The Complete Guide To Day Trading
The Complete Guide To Day Trading
The Complete Guide To Day Trading
GUIDE TO DAY
TRADING
A Practical Manual
From A Professional Day Trading Coach
Markus Heitkoetter
BookSurge, LLC
North Charleston, SC
The opinions expressed in this manuscript are solely the opinions of the author and do not represent
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ISBN: 978-1-4196-9563-6
PREFACE ........................................................................................................ IX
INTRODUCTION: WHY DAY TRADING? ....................................................... XIII
HOW TO GET THE MOST OUT OF THIS BOOK .............................................. XIX
PART 1: DAY TRADING BASICS – WHAT YOU SHOULD KNOW .......1
WHAT IS DAY TRADING?................................................................................. 3
WHO SHOULD BE DAY TRADING? ................................................................... 5
IS IT REALLY POSSIBLE TO MAKE A LIVING AS A DAY TRADER?.................... 9
HOW TO GET STARTED - DEFINE YOUR GOALS AND MAKE A PLAN .............. 17
1.) Define Your SMART Goal.................................................................. 18
2.) Make a Plan ....................................................................................... 19
3.) Execute the Plan ................................................................................ 20
HOW MUCH MONEY DO YOU NEED TO GET STARTED? ................................ 23
DETERMINING YOUR RISK TOLERANCE ......................................................... 27
WHAT YOU NEED TO BEGIN TRADING .......................................................... 29
A Computer .............................................................................................. 29
An Internet Connection ............................................................................ 30
A Charting Software................................................................................. 30
A Broker ................................................................................................... 39
A Properly Funded Trading Account ....................................................... 42
A Trading Strategy ................................................................................... 43
PART 2: YOUR TRADING STRATEGY –
THE CORNERSTONE TO YOUR TRADING SUCCESS ..........................47
HOW TO DEVELOP YOUR OWN PROFITABLE DAY TRADING STRATEGY ........ 49
STEP 1: SELECTING A MARKET ...................................................................... 51
Trading Stocks.......................................................................................... 52
Trading Forex .......................................................................................... 57
Trading Futures ....................................................................................... 65
Trading Stock Options.............................................................................. 80
STEP 2: SELECTING A TIMEFRAME ................................................................. 85
STEP 3: SELECTING A TRADING APPROACH ................................................... 87
Fundamental Analysis .............................................................................. 87
Technical Analysis ................................................................................... 90
Day Trading Charts ................................................................................. 93
Technical Indicators............................................................................... 103
Popular Trading Approaches................................................................. 135
STEP 4: DEFINING ENTRY POINTS ................................................................ 149
STEP 5: DEFINING EXIT POINTS ................................................................... 151
Stop Losses ............................................................................................. 152
Profit-Taking Exits ................................................................................. 160
Trailing Stops ......................................................................................... 167
Taking Partial Profits............................................................................. 169
Time-Stops.............................................................................................. 169
STEP 6: EVALUATING YOUR STRATEGY....................................................... 171
How to Read and Understand a Performance Report............................ 176
STEP 7: IMPROVING YOUR STRATEGY ......................................................... 183
THE 10 POWER PRINCIPLES –
MAKING SURE THAT YOUR TRADING PLAN WORKS ................................... 191
Principle #1: Use Few Rules – Make It Easy to Understand ................. 192
Principle #2: Trade Electronic and Liquid Markets .............................. 193
Principle #3: Have Realistic Expectations............................................. 193
Principle #4: Maintain a Healthy Balance Between Risk and Reward .. 194
Principle #5: Find a System That Produces
at Least Five Trades per Week ......................... 195
Principle #6: Start Small - Grow Big ..................................................... 195
Principle #7: Automate Your Exits......................................................... 197
Principle #8: Have a High Percentage of Winning Trades.................... 198
Principle #9: Test Your Strategy on at Least 200 Trades ...................... 198
Principle #10: Choose a Valid Back-Testing Period ............................. 199
PART 3: THE SECRETS TO DAY TRADING SUCCESS.......................203
THERE’S MORE TO TRADING THAN JUST HAVING A STRATEGY.................. 205
THE SEVEN MISTAKES OF TRADERS AND HOW TO AVOID THEM ................. 209
Mistake #1: Struggling To Identify the Direction of the Market ............ 212
Mistake #2: Not Taking Profits .............................................................. 213
Mistake #3: Not Limiting Your Losses ................................................... 214
Mistake #4: Trading the Wrong Market................................................. 215
Mistake #5: Lack of a Trading Strategy ................................................. 216
Mistake #6: Not Controlling Your Emotions.......................................... 217
Mistake #7: Overtrading ........................................................................ 218
THE TRADER’S PSYCHE ............................................................................... 221
THE THREE “SECRETS” TO DAY TRADING SUCCESS .................................... 227
THE TENETS OF DAY TRADING .................................................................... 231
HOW TO START TRADING WITHOUT RISKING A SINGLE PENNY .................. 235
BONUS MATERIALS ...................................................................................241
APPENDICES.................................................................................................243
APPENDIX A – TRADING PLAN TEMPLATE ................................................... 245
APPENDIX B – BROKER CHECKLIST ............................................................. 249
APPENDIX C – ADDITIONAL RESOURCES ..................................................... 251
APPENDIX D – READING RESOURCES .......................................................... 253
APPENDIX E – GLOSSARY ............................................................................ 257
APPENDIX F – ABOUT MARKUS HEITKOETTER ............................................ 271
APPENDIX G – COACHING PROGRAMS ......................................................... 273
Preface
I know that there are many websites and late-night infomercials that try
to tell you differently. They make you think that you just have to read a
few pages or attend an online class, and then, magically, you’ll become a
successful trader.
Don’t be fooled.
Like in any other profession, you need a solid education before you get
started. After all, the goal is to make more money than a lawyer or a
doctor, but many aspiring traders expect to learn everything they need to
know from an eBook that they might get somewhere on the Internet,
most likely for free. And how could a small amount of free information
teach you to make more money than people who have gone to school for
years and years?
Some aspiring traders think they don’t have to learn a single thing. They
believe that they can buy a “magic system” or “XXX software” that will
place their trades for them and make them rich while they sleep. Or they
rely on the advice of some “guru” for their trading decisions, blindly
following his recommendations without knowing anything about the
markets.
IX
The Complete Guide to Day Trading
You picked up this book because you’re serious about becoming a suc-
cessful day trader. And, by reading this book, that’s exactly what you’ll
learn how to do.
WARNING: Be aware, though, that just reading this book will NOT
automatically make you an instant millionaire. You’ll learn a lot of facts
and concepts about day trading, but in order to make the most out of this
book and become the trader you want to be, you’ll have to adapt the
ideas that you’re about to learn to what you already KNOW.
I moved from Germany to the U.S. in 2001, and one of my first “tasks”
here was buying a house. It should have been no problem – I mean, we
do have houses in Germany. It’s basically the same process, right?
But, I have it now. A friend of mine told me that an acre is about the size
of an American football field without the end zones.
X
Preface
The same is true in trading. You might already know many of the con-
cepts presented in this book (e.g. that you should use a stop loss). And
there might be some concepts that are new to you (e.g. using a time-stop
when exiting a trade).
But don’t worry: I’ll present all of these concepts in a very practical way.
You’ll be getting a great deal of examples and scenarios to look at – this
entire book is about you getting that “grasp” on trading that you’ll need.
And by the last page, you’ll have it.
Enjoy!
Markus Heitkoetter
January 2008
XI
Introduction: Why Day
Trading?
I f you’re thinking about getting into day trading, then you’ve proba-
bly got a pretty strong motivation. More often than not, that motiva-
tion is money. You want to be rich. No, wait. Let me be a little more spe-
cific: you want to be wealthy.
Just to make sure that we’re on the same page, let me touch on the key
difference between being “rich” and being “wealthy:”
2.) “Being wealthy” means that you actually have time to enjoy
your money, time to do what you want to do when you want to
do it.
So, is day trading really the ultimate solution to becoming wealthy? Let’s
see.
XIII
The Complete Guide to Day Trading
Having your own company means that you’ll have to find or create a
product, market the product, sell the product, deliver the product to your
customers, and collect the payments.
These days, there are many “Internet Marketing Gurus” trying to sell you
on the idea that you can automate everything, which will allow you to
sleep late, do nothing, and cash very fat checks on a regular basis. We
both know that this is a dream, nothing more.
You can automate the routine, sure, but not the exceptions. And believe
me: there are always exceptions when dealing with people – your cus-
tomers. Plus, as long as you have computers involved, you need to keep
Murphy’s Law in mind: "Whatever can go wrong, WILL go wrong.”
Nothing could be truer!
Even if you could automate most of the delivery, you still have to find or
create a product, set up a website, write salescopy, put the automation in
place, and generate traffic. And since the Internet is evolving so quickly,
you will constantly have to update your website and traffic generation
methods.
Okay, so what if you skipped the Internet part? If you have a “physical”
business, the headache might be even bigger: employees, vendors, law-
yers, competitors, invoices, customers, production problems, office
space, equipment, etc. I’ve known a number of small business owners
who have simply given up and gotten a regular 9-5 job. Sometimes the
reward just isn’t worth the stressful lifestyle.
XIV
Introduction: Why Day Trading?
Our second option on the road to wealth is investing in real estate. But
with the market slowing down and the current credit crunch, it’s not that
easy anymore. Most lenders these days require a down payment of 10-
20% for investment properties, so you also need substantial capital to
even get into the business.
You need an appraisal, too, and you might have to argue with the ap-
praiser about the value of the house; you need a home inspection and
might be surprised when you learn of all the things that need to be fixed
before you can sell; and, last but not least, your buyer might have to ob-
tain a mortgage. As you know, the mortgage industry has really become
“interesting” in 2007 (to say the least), and buyers that were pre-ap-
proved and pre-qualified might learn the day before closing that they
won’t receive the promised loan. And all of these problems are just the
tip of the iceberg. When it comes to hassle and problems, real estate in-
vesting is a flip of the coin, at best.
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The Complete Guide to Day Trading
In my opinion, it’s the perfect way to become wealthy. Here are ten rea-
sons why:
XVI
Introduction: Why Day Trading?
You don’t need a lot of money to get started. This is not like
buying property, for example, where you’re on the hook for
a monthly mortgage and other cash-draining expenses. In
trading, you can start with as little as $1,000! (We’ll talk
about how a little later.)
I'm talking "fast cash" in the sense that trading allows for
quick liquidation. You can convert trades for cash within
seconds. Where else in the world can you make money this
fast and comfortably? You can buy and sell and buy again in
minutes. You don’t have to wait to see your profits. Try this
with real estate or physical goods, where you might have to
wait weeks, or even months.
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The Complete Guide to Day Trading
9.) It's simple to learn how to make money with day trading
a.) A computer
b.) An Internet connection
c.) A charting software
d.) A broker
e.) A properly funded trading account
f.) A good trading strategy
I could go on and on, but I think you get the picture. Throughout this
book, we’re going to cover a lot of material that will help you get started
with trading successfully. Here are a few of the essentials:
In short: you will learn everything you need to know to start making
money with day trading. Ready?
XVIII
How to Get the Most Out
of This Book
T his book will help you become the trader you want to be, but it
won’t happen automatically. You will not instantly become suc-
cessful the minute you finish reading.
Making money with day trading IS possible, but it requires time, disci-
pline, effort, and commitment on your part.
Let me explain. Throughout the book, you’ll learn key concepts that you
can apply to your trading right away. The knowledge you accumulate is
extremely important, because it’s what you base your trading decisions
on, the decisions that will determine your ultimate success or failure.
One of my key goals in this book is to help you expand your trading
knowledge so that you can make well-informed decisions. I’ll provide
you with lots of valuable resources to help you learn what you need to
know.
At the end of each chapter, you’ll find ‘Action Items,’ exercises relating
to the topics recently covered. If you want to get the most out of this
book, take a few minutes to complete these Action Items. The results you
achieve will, in most cases, be directly proportional to the effort and
commitment you invest in creating them.
It is my pledge to help you become the best trader that you can be, but
I’ll need your help to do it.
XIX
Part 1:
Day Trading Basics –
What You Should Know
What Is Day Trading?
3
The Complete Guide to Day Trading
In this example, the day trader makes $1,000, minus commission. With
today's cheap commissions of $10 or less per trade, that's a quick $990 in
just 10 minutes!
When traded strategically, the trends and fluctuations in the markets al-
low for quick profits to be made in brief periods of time.
Quite simply, day trading is just like any other business venture: in order
to be successful at it, you need to have a PLAN. It would be very risky to
dive in head-first without looking. However, with the right tools – and
with the knowledge to use those tools efficiently and effectively – the
risks of day trading can be greatly reduced. With perseverance and com-
mitment, you CAN find trading success.
4
Who Should Be Day
Trading?
Traders who enjoy the most success in day trading, regardless of whether
they’re in it for a living or for some extra income on the side, generally
have solid trading strategies and the discipline to stick to their trading
plan.
Keep in mind that day trading is a very competitive field. In order to suc-
ceed, you need to maintain focus on a set of strategies which you can
implement immediately, without hesitation. Remember, a proven, strate-
gic trading plan can give you an edge over the rest of the market.
Unfortunately, even with a tested, proven trading strategy, you are not
guaranteed trading success. It takes something else. It takes discipline.
5
The Complete Guide to Day Trading
Whether you’re new to trading or have been trading for years, it’s all too
tempting to place the entirety of your trust in graphs, charts, and soft-
ware. If only trading was as easy as that!
Too many hobby traders have tried that, and, unsurprisingly, they’ve
failed. They bought the tools, but they didn’t have the knowledge they
needed to succeed. As in all things, education will do wonders for the
aspiring – and experienced – trader.
Of course, this is not to say that software programs and markers are not
helpful when it comes to day trading. On the contrary, many traders use
technical indicators which are instrumental to their success – a few ex-
amples of these are the MACD, moving averages, and Stochastics. How-
ever, though profitable day traders DO follow their indicators, they are
also aware that nothing is 100% foolproof.
Successful traders know that trying to hit a lucrative home run on just
one trade is a sure way to get burned. The key is consistency. You need
to devise a solid strategy that produces consistent trading profits, and you
need to learn and adapt as your experience with day trading grows and
evolves.
If you want to succeed with trading, then you MUST invest both time
and money to acquire the knowledge that you need, the discipline to
follow your trading strategy, and the patience to wait for the “perfect
trade.”
6
Who Should Be Day Trading?
Trading can be simple, but it is not easy. Along the line, you will
face losses, but you need to get up every single morning believ-
ing in you, your strategy, and WINNING. Have you ever heard
of “The Law of Attraction?” Basically, it states that in order to
achieve success, you need to focus and concentrate on attaining
that success. And the opposite applies too: if you focus on the
negative – on losses – then you’ll probably experience losses. It's
extremely important that you ARE positive and that you STAY
positive.
You overtraded this week? You let your emotions get the best of
you? You didn't stick to the strategy? Fine – these things happen
to the best of us. But don't lie to yourself, and don't make ex-
cuses. Take responsibility for your actions and your decisions.
Admit a mistake, learn from it, and move on.
4.) Be Committed
7
The Complete Guide to Day Trading
Trading is like every other profession: you learn the basics, you
apply them, you gain experience and then you refine your trad-
ing. The learning never stops. Do you really expect to make mil-
lions of dollars after only investing a few hours of time into your
education? You wouldn’t trust a doctor whose only education
was from free, downloaded Internet eBooks, would you?
There’s no doubt about it: day trading can be a profitable and exciting
way to earn money. With the right knowledge, you can radically reduce
the risk, which will create even more opportunities for achieving trading
success.
If you’re not willing to spend the time learning the techniques of trading,
reading about new and improved trading strategies, and working whole-
heartedly in a fast-paced trading environment, then day trading is proba-
bly not for you.
However, if you have the drive, dedication, and discipline, day trading
could seriously impact the shape and success of your financial future.
Action Items:
Decide right now that you will have the discipline to follow your
plan, that you will play above the line in your trading, that you
will maintain a positive attitude, that you exercise honesty, and
that you are 100% committed to your trading success.
8
Is It Really Possible to
Make a Living As a Day
Trader?
T his question is asked over and over and over again by many,
many people. The answer is: “Yes, it is possible!”
Sometimes people don’t believe me when I say that they can become
successful, full-time day traders, but it’s true. And I’m going to prove it
to you right now.
Before we get started, I need you to ask yourself one very important
question: “How much is ‘a living?’” Many people want to be ‘rich,’ but
they fail to quantify what ‘rich’ means to them. Are you ‘rich’ if you
have one million dollars?
Maybe so, but if you told Donald Trump that he had one million dollars
in his bank account, he’d wonder what had happened to the rest of his
money. He’d be furious!
9
The Complete Guide to Day Trading
Over the past couple of years, I’ve taught hundreds of people how to
make money with day trading.
I’ve taught people in countries where $2,000 allows you to live like a
king in a 6,000 square foot mansion with a butler, a gardener, and a cook.
And I’ve taught people who live in California, where they have to make
at least $20,000 just to pay for their mortgage, their utility bills, and gas
for their cars.
I’ve taught musicians who wanted to make $5,000 per month, which is
twice as much as they have made throughout their whole career.
Since I don’t want to get into a deep discussion about “how much money
is a decent living for you,” let’s just assume that you would be pretty
happy if you were making $150,000 per year, and let’s say that you are
making this money with your trading. Does that sound reasonable?
Let’s break it down: $150,000 per year would be $12,500 per month, or,
if you prefer, $3,000 per week. This is assuming that you are taking two
weeks of vacation per year.
IMPORTANT: Don’t set daily targets when you trade. In order to make
money, two conditions have to be met:
There will be days when YOU are not at your best (sickness, emotional
stress, no time because of an emergency, etc.), and there will be days
when the market is not ready to be traded (e.g. holidays, including the
days before and after holidays, days before a major news release, like the
Federal announcement regarding interest rates or the unemployment re-
port, etc.).
10
Is It Really Possible to Make a Living As a Day Trader?
Take a look at the following chart. The markets were open the day after
Thanksgiving and on Dec 24th and 26th, but there was barely anybody
trading, which you can see reflected in the volume bars. It’s the same
between the rest of the days after Christmas and through New Year’s
Day in 2008. Though the markets were open, the volume was very thin.
During these types of low-volume days, markets can be easily manipu-
lated and might behave very erratic, so it would be best to stay away
from trading.
And that’s why you shouldn’t set daily goals in your trading: those goals
will force you to trade on days when both of the previously mentioned
conditions – you AND the market being ready – are NOT met.
It’s important to start small and set a weekly goal for only ONE contract,
or 100 shares. This goal should be LOW, very low, so that it is easy for
you to reach it. Think about high-jumping: you train with a bar that’s
only three feet high. It’s easy to jump. Then, once you manage three feet,
you raise the bar another inch. And another. And another.
11
The Complete Guide to Day Trading
In order to trade successfully, you shouldn’t raise the bar too high too
fast. Put it at a level that you can manage every single time. You can al-
ways increase it at a later date, once you’ve proven that you can meet
your goal consistently.
Example:
In the first four weeks of your trading, you might set your weekly target
at $100 per contract. This might sound too easy for you, but keep in mind
that 90% of traders lose money in the markets. When you can make $100
per contract consistently, you can start “raising the bar.” Try $150 per
contract per week. Raise the bar again and again, but make sure that
you’re still comfortable in achieving your goals.
When day trading futures, options, or forex, you can use leverage and
trade multiple contracts on a rather small account. If you’re thinking
about trading the futures market, then you can easily find a broker who
will enable you to trade one contract of almost any futures instrument
that’s out there – E-mini S&P, E-mini Russell, currency futures, interest
rates, commodities, etc. – on a $2,000 account.
After awhile, you might raise the bar to $300 per contract per week. So,
if you want to make $3,000 per week, then you need to trade ten con-
tracts. The same applies to stock trading: if you can make $300 per week
trading 100 shares, then you need to trade 1,000 shares in order to make
$3,000 per week.
At this point, you might not have enough money in your trading account
to trade in these increments, but don’t worry – we’ll get there.
Ideally, to achieve your weekly goal, you’ll have a high average profit
per trade. The average profit should be at least 50% higher than your av-
erage loss, preferably even twice as high.
12
Is It Really Possible to Make a Living As a Day Trader?
One of the strategies that I use and teach to my students calls for a profit
target of $300 per contract and a stop loss of $200 per contract. You’ll
notice that the profit target is greater than the stop loss. That’s the beauty
of it: all you need is one net winning trade, and you’ll have achieved
your weekly goal of making $300 per contract.
So if you’re lucky, you could achieve your weekly profit target on Mon-
day morning with the first trade.
As everyone in trading knows, losses are a part of the business, and you
can’t avoid them. If that’s something you have trouble accepting, then
you shouldn’t be trading. However, there’s a huge difference between
losing big on a regular basis and losing small in a controlled trading plan.
You already know that you should keep your losses small; the key is to
keep them smaller that your average wins.
Let me take this a little farther and actually break it down for you: you’ve
lost $200 on your one losing trade, and then you make $600 on your two
winning trades ($300 each). Your net profit = $400. Goal achieved. Now,
STOP TRADING. Otherwise, you’ll end up giving back the money you
just made to the markets. Lock in your profits!
Of course, you’re not always guaranteed a week with only one loss. Let’s
look at a week that starts off with three losses. With three losses, you are
now down $600 ($200 each). So you would need to have three wins that
result in $900 ($300 each). Subtract the $600 you lost on the losing
trades from the $900 you won on the winning trades, and your resulting
net profit is $300. Goal achieved. Stop trading.
“Wait a minute – you’re saying that I will achieve my goals with a win-
ning percentage of only 50%?”
13
The Complete Guide to Day Trading
YES! That’s exactly what I’m saying! Read the example above again:
you lost $600 on three losing trades, made $900 on three winning trades,
and came out with a net profit of $300. This means that you could pick a
losing trade every other time and STILL achieve your weekly profit
goals!
I want to stress this point again, because many traders neglect this im-
portant concept of setting weekly goals. They define daily goals, which
create an enormous psychological pressure, and then they trade markets
when they shouldn’t, and they lose.
So let’s just assume for a minute that you do end up achieving an actual
winning percentage of only 50%. Now, when you start trading again on
Monday morning, what are your chances of having a winning trade?
50%! You have a one in two chance of meeting your weekly profit goal
in just one, single trade!
So if you DO achieve your weekly profit goal on the first trade Monday
morning, what next?
Stop trading for that week! Just enjoy life! It doesn’t get any better than
that.
Remember, you need to stick to your trading plan and your weekly goal.
Do NOT enter into another trade once you’ve already achieved your
weekly goal; the chance that your second trade may be a losing trade is
too great, and you would be giving your money and profits back to the
market. Overtrading and greediness are a trader’s downfall, so resist
them and stick to your strategies.
Now, you know that you can achieve your weekly profit goal with a
winning percentage of only 50%. Throughout the course of this book, I
will help you to get an even sharper edge in your trading, creating a
trading strategy with an even higher winning percentage.
A Quick Recap:
The first step towards financial success is to define your weekly profit
target. Next, you need to find a reliable, straightforward trading strategy
that will help you achieve your profit goal. When you enter into a trade
14
Is It Really Possible to Make a Living As a Day Trader?
and your trade hits either your profit target OR your stop loss, exit that
trade immediately. Stick to your trading plans and strategies until you
achieve your weekly profit goal, and then give yourself a rest until next
week.
If you’ll think back to the case I gave at the beginning of this section, in
order to make $150,000 per year – assuming a 50-week year and two
weeks of vacation – you’d need to make $3,000 per week. At a $300
profit per trade, this means that you would need to trade ten contracts (or
1,000 shares). Of course, this illustration can be applied to various
amounts. If you wanted to make $225,000 per year with a weekly profit
target of $300 per contract, for example, then you would have to trade 15
contracts (or 1,500 shares), and so on, and so on.
If you don’t have a trading account that let’s you trade the amount of
contracts or shares that I’m talking about yet, then now is the perfect
time to start building it. Remember, be patient with your trading, be
smart, be slow, and be steady. Trading success doesn’t happen overnight,
but with the right strategies and structure, you can achieve profitable re-
sults in a much shorter time period than you may have thought possible.
Plan your trades and trade your plan. THAT’S how successful traders
make money.
Action Items:
Start your trading plan now. You will find a trading plan tem-
plate in the appendix on page 245. Define how much money is
“making a living” for you. How much money do you want to
make with trading? Break down your overall goals into monthly
and weekly targets.
15
How to Get Started -
Define Your Goals and
Make a Plan
Before you dive in, you need to determine what your goals are. What do
you hope to achieve with your trading activities? Why do you want to
trade?
Before you trade a single penny, really think about what you hope to
achieve with that investment. Knowing what your goal is will help you
17
The Complete Guide to Day Trading
stay motivated when you’re facing a tough spell of trading, and it’ll help
you make smarter investment decisions along the way.
But be realistic:
Too often, people start day trading with dreams of becoming rich over-
night. I’m not going to say that it is impossible (because it is possible),
but let me remind you that it’s also very rare. It’s much safer to create a
trading strategy that will allow your account to grow at a slower pace
over time, which can ultimately be used for retirement or a child’s edu-
cation.
So let’s talk about how to define your goals and make a plan for your day
trading endeavors.
1.) Specific
2.) Measurable
3.) Attractive
4.) Realistic
5.) Timeframe
Fortunately, when it comes to day trading, it’s very easy to define a goal
that meets all of these criteria. You simply specify exactly how much
money you would like to make per month with your day trading.
Example:
• Is this SPECIFIC? –
18
How to Get Started - Define Your Goals and Make a Plan
• Is this MEASURABLE? –
• Is this ATTRACTIVE? –
• Is this REALISTIC? –
19
The Complete Guide to Day Trading
Many traders look for a trading strategy first and then hope that the
trading strategy will help them achieve their goals. That’s putting the cart
in front of the horse.
Regardless of what you’re doing, you should first define WHAT you
want to accomplish, and then plan HOW to achieve that goal. Otherwise
you might find out that you started climbing up the wrong ladder right at
the very beginning.
This is where the rubber meets the road. Once you have your plan, you’ll
need to actually execute it. And naturally, that’s where most of us fail.
Amazon lists 18,361 books for “Weight Loss” and another 28,707 books
for “Exercising and Fitness.” That’s a total of 47,068 books on the
popular topic “How to Lose Weight” (compared to only 4,463 books in
the category “Stock Trading and Investing”).
Come on, it’s simple: we all know that we can lose 10 pounds in 10
weeks if we just follow those two rules.
We reduce our calorie intake to 1,500 or 2,000 calories per day, and then
we do some aerobic exercises at least three times a week for a minimum
of 30 minutes.
20
How to Get Started - Define Your Goals and Make a Plan
And then we blame the plan: “it’s too hard,” “it’s impossible,” “it doesn’t
work.” This isn’t true. We didn’t succeed because we were simply too
lazy, or we didn’t have the discipline to execute our plan. But instead of
working on the true problem – the execution – we change the plan itself,
hoping that there’s an easier way.
Successful people will realize that their problem doesn’t lie in the plan,
but in the execution.
Here’s what you can do in order to ensure your own motivation and dis-
cipline when it comes to executing your plan:
It’s important to focus on the big picture. It’ll help you stay motivated
when your learning reaches a plateau, or when you face a couple of
losses. All great accomplishments start with a great vision.
Once you’ve defined your SMART goal and the amount of money you
want to make with trading, ask yourself this: “How would achieving this
goal impact your family life?” and “how would it affect you personally?”
Take your time to answer these questions and write down the answers.
When you take the time to actually think about the answer, it will be a
huge motivator. Little tricks like this will help you stay focused on your
long-term goal, which will help you to execute your plan.
21
The Complete Guide to Day Trading
Action Items:
Write down the impact that your trading success will have on
YOUR life and the life of your family. This is an important step,
because it’ll help you get through the challenging times, which
all traders experience.
22
How Much Money Do
You Need to Get Started?
1.) If you want to day trade stocks, then you need at least $25,000 in
your trading account.
2.) If you want to day trade futures, then you should have between
$5,000 and $10,000 in your trading account.
3.) When trading options, you should have between $1,000 and
$5,000 in your trading account.
4.) If you’re thinking about trading forex, then you can start with as
little as $500 in your trading account.
Financial considerations are always important, but don’t make the com-
mon mistake of letting your current financial situation dictate which
market you’re going to trade.
Remember: you first define your goal, and then you plan how to achieve
it.
23
The Complete Guide to Day Trading
If you don’t have sufficient funds to trade the markets you’ve outlined in
your goals, then start doing something about it now – save more money
or put in overtime hours. There are a lot of ways to make a few more
bucks, and it’s better to wait for the funds you need than to begin trading
in a market that isn’t right for you and your goals.
For those of you who already have the right amount of money in your
savings account, let’s talk about the question, “How much money
SHOULD you trade?”
Many first-time traders think they should trade all of their savings. This
isn’t true! To determine how much money you should trade, you must
first determine how much you can actually afford to lose, and what your
financial goals are.
Take a good look at how much money you can currently afford to trade.
You don’t want other parts of your life to suffer when you tie your
money up in a trade, so make sure to consider what these savings were
originally for.
Next, determine how much you can add to your trading activities in the
future. If you are currently employed, you will continue to receive an
income, and you can plan to use a portion of that income to build your
investment portfolio over time.
24
How Much Money Do You Need to Get Started?
2.) Never borrow money to trade, and never use money that you
can’t afford to lose!
Action Items:
If you don’t have enough money to start trading yet, make a plan
of how you will save or earn the money that you still need.
Continue your trading plan on page 245 and fill in the amount
under “My Account Size.”
25
Determining Your Risk
Tolerance
For instance, if you plan on retiring in ten years, and you haven’t saved a
single penny yet, you’ll need to have a high risk tolerance, because you’ll
need to do some aggressive trading in order to reach your financial goal.
On the other side of the coin, if you’re in your early twenties and you
want to start investing for your retirement, your risk tolerance can be
low. You can afford to watch your money grow slowly over time.
Realize, of course, that your need for a high risk tolerance or your need
for a low risk tolerance really have no bearing on how you feel about
risk. Again, there is a lot in determining your tolerance.
For instance, if you entered a trade, and you see that trade go against
you, what would you do?
27
The Complete Guide to Day Trading
Let’s say you are facing a $100 loss. Would you sell out, or would you
stay in the trade? If you have a low tolerance for risk, you would want to
sell out. If you have a high tolerance, you would wait and see what hap-
pens.
This decision is not based on what your financial goals are. This toler-
ance is based on how you feel about your money.
And, of course, your account size plays a vital role in determining your
risk tolerance. If you have a $2,000 account, then a $1,000 loss might
make you nervous, since you are losing 50% of your capital.
But if your trading account size is $100,000, and you are facing a $1,000
loss, then you might be more relaxed, since it is only 1% of your ac-
count.
Action Items:
Continue your trading plan on page 245 and fill in the amount
under “I Am Willing to Risk…”
28
What You Need to Begin
Trading
1.)
2.)
A computer
An Internet connection
3.) A charting software
4.) A broker
5.) A properly funded trading account
6.) A good trading strategy
A Computer
You don’t need the latest computer, and you don’t need the most expen-
sive. Basically, any computer that you’ve purchased in the past two years
will do the trick. Most charting software and trading platforms run on
Windows, so if you’re thinking about getting a MAC, make sure that the
software you are considering is MAC compatible. Notebooks are fine,
too. Just as a guideline, here are the minimum specifications:
29
The Complete Guide to Day Trading
You’ll also need a second screen. You should have your charting soft-
ware on ONE screen for the entry and exit signals, and your trading plat-
form on ANOTHER screen for entering the orders. A second monitor
will cost you around $150-$250. Don’t be cheap on monitors; you need
to make sure that you can see your charting software in crystal-clear
clarity. A 17” monitor will do the trick. A 19” is even better. Over 19” is
pretty much overkill. You can have a bigger monitor, but you don’t need
one.
An Internet Connection
Don’t be cheap here. Don’t ever try to trade using dial-up or a modem
connected to your phone. A reliable Internet connection is essential for
your trading success. After all, the data you receive from the market is
what you’ll base ALL of your trading decisions upon, so you can’t afford
a delay.
A Charting Software
Online day trading has developed to the point where charting software is
an indispensable tool of both professional and novice day traders alike.
The times when you drew your own charts in a notebook using quotes
from the morning newspaper are long gone. These days, powerful chart-
ing software packages allow you to access the market information in
real-time; this information is displayed in a variety of ways, all of which
can help you in carrying out your trades.
30
What You Need to Begin Trading
The bottom line is that you need to have a list of criteria, and you need to
compare and contrast the available charting packages using that list.
Make your choice based on the results. Here are some examples of crite-
ria you may want to use:
• Real-Time Data
You need a solid platform that can deliver real-time data in-
stantly. This feature alone will exclude many of the options
available, because a lot of web-based programs will have some
sort of delay. When it comes to day trading and/or swing trading,
you can’t afford to deal with a delay, even if that delay would be
perfectly acceptable in long-term trading.
Check out the markets that are covered by the charting software.
Most packages include the major U.S. markets, but if you need
other international markets, like Asian or European markets, then
you need to make sure that data is available in real-time.
You need trading software that will not cost you all of your
money before you even enter your first trade. It’s important to
shop around. However, finding a competitive rate does not mean
that the provider’s software is the cheapest. You have to be care-
ful on this one – the old saying “you get what you pay for” defi-
nitely applies when it comes to trading. Weigh your options. You
31
The Complete Guide to Day Trading
don’t want cheap trading software that offers you next to noth-
ing, but you probably don’t need the most expensive package –
with features you won’t even use – either.
And make sure that the provider you select will allow time for
you to test how the software platform actually works. If you’re
uncomfortable with using it, you should be able to claim a refund
within the first 30 days.
And, if you just can’t seem to find trading software out there that
is EASY to use, then find a software platform that comes with a
detailed user guide. A guide will help you become familiar with
the system and educate you at the same time.
• Reputable Company
Keep in mind that you can add other criteria to this list based on
your trading goals, such as the ability to quickly switch between
different timeframes. As I said previously: it’s a very personal
choice that only you can make.
32
What You Need to Begin Trading
eSignal
(www.esignal.com)
As of February 2008, the prices for eSignal range from $125/month (for
eSignal Premier) to $195/month (for eSignal Premier Plus), which makes
this package slightly more expensive than a number of other trading plat-
forms out there. If you’re an options trader, you’ll have the capability to
see 1,000 symbols through an options analysis package. In other words,
you can expect to pay as much as $249 to $360 every month.
However, given that eSignal’s charting and data feeds are coming from
the same provider, there will be no issues that the software provider can
blame on the data feed, or vice versa. (This “blame game” is something
that every professional trader has – or will – experience at some point
while using trading software).
Now, after you set up a chart in a way that you're comfortable with –
which is done by customizing sizes, colors, indicators, etc. – you can
save this format and apply it to other charts without delay. The sets of
charts and quote lists can be saved as ‘Pages,’ and it’s possible to switch
between these pages swiftly and easily.
Each and every window in the platform can be popped out of the main
eSignal window, which is a tremendous help when it comes to getting
33
The Complete Guide to Day Trading
the best out of that multi-monitor systems of yours. Besides the charts,
eSignal offers quote lists, level 2 screens, and news tickers to keep you
updated. All of these features can be connected to one another. For ex-
ample, picking a symbol in a quote list will make all of the linked charts,
level 2 screens, etc., change to the same symbol almost immediately.
All of the standard technical indicators are available, and there’s also a
program using JavaScript language called EFS (which is the foundation
language for eSignal Formula Script) for writing your own series of pro-
cedures; these procedures can be employed repeatedly all throughout the
life of the programs. EFS can also be used for communicating with bro-
ker interfaces, and, of course, for back-testing.
If you really want to get into a more advanced customization, there are a
couple of levels of API offered at additional cost, and these supply raw
access to the eSignal data feed. A standard subscription will let you
monitor up to 100 symbols, the next level up being 250, and if that’s not
enough, you can pay a little extra to get even more symbols to monitor.
The data feed itself is probably the best ingredient of the eSignal pack-
age. A trustworthy global market data feed, which eSignal has staked its
well-known reputation in the active trader community on, is available
right in front of you. To guarantee a nonstop transmission and perfect
accuracy of data, the company maintains fully redundant ticker plants,
and data can be exported through a flat file for you to open in Excel or
another spreadsheet application.
eSignal is without a doubt one of the best data feeds you can find on the
Internet. The charting product is powerful enough for most traders, with
EFS adding to its effectiveness.
TradeStation
(www.tradestation.com)
34
What You Need to Begin Trading
Award for Best Trading Software five years in a row, from 1994 to 1999.
It is generally accepted as the industry standard when it comes to chart-
ing software.
TradeStation is probably the first trading platform in the world that gives
you the ability to create, test, and fully automate your own rule-based
trading strategies on a daily basis. When you’re ready for your first trade,
TradeStation can watch your trading rules and even carry out your trades
100% automatically.
It’s also designed to help you discover some potential market opportuni-
ties and then perform your trades more professionally than you could
ever do on your own. TradeStation essentially monitors the markets for
you tick by tick, in real-time on the Internet, and seeks out all of the op-
portunities based on your trading plans.
The instant an opportunity arises based on your custom buy or sell rules,
it's designed to automatically generate your entry and exit orders and
send them to the marketplace within fractions of a second of the market
move.
35
The Complete Guide to Day Trading
bly worth your time to become skilled and get acquainted with this trad-
ing platform.
MetaStock
(www.metastock.com)
You can use QuoteCenter, which receives real-time data directly from
Reuters – the leading source of financial news to the world's media – and
combine it with MetaStock Pro. The main program itself is very user
friendly, and it’s quite easy to familiarize yourself with all of its func-
tions, even if you’re a beginner. The program is also fully compatible
with Microsoft Office, which means you can cut and paste data directly
into Excel or Word.
Equis has provided all types of chart forms and features; trendlines,
moving averages, resistance lines, support lines, and various other tools
of the trade are accessible by simply clicking and dragging your mouse.
You can also choose the Internet option to receive quotes, news, and op-
tion symbols straight from Reuters, without any charge.
36
What You Need to Begin Trading
Many traders say that one of the best features in Metastock is the search
facility. The search facility will let you search your entire database of
stocks and shares based on your specified criteria. The plan is to uncover
any stocks that display according to your trading strategy. The program
will then calculate how much money you could make using a particular
trading strategy. The results will give you detailed information, such as
when to buy and sell at what price, and how much was made or lost from
each trade.
Equis will also give you a CD full of historical data from which you can
create charts, along with the online connection you need to upgrade the
database anytime you want. You’ll receive a 550-page manual of Tech-
nical Analysis, from A to Z, which will make even the novice trader able
to master the software and technical analysis methods in no time. Not to
mention that the ‘HELP’ menu even includes an interactive visual tuto-
rial, so you won’t get bored.
37
The Complete Guide to Day Trading
With Tradesense, you can take any strategy idea – whether it’s from a
trading book, a seminar, or even from your friend – and test it using a
variety of order types (such as limit orders and stop orders) to develop
and analyze its performance. Tradesense will spot the indicators you’re
looking for, and then automatically fill in the values for you.
Precision Tick is also another unique feature from the Genesis testing
system; it allows you to back-test any strategy, and it ensures that every
rule is executed precisely based on real-time market conditions. You also
have the ability to create your next bar orders. Any strategy you put into
the program can be completed with an “Action.” Once certain criteria are
met, whether Long or Short, it will let you place a given order.
With Trade Navigator, you can create your own custom indicators and
strategies, you can trade direct from the chart, and you can use the In-
stant Replay mode if you want to practice your trading. Speaking of
which, with Instant Replay, you can go back to a certain date in the past
and observe the data as it fills in, watching the way it moves on the days
that the bars were created.
It’s like having your own time machine, which allows you to travel back
in time and then move forward to the present time as you watch the chart
changing in front of your eyes. Instant Replay mode is the perfect tool
for any type of trader to plan for real-time trading without any risk at all.
38
What You Need to Begin Trading
Genesis also has a variety of training videos available and offers free
webinars on a regular basis, to help you get the most out of their software
package.
Hopefully you now have a better idea of what type of trading software
will best fulfill your needs. Remember, powerful charting software is
what gives you the velocity and ability to carry out nearly instantaneous
trades in response to breaking news. In time, you might want to move on
to more sophisticated software as you become more experienced in the
trading world.
If you need any help setting up your trading platform, or have any other
questions, you can always utilize the company’s customer support.
A Broker
You may wonder if you really need a broker. The answer is yes. If you
intend to day trade, then you must have a broker. And it doesn’t matter
whether you are trading stocks, futures, forex, or options: unless you are
a member of the exchange, you won’t be able to place your orders with-
out a broker.
39
The Complete Guide to Day Trading
Discount brokers typically do not offer any advice or research; they just
do as you ask them to do, without all of the bells and whistles.
So, the biggest decision you must make when it come to brokers is
whether you want a full-service broker or a discount broker.
If you are new to investing, you may need to go with a full-service bro-
ker in order to ensure that you are making wise investments. They can
offer you the skills that you lack at this point. However, if you are al-
ready knowledgeable about the market you want to trade, then all you
really need is a discount broker to make your trades for you.
Selecting the right broker can be a tedious battle for most novice traders.
There are more than a hundred online brokers today and additional
choices are becoming available all the time.
The challenge lies with too many choices – it isn’t easy to choose which
broker is best for you amongst all of the many options out there.
This section, though, is all about providing you with some necessary tips
for picking an ideal trading broker.
40
What You Need to Begin Trading
First off, you’ll need to double your diligence if you’re looking for a
forex trading broker. Since the foreign exchange market is worth trillions
of dollars, it offers lucrative opportunities for brokers to set up their
firms online. And since the foreign exchange market is decentralized, it
can be hard to identify quality brokers amongst all of the unscrupulous
brokers with fraudulent practices.
Your chances of finding an honest and reliable forex trading broker will
dramatically increase if you follow the guidelines below:
• Do a check with the local regulatory agencies and make sure that
the forex trading broker is registered. For U.S.-based brokers,
see if they are registered as Futures Commission Merchants
(FCM) with the Commodity Futures Trading Commission
(CFTC), and registered with the National Futures Association
(NFA).
I’ve also included a list of questions for you to ask your broker in the
appendices.
41
The Complete Guide to Day Trading
Obviously, you need money to trade. But you’ve also heard this warning
several times: “Don’t trade with money that you can’t afford to lose.”
You might think that this is just the typical disclaimer that every profes-
sional in the trading industry has to use. But it’s not. It’s much more.
A few weeks ago, I received an email from a trader who told me that his
wife had given him a deadline: if he was not trading profitably within the
next four weeks, he would have to stop trading altogether and get a ‘real
job.’
I’m not saying that this trader’s wife didn’t have ground to stand on, but,
as you’ll learn in the third part of this book, there’s more to trading than
just having a strategy. You might have heard that a trader’s two biggest
enemies are fear and greed. This is very often the case. That’s why con-
trolling your emotions is extremely important to your trading.
I can’t stress enough how important it is not to put too much pressure on
yourself or your trading performance. And in order to keep the pressure
to a minimum, you probably shouldn’t quit your day job just yet. Before
becoming a professional day trader, your trading must be consistent, and
your profits should be almost predictable. Give yourself some time to
prove that you have what it takes to trade for a living.
42
What You Need to Begin Trading
So, in order to avoid situations like the afore-mentioned trader got him-
self into, fund your account appropriately – not too much and not too
little. And be prepared for a period of time where you may not make a lot
of money with it. As with everything, there is a learning process when it
comes to trading.
For more information on the right amount of money to get started with,
see the chapter “How Much Money Do You Need to Get Started?” on
page 23.
A Trading Strategy
You can have the latest computer, six screens, a T1-Internet connection,
the best broker in the world, and a well-funded trading account, but none
of these will produce trading profits for you.
In the next part of this book, you’ll learn how to develop a profitable
trading strategy that works for you.
43
The Complete Guide to Day Trading
Action Items:
44
Part 2:
Your Trading Strategy –
The Cornerstone to Your
Trading Success
How to Develop Your
Own Profitable Day
Trading Strategy
The next part of this book will show you how to develop your own trad-
ing strategy in seven simple, but very important, steps.
49
Step 1: Selecting a Market
W ith the fame of online trading, more and more financial in-
struments are available to trade. You have a variety of
choices, not just stocks, options, and futures. In recent years, financial
instruments like Exchange Traded Funds (ETFs), Single Stock Futures
(SSF), and the Foreign Exchange Market (forex) have become available
for the private investor.
These days, you can basically trade ANYTHING. For example, if you
want to participate in the real estate market without owning properties,
you can invest in Real Estate Investment Trusts (REITs), or even Real
Estate Futures of a particular area, like Chicago or Denver (traded at the
CME).
In this chapter, we’ll focus on the four main markets: stocks, forex, fu-
tures, and stock options. We’ll examine each of these markets according
to the following criteria:
Low initial capital means that you can start your day trading
activities with a low initial deposit. It’s always better to trade
51
The Complete Guide to Day Trading
2.) Leverage
3.) Liquidity
4.) Volatility
Throughout the course of this book, you’ll learn how to trade any market,
but it certainly helps to know something about the market you’re trading.
So, we’ll include a brief description of markets and participants in the
beginning of each of the following sections.
Trading Stocks
The stock market is a private or public market for the trading of company
stock at an agreed price. Companies are given a value by investors. The
value of the company is divided into many shares. These shares can be
bought or sold (raising or lowering the value of the company).
52
Step 1: Selecting a Market
When you buy stocks, you essentially own a little piece of that company
whose shares you just bought. You’ll become a shareholder. So, the more
shares you buy, the larger the portion of the company you own. If the
value of the company rises, the value of your shares rises. If the value of
the company decreases, the value of your shares decreases.
When the company makes a profit, you may receive some of that profit
in the form of dividends; the profit is shared amongst all the people who
own the stock.
There are two main types of stocks – preferred stock and common
stock – and there are many advantages to owning preferred stock over
common stock. Here are the main ones:
However, as a day trader, you really don’t have to worry about the dif-
ferent kinds of stocks or dividend yields, since you’re just holding a
stock for a few minutes or hours.
If you have an email account, then you’ve probably received a great deal
of emails with Free Stock Trading Tips. In these emails, somebody rec-
ommends a “hot stock.”
If you were to follow these tips, you’d probably end up getting caught in
a so-called "pump-and-dump" scheme.
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The Complete Guide to Day Trading
These so-called stock picking services buy a certain stock that's usually
trading at $0.02-$0.30. Many times, these stocks are not even listed on
the exchanges, and the volume is typically only a few thousand shares
per day.
After these stock picking services buy tens of thousands of these shares,
they start recommending it to their subscribers. You’ll find that it’s not
easy to buy these stocks since they’re not listed on regular stock ex-
changes. And, if you ask your broker to buy this stock for you, you might
end up paying 4-5 times more than normal in commissions.
The stock picking service is now hoping that many of their subscribers
will start buying this stock. They typically say, "It's trading now at $0.02
and it should go up to $0.12.” That would be a whopping 600% increase!
Since stock traders are greedy by nature, many will probably start buying
this stock, and since there is a sudden demand, the stock prices will go up
– initially.
But, before the stock hits the predicted exit price, the stock picking ser-
vice starts selling (or dumping) the shares that they bought BEFORE
they recommended it to you.
Since they bought such a large amount of this stock, there's suddenly an
enormous supply available again, and prices start falling. More and more
investors panic and sell their stocks, which drives the stock prices even
further down.
After a massive sell-off, the stock is generally trading at the same level it
was BEFORE the stock picking service started recommending it. And, in
some cases, it’ll be much lower, resulting in a loss for whoever was
drawn into the trap. So, investors are losing their money, and the only
winner is the stock picking service.
54
Step 1: Selecting a Market
As you can see, stock prices start moving two days before the “hot tip”
at unusually high volume. If you were to buy MOSH on Dec 18th, 2007,
at the point of the arrow, as recommended by this service, you would
have bought it at a price between $0.25 and $0.35 per share.
Note that a few days later, the “hot stock pick” is trading at $0.20, and
you would have lost between 25-75% of your capital.
55
The Complete Guide to Day Trading
2.) Leverage
56
Step 1: Selecting a Market
3.) Liquidity
4.) Volatility
And that’s just naming the first three stocks of the Dow
Jones. Volatility has NOT been a problem in the stock mar-
kets, especially in 2007.
Conclusion:
Stock markets have good liquidity and volatility, but the initial capital
requirements are high ($25,000) and the maximum leverage is only 1:8.
Trading Forex
This market may sound really complicated and frightening to tackle, but
trust me, it’s not. Just like any other type of trading, the basic rule in the
forex market is that you have to buy when the market is going up and sell
when the market is going down.
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The Complete Guide to Day Trading
The word “forex” comes from Foreign Exchange, and forex is often ab-
breviated to FX.
All the currency of the world is involved in the forex market. It may be
confusing to choose which one to trade, but all you really need to know
are the major currencies, which are the most frequently traded.
The next thing you need to know is that forex is traded in currency pairs.
Trading currency pairs means you’re buying one currency while simulta-
neously selling another currency.
58
Step 1: Selecting a Market
Examples:
The most heavily traded products in the forex market are typically:
• EUR/USD
• USD/JPY
• GBP/USD
It’s very important for you to know that the forex markets are extremely
volatile. You can easily make (or lose) thousands of dollars in a single
day.
Many forex brokers offer "free quotes and charts" and "no commissions,"
but keep in mind that nothing is for free. You are paying a spread – i.e.
you CANNOT buy a currency and immediately sell it for the same
amount.
It's like at the exchange booths when you’re on vacation: you might ex-
change $100 into 80 Euro, but when you change the 80 Euro back into
dollars, you only receive $96. The same concept applies when trading
forex: you’re paying at least 2 "pips." This amounts to approximately
$20, depending on the currency pair you're trading.
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The Complete Guide to Day Trading
You’re trading against your broker: if you’re selling, then your broker is
buying from you, and vice versa. And that's why your broker is giving
you the quotes for free: he can basically give you *any* quote he
chooses, since there are no regulations.
Example:
Take a look at these forex quotes. All three of the following screenshots
were taken on Tuesday, January 1st, 2007, at 3:00pm U.S. Easter Time.
Note: The time in the first two charts is displayed at GMT (+6 hours)
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That's a difference of 137 ticks, which equals $1,370! Do you see the
problem? Forex prices are completely subjective.
Mini-Forex Trading
Although the capital requirements for trading the forex markets are al-
ready low, "Mini-Forex Trading" has become very popular recently.
Mini-forex trading is good for people who have just started in the forex
market and who don’t have enough funds to open a regular account. It
requires a smaller amount of capital compared to regular forex accounts
– a minimum of $250.
On this account, you can trade up to 5 mini lots. A mini lot is only 1/10th
the size of a standard forex account.
Example:
Even with just a small stake involved, you still get to enjoy benefits such
as a free trading platform – just like regular forex traders. A few other
benefits include state-of-the art trading software, charts, and resources.
In this way, you can build up your confidence in your trading skills while
slowly increasing your profits and trading position in the market. You get
to manage your money on a small scale before going for the higher
stakes in regular forex trading.
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You can also develop a sound trading strategy without getting too emo-
tionally involved in possible profits or losses. For practice, newbies can
start with paper trading; in the real market, they can start small with
mini-forex trading.
Conclusion:
2.) Leverage
3.) Liquidity
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4.) Volatility
You will find decent volatility in the forex market. It’s not as
great as in the stock market, but because of the extremely
high leverage, even small movements can yield substantial
profits. Here are the average daily movements for three dif-
ferent currency pairs:
Conclusion:
Forex markets are extremely liquid and the capital requirements are as
low as $1,000. The leverage is at least 100:1 and there’s decent volatility.
Overall, forex seems to be a good market to trade, but keep in mind that
there are some disadvantages, too, as mentioned earlier in this section.
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Step 1: Selecting a Market
Trading Futures
So what are futures? Futures contracts, simply called futures, are ex-
change-traded derivatives. They are standardized contracts among buyers
and sellers of commodities that specify the amount of a commodity, the
grade/quality, and the delivery location. These futures contracts are typi-
cally traded at futures exchanges, like the Chicago Board of Trade
(CBOT), the Chicago Mercantile Exchange (CME), the New York Mer-
cantile Exchange (NYMEX), and others.
2.) Interest Rates – Interest rates are traded in two ways on this
market: long-term interest rates are represented by T-Bonds,
while T-Bills are used for short-term interest rates.
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4.) Food Sector – Sugar, coffee, and orange juice are just a few of
the regular goods traded in this sector.
Futures are not borrowed like stock, and therefore initiating a short posi-
tion is just as common and easy as buying the futures.
All futures transactions in the United States are regulated by the Com-
modities Future Trading Commissions (CFTC), an independent agency
of the United States government. Each futures contract is characterized
by a number of factors, including the nature of the underlying asset,
when it must be delivered, the currency of the transaction, and at what
date the contract stops trading, as well as the tick size, or minimum legal
change in price.
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1.) S&P 500 E-mini – This contract has all of the advantages of
the S&P 500, but the cost of investment is much lower. It
can be traded electronically five days a week, almost 24
hours a day. It’s become exceptionally popular in the futures
markets.
2.) E-mini NASDAQ 100 – As with the S&P 500, this contract
is electronically traded; it tracks the movement of the
NASDAQ 100. The margin amount required to trade is sig-
nificantly smaller than a standard contract, and since not all
traders have the funds to trade on the regular NASDAQ 100,
this E-mini is the perfect solution.
3.) Light Sweet Crude Oil – Oil futures are one of the most
well-known commodities out there. Every time you hear
about “the price of oil” in the paper or on the news, this is
the contract they’re talking about.
The growing popularity of futures trading stems from the fact that only a
relatively small amount of money, known as initial margin, is required to
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Whenever you open a position by buying or selling futures, you will pay
a small initial margin. The advantage is that the initial margin on a stock
future is much less than the cost of buying the actual stock outright.
Example:
The following graphic shows an actual stock index, the S&P 500.
This index could rise from 1560 to 1570. As of October 12th, 2007, it is
trading at around 1561.80. Some people think it’s less risky to trade the
whole market index rather than an individual stock. Therefore, the stock
exchanges have introduced an artificial stock named the SPY (also called
the SPYDER contract).
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Step 1: Selecting a Market
The SPY stock actually mirrors the S&P 500 Index, because tradition-
ally, you cannot trade the whole index. If you wanted to trade the whole
S&P 500 index, you would literally have to buy all 500 stocks in the in-
dex. Obviously, you can’t do this. In order to make it affordable for pri-
vate traders, the SPY is divided by ten.
So, we’re tracking the index, and the artificial stock is reduced by a fac-
tor of 10 – it’s trading at 156. If the SPX (the index) moves from 1560 to
1570, then the SPY will move from 156 to 157.
If you’re trading one share of SPY, you will make or lose one dollar.
And how much capital is needed in order to trade one share? 156 dollars.
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So, for 156 dollars, you will be rewarded with a one dollar profit if the
whole index moves by 10 points.
And, if you were trading 500 shares of the SPY, then you would make
500 dollars on a move of 10 points. Obviously, the capital needed for
500 shares is much higher than for one share. The capital needed is actu-
ally 156 dollars per share times the 500 shares that you would want to
trade.
The total amount of capital needed to trade 500 shares would be 78,000
dollars.
78,000 dollars is quite a lot. The thing to look at here is your return on
investment, which is what most traders use to measure their success.
If you make five hundred dollars after investing 78,000 dollars, the re-
turn on that investment would be 0.6%. That’s a very small amount for a
10-point move in the underlying index.
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Now, the following chart shows the futures contracts, the so-called E-
mini S&P:
You’ll see that the E-mini is tracking the index much closer – here we’re
looking at a current value of 1574.50. The important thing to know is
that if the E-mini S&P – which is also abbreviated as ES – moves from
1560 to 1570, you would actually make 500 dollars per contract.
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And how much of an investment is required to make 500 dollars off one
contract in this move?
So, you can deposit 4,000 dollars and participate in a 10-point move for a
profit of 500 dollars. Let’s calculate our return on that initial investment.
Instead of 0.6%, we are looking at 12.5%. That’s more than twenty times
the return you would have gotten using the SPY contract.
Of course, this can be a double-sided sword. You can easily make 500
dollars, but if the trade goes against you, you would lose 500 dollars. So
basically, trading one contract of the E-mini S&P is no different than
actually trading 500 shares of the SPY.
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As you can see at the bottom of the previous chart, there are small Rs.
These Rs indicate expiration dates. A futures contract is only valid for a
certain period of time. In the case of the E-mini S&P, a futures contract
is valid for 3 months. You might know this concept from options. Op-
tions also have an expiration date.
After the expiration date, a new futures contract starts trading and the old
contract expires. You might have heard horror stories that if you are
holding a position and the futures contract expires, then you will have to
take delivery. So, according to these tales, if you are trading the grains –
corn, for example – and the contract expires, you will get the corn deliv-
ered to your doorstep.
Basically, what will happen is this: before the futures contract expires,
your broker will get in contact with you and send you some information.
It will probably be something to the effect of, “Alright, in a couple of
days, this futures contract will expire. We should get rid of this position
or roll it over.” Rollovers are when one contract expires, and the other
contract actually starts trading. This is something your broker will take
care of, so you don’t have to do anything on your end.
Believe me, your broker doesn’t have any interest in you getting a physi-
cal delivery of corn, you don’t have any interest in getting a physical de-
livery of corn, and it’s unlikely that anyone else has any interest in you
getting a physical delivery of corn either. So, don’t believe these horror
stories.
Just be accessible to your broker, and you shouldn’t have any problems.
Make sure that he has a number where you can be reached so that he can
inform you of what’s going on.
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Let’s go back to the S&P 500 Index. As you can see by the decimals in
the following graph, it’s trading at one-cent increments.
In order to make futures trading a little easier, it’s been simplified even
further. If you look at the following example, on the very right side, it’s
trading in quarter increments. If the E-mini S&P futures contract moves
from 1560 to 1570, you’ll make or lose 500 dollars, depending on what
kind of position you took. And if a 10 point move translates into a $500
gain or loss, then a 1 point move is worth $50.
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When trading the e-mini S&P, the minimum tick movement (or mini-
mum movement) is a quarter. So, you can see that it goes from 1550 to
1550 and a quarter, 1550 and a half, 1550 and three quarters, and then up
to 1551. If the minimum movement is a quarter, then every tick move
totals $12.50 (one quarter of $50). Very easy. There are four quarters in
one point, so you just have to divide the 50 dollars by four.
So, why is that important? Well, it’s not really – all you need to know is
that when trading one futures contract with anywhere between 2,000 to
4,000 dollars, you can make a return of 50 dollars per point. Keep in
mind that you can also LOSE 50 dollars per point.
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Remember, the 2,000 to 4,000 dollars we’re talking about is the initial
margin, which is the sum of money that a customer like you must deposit
with the brokerage firm for each futures contract that you buy or sell.
Now, just think about this for a minute: let’s assume that you have an
80,000 dollar account – what can you do with it? Well, you could buy
500 shares of the SPY stock. Or you could trade 20 futures contracts in
the ES. If you choose to trade the 20 futures contracts instead of the 500
SPY stock shares, you’ll make 10,000 dollars! If you stick with the SPY
shares, you’ll only make 500 dollars per 10-point move.
You can see the difference. You get a much bigger leverage on your ac-
count with futures trading, and a higher leverage is exactly what will
help you grow your account (as long as you know what you’re doing).
There are two types of margins. The initial margin (sometimes called
the original margin) is the sum of money that the customer must deposit
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with the brokerage firm for each futures contract to be bought or sold.
Initial margin is paid by both buyer and seller.
So, when profits occur on your futures contracts, they will be added to
the balance of your margin account, and on any day losses accrue, the
losses will be deducted from the balance of your margin account.
Keep in mind, if the funds remaining in your margin account dip below
the maintenance margin requirement, your broker will require that you
deposit additional funds to bring the account back to the level of the re-
quired margin. Again, this is called a margin call.
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fast. But, as stated before, if you take futures trading lightly, you could
also wipe out your trading account in a matter of days. Therefore, it’s
crucial to your trading success that you diligently educate yourself in
futures trading, and trade only with a proven and solid trading strategy.
The more you know about the basics of futures contracts and commodi-
ties like this, the better your chances of trading success.
2.) Leverage
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3.) Liquidity
4.) Volatility
Conclusion:
Futures markets can be very liquid, and the capital requirements are as
low as $2,000. The leverage is at least 1:50, and there’s decent volatility.
Futures markets are regulated and the spread is typically 1 tick (mini-
mum movement of the contract). Commissions are usually below $5 per
transaction. It’s no surprise that many day traders choose the futures
market for their trading endeavors.
Make sure to check the volume and liquidity of the market you want to
trade, since there are huge differences between the markets.
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Stock options trading is quite similar to futures trading – they both in-
volve the process of buying stocks at a pre-determined price and then
selling them when the price rises above its original amount.
When you buy an option you have the right – but not the obligation – to
buy (call) or sell (put) a specific underlying asset at a prearranged price
on or before a given date.
Example:
Let’s assume that you buy a call – a right to buy – 100 shares of ACME
Holding Inc. at an agreed price of $40 per share (strike price), on an
agreed date in March of 2008 (expiration date), and you pay $5 for the
option.
But, if ACME Holding, Inc. is trading at $50 per share on or before the
expiration date, your option is, in effect, worth $10. This is the difference
between the price your option to buy ACME Holding, Inc. is set at – in
this case, $40 – and the price at which it is actually trading – $50.
This will give the individual who bought the put option the right to sell
that option at an agreed upon price (strike price) on or before a specific
date (expiration date).
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Step 1: Selecting a Market
Options are one of the oldest trading vehicles which man has ever used.
Around 600 B.C., Thales used the stars to predict that there would be a
bumper olive harvest, and he bought options on the use of olive presses.
When the harvest did in fact prove to be a great one, Thales was able to
rent the presses out at a significant profit.
2.) Leverage
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3.) Liquidity
Options are typically not very liquid. Even if you trade options
on the Dow 30 stocks, you will notice that only a few thousand
options are traded per day. The reason for the low volume is the
broad choice of options: at any given time you have several
strike prices and multiple expiration dates available.
4.) Volatility
Options that are traded “at the money” or “in the money” typi-
cally have a very high volatility. In our example, we chose an
IBM “at the money” option with 23 days to expiration. The cur-
rent price was $3.30, and throughout the day, it was trading as
high as $3.95. The previous day’s close was $4.30. Therefore,
the intraday volatility for this option was almost 20%. Consid-
ering the previous day’s close, the overall volatility was close to
30%.
Conclusion
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Action Items:
Decide which market you want to trade. Spend four more hours
learning about the market you choose. Surf the Internet and read
articles. Try to find out as much as you can about your preferred
market without being overloaded with information.
Continue your trading plan on page 245 and fill in the market
you selected under “Selecting a Market.”
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Step 2: Selecting a
Timeframe
When you select a smaller timeframe (less than 60 minutes), usually your
average profit per trade is relatively low. On the other hand, you get
more trading opportunities. When trading on a larger timeframe, your
average profit per trade will be bigger, but you’ll have fewer trading op-
portunities.
Smaller timeframes mean smaller profits, but usually smaller risk, too.
When you’re starting with a small trading account, you might want to
select a small timeframe to make sure that you’re not over-leveraging
your account.
You might think that you see an emerging trend just to realize that it was
only a short manipulated move and that the trend is over as soon as you
enter the market.
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Action Items:
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Step 3: Selecting a
Trading Approach
Fundamental Analysis
Source: www.daytrading.about.com
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In the following graph, you’ll find a snapshot of some “key statistics” for
IBM. In addition to this company-specific data, you need to take the
overall economic environment into consideration and start looking at
various macroeconomic indicators, such as economic growth rates, inter-
est rates, inflation rates, and unemployment rates.
As an example, interest rate hikes are seldom good news for stock mar-
kets. This is due to the fact that many investors will withdraw money
from a country's stock market when there is a hike of interest rates,
causing the country's currency to weaken.
Knowing which effect prevails can be tricky. When the Fed announced
an interest rate cut in December of 2007, the Dow Jones Index dropped
300 points. When the Fed cut interest rates in January of 2008, the Dow
Jones Index jumped 200 points up.
In addition, economic reports with key data like the PPI, CPI, PMI, GDP,
and, recently, even housing statistics, have proven to have a significant
impact on the stock market.
Confused?
If the abbreviations and the “key statistics” on the following graph don’t
make sense to you, or if they confuse you, then you are not alone.
Fundamental analysis is not easy. That’s why most market analysts have
some background in economics, both macro- and microeconomics. Big
trading companies like Goldman Sachs are employing analysts with
Ph.D.s in economics, and you shouldn’t try to compete with them.
Even if you decide NOT to trade stocks and want to focus on futures or
the forex market, then you still need to take a look at crop and weather
reports (if you are trading grain futures), interest rates and the country’s
economic data (if you are trading forex), or follow developments in the
Middle East and the status of the pipelines and refineries all over the
world (if you are trading energy futures).
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Technical Analysis
Source: www.daytrading.about.com
In summary, there are three main points that a technical analyst applies:
All three of the points above are important, but the first is the most criti-
cal. It’s vital that you understand this point, because it’s the basis of our
approach to trading.
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1.) The markets are driven by greed and fear, and not by supply and
demand. An economic report itself is meaningless: it is traders’
reactions to the report that moves the market.
2.) It’s easier (and therefore faster) to learn technical analysis. You
can learn the basics by reading a couple of books, whereas you
need to study micro- and macro-economics to master funda-
mental analysis. And even then, you might be fooled by the mar-
ket.
On Friday, April 7th, 2006, the unemployment rate for March was pub-
lished. The market expected an unemployment rate of 4.8%, and the
numbers came in better than expected.
Only 4.7%. That's good news, isn't it? The market should move up,
right?
"Not surprisingly, Friday’s equity trade was dictated by the March em-
ployment report. More specifically, it was the Treasury market’s reaction
to it that set the stage for stocks."
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"The Treasury market had a very divergent reaction to the data, and it
took the stock market down with it. For Treasury traders, the in-line data
essentially provided no evidence that the Fed will be inclined to soon end
its monetary tightening cycle."
Oops. So the stock traders thought there was good news and the market
was moving up, but the treasury trader in the other room thought the un-
employment data was bad news. So treasury instruments were rallying,
causing the stock market to drop like a rock. But don't stocks lead the
treasuries? Or do treasuries lead stocks?
But what does it mean? Should the stock market move up or down?
"As crude oil prices continue to plug higher, the debate over what it all
really means will begin again. The question that will be batted back &
forth: "Are sky-high oil prices indicative of a coming economic slow-
down or looming inflation?"
And more important: how will the Fed react? Will they cease increasing
interest rates or even lower the rates again? This would provide a boost
for the stock market.
Or will traders fear that there's an economic slowdown which might re-
sult in lower company earnings? This would move the market down.
As you can see, it's not the news that moves the market – it's the reaction
of the traders to the news that makes the prices jump up and down.
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Using a technical approach, you don’t have to twist your mind to come
up with an explanation for why the market behaves as it does. You sim-
ply believe that the factors which affect price – including fundamental,
political, and psychological factors – have all been built into the price
you see.
This means that anything which can affect the price of a financial in-
strument has already been factored into the current price by the market
participants. Technical analysts look at charts the same way a doctor
would look at x-rays: they examine the charts for information on the fu-
ture direction of the markets.
If you’re new to the trading game, and you’re not a Ph.D. in Economics,
then charts are the way to go. The most basic charts are bar and line
charts. In fact, even if you’re an experienced trader, bar and line charts
probably still have a special place in your daily trading life. These charts
are simply indispensable.
“A picture speaks a thousand words.” This proverb holds just as true for
charts. Charting is the graphical expression of a financial market’s be-
havior over a period in time.
Any market has four different trading points throughout one day. They
are: opening price (O), closing price (C), absolute high price of the day
(H), and the absolute low price of the day (L). All of these points appear
on the charts.
The opening price (O) is the first trade of the day. Individual traders tend
to place orders when the market opens, in reaction to the previous day’s
close. This price will normally be based on emotional decisions and
could well indicate how the first half – or the whole day’s trading – is
going to pan out.
The closing price (C) is the last trade of the day. It is generally institu-
tional investors that place orders towards the day’s close. Unlike the
opening price, the closing price will normally be representative of deci-
sions made by reason and research – not gut feel.
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The day’s low (L) and the day’s high (H) are pretty self-explanatory. The
difference between the high and low on the charts is referred to as the
Range.
The fifth variable displayed on a chart is typically the volume (V), speci-
fying the number of shares, lots, or contracts traded during the time pe-
riod between the open of the market and the close.
Purely looking at these five points on the charts will not be enough to
plan future trades. You need to look at them over a series of time in order
to evaluate trends in the market.
Day traders use trading charts to watch the markets that they trade, and
decide when to make their trades. There are several different types of
trading charts, but they all show essentially the same trading information,
such as the past and current prices.
In the following section, we’ll discuss the three most popular types of
trading charts.
Bar Charts
A bar chart, also known as a bar graph, is a chart with rectangular bars
whose lengths are proportional to the value they represent. Bar charts are
used for comparing two or more values.
The bar chart is one of the most common charting methods. A bar chart
indicates a single bar that extends from the high to the low of the trading
period it is meant to depict. In addition, the opening and closing price
levels could be displayed as small branches coming away from the main
bar at the appropriate level. Closing prices are put on the right side of the
bar. Opening prices are put on the left side.
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Bar charts consist of an opening foot, a vertical line, and a closing foot.
Each bar includes the open, high, low, and close of the timeframe, and
also shows the direction (upward or downward), and the range of the
timeframe.
During live trading, you can read the bar chart like this:
1.) Open – The open is the first price traded during the bar, and is
indicated by the horizontal foot on the left side of the bar.
2.) High – The high is the highest price traded during the bar, and is
indicated by the top of the vertical bar.
3.) Low – The low is the lowest price traded during the bar, and is
indicated by the bottom of the vertical bar.
4.) Close – The close is the last price traded during the bar, and is
indicated by the horizontal foot on the right side of the bar.
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6.) Range – The range of the bar is indicated by the locations of the
top and bottom of the bar. The range is calculated by subtracting
the low from the high (range = high - low).
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Candlestick Charts
Candlestick charts are not new – they’ve been used for hundreds of years
by Japanese traders to predict and act on market movements.
In the 1700s, Homma, a Japanese trader in rice, noticed how the price of
rice was influenced by human psychology as much as by the supply and
demand situation. Homma used candlestick charts to trade rice and
amassed a huge fortune in the markets. In fact, it was rumored that he
never had a single losing trade!
Even though they may look a little complicated, there are some great rea-
sons to use candlestick charts. Here are the main ones:
You can use candlestick charts as you would use the common
bar chart, and you can combine them with traditional market in-
dicators. Candlestick charts are a great way to spot opportunities,
filter, and time trades with other indicators.
Because of the way candlestick charts are viewed, they can give
you visual warnings of market reversals much more clearly than
traditional bar charts. If you look at candlestick charting, the
human psychology of the move literally jumps out of the page at
you.
Candlestick charts use the same open, high, low, and close data
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that traditional bar charts use, and are easy to draw. The different
candle names are also easy to remember.
The way the candlestick chart is drawn not only gives the direc-
tion of price, but also the momentum behind the move.
During live trading, you can read the candlestick chart like this:
1.) Open – The open is the first price traded during the candlestick,
and is indicated by either the top or bottom of the wide vertical
line (the bottom for an upward candlestick, and the top for a
downward candlestick).
2.) High – The high is the highest price traded during the candle-
stick, and is indicated by the top of the thin vertical bar (the wick
of the candlestick).
3.) Low – The low is the lowest price traded during the candlestick,
and is indicated by the bottom of the thin vertical bar (the upside
down wick of the candlestick).
4.) Close – The close is the last price traded during the candlestick,
and is indicated by either the top or bottom of the wide vertical
line (the top for an upward candlestick, and the bottom for a
downward candlestick).
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The candlestick has a wide part, called the "real body." This real body
represents the range between the open and close of that day's trading.
If the real body is filled with red, it means the close was lower than the
open. If the real body is green, it means the opposite – the close was
higher than the open.
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Above and below the real body we see the "shadows." We see these as
the wicks of the candle (which give them their name). The shadows actu-
ally show the high and the low of the day's trading.
If the upper shadow on the green filled-in body is short, it indicates that
the open that day was closer to the high of the day. On the other hand, a
short upper shadow on a red or unfilled body shows the close was near
the high.
They’re easy, and they’re fun to use. Plus, they provide greater insight
into market moves, along with the versatility to be used in any type of
trading. If you aren’t already using candlestick charting, then it’s time to
start.
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Line Charts
A simple line chart draws a line from one closing price to the next clos-
ing price. Line charts show the general price movement over a period of
time. Some investors and traders consider the closing level to be more
important than the open, high, or low. By paying attention to only the
close, intraday swings can be ignored.
Line charts are also used when open, high, and low data points are not
available. Sometimes only the closing data is available for certain indi-
ces, thinly traded stocks, and intraday prices.
Line charts consist of individual points that are connected with straight
lines. Usually, each point shows the close of the timeframe, but this can
be modified to show any info – open, high, or low. Line charts also show
the direction (upward or downward) of the timeframe.
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Most charting software supports bar, candlestick, and line charts. Nor-
mally, you can customize the display and colors according to your wish.
You can use any reliable online charting service you want. Just make
sure they provide the basic analytical tools (e.g. the capability to draw
trendlines, and the option to add moving averages). There are so many
charting services out there that it would be hard to mention any one in
particular.
Let’s just put it this way: charts are not the crystal ball of trading.
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Technical Indicators
Let’s keep it simple: money is made if you buy when the market is going
up and sell when the market is going down. That’s why technical ana-
lysts hold to the motto "the trend is your friend.”
Finding the prevailing trend will help you become aware of the overall
market direction and offer you better visibility – especially when short-
term movements tend to clutter the picture.
Trends
The price chart of a security may appear like a random distribution, but
this is not so.
About 30% of the time, a security will be in a definite trend. The rest of
the time, prices will trade more or less in a sideways range. Our job is to
recognize trends early, as they emerge from non-trends, or as reversals of
prior trends.
Our goal is to buy or sell our security early in these new trends, exiting
the trade profitably when the trend ends. This identification of trend,
both its beginning and end, is the most important task we have as traders.
When prices move without such a discernible series, prices are said to be
trading sideways in a range, or trading trend-less. Once a trend is dis-
cernible, then trendlines can be drawn to define the lower limits of an
uptrend or the upper limits of a downtrend.
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I know that these simple definitions sound mundane, and that many trad-
ers would like to jump right into complicated indicators and complex
trading strategies.
Trading can be simple: you buy when the market is going up and you sell
when the market is going down. That’s how money is made.
But if you don’t know HOW to recognize when the market is going up,
and when it’s going down, then you’ll lose money very quickly. So you
MUST find an easy way to identify the direction of the market.
Indicators are another way to determine the direction of the market, but if
you learn how to identify the trend using simple trendlines, then you’ll
never have to worry about indicators again.
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Uptrend
The following chart is a 5-minute bar chart of the E-mini S&P. The
trading day is December 20th, 2007.
As you can see, prices have been moving down all morning, and then
they started moving sideways during the lunch break.
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In order to draw a line, we need two points. The first point is the low of
the day and the second point is the first retracement, when prices are no
longer making higher lows.
The first time prices are not making a higher low occurs at the 12:15pm
bar, and we can draw our trendline. The dark part of the line is the
confirmed trend and the light part of the line is the projected trend.
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At 12:35pm, we see a lower low in an upward trend for the second time,
but we do NOT adjust the trendline.
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At 12:45pm and 12:50pm, a lower low is made again, and this time we
adjust the trendline. It’s only a slight adjustment and the trendline be-
comes a little bit flatter. All previous prices are above the trendline, so
the trend is still intact.
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The next lower low occurs at 1:05pm, and we can extend our trendline.
It’s a simple extension: no adjustment is needed, and we see that the
uptrend has now been in place for 40 minutes, since the breakout through
the resistance level at 1462.50 at 12:25pm.
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Ten minutes later, we get the next lower low, and we adjust the trendline
accordingly. See how beautifully the previous lower lows are almost
touching the trendline? A perfect trend.
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Again we see a lower low, but we don’t adjust the trendline since it
would make the line steeper. Remember the rule: we can only flatten the
line, we can’t make it steeper.
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Another lower low occurs at 1:50pm, but we don’t adjust the trendline.
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In this next chart, we see a series of lower lows, but only the lower low at
2:05pm allows us to adjust the trendline. The series of lower lows indi-
cates that the trend is coming to an end.
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Fifteen minutes later, we have another lower low, but at the same time,
we are experiencing a higher high after a series of lower highs. Lower
highs are indicating a possible downtrend, and when we see the first
higher high, it’s time to start drawing a downtrend line.
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It seems that our uptrend has come to an end. The uptrend line is broken,
and we have another higher high that confirms our downtrend line.
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The uptrend was in place from 12:25pm until 2:25pm, for a full two
hours. During this time, prices moved from 1462.50 (a break through the
resistance level) to a high of 1472. The uptrend was broken at 1467.75.
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2.) Keep a trendline close to the lower lows and don’t move it
too far away.
If there’s too much distance between your line and the lower
lows, you risk missing a change in the trend.
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Downtrend
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Step 3: Selecting a Trading Approach
The market keeps falling, and at 9:10am, we see the next higher high.
However, we don’t adjust the trendline since it would mean making the
line steeper.
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We see another higher high at 9:35am, but we still don’t adjust the
trendline. The 9:40am bar marks another higher high and confirms our
previous trendline.
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Ten minutes and two bars later, we have another higher high, and we can
adjust our line. Note that it’s still very close to the previous higher highs,
so the adjustment is valid.
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The market makes another higher high, but we don’t adjust the trendline
since it would make the line steeper. See how beautifully our trendline
captures this downtrend?
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Step 3: Selecting a Trading Approach
The trend continues, and at 11:15am, almost three hours after the open-
ing, we can adjust the trendline again. The trendline is still very close to
the previous higher highs.
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Fifteen minutes later, we get the next higher high, but if we adjust the
trendline, it will move it too far away from the previous higher highs; the
downtrend is broken.
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Adjusting the trendline would move it too far away from previous higher
highs, and we risk missing a change in the trend.
Trendline Validity
The longer the trendline has been in effect and the more times it has been
successfully tested, the more important the trendline becomes. Conse-
quently, when a trendline of long duration – which has been successfully
tested many times – is violated, then an important reversal of trend is
likely to have occurred.
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Trading Range
Support and resistance levels are points where a chart experiences recur-
ring upward or downward pressure. A support level is usually the low
point in any chart pattern (hourly, weekly, or annually), whereas a resis-
tance level is the high or the peak point of the pattern.
These points are identified as support and resistance when they show a
tendency to reappear. It’s best to buy near support or sell near resistance
levels that are unlikely to be broken. Once these levels are broken, they
invariably reverse their roles. Previous support becomes resistance and
previous resistance becomes support.
Support and resistance levels are very important to your trading; it’s
critical that you understand them.
In uptrends, every time the price drops to the uptrend line and then re-
sumes its advance, the trendline has acted as support to the price uptrend.
Support can also be found at prices of previous support or resistance.
In downtrends, every time the price rises to the downtrend line and then
resumes its decline, the downtrend line has acted as resistance to the up-
ward move of market prices.
Consider the following: when price action drops to a certain level, the
bulls (the buyers) take control and prevent prices from falling lower.
Similar to support, a resistance level is the point at which bears (the sell-
ers) take control of prices and prevent them from rising higher.
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The price at which a trade takes place is the price at which a bull and
bear agree to do business. It represents the consensus of their expecta-
tions. The bulls think prices will move higher and the bears think prices
will move lower.
Example:
As you can see from the following chart, prices have been in a down-
trend. On the same bar that broke the downtrend, prices went to the re-
sistance level at 1464.00 and retraced. 10 minutes later, they went 2 ticks
above the resistance level, but closed AT the resistance level.
For the next 2 hours and 30 minutes, prices never go above the resistance
level of 1464, but they repeatedly test this level, eventually breaking out.
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Whenever you can draw a resistance line, you can typically draw a corre-
sponding support line, as shown in the following chart.
As you can see, the support line holds very well, even though it’s broken
later. However, the break isn’t significant, since prices close above the
support line.
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The logic dictates that as the price declines towards support and gets
cheaper, buyers become more inclined to buy and sellers become less
inclined to sell. By the time the price reaches the support level, it’s be-
lieved that demand will overcome supply and prevent the price from fal-
ling below support.
The logic dictates that as the price advances towards resistance, sellers
become more inclined to sell and buyers become less inclined to buy. By
the time the price reaches the resistance level, it’s believed that supply
will overcome demand and prevent the price from rising above resis-
tance.
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The continuation of the line helps determine the path along which the
market will move. An upward trend is a concrete method to identify sup-
port lines/levels. Conversely, downward lines are charted by connecting
two points or more. The validity of a trading line is partly related to the
number of connection points. Yet it's worth mentioning that points must
not be too close together.
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Note that when drawing trend channels, you first draw the trendline and
then construct the “channel line” as a parallel line to the primary
trendline.
Trend channels are typically constructed to derive entry and exit points
in an uptrend or downtrend.
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In a downtrend, you’d sell at the primary downtrend line and buy back at
the secondary channel line, as shown in the following example:
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Step 3: Selecting a Trading Approach
By now, you know that any market is either trending or moving side-
ways. Therefore you’ll apply one of the following two trading strategies:
1.) Trend-following – when prices are moving up, you buy, and
when prices are going down, you sell.
Most indicators that you’ll find in your charting software belong to one
of these two categories: indicators for identifying trends (e.g. moving
averages), or indicators that define overbought or oversold situations,
which offer you a trade setup for a short-term swing trade.
Trend-following:
Trend-fading:
1.) Williams %R
2.) Relative Strength Index (RSI)
3.) Bollinger Bands and Channels
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Step 3: Selecting a Trading Approach
You can see that this strategy works very well in trending markets (see
first buy signal), but in sideways moving markets, you’re getting whip-
sawed (see second buy signal).
You might want to use trendlines or other indicators to ensure that the
market you’re watching is actually trending, and then use moving aver-
ages to get your specific entry signals.
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The upper line is the slow-moving average (20 bars), and the lower line
is the fast moving average (14 bars).
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Turtle Trading
You’ll find plenty of articles on the Internet that will explain the turtle
trading rules in detail. Basically, the turtles look at the high and the low
through the past 20 days and generate the following signals:
Prices moved below the 20-bar low at 1.4372 and generated a short sig-
nal. Prices moved as low as 1.4324 (= 48 pips or $480) before retracing.
Please note that we just defined an entry signal. You still need to apply
profit targets and stop losses (see the next two chapters).
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A 9-bar EMA of the MACD, called the "signal line," is then plotted on
top of the MACD, functioning as a trigger for buy and sell signals (dark
gray line).
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Step 3: Selecting a Trading Approach
Traders utilize the MACD in different ways, but the most popular is to
use the signal line for entry signals:
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Williams %R
The formula is quite simple: it subtracts the current day's close from the
lowest intraday low of the last ‘X’ number of days, and then divides this
distance by the highest high minus the lowest low of the last ‘X’ number
of days. This computation tells us where, within the next day range, to-
day's close is located. If it’s high in the range it will be in the high per-
centiles, say over 80%. If we’re closing low in the range of the last ‘X’
number of days, it would be in the 20% or lower area.
The index has many uses, but the simplest one is just allowing it to iden-
tify or suggest an overbought, oversold zone.
The index can be used in all markets and in all timeframes. Most traders
use it successfully on intraday bar charts with a parameter of 14 bars.
As stated above, the indicator shows the relationship of the closing price
to a high-low range over a specific period of time, typically 14 bars.
The result is plotted on a chart and oscillates between 0 and 100. The
basic idea is that if prices are trading at the high of the high-low range
(indicator reading close to 100), then the market is overbought, and if the
current prices are trading close to the low of the specified range (indica-
tor reading close to 0), then the market is oversold.
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In this example chart, the %R moves above 80, indicating that Google
(GOOG) is “oversold,” and a sell signal is generated.
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• A sell signal is generated when the RSI crosses the 70-line (over-
bought-zone) from above.
As with the %R, the RSI indicator works best in sideways-moving mar-
kets.
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Step 3: Selecting a Trading Approach
The most popular setting is a 21-bar moving average (solid dark grey
line) and 2 standard deviations for the upper and lower band (dotted grey
line).
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Two hours later, prices move below the lower Bollinger Band and create
a buy signal.
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Step 3: Selecting a Trading Approach
Trading Approaches
Don’t fall prey to the common mistakes. Many traders simply decide on
one trading approach and trade it all the time, whether the market is
trending or not. That’s a sure way to failure.
Successful traders use multiple trading approaches: they have at least one
approach for a trending market and another approach for a sideways-
moving market. Using the basic principles outlined on page 103, you can
determine the direction of the market and use the right trading approach.
Don’t make the mistake of using only one trading approach. Learn to
identify whether a market is trending or not and adjust your trading strat-
egy accordingly.
Action Items:
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Step 4: Defining Entry
Points
Use as few entry rules as possible and be as specific as you can. The best
trading strategies have entry rules that you can specify in only two lines.
Action Items:
Practice identifying the entry rules of the two approaches you se-
lected. Identify the underlying market condition (trending/
sideways) and apply the strategy you’ve selected. When should
you enter? Only mark the entry points. Don’t worry about exit
points yet.
Continue your trading plan on page 245 and write down your
specific entry points under “Entry Signals.”
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Step 5: Defining Exit
Points
I once heard the saying: “A monkey can enter a trade, but money is made
(and lost) when you EXIT it.”
This couldn’t be truer. Most traders are right about the direction of the
market when they enter a trade, but they end up taking a loss because
they fail to capture profits at the right time.
Read this chapter again and again until you understand ALL of the con-
cepts outlined here. Knowing HOW and WHEN to exit a trade will ulti-
mately determine your success or failure as a trader.
3.) Time-stops to get you out of a trade and free your capital if the
market is not moving at all.
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Stop loss and profit-taking exit rules can be expressed in four ways:
Stop Losses
A stop loss is used to limit the potential loss if the trade goes against you.
It’s the level at which you’ll close a trade on the basis that it has gone too
far in the 'wrong' direction, and, therefore, negated the reason for you
being in that trade.
If you don't apply stop losses in your trading, you won't be trading for
long – you’ll end up wiping out your trading balance in no time. It can be
too easy for a $300 loss to become a $5,000 loss. A good trader will
know when to take a small loss and go on to the next trade.
I can’t stress this enough: even the most experienced traders have a stop
loss order in the market, whether they’re trading forex, futures, options,
or even stocks.
Remember that your trading capital is your business – if you burn it,
there’s no insurance. You’re done. Once you’ve entered a trade, immedi-
ately place a stop. This safeguards you from losing your entire account.
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Step 5: Defining Exit Points
It's important to ensure that your stop is canceled if you close your posi-
tion. I mention this because I happen to know a trader who is very disci-
plined, who always enters a stop loss and a profit target order once he
has established a trade. A few years back, this trader suffered a number
of losses over the course of several days. So, naturally, he was quite
happy to see that a trade finally moved in his direction.
According to his strategy, his stop losses were very small and his profit
target was rather large, so if this trade reached the profit target, he would
make up for all the losses of the past couple of days PLUS bring in a
small profit on top of it.
And it happened: the market continued to move in his favor and he real-
ized a profit.
He was so happy that he jumped up from his chair, ran into the kitchen,
and told his wife all about the fantastic trade. FINALLY he had made
some money. They enjoyed a happy cup of coffee together, and he
couldn’t stop talking about his strategy, the trade, and how it paid off.
The stop loss order was a sell order, and now the trader had a short posi-
tion in a rising market. All of his profits were gone.
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The most important thing, regardless of how you approach the decision,
is to know where you’ll cut a losing position BEFORE entering the trade.
Set the rules and ALWAYS follow them. With this in mind, let’s talk
about stop loss strategies.
Easy, fast, and simple. Just specify a dollar amount that you’re willing to
risk, subtract it from your entry price, and place a stop loss order.
Simply subtract the dollar amount you specified from your entry price.
Example:
Let’s say you’re trading the EUR/USD currency pair. You entered the
market at 1.4585 and you want to risk $100. Since 1 pip (= 0.0001)
equals $10, you place your stop loss at 10 pips (= 0.0010) below your
entry price at 1.4575.
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Step 5: Defining Exit Points
Just as a reminder:
It’s easy to make mistakes when the market starts moving fast and you
get nervous. Many traders use post-its after they’ve entered a trade: you
stick a ‘SELL’ post-it on your screen if you went long, and a ‘BUY’
post-it if you went short. This way, you ensure that you’ll ALWAYS exit
the position as planned.
This strategy is perfect for beginners, since you don’t have to perform
complex calculations. You simply add or subtract your stop loss to or
from your entry price and that’s it. It works best if you’re trading only
one stock or one market, and if the security doesn’t fluctuate too much.
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When applying this stop loss strategy, simply multiply the entry price by
(1 - your stop loss (in percent form)) to get your exit point.
Example:
If you’re trading the E-mini NASDAQ, and you’ve defined a 0.5% stop
loss, then you would multiply your entry price of 2151.75 by 0.995 (1 -
0.5%) for an exit point of 2141.
You should apply this exit strategy if you’re trading multiple markets or
different stocks. You’ll find a more detailed explanation in the next sec-
tion: “Profit-Taking Exits.”
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Step 5: Defining Exit Points
This exit strategy is another way to specify stop losses in volatile mar-
kets. The underlying idea is to adjust your stop loss based on the volatil-
ity of the market: you apply a larger stop loss in volatile markets and a
smaller stop loss in quiet markets.
Example:
The average daily range in corn is $16. You can use the Average True
Range (ATR) function of your charting software to determine this num-
ber. Multiply it by the percentage you specified, e.g. 50%, and arrive at a
profit target of $8. Then, subtract $8 from your entry point amount.
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This strategy is perfect for markets with high changes in volatility, like
the grain markets. As you can see in the chart below, corn prices are
more volatile in summer months than in the winter.
Many traders like to use major support or resistance points on the chart
to determine their exits. Instead of support and resistance levels, you
could use Pivot Points, Fibonacci Levels, upper or lower levels of trend
channels, or Bollinger Bands, just to name a few.
Example:
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Step 5: Defining Exit Points
This strategy is perfect for traders who use technical analysis for their
entry points. If you’re using trendlines, indicators, or support and resis-
tance lines, placing your stop at these levels will seem very natural.
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Profit-Taking Exits
The main problem with taking profits is that, by our very nature, we hu-
mans (and especially traders) are greedy. After all, we want to make
money. A lot of money. And we want to make it fast. “Get rich quick,”
right?
This is a definite problem, and many traders are way too greedy. They
want to get rich on just one trade. And that’s when they lose.
Consistency is the key, because if your profits are consistent and predict-
able, then you can simply use leverage to trade size. Therefore you
MUST know when to exit with a profit.
Good traders use a stop loss; great traders use a profit target.
Here are some different types of exit strategies for profitable trades.
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Step 5: Defining Exit Points
This is the easiest way to exit a trade. Simply specify a dollar amount
that you would be happy with, add it to your entry point, and place a
profit target order in the market.
Simply add the dollar amount you specified to your entry price.
Example:
Let’s say you’re trading 100 shares of IBM and enter at $110.13. Your
profit target is $100, so you would exit the trade as soon as prices move
up $1, to $111.13.
This strategy works best if you are just trading one stock or one market,
and if the security doesn’t fluctuate too much.
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When applying this profit exit strategy, simply multiply the entry price
by (1 + your profit target (in percent)) to get your exit point.
Example:
If you’re trading IBM, and you’ve defined a 1% profit target, you would
multiply your entry price of $110.13 by 1.01 (1 + 1%) for an exit point of
$111.23.
You should apply this exit strategy if you are trading multiple markets or
different stocks.
The reason is simple: let’s say you’re trading IBM and Ford. As I write
this, IBM is trading at $110.13 and Ford is trading at $6.72. As in the
previous example, let’s assume that you’re trading 100 shares each and
you want to make $100 per trade. IBM would only have to move 0.9% to
reach your profit target, but Ford shares would have to move almost 15%
in order to reach your profit target.
The following charts illustrate how easy it will be for IBM shares to
reach the target price, and how difficult it might be for Ford shares to do
so.
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Step 5: Defining Exit Points
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The same applies to markets with a high volatility, like gold or energy
futures. In the beginning of 2007, gold was trading at $650. In November
of 2007, gold was trading 30% higher, at $850. A $20 move in gold
would have been 3% in January of 2007, but only 2.3% in November of
2007.
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Step 5: Defining Exit Points
This exit strategy is another way to specify profit targets in volatile mar-
kets. The underlying idea is to adjust your profit target based on the
volatility of the market: you apply a higher profit target in volatile mar-
kets and a lower profit target in quiet markets.
Many traders like to use major support or resistance points on the chart
to determine their exits. Instead of support and resistance levels, you
could use Pivot Points, Fibonacci Levels, upper or lower levels of trend
channels, or Bollinger Bands, just to name a few.
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Example:
In this example, we’re using the previous day’s high and low as potential
profit targets. The following chart is a 15 minute chart of the E-mini
S&P. We wait for the first bar of the day, and, as soon as we realize that
the market has been moving up in the first 15 minutes, we enter at 1452.
We set our profit target at the previous day’s high – 1465.25 – for a total
profit of 13.25 points = $662.50. Later that day, we reach our profit tar-
get, and we could reverse the position by going short. Now we can use
the previous day low as a profit target and realize another profit of 21.75
points = $1,087.50.
This strategy is perfect for markets that are moving sideways between
major support and resistance lines.
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Step 5: Defining Exit Points
Trailing Stops
Trailing stops are “hybrid” stops. When entering a position, the trailing
stop is typically a stop loss, and as the trade moves in your favor, the
trailing stop becomes a profit exit.
If you were to set a straightforward $300 trailing stop, and the security
moved in your favor by $1,000, you could change your stop to only $300
behind the price and lock in $700 of profit.
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Below is a 60-minute chart of the E-mini S&P. Let’s say you went short
at 1502. You would place your trailing stop at the high of the current bar
at 1504. Once the next bar is completed, you move your stop to the high
of this bar to 1502.50. 60 minutes later, you move your stop to 1499, and
now your stop loss becomes a profit exit. Whatever happens to the trade
now, you’ll make at least 3 points (= $150). One hour later, you move
your stop to 1494.50.
So, when prices retrace, you’re stopped out at 1494.50 for a profit of 7.5
points (= $375).
This strategy is perfect for trending markets. You should use this strategy
to take advantage of longer-lasting trends. Keep in mind that this strategy
requires your constant attention, since you MUST move your trailing
stops according to your rules.
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Step 5: Defining Exit Points
You can combine the strategies outlined above for more sophisticated
exit strategies. As an example, you could close half of your position once
you’ve achieved a fixed dollar amount in profits, and let the other half
continue to trade to the next support or resistance level.
Or you could take 1/3 of your profits at a predefined profit target, take
another 1/3 at the next support or resistance level, and then apply a trail-
ing stop to the remaining 1/3.
The possibilities are endless. That’s why many professional traders focus
on perfecting their exit strategy. In contrast, many amateur traders and
beginners tend to focus on entry strategies.
Don’t make the same mistake. Once you’ve defined sound entry rules,
test different exit strategies to optimize your profits.
Time-Stops
A time-stop gets you out of a trade if it’s not moving in any direction.
You probably have a good reason for entering a trade. So, immediately
after entering, you apply your stop loss and your profit target and wait.
And wait. And wait. And nothing happens.
Simply specify a “time-out,” after which you will exit the market. Then
set a timer and exit the trade after the specified time, regardless of
whether you reached your stop loss or profit target.
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Example:
Always! Whatever the reason behind your entry signal, you want to see
something happen. If nothing happens after a certain amount of time, the
underlying assumption of your entry may be wrong. If you stay in the
trade, then you’re gambling not trading.
As traders, we want to make money fast. The longer you have your
money in the market, the longer it’s at risk. You can dramatically reduce
the risk by applying a time-stop and exiting the market if it doesn’t
move. Free your capital and take the next trading opportunity. Don’t
gamble!
Action Items:
Continue your trading plan on page 245 and write down your
specific exit points under “Exit Signals.”
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Step 6: Evaluating Your
Strategy
1.) Back-Testing
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This is a fantastic way for new traders to kill a whole tree full of
birds with one stone. First off, you’ll learn the tricks of the trade
without putting your own money at risk. Second, you’ll be able
to gain some much-needed confidence when it comes to maneu-
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Step 6: Evaluating Your Strategy
vering in the markets. And third, you’ll be able to test out your
trading strategy in real-time simulation.
The more trades you use in your back-testing, the higher the probability
that your trading strategy will succeed in the future. Look at the follow-
ing table:
Somebody with a Ph.D. in statistics once told me that you need at least
40 trades in order to produce statistically relevant results.
So, the question “How long should you test your trading strategy?” de-
pends on the trade frequency.
How many trades per day does your trading strategy generate? If your
strategy generates three trades per day (i.e. 15 trades per week), then you
might get decent results after three weeks of testing. But if your trading
strategy generates only three trades per month (i.e. 36 trades per year),
then you should test your strategy for at least one year to receive reliable
data results.
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Let me use the E-mini S&P as an example. In 2000, the average daily
range was 100-150 ticks per day; in 2004, it was only 40-60 ticks per
day.
What happened?
There are a couple of plausible explanations. Probably the best and most
important one is the introduction of the Pattern Day Trading Rule in Au-
gust and September of 2001, by the NYSE and NASD. If a trader exe-
cutes four or more day trades within a five-business-day period then he
must maintain a minimum equity of $25,000 in his margin account at all
times. Because of this rule, traders stopped day trading equities and
started trading the E-mini S&P futures instead.
Look at this graph showing the sudden increase in volume in the E-mini
S&P in the beginning of 2001.
Many of these stock day traders used methods to scalp the market for a
few pennies. Using the E-mini S&P, they suddenly had a much higher
leverage and paid fewer commissions, and their methods were extremely
profitable.
Another reason for the dramatic change of the market was the introduc-
tion of the automated strategy execution in TradeStation. In 2002, the
TradeStation customers who were using this feature increased by 268%.
Overbought/oversold strategies became very popular, and when the mar-
ket made an attempt to trend, these strategies immediately established a
contrary position.
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Step 6: Evaluating Your Strategy
Conclusion
When back-testing, there are definitely things you need to be aware of.
It's not enough to just run a strategy on as much data as possible; it's im-
portant to know the underlying market conditions.
That's when clever back-testing helps you. If your back-testing tells you
that a trend-following method worked in 2000-2002, but doesn't work in
2003 and 2004, then you should not use this strategy right now. And vice
versa: when you see that a trend-fading method produced nice profits in
2003, 2004, and 2005, then trade it.
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While testing your trading strategy, you should keep detailed records of
the wins and losses in order to produce a performance report. Many
software packages can help you with that, but a simple excel sheet will
do the trick just as well.
The first figure to look for is the total, or net, profit. Obviously you want
your system to generate profits, but don’t be frustrated when, during the
development stage, your trading system shows a loss; try to reverse your
entry signals.
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Step 6: Evaluating Your Strategy
You might have heard that trading is a zero sum game. If you want to
buy something (e.g. a certain stock or futures contract), then somebody
else needs to sell it to you. And, you can only sell a position if somebody
else is willing to buy from you at the price you're asking.
This means that if you lose money on a trade, then the person who took
the other side of the trade is MAKING money. And vice versa: if you’re
making money on a trade, then the other trader is losing money. In the
markets, money is not "generated." It just changes hands.
So, if you’re going long at a certain price level, and you lose, then try to
go short instead. Many times this is the easiest way to turn a losing sys-
tem into a winning one.
The next figure you want to look at is the average profit per trade. Make
sure this number is greater than slippage and commissions, and that it
makes your trading worthwhile. Trading is all about risk and reward, and
you want to make sure you get a decent reward for your risk.
Winning Percentage
Many profitable trading systems achieve a nice net profit with a rather
small winning percentage, sometimes even below 30%. These systems
follow the principle: “Cut your losses short and let your profits run.”
However, YOU need to decide whether you can stand 7 losers and only 3
winners in 10 trades. If you want to be “right” most of the time, then you
should pick a system with a high winning percentage.
Let's say you purchased or developed a system that has a winning per-
centage of 70%.
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Does that mean that when you trade 10 times you will have 7 winners?
No!
It means that if you trade long enough (i.e. at least 40 trades) then you
will have more winners than losers. But it doesn’t guarantee that after 3
losers in a row, you’ll have a winner.
Example:
If you toss a coin then you have 2 possible outcomes: heads or tails. The
probability for each is 50% – i.e. when you toss the coin 4 times, then
you should get 2 heads and 2 tails.
But what if you tossed the coin 3 times and you got heads 3 times?
50%, or less?
If you answered 'less,' than you fell for a common misconception. The
probability of getting heads again is still 50%. No more and no less.
But many traders think that the probability of tails is higher now because
the three previous coin tosses resulted in heads. Some traders might even
increase their bet because they are convinced that now “tails is overdue.”
Statistically, this assumption is nonsense; it’s a dangerous – and many
times costly – misconception.
Let's get back to our trading example: if you have a winning percentage
of 70%, and you had 9 losers in a row, what’s the probability of having a
winner now? It's still 70% (and therefore there's still a 30% chance of a
loser).
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Step 6: Evaluating Your Strategy
The average winning trade should be bigger than the average losing
trade. If you can keep your wins larger than your losses, then you’ll
make money even if you just have a 50% winning percentage. And every
trader should be able to achieve that. If you can’t, reverse your entry sig-
nals as described previously.
Profit Factor
Take a look at the Profit Factor (Gross Profit / Gross Loss). This will tell
you how many dollars you’re likely to win for every dollar you lose. The
higher the profit factor, the better the system. A system should have a
profit factor of 1.5 or more, but watch out when you see profit factors
above 3.0, because it might be that the system is over-optimized.
.
Maximum Drawdown
The maximum drawdown is the lowest point your account reaches be-
tween peaks.
Let me explain:
Imagine that you start your trading account with $10,000, and, after a
few trades, you lose $2,000. Your drawdown would be 20%.
Now, let's say you make more trades and gain $4,000, which brings you
to $12,000 ($8,000 + $4,000 = $12,000). And after this, on the next
trade, you lose $2,000. Your drawdown would be 16.7% ($12,000 -
$2,000). The $12,000 was your equity peak; that was the highest point in
the period we looked at.
If you started your account with $10,000 and the lowest amount you had
in your account over a six-month period was $5,000, then you had a 50%
drawdown.
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You would need to make $5,000 from the lowest point in order to recoup
your losses. Even though you lost 50% from your high of $10,000, you
would need to make 100% on the $5,000 to get back to your original
amount.
This isn’t true. If you started with $10,000 and lost $2,000 (20%), you
would need to make 25% in order to get back to even. The difference
between $8,000 and $10,000 is $2,000. If you calculate the $2,000 as a
percentage of $8,000 (not the original $10,000) it works out to 25%.
A famous trader once said: “If you want your system to double or triple
your account, you should expect a drawdown of up to 30% on your way
to trading riches.” Not every trader can stand a 30% drawdown.
Look at the maximum drawdown that your strategy has produced so far,
and double it. If you can stand this drawdown, then you’ve found the
right strategy.
Conclusion
The above examples provide you with some guidelines, but it’s up to you
to decide whether the numbers in the strategy’s performance report work
for you or don’t.
Ultimately, YOU’RE the one trading the strategy, and YOU’RE the one
who has to feel comfortable with the expected results of your strategy.
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Step 6: Evaluating Your Strategy
Action Items:
www.thecompleteguidetodaytrading.com
Continue your trading plan on page 245 and write down your ex-
pectations for your trading strategy based on the results of your
back-testing.
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Step 7: Improving Your
Strategy
Don’t look only at the net profit; look also at the profit factor, the aver-
age profit per trade, and the maximum drawdown. Many times, you’ll
see that the net profit slightly decreases when you add different stops, but
the other figures might improve dramatically.
Don’t fall into the trap of over-optimizing: you can eliminate almost all
losers by adding enough rules, but your resulting strategy will be almost
worthless.
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Example:
If you see that on Tuesdays, you have more losers than on the other
weekdays, you might be tempted to add a “filter” that prevents your sys-
tem from entering trades on Tuesdays.
Next, you find that in January, you have much worse results than in other
months, so you add a filter that enters trades only between February and
December.
You add more and more filters to avoid losses, and eventually you end
up with a trading rule like this, which I just saw recently:
Though you’ve eliminated all possibilities of losing (in the past) and this
trading system is now producing fantastic profits in your testing, it’s very
unlikely that it will continue to do so when it hits reality.
I’ll explain how we optimized the parameter, and why we selected 0.3 as
the current value for the parameter. I used Genesis Financial Trade
Navigator (www.genesisft.com) to produce the test results and the fol-
lowing graphics.
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Step 7: Improving Your Strategy
First, I run the optimization and look at the net profit, since that’s one of
the most important figures:
As you can see, a parameter between 0.25 and 0.7 produces robust re-
sults.
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Any parameter between 0.25 and 0.5 produces a rather low drawdown,
so using the combined information, I would pick a TF_Param between
0.25 and 0.5.
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Step 7: Improving Your Strategy
A parameter between 0.25 and 0.7 produces a decent average profit per
trade, so the current selection of TF_Param between 0.25 and 0.5 is still a
good choice.
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Now, I’m looking at the winning percentage. The higher, the better:
Again a value of 0.25 to 0.7 for the variable TF_Param produces the best
results. We leave our range for TF_Param between 0.25 and 0.5
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Step 7: Improving Your Strategy
As a last test, we look at the number of trades. Again, the higher, the
better.
No surprises here: the lower the parameter, the more trades we get. A
parameter value below 0.45 leads to the highest amount of trades.
Conclusion
That’s why 0.3 is definitely a good choice. Even if the market changes
slightly, the system would still produce excellent results.
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Action Items:
Do the same with your profit targets. I know that this is time-
consuming, but the good news is, once it’s done correctly, you
won’t have to do it again for a very long time. I have been using
the same trading strategy for four years now.
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The 10 Power Principles –
Making Sure That Your
Trading Plan Works
Now that you’ve defined your goals and created your trading plan, you
need to make sure it really works. Thus far, everything might look great,
but how can you be sure that the system works when you start trading it
with real money?
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You should use these Power Principles to evaluate your trading strategy,
whether you developed it on your own or are thinking about purchasing
one. By checking a strategy against these principles, you can dramati-
cally increase your chances of success.
It may surprise you that the best trading systems have less than ten rules.
The more rules you have, the more likely that you’ve "curve-fitted" your
trading strategy to past data, and such an over-optimized system is very
unlikely to produce profits in real markets.
It's important that your rules are easy to understand and execute. The
markets can behave very wildly and move very fast, and you won't have
time to calculate complicated formulas in order to make a trading deci-
sion. Think about successful floor traders: the only tool they use is a cal-
culator, and they make thousands of dollars every day.
Example:
Buy when the RSI is below 20, and the ADX is between 7 and 12,
and the 7-bar moving average is pointing up more than 45 de-
grees, and there is a convergence between the price bars and the
MACD, and, and, and…
Do you really think that you could follow this strategy while you’re
watching the markets LIVE?
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_The 10 Power Principles – Making Sure That Your Trading Plan Works
You should never place an exit order before you know that your entry
order is filled. When you trade open outcry markets (non-electronic), you
might have to wait awhile before you receive your fill. By that time, the
market might have already turned and your profitable trade has turned
into a loss!
When trading electronic markets, you receive your fills in less than one
second and can immediately place your exit orders. Trading liquid mar-
kets means you can avoid slippage, which will save you hundreds or
even thousands of dollars.
Fortunately, more and more markets are now traded electronically. The
recent addition of the grain futures markets in the summer of 2006 was a
huge success: in January of 2007, the volume traded in the electronic
contracts surpassed the volume traded in the pit markets. In December of
2007, the pit-traded corn contract traded with 621,800 contracts, while
the electronic corn contract had a trading volume of 2,444,400 contracts.
Most futures markets, all forex currency pairs, and the major U.S. stock
markets are trading electronically.
Losses are part of our business. A trading system that doesn't have losses
is "too good to be true." Recently, I ran into a trading system with a
whopping winning percentage of 91% and a drawdown of less than $500.
WOW!
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When I looked at the details, though, it turned out that the system was
only tested on 87 trades and – of course – it was curve-fitted. If you run
across a trading system with numbers too good to be true, then it's proba-
bly exactly THAT: too good to be true.
Usually you can expect the following from a robust trading system:
Use these numbers as a rough guideline, and you’ll easily identify curve-
fitted systems.
Make sure your trading strategy is using small stop losses and that your
profit targets are bigger than your stop losses.
Stay away from strategies that have a small profit target of only $100 and
a stop loss of $2,000. Sure, the winning percentage will be fantastic, but
2-3 losses in a row can wipe out your trading account.
The perfect balance between risk and reward is 1:1.5 or more – i.e. for
every dollar you risk you should be able to make at least $1.50.
In other words, if you apply a stop loss of $100, your profit target should
be at least $150.
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_The 10 Power Principles – Making Sure That Your Trading Plan Works
The higher your trading frequency, the smaller your chances of having a
losing month. If you have a trading strategy that has a winning percent-
age of 70%, but only produces one trade per month, then one loser is
enough to have a losing month. In this example, you could have several
losing months in a row before you finally start making profits.
If your trading strategy produces five trades per week, then you have on
average 20 trades per month. If you have a winning percentage of 70%,
then your chances of a winning month are extremely high.
And that's the goal of all traders: having as many winning months as
possible!
Your trading system should allow you to start small and grow big. A
good trading system allows you to start with one or two contracts, in-
creasing your position as your trading account grows.
You’ve probably heard about this strategy: double your contracts every
time you lose, and one winner will win back all the money you previ-
ously lost.
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Let’s take a look at the following table. It assumes that you are risking
$100 per trade and then doubling up after each losing trade.
As you can see from the chart, the losses are not really the problem; the
main problem is the amount of contracts or shares that you’re trading.
It's not unusual to have 4-5 losing trades in a row, and this strategy
would already require you to trade 16 contracts, or 1,600 shares, of a
stock after just 4 losses! If you’re trading the E-mini S&P, you would
need an account size of at least $63,200, just to meet the margin re-
quirements. And, if we assume that you’re trading stocks around $100
(e.g. IBM or Apple), then you would need $160,000 in your account.
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_The 10 Power Principles – Making Sure That Your Trading Plan Works
Now, you may ask how likely this type of situation actually is. The an-
swer: very likely. That was the entire point of the previous few pages.
Just think back to the example with the coins: an atypical negative trad-
ing run CAN and WILL happen.
Regardless of the strategy or method you use to trade, there will be occa-
sions when you have losses, or even a string of losses. When these occur,
it’s important to have faith in your trading plan; don’t try to double up
your trades to “catch up” on your wins.
The main point I want to make here is that every trading system you find
will go through times when it has more losses than wins.
Emotions and human errors are the most common mistakes that traders
make. You have to avoid these mistakes by any means necessary, espe-
cially when the market starts to move fast. You might experience panic
and indecision, but if you give in to those emotions, you’ll suffer a much
greater loss than you had originally planned for.
Your exit points should be easy to determine. The best solution for your
exit points is the use of “bracket orders.” Most trading platforms offer
bracket orders, which allow you to attach a profit target and a stop loss to
your entry.
This way, you can put your trade on autopilot, and the trading system
will close your position at the specified levels.
Of course, this assumes that you have easy exit rules. A stop loss of
$100, or 1%, of the entry price can easily be specified in today’s trading
platforms.
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Exit rules like “2/3 of the average true range of the past 5 trading days”
are more complex to automate. In the beginning, you should keep your
trading as simple as possible.
If you can’t make money with simple entry and exit points, you won’t be
able to make money with more complex trading rules. Think about driv-
ing a car: if you can’t drive a Ford, you definitely won’t be able to drive
a Ferrari.
Your trading strategy should produce more winners than 50%. There's no
doubt that trading strategies with smaller winning percentages can be
profitable, too, but the psychological pressure is enormous.
Taking 7 losers out of 10 trades, and not doubting that system, takes a
great deal of discipline, and many traders can't stand the pressure. After
the sixth loser, they’ll start "improving" the strategy, or stop trading it
completely.
The more trades you use in your back-testing (without curve-fitting), the
higher the probability that your trading strategy will succeed in the fu-
ture. Look at the following table:
The more trades you have in your back-testing, the smaller the margin of
error, and the higher the probability of producing profits in the future.
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_The 10 Power Principles – Making Sure That Your Trading Plan Works
You need at least 40 trades for a valid performance report. As you can
see from the table above, 200 trades are optimal, since the margin of er-
ror decreases fast from 14% to 7% with only an addition 150 trades.
If you test your system on more than 200 trades, the margin of error de-
creases at a slower rate. The next 100 trades only increase the confidence
by 2%.
The E-mini S&P was introduced in September of 1997, and the E-mini
NASDAQ was introduced in June of 1999; therefore, NONE of these
contracts existed before 1997.
Regardless, though, we only have to worry about the age of the contracts
for back-testing purposes. And, if you develop an E-mini S&P trading
strategy, then you should only back-test it for the past 3-4 years anyway.
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This is because, even though the contract has existed since 1997, there
was practically nobody trading it (see the following chart):
The same applies to strategies for the grain futures: they were introduced
in August of 2006. Do not make the mistake of back-testing your trading
strategy on the pit contract. When futures contracts start trading elec-
tronically, they attract a different kind of trader than their pit-traded
counterparts; therefore, the characteristics of the two markets can be
very, very different.
It would be foolish to think that the markets remain the same once they
can be electronically traded. Faster fills and lower commissions allow a
different kind of trading strategy, and the markets WILL behave differ-
ently than during the times when only pit traders traded them.
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_The 10 Power Principles – Making Sure That Your Trading Plan Works
Action Items:
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Part 3:
The Secrets to Day
Trading Success
There’s More To Trading
Than Just Having a
Strategy
You understand that a good trading strategy is one of the single most im-
portant factors when it comes to your trading.
With a proven, reliable strategy, you'll have a map for your trading future
and a guideline for your success. You'll have a plan. Believe me, most
traders out there just open a trading account and start trading, without a
clue as to what they’re getting themselves into. Only a few of them have
a trading strategy, and because of that, many of them fail.
In fact, the vast majority of them fail. According to a report from the
North American Securities Administrators Association (NASAA):
At least 70% will lose everything they invest. And only 11.5% of traders
will actually succeed. That’s just slightly over 1 in 10. Not great odds.
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But, if you’ve followed the action items outlined throughout the previous
chapters, then you should have a trading strategy mapped out. And, if
you do, then that small step has dramatically increased your chances of
belonging to the 11.5% of successful traders out there who are actually
making money.
But here's the thing about trading strategies: they're a dime a dozen.
These days, you can find hundreds of books with different trading strate-
gies, along with countless websites that offer trading strategies for free.
In addition, you’ll find “the trading strategy of the month” every couple
of weeks in nearly every trading industry magazine out there.
So, if there are so many trading strategies available, why do only 11.5%
of traders make money?
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There’s More To Trading Than Just Having a Strategy
Mr. Vince took 40 Ph.D.s and set them up to trade with a computer
game. Now, these 40 people all had doctorates, but Mr. Vince made sure
that none of their doctorates involved any sort of background in statistics
or trading. In the game, each of them were given $1,000 and 100 trades,
with a 60% winning percentage. When they won, they won the amount
of money they risked. When they lost, they lost the amount of money
they risked. Simple. As you can see, ALL of them had a profitable trad-
ing strategy.
So, after all 40 had completed their 100 trades, how many do you think
made money?
2.
Those are pretty convincing statistics. 95% of the candidates lost out.
And why? Because they fell into the age-old traps: poor money man-
agement, gambler's fallacy, and lack of discipline, guidance, and experi-
ence.
Remember, each one of the traders took 100 trades with a 60% winning
percentage. Mr. Vince gave them a profitable trading strategy to use, but
they still couldn’t succeed.
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So, it seems that there is definitely more to trading than just having a
strategy. And that’s exactly what you’ll learn about in this section of the
book:
The OTHER factors that are involved when it comes to your trading
success.
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The Seven Mistakes of
Traders and How to Avoid
Them
S o, let’s examine why traders fail. If you know the pitfalls of trad-
ing, then it becomes easier to avoid them. In this chapter, we’ll
talk about the mistakes that traders make and how you can avoid them.
First off, there are two types of mistakes that a trader can make:
Yes, you’ll definitely make small mistakes along the way – I guarantee
it. You might buy a security when you intended to sell it, simply because
you pushed the wrong button. Or maybe you’ll buy the wrong stock, just
because there’s a typo when you enter the symbol. Another possibility is
placing the wrong order because you enter a buy order at $213.5 instead
of $21.35. These types of things have happened to all of us.
However, there are big mistakes that you absolutely MUST avoid if
you’re going to be a successful trader.
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For instance, one of the biggest trading mistakes that you could ever
make is to try to learn and understand everything about trading…and
then never actually START to trade.
I know many aspiring traders who have read countless books, have de-
veloped dozens of trading strategies, and who have analyzed a number of
markets; but they’ve failed to pull the trigger when it comes to real trad-
ing. As you know, part of your education is your knowledge and your
experience. If you want to make money with trading, then eventually you
have to take the plunge and get started.
Yes, I know: there’s a chance of losing some money. That’s true. When
you trade, you're taking a risk. (If you want to know how to start trading
without risking any of your own money, please read the chapter “How to
Start Trading Without Risking a Single Penny,” on page 235).
Example: If you’re driving a car on the highway, then you're at risk. It’s
as simple as that. But, thankfully, there are certain things we can do to
control that risk:
Cars are equipped with certain security features, such as seat belts,
airbags, anti-brake systems, and – let’s not forget – a steering wheel,
which enables you to navigate around obstacles in your path.
When you’re new to driving, you usually practice with another per-
son (e.g. your parent) in an empty parking lot BEFORE hitting the
road. You start driving at 10 mph, and then, as you grow more com-
fortable, you can slowly increase the speed. When you’re confident
in your abilities, you’ll most likely leave the parking lot for the open
road (but let’s not move too fast – probably a country road, with no
traffic!)
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The Seven Mistakes of Traders and How to Avoid Them
All of these things help you control the risk when it comes to driving.
You’ll never be able to eliminate the risk completely, but you can take
appropriate action to reduce it.
You should have a formal education and prove your skills before you
start to trade. Unfortunately, there are no tests required before you
can open a brokerage account, but you should take the time to learn
about the markets and develop a strategy before you “hit the open
road.”
When trading, you can also apply certain “security features.” Two of
the most important are having a trading strategy and using stop
losses.
When you’re new to trading, you should paper trade first (see page
235). Then, after you’ve built up some confidence, you can start
trading with one lot/contract, or 100 shares. If you’re comfortable
and you achieve acceptable results, then you can increase the con-
tract or share size.
And never trade with money you can’t afford to lose. Get your current
financial situation in order first, and THEN start trading.
Get your credit cleaned up, pay off high interest loans and credit cards,
and put at least three months of living expenses in savings. Once this is
done, you’re ready to start letting your money work for you.
That’s the number one principle when it comes to controlling your risk.
If day trading was easy, everyone in the world would be doing the same
thing: trading like crazy every day and becoming insanely rich by night-
fall!
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We both know it’s NOT easy. So let’s take a look at the seven “deadly”
trading mistakes. These are the challenges that every trader faces, and
they’re the ones which usually cost traders a whole lot of money.
Being aware of these challenges is the first step in avoiding them. Think
about the car driving example again: if you know that driving on icy
roads is dangerous, you can try to avoid traveling in that particular
weather condition. But, if you don’t know about ice and the hazard it
poses, you might just get into your car and drive like normal. You won’t
even realize the danger until you feel your vehicle slipping right off the
road.
The same principle applies in trading: being aware of the possible mis-
takes and pitfalls will help you to avoid them.
They think that the more complicated a system is, the better it should
“predict” the trends.
As a result, they completely lose sight of the basic principle: buy when
the market is going up and sell when the market is going down.
About Indicators
These days, there are more than 150 indicators available, and you can
even get indicators for indicators. Keep in mind that indicators are based
on five variables: the open, the high, the low, the close, and the volume
of a certain timeframe.
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The Seven Mistakes of Traders and How to Avoid Them
Examples:
One of the easiest ways to identify a trend is to use trendlines. In the sec-
tion “Technical Indicators,” you’ve been shown exactly how to construct
and use trendlines.
By their very nature, traders are greedy. After all, you want to make
money. A lot of money. And you want to make it fast. “Get rich quick,”
right? Every trader wants to get rich, and they want to do it in one trade.
And that’s when they lose.
There are a lot of newbie traders out there who believe that their fortune
will be made in just one amazing trade, and then they’ll never have to
work again for their entire life.
The best, and usually only, way to make a fortune in trading is consis-
tency. And this fortune will probably be made in small amounts. Unfor-
tunately, most traders go for the big wins, which result in big losses.
It makes sense that traders are more interested in larger profits per trade.
What would you rather have – a fifty dollar bill or a five dollar bill?
Well, that’s obvious! But when it comes to trading, it’s not that simple. If
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you DON’T take the five dollar bill, you may lose fifty dollars of your
OWN money, or more.
The main thing to keep in mind is this: even though you can’t take the
fifty dollar bill right away, you can take ten five dollar bills over a longer
period of time. And the end result is the same – fifty dollars.
And that’s the main point here: small, steady profits add up. This is not
to say you’ll never have a big winner. In options trading for example, it’s
pretty common to have profits of 100%, 200%, or even 1,000% in just
one trade. So, it’s not impossible to snag the big profits – it’s just not
something you should count on. If you expect numbers like this all the
time and accept nothing less, you’re setting yourself up for guaranteed
disappointment.
Therefore, you MUST know when to exit with a profit. Resist the temp-
tation to stay in “just a little longer, for just a little more.”
The only way you can make a fortune with trading is to actually stay in
the game, and it’s hard to stay in the game when you’ve already lost all
of your dough.
Losses are a part of our business. The key to trading success is to limit
your losses. Too many traders are giving a trade way too much “room,”
and they’re taking big hits, which can shrink an account down by 20%,
30%, and sometimes even 40%. Set small losses.
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The Seven Mistakes of Traders and How to Avoid Them
Too many traders are fixed on only one market; they trade ONLY the
forex USD/EUR, or the E-mini Russell, or the E-mini DOW, or just cer-
tain stocks, etc.
So stay away from a market that is choppy or just moving sideways, and
start trading a market with nice trends.
Choppy Market
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Trending Market
Stick with the trending market and you’ll find the profits you’re after.
It means knowing what you’re doing instead of just gambling. Too many
people start off day trading without a strategy, which means that they’re
completely unprepared.
With a day trading strategy, you're way ahead of the crowd, and you’ve
dramatically increased your chances of making money with trading.
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The Seven Mistakes of Traders and How to Avoid Them
What are the main emotions of traders? There are many! Here’s just a
few:
• Greed – “I’m sure the market will continue rising, and I’ll make
millions!”
• Panic – “Oh no, the market is moving fast. Why? What should I
do? The sky is falling…!”
I recently saw the movie “The Guardian,” with Kevin Costner and
Ashton Kutcher. It’s about the U.S. Coast Guard. Kevin Costner plays an
instructor who trains young recruits to become rescue swimmers.
One day, they have a simple exercise in the pool: one of the instructors
simulates a victim and one of the cadets has to rescue him. When the res-
cue swimmer approaches the drowning victim, the victim grabs the
swimmer and holds him tight, trying not to drown.
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The rescue swimmer panics and can’t escape the victim’s grip. And both
of them almost drown.
After the exercise, Kevin Costner’s character explains this to the cadets;
the only difference between THEM and the drowning victim out there in
the ocean is that THEY have a strategy to rescue the victim and deal with
the situation. But all of the tools and equipment that they have are abso-
lutely useless if they panic, or have no idea what to do.
The same is true in trading: you can have the best trading strategy, supe-
rior software, the fastest computer, several 21” monitors, a $1,500 ergo-
nomic chair, and an office with the most stunning view, but all of these
things are absolutely useless if you’re in a trade and you panic.
Remain calm, cool, and relaxed. Control your emotions – don’t let them
control you.
Many traders think that “quantity” is better than “quality.” They believe
that if you just throw enough punches, one will eventually hit. They trade
like maniacs and make their broker rich.
Traders are overtrading for the following three reasons, and none of them
are good:
1.) Greed
You just closed a winning trade. You followed your plan and
made the profits that you were looking for. But the market keeps
going up. You think, “I should have stayed in this trade,” so you
jump right back in. And then you realize that YOU were the one
who just bought the high of the day.
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The Seven Mistakes of Traders and How to Avoid Them
2.) Revenge
You lost money. The market has been mean to you. “They” just
took out your stop and now the market keeps moving in your di-
rection. So you want to get back at them. You keep trading,
thinking, “The next trade will make back all the money I lost so
far, and that will hurt them.” Believe me: the market is AL-
WAYS stronger, and it will be YOU who gets the bloody nose.
3.) Boredom
There are some days when the ducks simply don’t line up.
You’re watching the markets and it’s like watching paint dry:
nothing moves. You wait…and wait…and wait…and suddenly
you just get that “itch” to trade. You think, “If I don’t trade, I
won’t make any money!” and you jump into a trade immedi-
ately. Of course, the trade isn’t according to your plan, and you
end up with a loss.
I haves some news for you: if you don’t trade when there’s
nothing to trade, then you won’t lose any money – guaranteed!
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The Trader’s Psyche
Y ou know that you need a strategy. And you know that there’s
more to trading than just having a strategy. In the previous
chapter, you learned about the major mistakes that traders make, and you
learned that your biggest enemy is not another trader, or market makers,
or your broker – it’s YOU.
In this chapter, you’ll learn about the mindset and psyche of successful
traders. Having a profitable trading strategy AND the right mindset will
catapult you right into the 11.5% of successful traders we talked about
earlier.
In order to develop the right mindset, you need to know what to expect
when day trading.
But you already know that losses are a part of our business as traders.
There will be some days and weeks when your trading exceeds your ex-
pectations, and there will be periods when your trading results are far
worse than you expected.
Day trading means playing a numbers game. You already know that you
need to place at least 40 trades before you can look at the performance of
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the strategy. Most traders only evaluate their performance once a month,
trying to have as many profitable months as possible. Hedge funds
evaluate their performances quarterly or yearly.
Long-term evaluations have their place, but if you look at your trading
results daily, it will drive you crazy. That’s why we define weekly goals.
Sure, nobody likes going through a drawdown. But when you’re trading,
it’s inevitable. The key is in how you deal with it.
And way too many traders focus on short-term results and lose their per-
spective. That's why they fail: they experience a loss or a bad week, and
so they start trading a different strategy. And while the trading strategy
they just abandoned is recovering from the drawdown, the new trading
strategy may result in yet more losses, so again, they start looking for
another.
It’s like a dog chasing too many rabbits: at the end of the day, he's totally
exhausted and he has absolutely nothing to show for it, because he didn’t
catch a single thing.
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The Trader’s Psyche
1.) Successful traders do not blame. They accept the losses they
have, and they don’t dwell on them, or blame other people or
conditions. They learn from their mistakes and move on with
their trading.
3.) Successful traders have patience. They know that most posi-
tions will not be profitable the minute they are opened.
7.) Successful traders do not rush into trades. They take their
time while selecting trades, and they are picky about which
trades to jump on. They don’t place orders just for the sake of
having a position in the market every second.
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10.) Successful traders know what type of trader they are. They
don’t force themselves to trade with methods or strategies that
do not fit their personality.
12.) Successful traders take action. They don’t let their fear con-
trol their decisions or interfere with their trading.
15.) Successful traders take time off. They realize the importance
of taking breaks from trading and the markets to clear their
heads.
16.) Successful traders do not fear losses. They realize that losses
are a part of their business, and they expect them.
If you can adopt the right psychological mindset, then you’ll gain a sig-
nificant edge in the market.
The right mindset is one of the keys to investment success, and most
traders fail to understand this.
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The Trader’s Psyche
When day trading, two emotions are constantly present: greed and fear.
If your trade goes well, your natural inclination will be to trade even
more, opening yourself up to significant loss. And if your trade goes
wrong, fear will torture you. Fear of loss or fear of a further loss makes
traders scared.
Greed and fear are destructive emotions, and all traders are influenced by
them; they’re a natural part of every trader’s psychology. Greed and fear
can make traders act irrationally: they may know what they should do,
but they simply can’t do it.
The bottom line: if you’re scared or greedy, and you can’t control your
emotions when day trading, then you’ll have a very difficult time being
profitable.
But, when you trade well, in accordance with your trading plan, you will
have a fantastic chance of success. Feel proud of yourself for good trades
and decisions, but don’t dwell on them, or allow arrogance to set in.
Keep your head up and continue to apply a sound trading strategy, even
when you suffer losses – remember, they are just a part of the business.
Work on your mental state. If a trade goes wrong, try and work out why
it did, and learn from it. Executing a trading method with discipline is the
only way to overcome destructive emotions. Whether you’re a day trader
or an investor, and whether you trade in commodities, stocks, or curren-
cies, the fact is that your trading psychology WILL influence your re-
sults.
You should never trade without a solid reason. Don’t chase the market. If
a market moves sharply, but you don’t participate in this move because
your entry criteria weren’t met, don’t worry about it. If you miss a trade,
another one will be just around the corner. Practice patience and disci-
pline.
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The more you are prepared mentally for trading, the better you will trade.
Note my emphasis on better trading, not better winning. A good day in
day trading is not defined by profits. Successful day traders define a
good day as one that is researched and planned and follows their overall
trading strategy.
Action Items:
The “Law of Attraction” says that “you get what you think
about.” Here’s how to avoid negative emotions and to have a
positive attitude:
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The Three “Secrets” to
Day Trading Success
T rading can be simple, but it’s not easy. And trading is definitely
more difficult if you complicate it. Remember the saying: “A
Confused Mind Takes No Action.” As a trader, you MUST take action,
every single day; therefore, you must avoid confusion.
You must buy when the market is going up and sell when the
market is going down. That’s how money is made.
It is essential that you know when it’s the right time to exit with
a profit AND when it’s the right time to exit with a loss.
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Now you know why I put the word “secrets” in quotation marks. These
are not “secrets” at all. Unfortunately, though, most traders don’t realize
the importance of these facts and tend to forget them.
Remember, the “secrets” to day trading success are universal. They apply
to every market, whether you’re trading stocks, futures, options, or forex.
And they apply to every timeframe, which is why they’re so powerful.
2.) Learn when to exit a trade, when to take a profit, and when to
bail if the market is not moving in your favor.
Don’t make your trading overly complicated. Stick to the basics. As you
already know, if you can’t drive a Ford, you won’t be able to drive a Fer-
rari. And if you can’t drive a car at 10mph, you shouldn’t try to drive it at
80mph.
Remember Power Principle #1: Use Few Rules – Make It Easy to Under-
stand (page 192). That’s how your trading plan should be.
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The Three “Secrets” to Day Trading Success
Action Items:
Take a look at your trading plan right now and answer the
following questions:
o Are you using more than two indicators? Are they com-
plementing each other or contradicting each other?
o Are you sure you’re trading the right market? Did you
select a market based on your goals or based on a
“friend’s” recommendation?
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The Tenets of Day
Trading
T hroughout the course of this book, you’ve learned a lot, and you
should be well on your way to becoming a successful day trader.
In this chapter, you’ll find a summary of the most important tenets of
trading success.
First, people don’t begin with specific objectives. Most people approach
the markets and they don’t have a clue what they’re trying to do. The
first rule is to decide what you’re trying to accomplish. That’s your busi-
ness plan.
Take a look at the following – my list of basic tenets for day trading.
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The Tenets of Day Trading
Also, consider a few of these effective day trading strategies to stick to:
• Trade only twice a day – once in the morning and once in the
afternoon. Continue trading this way for at least the first 2 to 3
months. A conservative schedule will save you from the tempta-
tion of overtrading.
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contracts), you’ll be very glad that you took the time to focus on
the smaller goal first.
If, for some reason, you’re not able to meet your set profit goal in a par-
ticular week, don’t worry. It’s happened to everyone. Just focus on con-
sistency in your trading results and you WILL find success.
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How to Start Trading
Without Risking a Single
Penny
T hat’s it! Now you KNOW what to do. The next step is putting it
into practice.
If you completed the action items at the end of each chapter, you now
have a trading strategy. You have tested it against the power principles.
You back-tested it, and everything looks good. You have prepared your-
self for the mental challenges of trading.
Now, you NEED to begin trading. It's time for the rubber to meet the
road!
You can have the best trading plan ever, but you'll never make any
money if you don't take action and actually start. Of course, it always
helps to have a little risk-free practice first, right?
After all, you might still be pretty new to trading, even after having read
this book and completing the action items. You don't want to lose thou-
sands of dollars because you made a small mistake in your trading plan,
do you?
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But how can you get started without risking a single penny of your own
money?
The best thing you can do is to get a "paper trading account." And the
best news you’ll hear today: you can get a paper trading account for
FREE from your broker. Or, just contact Rockwell Trading®, and we’ll
get you set up with a free paper trading account ourselves.
A paper trading account let's you trade your strategy with "virtual
money." You will get live quotes, and you can enter the trades according
to your plan. The system will simulate fills, and you'll find yourself in a
trading position. Paper trading accounts show the profit and loss in real-
time, and you can see LIVE how much money you are making or losing.
Keep in mind that we're talking about "virtual money," so you are not
actually making money yet.
If you’re serious about your trading success, you MUST trade your strat-
egy on a paper trading account first.
Here’s why:
Your system establishes a long position at 1190.00, and the profit target
order was placed at 1192.25 ($112.50 profit per contract). Prices move
up to 1192.00 and then reverse. One hour later, the system tries to re-
verse at 1191.00. Again, prices move up to 1190.75 and reverse. Two
times, the system missed the profit target by one tick.
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How to Start Trading Without Risking a Single Penny
Or should you manually override the strategy when something like this
happens?
Doing any of this is like opening Pandora’s Box. Let's say you start by
lowering your profit goal one tick. Of course, you would be instantly re-
warded, because the number of winners would increase.
Next week, though, you might experience the following situation: your
stop is hit and you are taken out of the trade, but then the market turns
and takes off and you are missing a nice winner. What now? Well, you
start moving your stop a little bit further away, and again, you’re in-
stantly rewarded: the number of losses decrease.
One week later, you experience a similar situation and you continue
"fine-tuning" your system by slightly moving down your profit goal and
minimally increasing your stop loss. And very soon, the winning system
that you once had turns into a losing one, because your losses are much
bigger than your profits.
I’ve seen it so many times: a trader will back-test his system with over
700 or maybe even 1,000 trades, and then he "fine-tunes" it after the first
5 trades. This doesn't make sense! If you have a sound logic to why your
system should work, then you shouldn’t "fine-tune" it after just 5 trades.
It doesn’t NEED fine-tuning.
So, again, exercise discipline: if your strategy worked well for over 1,000
trades, and you have sound logic, and you haven't curve-fitted the strat-
egy, then you should not override the plan or "fine-tune" it after only a
few trades!
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1.) Can you "pull the trigger" when your entry signal appears?
2.) How do you feel when you see the trade moving against you? Do
you feel the urge to move your stop loss?
3.) How do you feel when the trade makes a profit? Do you want to
get out? Or do you want to stay in a little bit longer?
And, of course, it’ll help you test your trading system under "realistic"
market conditions.
Stick to the successful things you know, follow your plan, and control
your emotions.
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How to Start Trading Without Risking a Single Penny
Action Items:
239
Bonus Materials
All of these resources, along with much more reader-only content, are
available to you today.
241
Appendices
Appendix A – Trading
Plan Template
Financial Goal
(see the chapter “Is It Really Possible to Make a Living As a Day Trader?” page 9)
$ per month
$ per week
My Account Size: $
(see the chapter “How Much Money Do You Need to Get Started?” page 23)
I am Willing to Risk: $
(see the chapter “Determining Your Risk Tolerance,” page 27)
Selecting a Market
(see the chapter “Step 1: Selecting a Market,” page 51)
Selecting a Timeframe
(see the chapter “Step 2: Selecting a Timeframe,” page 85)
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Entry Signals
(see the chapter “Step 4: Defining Entry Points,” page 149)
Long Entry:
Short Entry:
Exit Signals
(see the chapter “Step 5: Defining Exit Points,” page 151)
Profit Target:
Stop Loss:
246
Appendix A – Trading Plan Template
Other Rules
(see the chapter “Step 7: Improving Your Strategy,” page 183)
Expectations
(see the chapter “Step 6: Evaluating Your Strategy,” page 171)
Realized
Expected
(after 40 Trades)
# of Trades per Day
Winning Percentage
Total Profit
247
Appendix B –
Broker Checklist
(see the chapter “What You Need to Begin Trading,” on page 39)
Below is a list of questions that you can use when interviewing a broker.
It will help you tremendously when it comes to finding the right broker.
• How long has your firm been registered with the NFA?
(Only applicable to futures and forex brokers)
• What is my total cost per transaction, and are there any other
monthly costs?
249
Appendix C –
Additional Resources
Useful Websites:
http://www.rockwelltrading.com
http://www.candlecharts.com/
http://www.genesisft.com/
http://www.ireallytrade.com/
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The Complete Guide to Day Trading
http://www.stockweblog.com
http://www.superstockpicker.com
http://www.traderslog.com/
252
Appendix D – Reading
Resources
In this hands-on book, C.P.A. Robert Green provides traders with practi-
cal material on how to minimize the impact that taxes have on hard-won
profits, along with how to get immediate refunds from losses. Written in
a clear concise style that appeals to traders as opposed to accountants,
this book discusses the best ways to set up a trading business, key tax
forms and how to use them, tax treatment for specific types of securities,
commodities, futures, and currencies, what to do in case of an audit, how
to deal with the IRS, ways to lower your taxes legally, and more.
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A classic. Originally written in the early 1920s, this novel tells the story
of Larry Livingston, a pseudonym for Jesse Livermore, one of history's
most famous traders. You have probably heard many of the famous rules
that are introduced in this book, like: “The trend is your friend,” “History
repeats itself,” “No stock is too high to buy or too low to sell,” and “Let
your winners run and cut your losses quickly.” This book is a must-read
for beginners and a must re-read for all others.
254
Appendix D – Reading Resources
The Candlestick Course is a hands-on course book that will help you
master Steve Nison’s landmark techniques for Japanese Candlestick
Charting. Each chapter gives you specific learning objectives, key terms,
clear instruction, and real-world applications of the concepts. Plus, each
chapter ends with a review quiz, allowing you to perfect your charting
abilities before moving on to the next phase.
While Reminiscences of a Stock Operator will teach you the basic rules,
Van K. Tharp demonstrates in this book exactly how to “let your winners
run and cut your losses quickly.” In the first part of the book, Van Tharp
describes how the trader himself is a major factor in successful trading.
The second part conceptualizes the creation of one’s trading system, and
the third part helps you to understand the key parts of a trading system.
In covering these topics, Tharp brings in several outstanding traders,
each of whom contributes his own expertise.
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Appendix E – Glossary
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The Complete Guide to Day Trading
Bull Market – A market in which prices generally rise faster than their
historical average over a period of months or years. Some analysts re-
quire a market to rise 20% from a major low for a sustained period of
time before using the term ‘bull market.’ Buyers are often referred to as
‘bulls.’ A bull market is the opposite of a bear market.
258
Appendix E – Glossary
Closing Price (C) – The last trade of the day, as expressed in charts.
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The Complete Guide to Day Trading
Entry/Exit Signals – Signals that define when to open and close trading
positions; these signals are derived from a trading strategy’s entry and
exit rules.
260
Appendix E – Glossary
Initial Margin – The sum of money that the customer must deposit with
the brokerage firm for each futures contract to be bought or sold; initial
margin is paid by both buyer and seller. (Sometimes called original mar-
gin or initial deposit.)
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Market – A system which allows people to easily buy and sell (trade)
financial securities (such as stocks and bonds), commodities (such as
precious metals or agricultural goods), and other items of value. There
are always two roles in markets – buyers and sellers.
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Appendix E – Glossary
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Net Profit – A trader's total earnings (or profit). Often referred to as the
bottom line, net profit is calculated by subtracting a trader's total ex-
penses from his total revenue, showing what that trader has earned (or
lost) in a given period of time. (Sometimes called net earnings or net in-
come.)
New York Stock Exchange (NYSE) – The world’s oldest and largest
stock exchange; the NYSE is operated as an unincorporated association
with a governing board of directors and a full-time chairman. More than
1,600 companies are listed, representing some 60% of the total shares
traded in the United States.
Opening Price (O) – The first trade of the day, as expressed in charts.
Options Trading – The buying and selling of contracts which give the
buyers the right, but not the obligation, to buy or sell a specified quantity
of a commodity or other instrument at a specific price within a specified
period of time, regardless of the market price of that instrument (see the
chapter ‘Trading Stock Options’).
264
Appendix E – Glossary
Pip – The smallest price change that a given exchange rate can make.
The term ‘pip’ is most common in the Forex market, where prices are
quoted to the fourth decimal point.
Pivot Points – Technical levels calculated using the high, low, and
closing prices of a given security.
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Range – The difference between the high price of the day and the low
price of the day, as expressed in charts.
Resistance Level – Usually the high or the peak point in any charting
pattern (hourly, weekly, or annually). In technical analysis, resistance is
defined as a price area where new selling will emerge to dampen a con-
tinued rise. Resistance is the opposite of support.
SMART Goal – A goal that meets all of the criteria referenced in the
acronym SMART: specific, measurable, attractive, realistic, timeframe.
266
Appendix E – Glossary
Spread – The difference between the bidding price and the asking price
of a financial instrument. The bidding price is the amount at which a
market participant is willing to buy a security; the asking price is the
amount at which a market participant is willing to sell a security.
SPYDER Contract – An artificial stock that mirrors the S&P 500 Index.
(Sometimes called the SPY Contract or SPDR.)
Stop Loss – The amount of money that traders are willing to lose in a
trade. Once a stop loss is determined, traders set a stop order at that
price; if the contract price falls to the level of the stop loss, the stop order
will automatically remove the trader from his position in the market so
that he does not lose more money. A stop loss is the opposite of a profit
target.
Support Level – Usually the low point in any chart pattern (hourly,
weekly, or annually). In technical analysis, support is defined as a price
area where new buying is likely to come in and stem any decline. Sup-
port is the opposite of resistance.
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Tick Size – The minimum legal change in the price of a contract, either
up or down.
268
Appendix E – Glossary
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Zero Sum Game – A situation in which one participant can gain only at
the expense of another participant’s equivalent loss.
270
Appendix F –
About Markus Heitkoetter
Markus started trading 19 years ago, using point and figure charts from
published numbers in the morning newspaper, mainly with stocks. In
1996, he began developing a number of trading systems by using Super-
Charts (which is now TradeStation), MetaStock, OmniTrader, and other
software.
In 2002, Markus decided to quit his regular day job as a director at IBM
to become a professional trader. He moved from Germany to the United
States to get started.
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Markus currently resides with his wife and two children in Austin,
Texas.
272
Appendix G –
Coaching Programs
Rest assured that when you sign up with Rockwell, you're not getting a
run-of-the-mill trading course. You're getting something special. Our
personalized coaching is what sets us apart from our competitors.
Look at Tiger Woods. He's a phenomenal golfer, a real natural. But he's
still got a coach. And do you remember what happened to Tiger Woods
when he fired his coaches? It wasn't pretty. Everyone needs guidance and
constructive criticism to be successful. Even the athletes, geniuses, and
superstars.
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Rockwell’s coaching programs are not just about listening and note-
taking - though these are important factors, too – they are about the con-
structive guidance, input, and feedback from your coach, and the hands-
on application of your new trading habits.
Our Day Trading Coach program is perfect for active day traders who are
interested in trading the futures and currency markets. If you can spend
at least two hours per day following the markets, then this is the right
program for you.
274
Appendix G – Coaching Programs
Our Stock Trading Coach program is perfect for busy professionals who
can’t follow the markets during regular trading hours. You’ll be using
end-of-day data and weekly charts to make your trading decisions in the
evenings or on the weekend. If you’re looking to start trading part-time,
then this is the right program for you.
Our Day Trading Coach and Stock Trading Coach programs cater to both
novice and experienced traders alike. As a Rockwell student, you will
develop and streamline your trading skills and approaches at your own
pace through one-on-one coaching sessions and hands-on practice in the
markets.
www.rockwelltrading.com
275