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Trading Blog Archive Q4 2006
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A year end review and planning session

Paul King, December 21st 2006 

Although the end of a calendar year is an arbitrary point in time, everything seems to work on yearly cycles (taxes, contracts, business plans etc.)  Therefore it's a good idea to take some time to review how your year went compared to your measurable objectives and goals.
The measurable part is important.  If you have intangible objectives like "to be rich", or "to be happy", or "to travel all over the world", it is more difficult to measure how well you fulfilled those objectives (or even if they're possible).
In my trading business plan I set objectives for the next year in the context of my long-term (5-10 years) goals.  You can think of it as tactical objectives that are along the path of a strategic goal.  Each objective has a time frame, and can be quantified and measured.
For example, if I happened to have a "travel the world" strategic objective I would split that up into specific destinations I wanted to visit, for how long, and within what timeframe.  In this way, your measurement of success can be easily quantified so you know whether you achieved your objective or not.
One last thought is that what I actually achieve always seems to be proportional to the difficulty of my initial objectives.  I always tend to set myself seemingly impossible objectives on very tight timelines, but it always seems to work out that I achieve a certain percentage of what I set out to do each year.  My conclusion is that you should "dream as big as you possibly can" so that if you, say, usually accomplish about 80% of what you set out to do, it will be 80% of something huge rather than something insignificant.
Also, it's important not be too hard on yourself if you don't achieve 100% of your objectives for the year.  To me, that would indicate I was thinking too small and have actually under-achieved for the year if I do 100% of what I intend to do.
Remember to make BIG plans for the New Year and write them down so they actually exist.  You might just surprise yourself how much of a difference thinking big, writing it down, and measuring your progress actually makes.
Wishing everyone a very Merry Christmas and a Happy New Year (or Happy Holidays if you don't celebrate Christmas).

Good trading is not about prediction

Paul King, December 14th 2006 

I'm sorry that I haven't been writing my blog recently - things have been a bit busy with an office move and preparation for the publication of my book.  Anyway, I have a few minutes to write an entry now and though I'd briefly discuss prediction in trading.
Many traders get stuck in the "prediction rut".  A symptom of this is the never ending search for the next great "pattern" that gives you a winning trade almost every time.  This is based upon the assumption that future price movement is predictable if only you can find the cause and effect relationships.  Nothing in my trading assumes any such predictive data exists - I approach the whole thing much more like an actuary working out how much to charge in life insurance premiums to ensure they collect more than they're likely to have to pay out.
Actuarial calculations aren't trying to predict who will die when given a sample of customers with policies.  We all know the answer to how many of the clients will die at some point :-).  What they are trying to do is to look at the distribution of likely scenarios when certain percentages of their client population will die, and then attempt to set a policy premium that is competitive, but with enough of a cushion to ensure a decent profit for the company.
I treat my trading in a similar way.  Given a distribution of trades that your system or method will generate in the future, everything you do should be deigned around trying to get your average winners bigger than average losers, and trade frequency high enough to generate a good return, but low enough to minimize transaction/implementation costs.  I have no idea in advance which trades out of a given sample will be winners or losers, and I don't care.  I only care that the sample as a whole has a positive expectancy and I have processes in place that help me accurately implement my system rules.
In this way I can concentrate on good risk management via position-sizing, accurate trade implementation, and not have to worry about curve-fitting, pattern-matching, and finding relationships between past data and future data that may be no more than random chance.
If I don't get chance to post again before the Holidays I wish everyone who reads this blog a very Merry Christmas and a Happy New Year (or whatever holiday terminology you personally prefer :-) and I hope you all have a prosperous and interesting 2007.

Two Kinds of Self Sabotage

Paul King, November 27th 2006 

Self-sabotage is a common but often overlooked problem in trading. Why would anyone trade to lose money or purposely fail to reach their objectives? There are two main forms of self-sabotage and they are:
1 Sub-conscious self-sabotage: I'm not even going to evaluate the situation. I'm just going to take the "trade" and hope for the best.
2 Conscious self-sabotage: I have evaluated the risk:reward of a situation, it's not good, but I'll take the "trade" for some reason anyway.
The first one is difficult to detect and is symptomatic of an undisciplined approach to trading. If you have a complete plan which includes objectives and rules that allow you to manage your trades to meet your objectives, then any conscious deviation from your plan could be a sign of self-sabotage.
If you don’t have a plan then everything you do could be a form of sub-conscious self-sabotage, and even detecting it may be impossible. Trading without a plan is an obvious way you can make sure you don’t succeed from the start.
My advice: develop a complete trading plan that includes objectives and rules for your trading before you risk any cash at all.
The second type is making a conscious decision to deviate from your plan, especially when the risk:reward for a trade (or other decision) is poor, and you know it is poor. This kind of self-sabotage is most common when your objectives for your trading are in conflict with your actual desires or personality.
For example, you may have an objective to make 50% return per year, and have a plan that gives you a good chance of achieving that, but subconsciously you don’t believe you deserve, or will be pleased with that particular return. In this case you need to do some type of self-analysis to find out the root cause of your feelings, and why they are in conflict with your stated objectives.
Maybe you’re afraid the way your friends and family will perceive you will change for the worse if you succeed. Maybe you don’t believe you deserve to succeed. Maybe you don’t think trading is performing a useful function and doesn’t justify making any money at all. Maybe you believe trading is a “zero sum game” and your profits are someone else’s losses and you don’t want to take their money.
Whatever it is, you must identify and resolve the conflict or you will not succeed in achieving your objectives. I have found many of the products from Van Tharp Institute to be useful in identifying psychological-related problems that may prevent you from successful trading.  Continual self-analysis and psychological work is an essential ingredient in improving trading performance.



Tracking Trading Errors

Paul King, November 22nd 2006 
Every trader makes errors attempting to implement their trading systems or methods.  What differentiates successful (i.e. profitable) from unsuccessful ones is how accurately and consistently they implement their trading systems.  This assumes one already has a positive expectancy trading method to begin with, of course.  The most accurate implementation of a negative expectancy system will only slow down the inevitable loss of capital.

Today I made my 8th implementation error for 2006.  I left an exit stop in my account for a position that I had already closed out, and the stop got triggered and put me in a position I shouldn't have been in.  By the time I was able to work out what had happened and exit the spurious position I had a -0.15R loss. R is a measure of profit or loss per unit risk as determined by your initial stop.  By the way, if I hadn't spotted the error and exited quickly I would have ended up with a -0.5R loser by the end of the day.

My total errors for 2006 represent less than 1R total, which is about 0.5% of my total account equity right now.  I call this deviation from my system as defined "D" for short and track it on a cumulative yearly basis.  This year is my lowest D since I started trading and has reached a level I consider acceptable for my trading.  Zero deviation from your trading system as defined is generally not feasible; especially if you trade frequently.

If you don't track your errors accurately then you have 2 problems:

  • You can't tell whether your system is losing money or your poor implementation of it is causing the losses.
  • You can't put preventative measures in place to make sure errors do not happen again and again.

The result is that you can't accurately measure your performance as a trader unless you take errors into account.  For me, a decreasing error rate is a much better indicator of an improvement in my overall trading performance over time than absolute cash made or lost.  One can accurately implement a trading system all year and make no money.  That doesn't mean you're a bad trader, just that your method was not profitable this year.   Conversely, making 20R in a year when your systems should have made 40R is the sign of a poor trader in my opinion.

If you don't track your errors, or don't have a plan so everything you do is a "deviation", then starting to track errors is one of the most important things you can do to improve your trading.

A very Happy Thanksgiving to all my US readers :-)


Product Review: Why Traditional Technical Analysis Doesn't Work from InvestorFLIX

Paul King, November 15th 2006 
In this 1 hour DVD by Grant Noble, there are some useful ideas about why traditional technical analysis doesn't work.  The presentation is 10 years old, and the main body of what is presented isn't that useful, but there are two main ideas that are definitely worth thinking about.  These are:

  • All charts should be adjusted for inflation and base-currency rates
  • Technical analysis applied to fundamental data can be effective

The whole presentation lasts for about an hour and doesn’t once mention position sizing or exits in much detail although he does say that knowing when to take profits is a key part of trading, but doesn’t go on to say how you should do it.


Two beliefs that are prevalent through the whole talk are that a) off-floor traders have huge trading implementation expenses to contend with and so must trade longer-term than floor traders and b) successful trading is all about making accurate predictions and having effective entry signals.


Another quirky idea is that it’s OK to have 12 or so indicators in your trading so you aren’t dependant on any one indicator being right.  Which 12 to use is not covered and nothing is stated about what to do when they all contradict each other.


The discussion of historical cycles in the S&P 500 makes the normal mistake of “spotting” a pattern that has only occurred 3 times over the last 150 years and extrapolating from that what will happen in the future.


I haven’t read the book that Grant touts in the presentation (saying that this presentation is not a commercial) and I don’t feel inclined to after watching this talk.


My advice is to think about adjusting your charts for inflation, and possibly using some technical analysis techniques on non-price data. These may both be areas for useful research, but you don’t necessarily need to watch this presentation to find that out.

Visit InvestorFLIX

Read our other InvestorFLIX reviews here

Paul King, November 15th 2006
International paper today decided not to burn tire chips at its Ticonderoga Plant stating that they didn't believe it was "economically feasible".
Thanks to anyone who took the time to contact International Paper to let them know that polluting an unspoiled area of America is never a good business decision whatever the economics look like.
It's impossible to tell actually why the decision to stop the tire burn was made, but I would like to think that people not just sitting back and taking it had some influence on IP's decision.  If you contacted IP then a big "Thank you", people around Ticonderoga don't have to worry which way the wind is blowing and whether their kids are playing outside.
Feel free to send me your thoughts using the contact page here.
Paul King, November 15th 2006
International paper today decided not to burn tire chips at its Ticonderoga Plant stating that they didn't believe it was "economically feasible".
Thanks to anyone who took the time to contact International Paper to let them know that polluting an unspoiled area of America is never a good business decision whatever the economics look like.
It's impossible to tell actually why the decision to stop the tire burn was made, but I would like to think that people not just sitting back and taking it had some influence on IP's decision.  If you contacted IP then a big "Thank you", people around Ticonderoga don't have to worry which way the wind is blowing and whether their kids are playing outside.
Feel free to send me your thoughts using the contact page here.
Paul King, November 10th 2006
Let's get one thing straight.  This isn't financial advice, trading advice, or a prediction, or investment advice of any kind.  It's a personal request.  What do I want you to do?  Absolutely nothing (I'll explain in a minute).
Moving to Vermont was a wonderful thing to me and my family and pollution has been one of the last things on my mind since I moved here to live surrounded by mountains and forests.  Suddenly pollution is the word of the day as the International Paper Mill at Ticonderoga in New York starts burning used tire chips.
I'm not going to bore you with the description of toxic fumes spewing from the stack, or the fact that they are technically adhering to EPA guidelines, or even that the whole thing could be fixed with a pollution filter that costs less than $10 million and is installed in every other plant that burns tire chips for fuel.  I have a four year old son and even having to wonder whether it's safe for him to play in his own yard is not something I should have to be worried about right now.
So, what exactly do I want you to do?  Simply don't buy International Paper (IP) stock and use the 'contact us' page on the International Paper web site to say you're not buying their stock because of the Ticonderoga Tire burn.  If you own the stock then send them a message saying you're not happy with the tire burn.
This is a public company and if they think there is any chance at all of an adverse price effect on their stock due to an avoidable situation it will suddenly make the cost of the pollution filter technology seem pretty cheap won't it?
Thanks for your co-operation and I hope this small gesture can make a difference to the rate at which a beautiful unspoilt area of America is affected by pollution.
Feel free to send me your thoughts using the contact page here.
Paul King, November 9th 2006
It's not very often nowadays that I get to add a book to my Trader Recommended Reading List (details here) but John Carter's Mastering the Trade is one of the best trading books I've read in a long while.  John is obviously an experienced trader who "walks the walk" and doesn't just "talk the talk".
The sections of the book on trader psychology, markets, hardware and software and business planning are well-written, informative, humorous and easy to read.  If I had a criticism it would be that a large portion of the book is dedicated to intra-day and short-term specific setups for trades and I suspect these were included because the publisher said "that's what traders want to see" rather than dealing with complete trading system concepts including position sizing and exit strategies.
If you are looking for some ideas for useful intra-day setups, then this section will be ideal.  As with most trading books this one skirts round position-sizing and exit strategies when it is talking about specific trading "systems".
Overall a worthwhile read, although I would recommend waiting for the paperback version (assuming one is released eventually) since the $55 retail price is too expensive.  Even the discounted Amazon price is still too high for the casual reader in my opinion.
Paul King, November 2nd 2006
If you've been reading this blog recently you'll know about the concept of measuring the efficiency of movement of a financial instrument I outlined in my October 17th blog entry here.

In the latest eBook in the SmartTraderTM series I expand on this concept by defining an Efficiency Percentage indicator and describe a complete trading system that uses the concept.

The eBook also discusses how the key decisions were made for the other components of the trading system. The eBook comes with Excel formulas and TradeStation® Code in full detail.

If you're in need of an idea for a trading method that can be applied to almost any financial instrument in any timeframe then this eBook should give you some good areas for research.

Click here for more details.

Paul King, October 30th 2006
I get at least 100 unsolicited emails a day right now that look similar to the one show below:
"The accumulation of positions by those in the know has shot [some sub-$1 stock] up 33% in a few short days. We hope you all got in early like we told you to, and are enjoying your good fortune. But even if you didn't don't worry because the big announcement has yet to be made. [Some date in the near future] may be your last chance before this thing triples. Don't hesitate.
  • Price: 0.85
  • Projected: 2.30
  • Rating: 5/5

This is the break you've been waiting for! Spice up your holdings and WIN!"

The interesting thing if you do actually take a look at the stock mentioned is that price and volume does indeed increase shortly after you receive the email and then goes straight back to where it was before.  Amazingly, some people must actually be acting on these spam emails!  Either that, or a falling prey to some of the other phishing scams where hackers use remote recording software to discovery your brokerage login and actually buy a load of the penny stocks they are pumping for you!  All of this is so they can dump their own holdings at a good price in a classic "pump and dump" scam.

Some criteria for acting on these kinds of tips that I use are as follows:

Is the price greater than $10?

Stocks that are priced lower than about $10 are usually cheap for a reason - they probably didn't IPO at this price and it means they are in long-term down trend.  Avoid stocks selling at low prices - they are a low probability long trade, and also have limited potential as a short since they only have $10 to move lower.  Low price alone is a good reason to avoid a stock since they are close to, or already have been, de-listed from a major exchange and are trading "over the counter".  This assumes they were ever able to trade on a major exchaneg - some stocks never get big enough to even meet the exchange's listing requirements.

Is the average daily volume greater than 100,000?

If the volume isn't there in the stock you won't be able to enter and exit efficiently even for very small position sizes.  Don't trade illiquid stocks; implementation costs are just too high relative to the profit potential.

Is the market capitalization greater than $100,000,000?

Some low-priced stocks do actually trade a lot of shares per day, but the dollar value is still relatively tiny.  Unless the company has a decent market capitalization (value of outstanding shares) it will not trade in an orderly way.  Avoid tiny capitalization companies.

Just these 3 criteria alone will eliminate at least 100% of the stocks mentioned in spam emails so I don't even have to go into why trading from random unsolicited emails is a bad idea in the first place.  My advice:  Use Spam Arrest to eliminate these kinds of emails before they even get to your inbox so you are not tempted in any way to act on them "just to see what happens".

There are thousands of liquid, higher priced, higher capitalization stocks that trade on the major exchanges.  Why even bother with the tiny ones promoted by unidentified spammers?


Paul King, October 25th 2006
There are many ways to make (or lose) money trading but really it's all about trend following.  If you think about it, what you're really trying to do is buy something for one price and sell it for a higher price at some time in the future.  Going short is just doing the buying and selling in the opposite order.  I know there are some option strategies that profit when prices don't move, but they're not what the majority of traders are trying to do.
Whether you measure the length of time between buying and selling in seconds or years, you're still just trying to capture a trend.  What does this mean for your trading?  Don't get confused by all the different types of trading people mention: scalping, micro-trend, pattern day-trading, short-term, swing trading, medium term, long term, breakout trading.  It can all be thought of as trend following just in different time frames.  If you reverse your entry signal on a short-term swing trading system, voila; you have a short-term counter-trend system.  But it's still about capturing a price move in a particular direction over a certain timeframe and that sounds exactly like trend following to me.
If you believe the markets are fractal (i.e. price movement looks similar whatever bar length you look at) then trend following looks the same whatever the average trade duration you use.  The shorter your average trade duration and higher your trade frequency is, the more opportunity you have for errors, the more time and effort you have to put into your trading, the higher the implementation costs relative to profit potential are.  It's till trend-following in some time frame though.
That's why it's more difficult to suceed at day-trading than long-term trend following; not because it's an inherently different concept.  Next time you come across the latest, greatest, trading system concept or idea, just ask yourself this question:
How is this any different or better than "simple" trend following on a particular time frame?
If you think about it long enough you may be surprised at the answer; especially if you believe that nothing can predict future price moves so all your entry can do is get you in when things are moving and then all that's left to do is design exits that capture the prevailing trend in the desired timeframe.
Paul King, October 17th 2006
Efficiency is an important concept in trading, and I'm not talking about the efficient market hypothesis.  When I talk about efficiency I mean how smoothly an instrument's price has moved from price A to price B over time T.  A gap opening from $10 at the previous close to $20 at the next open and then "flat-lining" for the next 10 days is very different than a gradual move from $10 to $20 over the same time period.  The first one is indicative of a public company takeover, and the second one a very strong uptrend.
Having a way to measure how efficiently a price moves is useful in order to compare it to historical efficiency and also to the efficiency of a whole market.  In my experience efficiency goes up and down in a "normal" range that is random, but when it gets to an extreme it can be a useful indication.   For example, stocks that have periods of very low efficiency (i.e. noisy, sideways movement) are sometimes followed by high efficiency moves (up or down).  It's almost as if the low-efficiency period is winding up a spring that then has to be released at some point.
So how exactly should you measure efficiency of movement?  There are a couple of ways, but I find the most effective is to compare the actual "distance traveled" to the "optimum path".  If you think of a chart with time on the bottom, and price up the side, then the "optimum path" is the "stepped line" going from A to B.  This is the "shortest" distance from A to B over time T and is represented by B-A.  This gives you a positive value for up moves and a negative one for down moves.
The actual "distance traveled" by the instrument is represented by the sum of the True Range (the daily range including any opening gaps) over the same period.  You could use every single tick to measure the distance traveled, but the sum of the True Range works just as well and is much easier to calculate since it requires only end-of-day data.
To calculate an efficiency percentage, simply divide the Optimum Path (O) by the Actual Path (A) and multiply by 100 to get a percentage value.  100% efficiency means the price moved in a straight line from A to B over time T.  This basically never happens in the real world.  Close to 100% efficiency means that there was a large gap in prices to get from A to B.  Low percentage efficiency means the move was full of noise and up and down movements to get from A to B.  The efficiency percentage of any particular instrument will oscillate in a normal range that represents "normal" price movement with a certain amount of "noise".
As with most indicators, this one is more usuful as a relative measure than an absolute measure; how currenct efficiency compares to historical efficiency, and how an instrument's efficiency compares to the efficiency of the market it belongs to is more useful than the absolute efficiency percentage itself.
How you choose to use this in your trading is the key important decision you have to make, and this should be based on your beliefs about whether the way a price moves from A to B is as important as the absolute price move itself.
Paul King, October 13th 2006
So the Dow Jones Industrial Average made new all-time highs this week.  What does that mean?  Nothing in my trading has anything to do with the DJIA and the main reasons are discussed below.
It's an index of only 30 US equities - barely a statistically significant sample.  The S&P 500 has a whole 470 more companies in it, so that's far more representative than just 30.
Only 1 of the original 30 companies in the DJIA still exists (it's General Electric).  This means the index is a "moving target" so making a high relative to any previous value with different components isn't really relevant.
The index is calculated using equal price weighting for each component.  This means a $1 move in DIS has the same effect as a $1 move in UTX.  Since DIS has about 10 billion outstanding shares and UTX has about 1 billion, the actual difference in price moves based on shareholder value are hugely different in the two cases.  The DJIA treats them both the same though in terms of their effect on the index's price.
Lastly, when an index is making a new high, it's useful to look at what components have contributed to the move up.  It is one or two, or all of them that have made new high prices?  This can give you an idea about what's actually going on.  Maybe that's a nice idea for some homework if you're interested.
It's very true that new highs are pretty bullish for any financial instrument since everyone who is a long has a winning position and may make different decisions and feel differently.  Normally there are a mixture of winners and losers based on when people got into a position.  How is this predictive of the future or significant in any way?  I don't believe it is.  But that's just my belief.  A highest high is an indication of a trend that has happened; it doesn't necessarily mean anything about what will happen in the future.
Paul King, October 2nd 2006
Profits Run recently released a new product called "Super Divergence Blueprint" (see short video here).  This is an entry signal based on a divergence between price (a highest high, or lowest low) and Relative Strength Index (RSI) that is a simple counter-trend-following entry.
Why am I mentioning this?  Well its because people generally make a number of mistakes when assessing whether an entry signal is right for them by "testing" it in the wrong way.  Firstly, you need to look past the normal set of a few "well chosen" examples that show the signal "working" every time.  The question you really want an answer to is "How often does this particular pattern occur and NOT exhibit the behavior you're looking for?"  The answer is seldom presented and it's up to you to test for it.  If the entry occurs many times and does not result in the behaviour you are looking for then it may not be of value.  On the other hand, if the desired behavior ocurrs 100% of the time after the chosen entry then it could be due to an anomalous pattern (i.e. chance).
The second question should be "Does this method work for multiple instruments and timeframes?".  If the answer is "No" then it's probably becasue it's not based on a fundamental way that the markets work.
The third question should be "Can a tailor the sensitivity of the entry to generate the desired number of trades per period?"  If you can't change this then how can you design the entry to give you the number of trades you are looking for in your system design?
Lastly, you should ask "Does this really make sense as an entry signal to me?"  If there is not an obvious reason why that particular entry should get you into trades at a "good" time then it probably has no value.  What determins "good" is another topic entirely and is based on your own objectives.
One question you should not ask about an entry is "What percentage of the time is it right?"  If you've read my mini-ebook "Exits are where the Money Is" you'll know that it is your exit strategy, not your entry that determins winning percentage.
There is an almost infinite combination of entry criteria you can use for your trading.  The important thing is to ask the right questions about what the entry is doing for you, and whether it meets your objectives.  Asking these questions will help you avoid the common "trading trap" of designing a trading system around the concept that entry signal is predictive of future price action when it usually isn't.
Paul King, September 28th 2006
Have you ever wished there was a trading journal/calendar/diary thing specially for traders?  Do you write your thoughts about trading, trades, orders, or mistakes on the back of used envelopes?  Do you have any idea why I'm asking you these questions?
I found that regular desk calendars either had too little room for writing stuff, skimped on the weekend days, or took up too much room on my desk so I just designed and published my own version specially for trading.  I liked it so much I wanted to make it available to other traders and the details are here.
I hope you find it as useful as I do, and don't mind waiting 3 months to be able to use it.



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