenario as well. Tip: Just keep in mind that this is a general rule that will save you money most of the time. It does not mean that a stock cannot rally after experiencing a mild set back. I am only suggesting that the safest thing to do is stay away, because, as you know, "missed money is better than lost money." As always, when you are in doubt, call us before you act. That's what we're here for.

    Rule 3: Consider buying only 1/2 your normal size of any stock that gaps open within our suggested buy range. As mentioned above, we will limit our buys to a maximum $.50 above our suggested buy price; however, when a stop gaps open less than that (say 25 cents) it is still buyable but should be bought with 1/2 the funds you were initially willing to commit to the trade. Why? Because any gap open will translate into a higher purchase price, and a higher purchase price obviously means a higher degree of risk. If our stated downside risk is $1.50 based on our recommended stop loss (assuming no gap), adding 50 cents to the cost will now make the downside risk $2.00. To compensate for the additional risk, a trader limits his/her size.

Tip: Additional risk can always be compensated by buying less than your normal lot size. Whenever you are not buying at the ideal point, you are assuming more risk. Buying less will help offset the added risk. Make sense? I hope so.

On the Single Gap Exception

There is only one exception to the rule(s) mentioned above, and I feel compelled to briefly mention a few comments regarding this exception to the rule(s). Exception: Anytime a stock gaps out of a six to eight week base, it should be bought according to Rule 3 (above). At times, we will recommend a stock based on a strategy we call The 6 - 8 Week Break-Out, which is an extremely powerful stock play that often leads to big price moves. Because of the enormous upside potential that this particular strategy possesses, the underlying stock can be bought irrespective of a gap opening. Tip: An important point to note is that "gaps" are a sign of strength (although often temporary in nature), but one does need to have a general idea of when that strength is likely to be the start of something big, versus a temporary phenomenon that will quickly die out. The 6 -8 Week Break-out plays recommended in The Pristine Day Trader will offer you that clue. Look out for them and play them.

Pristine on Miscellaneous Points

Below you will find a list of miscellaneous points that do not command their own category, but are just as important as the aforementioned rules (some are even more important). In fact, this page may be the page to which many of you turn the most frequently for daily guidance. Repeatedly read each item with care, internalizing the rich meaning contained within.

    Point 1: Consider "6-8 Week Break-Out Plays," "50 Day Moving Average Plays," "Channel Plays," "Stair Step Plays" and "3 to 5 Down Day Plays" our most compelling trading strategies. As a Pristine subscriber, you will be exposed to, and learn from, a large number of reliable trading tactics, but the above mentioned strategies (listed in order of importance) are by far the most reliable and the most plentiful. In fact, some traders may want to play these strategies exclusively.

Tip: Whenever these strategies are used, they are very clearly stated in the commentary and/or on each accompanying chart.

    Point 2: If a recently recommended stock is not mentioned in our "Pristine Stocks Update" section, it is to be assumed that the original (or last updated) strategy is to be adhered to. Because of limited space, there are times when we are simply not able to update every one of our open positions; however, this is not usually necessary, anyway. Each of our stocks is accompanied by a very detailed buy a sell strategy at the time of its recommendation. That original strategy (namely stops and price targets) should be strictly adhered to, in the event that no update appears. Typically we will not mention a stock in our update section if it requires not change or adjustment in strategy. Tip: There will be times when a stock is not updated, despite having met its upside target or violated its downside stop. This lack of an update is not to be construed as no action taken on our part. In these cases, all stocks meeting their up or downside objectives should be assumed closed by us.

    Point 3: Please keep in mind that our suggested price objectives are calculated from the most current price, not from where you buy the recommended stock. For instance, let's assume that a stock is currently at $35, and we are looking for a $3 rise. this will make our upside target $38 ($35 + $3 = $38). Should you happen to buy the stock at $36, your upside potential profit will then be $2. Tip: Consider this important point whenever choosing which stock(s) to play.

    Point 4: Do not anticipate (jump the gun) by buying a stock BEFORE the suggested buy point is met. Very often we will recommend that you buy an issue once it trades "above" a certain price (example, XYZ: Current price $20. Buy once it trades above $20.25). We obviously choose to buy certain stocks this way for a good reason. Buying them before the upside buy point is met can prove very costly. DON'T DO IT. That is if keeping your hard earned money is important to you.

    Point 5: Do not buy any recommendation that hits its entry price in pre-market trading, before the market is actually officially open for trading. Occasionally, one of our over-the-counter recommendations will trade up to meet our stated entry price before the bell, but oftentimes these pre-market machinations are nothing more than market maker games best to be left alone by all but the most experienced traders.

    Point 6: Consider buying only 1/2 your normal lot size on any stock recommendation that has a stop loss more than $2.00 away. Playing half when the potential for loss is a bit healthy is a very important element in our approach. There is nothing more important than our (your) original capital, and keeping it in tact is the paramount objective. We'd rather err on the side of making far less than we could have to save ourselves from the potential of being devastated by a large loss. Tip: always err on the side of caution. You may not become a billionaire, but at least you'll be around to play another day.

    Point 7: Whenever choosing which of our four stocks to play, always consider the worst case scenario first. Each of our stock recommendations will have a suggested stop price at which to sell, should the trade go sour. If the noted stop loss is $2.50 away, tabulate the loss you will sustain if the stop is hit. If you feel that you will have no problem taking a loss of that size, then all systems are go (green light). If the tabulated loss will cause emotional and/ or financial difficulty, either reduce your size (example: reduce from 500 to 200 shares), or disregard the trade. Its fortunate that as traders we do have choices. You'd be very surprised how just a little forethought can save us a lot of heartache and pain, not to mention money.

    Point 8: Do not believe that trading big size (1,000 share lots) is necessary to make big money in the stock market, because it is not. This was one of my greatest discoveries and it literally marked the beginning of an unbelievably profitable era for me. Some traders simply don't have the mental wherewithal to trade in sizes in which each up and down tick dramatically effects their financial well-being (I know I don't). The large size often causes them to "dollar count" with each tick (a dangerous practice) a make premature decisions out of sheer greed and fear. What's more, large sizes will make the most meaningless move emotionally and financially dramatic,a fact that will certainly evoke frequently "stupid" decisions. Trading with smaller lots eliminates many of these concerns by evoking a calm that produces a high level of mental clarity. It is only in the state of this calm that sound decisions and responses can be made. I dare you to try this. Stop being greedy, and start being consistent.

Most traders, lacking consistency, try to substitute a high batting average with size (obviously going for the grand slam). I say lower your lot size, and go for the higher batting average. When you are wrong and lose, it will be easily dealt with. When you're right (consistently) you'll laugh all the way to the bank. "Small" is a very good thing at times. Try it!

*We hope that you find all of the items above to be informative, educational and financially rewarding*

Any redistribution of the above information, without Pristine's written consent, is strictly prohibited.

10 WAYS TO MASTER THE TRADE

How do you know you're making progress on the road to successful trading? There's one obvious answer: Check your financial results. There is little doubt you're doing well if you're booking consistent profits.
But raw capital production may not be the best way to judge your growth as a trader. The road to success has many detours where profitability isn't the best measure of results. For example, we all go through phases in which introspection and skill development are more urgent than short-term profits. So let's look at 10 ways to know you're making solid progress on the road to market mastery:
1. Money management becomes your lifeline, and all your trading strategies start to revolve around its core. Risk control becomes a key aspect of every position you take. You accept that controlling losses has a far-greater impact on your bottom line than chasing gains.
2. You develop your own trading plans and strategies rather than relying on books, gurus or other people's opinions. You notice how you're finding more opportunities than you have time to trade while looking through your charts. You look forward to the trading day with a growing sense of confidence and empowerment.
3. You feel more like a student than a master. You learn new things every day and can't wait to apply them to real-life trading scenarios. You listen closely to everything you hear, trying to pick up hints and concepts that will improve your performance. You expand your studies into everything market-related, including economics, fundamentals and balance sheets.
4. You stop visiting stock boards and chatrooms, because they don't add anything to your trading goals. You realize that everyone in those places has ulterior motives. You develop a healthy skepticism about companies, market-makers and even other traders. You realize that no one is really interested in your success as a trader, except for you.
5. You become more private in your discussions about the market with family and friends. You learn to keep your opinions to yourself, because they're just idle discussion. You never talk about open positions or ask others what to do with them. You recognize that opinions count only when they're backed up by cold, hard cash.
6. Trading starts to feel like any other successful profession. Your average profits get bigger while your losses get smaller. You experience fewer drawdowns that drain your capital and undermine your confidence. Your trading day starts to get a little boring, but you prefer the lack of emotional highs and lows.
7. You grade your performance each day and recognize when your actions did not meet your rising standards. You notice how certain times of the day are particularly dangerous or rewarding for your trading style. You keep a written diary that describes your strengths and weaknesses in stark detail.
8. You never cut corners in your market analysis, no matter how tired or exhilarated you feel at the end of the day. You set aside time to review your daily results, download fresh data and uncover themes for the next session. You don't trade at all when nonmarket matters keep you from finishing your nightly preparation.
9. You watch all types of markets, even those you're not trading at the time. You realize the next opportunity could come from anywhere, and you want to be prepared. You also understand that your trading interests will change over time, so you want to be ready for the next big thing.
10. You keep detailed trading records and update them on a nightly basis. You look at both profits and losses with complete detachment and a keen eye for self-improvement. You don't "conveniently" fail to include those trades you'd rather forget about.