Exit Type #1: The Initial Stop

Three Types of Exits
In WAI, new traders are taught 3 types of exits.  Conceptually, this can be thought of as follows:
Type #1. The Initial Stop - when "stock price hits stop loss price"
Type #2. The Raised/Trailing Stop - when "stock price reverses into downtrend"
Type #3. Profit Take Exits - when "stock price hit profit target".
This article considers the first type, which is the Initial Stop, and elaborate more beyond what is taught in WAI.

The Edge of knowing the Initial Stop - RRR Assessment
As Traders, our primary job is to design trades with positive expectancy.  This means we want to look for trades where RRR is at least 3 times.   We may compromise and accept trades where RRR > 2 times, but ideally, we want higher RRR, especially if the win rate is only 50%.   The higher RRR trades generally has lower risks and higher expected returns.

Therefore, the professional Trader always know his Stops first, before he enters the trade.  This then allows him to assess the Risk portion of the RRR assessment, to decide if he wants to proceed with the trade or not.   If he doesn't do this, he just threw away an Edge he has over the majority of the market participants.   When he doesn't do this, the Trader behaves no differently than the amateur who gambles without knowing the odds nor the payoffs.  The professional Trader (and the professional Gambler) both knows the payoffs AND the odds, before they put on the trade.

The Edge of knowing "1R"
On the charts, your 1R = f (Entry Price - Stop Loss Price).
Van Tharp defines 1R = the amount (in $$$ terms) that you are willing to risk on a trade, if you are stopped out.   Therefore, for the Stock Trader, 1R = number of shares x (Entry Price - Stop Loss Price) which is usually defined as 1%-3% capital. (plus commissions & fees).
The professional trader knows that this is his Edge.  When he decides how much he is willing to lose in advance, he becomes calmer and rational, increasing his odds of Trading his Plan.  Through practice and experience, when he found that he becomes emotional when trading 2% capital, he has a benchmark to fine-tune his future trades, perhaps dropping that down to 1% capital.  This experience and benchmarking is an edge.   His selection of the % capital to risk fits his personality, character, and objectives, and strengthens the odds of winning, itself an edge.  The trader who is rationale, calm and able to control his emotions to trade his Plan has a huge edge in the market place that promotes emotional trading.

Where to place the Initial Stop?
As WAI is targeted for new traders, Adam has kept the materials very simple, but it was never intended to be the final authority, but just a starting point.  There are 3 Initial Stops that he recommends:
1. 3xATR below Entry Price.
2. 1-2 x ATR below Key Support Line / Moving Average
3. Below the Previous Swing Low that bounced off Key Moving Averages.

The size of these 3 stops can differ substantially, depending on which of the 8 different Entry System used and the specific chart.  For example, a Trader using Entry Method #1:  Buy the Dip, may find that Stop #3 is the nearest and tightest, perhaps just 1xATR or less, especially if the entry is combined with Entry Method #8: Special Bounce Strategy.   Whereas Entry Method #3: Buy the Horizontal Breakout will typically find Stop #3 to be the furthest, which sometimes can be many multiples of ATR.  The decision on which of the 3 methods to use must first consider the RRR assessment.   In the WAI course, IMHO, there was not enough practice time to combine the 8 Entry Methods with the 3 types of Initial Stops above to truly appreciate RRR > 2 or 3 times, that the new trader is expected to discover for himself through self-practice and experimentation, before he can gain the insights and discover the nuances of the different type of stops combined with various Entry Methods to understand the impact on RRR.

Additional Considerations on placing the Initial Stop

1. As noted above, The Initial Stop should not be too far, to make the Outlay very small or cause the RRR to become less than 2 times. 

2. The Initial Stop should not be too near, to make the Outlay extremely large.  Whilst tight stops improves RRR, it will also cause a lower win rate, and hence, the win rate should not be extremely low, that the resulting system does not fit the Trader's natural character.  

3. The Initial Stop should not be at obvious places where it can be raided very easily by the Stop raiders, such as round numbers which can act as a magnet to trigger the stop unnecessarily.  "Touching price X" is NOT the same thing as "Closing at price X".

4. The Initial Stop should be put at a place where it would prove your trend assumption wrong.  

Implementing the Initial Stop - maximizing edges
1. New trader consideration.   New traders in the US markets are often advised to place the entire Initial Stop at the same time as the Entry Order is placed.  Some students tout this as "best practice".  This is not only to build good trading habits but necessary, since the new Trader often has a full time job, not able to monitor the US markets, and has not build the sufficient trading experience in different types of market conditions.  For new traders, not hardcoding the stops often creates much larger unnecessary losses, and hence is the New Trader's Edge.   Unnecessary loss here is defined as actual loss that exceeds the Initial Stop Loss.

2. Master trader actual practice are exceptions.  The Master Traders on the other hand very rarely hardcode the entire Initial Stop, as this is their Edge.  Whilst appearing contradictory, what is "best practice" for students are often NOT "best practice" for the Masters.   Conrad for example has admitted more than once that he doesn't always use hard stops, even though he teaches his students to do so.   Leong Wei Ping himself also doesn't always use hard stops.   Even in the US, master traders are known to have their positions still on, when their students got stopped out on the same trade.   The reason Master traders don't hard code their stops in certain trades, is because they are able to utilize the edge of their combined experience, knowledge, discipline and practice.  They know the expected behaviour of the stocks they trade under various different market conditions, they have extremely clear mental stop, and they never question the execution when it is needed, they are able to execute it fairly precisely.   They know when to follow and when to break the rules.   And when they don't know, they too get out or they hardcode the stops.

3. Practicality from many open positions.  The edge of hardcoding is "Know thyself".  For a trader who holds many open positions at one time (e.g. it is quite common for me to hold more than 20 open positions at the peak, as well as zero position at certain times), a hard-coded stop in many situations is practical.  I typically place at least 1 contract on a hard stop, to act as alert.   For my smaller positions, I would hard code larger or the entire line, as they are not particularly material, and I want to spend more of my time focusing on fewer selected stocks.  If the RRR is extremely good, I may place a final "fail safe" stop at lower than 1R with 1 contract at 1R point.  For a few positions, I would hardcode less than 50% position.  All these are not arbitrary decisions, but logical decisions for the unique situations, based on my personal assessment of these situations (which many are invariably wrong).   In short, I employ mental stops in the few cases where I feel there is an edge, but only when I am able to monitor the position.   Even if I don't have the stops on, all of my trades will have considered RRR > 2 times before I enter them.

4. Temporarily High volatility considerations.   New traders are advised to close their trades during expected high volatility environments such as earnings, until they have personally experienced sufficiently wide volatility experience - then they will usually want to close out these trades by themselves.  Whilst "earnings" is most frequent cited, it is not just limited to earnings.   Sometimes, Fed announcements can cause very high implied volatility too, or Fed announcements of coming interest rate increases.   However, as noted in 2. above, Masters frequently violate this rule as it is their Edge - they know when to hold through earnings and when not to.  When they have decided to hold through earnings, they would not use hard-coded stops but mental stops, as the high volatility will more likely cause prices to "touch" stop points but not necessarily stay below the stop loss points by the end of the day / after volatility subsides.   Other situations that could cause temporary high volatility may include certain Opening days, certain Closing days, certain periods where the trading volume is thinner (e.g. long Christmas holidays) and potentially more volatile.   Note that not all these days have the same volatility - if you can't tell the difference, follow the rules taught by Adam

5. Don't trade low/non-liquid or manipulated stocks.  

6. Don't place stops during Extended Hours, where volume is thinner and volatility higher.  The risk of unnecessary stops is much higher during Extended Hours.   As mentioned in point 4. above, even during Day Hours, there are certain times like the Opening Hours that shows higher volatility that on some days, can exceed 1x ATR.

Responding to Stopped Trades
It is natural to feel angry or frustrated when we are stopped out from our Initial trades.   Here, you must be true to yourself and utilize your character edge.  As I don't know you and I am not you, I cannot define for you, your character edge.   You must figure this out for yourself, know yourself, and turn your innate and natural strengths into an Edge.   If you are lucky, you may discover this insight very early after a small number of trades.  If not, it could take years to figure out yourself through thousands of trades.  For me, it is closer to the latter.

For many traders, I believe seeing the Bigger Picture helps to deal with stopped trades.   For example, in the experiment reported here, I made 64 trades over a 2 week period, where there were 31 losses.   I am glad to say that I wasn't overly sad incurring these 31 losses.  If I had only made 1 trade, I know it is easy for me to feel upset when I have a loss.  If I bet too large an amount that exceeded my risk tolerance, I know it is easy for me to feel upset and angry when I have the big loss.   This is because we would incorrectly be looking at the trade as our last trade, which is of course not rational.   We learn trading because we want to be able to trade for the rest of our lives.  If each year we make 250 trades, and we trade for the next 20 years, we can expect to make 5,000 trades in our lifetime.  For many of you who are younger than me, you could expect to make 10,000 or more trades in your lifetime.   What is a single trade loss in that context?   Why experience the emotional roller-coaster, 5,000 times, when our Trade Plan requires us to expect 50% x 10,000 trades = 5,000 losses over our lifetime.  Stopped trades are good trades, because they are part of the necessary losses.  They are part of the broader Plan to make money.   This is where the various sayings come - "we must first give to receive".  "If we don't give, we can't receive".  "When you are ready to lose, you are on your way to winning".   "You cannot win if you haven't yet learnt how to lose".  And so on.

In short, be happy when we are stopped out per our individual Trade Plan.  This is a good and necessary loss.  Ideally, we should give thanks when we are stopped out.  When our losses are kept to 1R, and the win lose ratio is consistent with our broader Objectives and 250 Trade/Year Trading Plan, then, there is no need to feel overly upset, so much so that it adversely affects our future trading goals or spillover into other aspects of our lives.   Of course, if it's much bigger than 1R, or we have losses far beyond any reasonable parameters of our Trading Plan, then, we should take some time off and reevaluate our entire approach.

Experimental System - Analyzing Trading Results

Below are the trading results of my experimental OTM Options which I started 2 weeks ago, from 11 March to 25 March inclusive (10 trading days).

Market Review
The market was choppy the past 10 days, and traded sideways (with potential downtrend).  Market was higher the day I started on 11 March, than when I ended on 25 March.

I am glad I am not a typical investor who monitor the market daily (an oxymoron) - it would be an emotional roller-coaster experience.

Highly Active Short Term Trading
Below show the results for the experimental system only, not all of my trading systems.  The experimental system is a highly active.  It is a short term trading system which utilizes OTM options, which I do not recommend anyone blindly following for these reasons:
- vast majority of active traders lose money. 
- vast majority of short term trading loses money. 
- vast majority of Options trader loses money.
- vast majority of OTM (Out-The-Money) expires worthless and loses money.
When you combine these 4 attributes - odds are very good that you will lose money.
To make money, your Edges must be greater than these, so that it is large enough to offset all of these disadvantages.

Definition of a "Trade"
Overall, 64 "trades" over 10 trading days.   63 out of 64 are Options on underlying stocks.  I actually traded options on 37 unique underlying stocks, but for some stocks, I traded more than 1 option instrument.   There are 64 unique instruments (63 options + 1 JCP stock) altogether.   In more detail, some instruments has one Buy and one Sell activity.  Other instruments have several Buy or several Sell activities.  For analysis, I have defined a "trade" as the profit/loss result by unique instruments, and not activities (since some instrument may have 2 buy activities but 4 sell activities, or some other combination).

Individual Trade Results
Two sets of results, sorted by $ Profit/Loss, and sorted by R-multiples.

Analyzing Losses First
1.  Biggest $ loss is $993, for MMM Apr $165 Call where I lost 22% of the Option Premium.
2. Biggest R-multiple or % loss is -101%, for AMZN Apr $387.5 Call as I short sell this and the loss is 101% of the Option premiums I receive.
3. 31 out of 64 trades are losses.
4. Total losses =$9,445.

Analyzing Winners
1. Largest $ winner is $2,539, for MRK Apr $57.5 Call.
2. Largest R-multiple or % winner is 109%, for IBM Apr $160 Call.
3. 33 out of 64 trades are winners.
4. Total winners = $14,552.

Analyzing Net Result
1. Net Result = $14,552 - $9,445 = $5,107.   By nature, Net Result is always smaller than total absolute winners and losers.
2. Max Loss = $9,445 / $5,107 = 1.85 times.  This means that to earn $5k, I must be willing to suffer a maximum losing streak of $10k first.
3. Max Profit = $14,552 / $5,107 = 2.85 times.   This means that to earn $5k, I must be willing to let a maximum winning streak of $15k turn into $5k.

Analyzing Trade Results using Van Tharp Principles
If you have been following Van Tharp, you may understand the terminologies below.  If not, buy his books - they are highly recommended for the very experienced trader seeking to improve his trading results.

Analysis by R-multiples (RHS column)

1. The SQN100 score = 1.44.   A normal interpretation is that this is a "Below Average" trading system.  It is not even a Fair trading system for professional traders.

2. The main reason why my R-multiple result is poor is because I misread the Big Picture.  I held on to most of my trades for too long, that a Big Down day on 25 March took out most of my worst case scenario stops.  In fact, over the same 10 trading day period, the market was negative.  And some, I had to manually scramble to get out on 25 March morning, as my mental stops were hit.   The carnage on 25 March was quite bad.   At the peak, I had over $15k profit during that week, but manage to scramble out with $5k profit.

3. The error is what Mark McDowell from Van Tharp Institute captures very accurately here - The S&P500 charts were already screaming "sideways" market since end 2014.  Adam was already expecting 2015 to be a sideways consolidation market, as 2013 and 2014 was excellent years.   I was long from Buy the Dip in nearly all my positions (except for say less than 10%), and missed this sideways picture, and held on too long and did not profit take much earlier.   It is clear that the market will be moving sideways with upward bias, so, my trading strategy should reflect that perhaps selling 80% on strength, and only keeping 20% on trailing stops - had I done that to reflect the Big Picture, then, my SQN would have easily been 3 or more (a good system), instead of 1.44-1.46 (Below Average).  I had a very good system, but a single episode of mis-reading the Big Picture had turned a Good System into a Below Average System.   Trading Edges are small and very fine - one small mistake is enough to make massive differences.

4. Could I have avoided this mistake?  Today, I have started to Buy the Dip again (but small % capital).  My belief is that the Bull Market is still intact, but we could experience a more severe correction (retesting 200-day MA like in October 2014), or go into sideways consolidation mode over the next 2-8 weeks.   Either way, the possibility of making a higher high in SPY appears in the minority - if I have to put in 3 possible outcomes over the next 2-8 weeks:
- 20% chance we make a new high
- 50% chance we stay in a sideways consolidation/trading range.
- 30% chance we retest the 200-day Moving Average.
If my Big Picture remains the same, then, the right selling strategy for my style must be to sell at least 80% or more on strength, since I feel there is only 20% chance of making a new high over my trading timeframe (less than 1 month).

This is what Mark McDowell says in that article - your Trading System must reflect your Big Picture of where the market has been and likely to do over the next 2-8 weeks (for my trading system). 

Other Things That Went Right

1. This experiment benefited from "Hard Stop" in some instances.
An example is IWM on 25 March where I was stopped out entirely from the extended IWM move at the Open, protecting either my large positions or profits.  Prior to this experiment, my tendency was to use Mental Stops than Hard Stops, and mental stops would most likely be worse.  As the trade moves more in our way, we should be happy to be "unnecessarily" stopped out as short term traders.  We never want to over-stay.  The short term Trader's goal is to sell most/all at Resistance (except if it shoots up, which doesn't look likely here).
Unfortunately, I only applied this to some positions, not all.

2. This experiment benefited from hardcoding entries and exits based on rules for 1 contract.
- I would have missed many entries if I didn't hardcode the conditions to trigger the entry using 1 contract.
- I would have missed many exits, if I didn't hardcode the conditions to trigger the exits using 1 contract.

3. Pyramiding reduces loss.
- E.g. LL trade - it was a loser from the start.  I risked nearly $400 and didn't add anymore.  The loss is 83%, but in $ terms, it was only $317, which is typical of Average Loss Size of $300.  When a catastrophe happens and we just lose Average Loss, it is an extremely good result.

4. Pyramiding cannot completely avoid larger loss.
- E.g. MMM trade losing over $900.   This happened because the trade was a winner initially and I pyramid up.  And suddenly turned into a loser.   This is unavoidable, but still acceptable as it is only $900+ loss and not several thousands.

5. Pyramiding enable outsize winners.
- E.g. MRK - this position had 4 bullets, buying at $0.55 ($0.4k), $0.95 ($0.8k), $1.11 ($1.3k) and $1.21. ($0.2k)  The exits are $1.50, $1.56, $1.68, $2.09, $2.14.   It generated $2.5k profits, the largest profit.   I am extremely lucky to catch this move, which I could not predict in advance when I first entered at $0.55.   This trade took 2 weeks, with the first bullet entry on 11 March, and the last exit was 25 March.  However, the bulk of my buys were in the 3rd bullet at $1.11, which was more than twice my first bullet of $0.55.

6. More stable Position Sizing.  
- In the past, I didn't have a consistent strategy for position size, fluctuating from very small to very large positions.  In these 64 trades, I kept my position size close to my Positing Sizing rules.
- My rule is quite basic.  The rules for this experiment (which I plan to fine-tune) is as follows:
a. No more than $3k-$4k purchase  per Instrument.  
b. If catch bottom at Strong Support, limit the size of the first buy to no more than $300-$600 (10%-20%).  
c. Only add as the move goes my way.  Last resort is EMA20>EMA40 at various time-frames.
d. Pyramid up can be bigger if Daily Trend is rising.  If Daily trend is falling, limit the buys to half.

7. Possible Improvements to Position Sizing.
- If the Daily Trend is rising (and nearest strong Resistance is still quite far away), then, can add up to 4 times.  If Daily Trend is still falling (and nearest Resistance is quite near), reduce the number of pyramid up.  It is okay to have a smaller position when Resistance is nearer.  Better is not to enter if the RRR is less than 1.5 times.   My overall RRR of 1.5 times is also because of late entries - e.g. the last bullet in MRK at $1.21 does not have an RRR of at least 1.5 times, but just 0.5 times perhaps ... 

6. Appreciating more RRR > 2 at Entry and balancing against Pyramiding.
- Van Tharp and Adam stressed the importance of making sure that initial entry should have RRR of at least 3 or at least 2 times.
- It gets very difficult to pyramid up to 4 times, and still have RRR of at least 1.5 times.
- Perhaps the solution is to limit it to 3 times, with 30%/40%/30% or 30%/50%/20%, with RRR of at least 1.5 times at the last bullet.  

7. Short cut to quickly assess Risks.
- In trading OTM Options, on 11 March, I thought the entire premium is a quick and easy way to approximate risks, since it is my maximum loss scenario.
- The Average loss of $300 vs a full position of $3000 showed that it is very conservative.
- I did not compare against trades where I got stopped out before the trade went right, because I knew my bullet was small and so, I try not to micromanage, but looked out for other trades that went right.  Basically, I just ignored my quick losers, as they had built-in stops, as I wanted to keep finding winners to add.  I also wanted to pay attention to trades that showed extreme profit or extreme loss sizes, to better manage these.
- It seems, there is room to increase the risks on the Average Trade Size, given I planned to risk $3,000 per trade on average.  I may embark on this later once I get more trade results.

8. Be more careful to FAST rise or big volatility days.
- Exit larger percentages to reduce volatility.   Tighten stops on most percentages.   Set 1 contract alerts if necessary.  Keep it simple as you have many instruments.

9. Be ready to roll down the Strikes if the Stock doesn't look like it will rise, or even better, Buy the Bull Call Spread instead.
- If too far out of the money, the Time-Value can fall extremely fast when the stock does nothing.  Examples are the PEP trades where I had to cut loss, as my Strikes are too far OTM and losing money rapidly when PEP didn't move - I rolled down the $100 and $97.5 Strikes down to $95 to avoid further damage, and the $95 strike made money as the $100 strike keep losing money.  A Bull Call Spread to buy the $95 strike and Sell the $100 strike would have been the perfect strategy for Range Trading, instead of Buying the $100 strike.   Chalk the $370 and $248 losses as "Tuition Fees".

10.  With $1/contract commission, each contract costs $0.01.  Hence, try to avoid contracts priced less than $0.20 as commissions is 5% or more, unless it is a "sure thing" (which occurs very rarely).

11. Choose Time to Expiry carefully on Option selection.  First priority is careful assessment on the underlying, what you think it will do and how long it would take.  In general, naked contracts should have at least 1-2 month to expiry, if the move will take around 1-3 weeks.   If the time to expiry is less than a month, trade Spreads to minimize Theta Decay, or go to a longer contract if still "responsive" and "liquid" enough.  Sometimes, better to avoid trading if market doesn't give you the right feel.

12. Choose the Strikes carefully on Option selection.  Sometimes, you just have to pick the nearest OTM strikes to be safer at the start, since majority of the moves tend to be small and only extremely few reach targets.  Sometimes, you trade spreads where the first leg may be ITM so have balanced / minimal Theta Decay.  Sometimes, Theta Decay can be minimized by a combination of naked calls, Bull Call spread and selling Puts to have higher Delta and Gamma compared to a pure Bull Call spread.  The choice must be inflexibly flexible depending on the circumstance, and you need to continue experimenting and journal the results.   Also, you must be inflexibly flexible to quickly roll up or roll down the expiries.   Hence, avoid anything less than 50 cents as the costs of rolling up and down can quickly add up.  Ideally, you want to avoid doing anything like this.

13. Portfolio Heat - do not exceed 5% normally, max is 10%-15% capital.
Steve Burns is conservative - he rarely exceed 5% capital.   Alexander Elder states that if you lose 6% capital in a month, you should stop trading for the month.   Adam on the other hand has up to 10 open trades, each risking 2%, suggesting that he could have portfolio heats of up to 20% capital.  LWP limit is 20%.  Adam's forex friend makes 10% capital risk trades, and don't mind losing 50% capital.  I think, be happy with 5% limit, and be extremely careful to exceed 5%.  Sometimes we think the day is bottomed, and we have full 5% at risk.  But subsequent days showed new clear bottoms.   We should be careful and plan accordingly since we are already wrong.  But on the new bottom days, there are legitimate buys and we may increase to 7.5% or 10% capital.  But the absolute limit must be 15% capital at risk.   Actual loss are likely to be much less as we can still exercise stop loss.   In the best case scenario, 5% at risk could turn to 10% gain if markets does what you think, and 10% gain in a month exceeds your monthly targets, so, we never want to be too greedy, but aim for consistent results, month after month.

14. Never forget the Big Picture.
The Big Picture drives the Strategy, whether Bull Market, Range Trading or the start of the Bear Market.   It impacts directly Profit Taking and Exits.  In a Bull Market, we try to minimize Profit Take to perhaps only 20% to buy insurance and the rest on trail stops as the odds are higher than it'll make higher lows.   In Range Trading, we switch to 80% profit take, as the odds of Resistance is very strong.   In the transition to bear markets, we exit 100% on strength for long positions and look for Shorts.   Blindly forcing the same exits on different market types does NOT make sense.   This is what Mark McDowell says in his article above.   Similarly to exits above, all entry and all position size/pyramiding strategies must be flexible and be consistent with your Big Picture assessment first.

15. Take Profits when Returns > 100% is viable, as it is still more than 3-to-1
I need to find my own middle ground - in the past, I'd taken it too soon, I then swing to the other way and not take them, I then swing back and I think I'm getting a better feel - the key is the Big Picture, and be inflexibly flexible to be consistent with the Big Picture.   In short term trading, another Big Picture is that the stock don't zoom up or down in a straight line.  Hence, tilt more towards big profit taking when you have the chance for big profits.  If get more than 100% returns, take most of it.   The odds of having 50% loss from above is small - only 3 out of 31 losses are more than 50% loss.   The average loss size is only 30% for the 31 losses, so, taking 80% profits at 100% gains is more than 3 to 1 already.

16. Consider setting a limit like $1,000 to take more profits
Many of the winners had more than $1k unrealized gains, some nearly $2k before they fell back below $1k.   GOOGL, IWM, QQQ, MSFT, and a few others.  25 March took away much of it.
As your position size is not constant, you are not able to define the absolute $ limit - in short term trading, you must know and be ready.   It is not always going to be $1k, as it depends on the position size, which you are changing.  Know your numbers constantly.

17. Beware in all your analysis, that the results above are only in respect of 10 trading days when the market did what you showed above.  If the Big Picture market performance is different, it is possible to get a very different set of results.

Trading Facts and Beliefs

Here are some of my trading facts and current beliefs.  I didn't include many detailed beliefs, as there are far too many.  Even without the detailed beliefs, I know I missed many, so, I may add over time.  My beliefs will change over time.  It is very likely that you will hold different beliefs.

The figures in brackets marks my personal view on the strength of the belief.  10 = Fact.  7-9 = Strong Belief.  4-6 = Moderate Belief.  1-3 = Weak Belief.

#1 (10). All trading are probabilities.  There are no certainties in trading or Technical Analysis (TA).  This applies to all trading systems.

#2 (10). No one can predict the markets accurately all the time (lacks predictability).  No one knows what future prices will be, even insiders.  No one knows if a trade entered today will be profitable in a week's time. 

#3 (10). Markets are dynamic because the participants are intelligent and strongly motivated to make money.  The "smart monies" learn and adapt very fast.  If there is a pattern that starts to consistently works (e.g. if price falls whenever indicator does X), then, the smart monies start selling even before X appears, and their selling actions will cause prices to fall, even before X appears, rendering the indicator ineffective.  After a period of neglect, one day, indicator X will start to work again.   And so forth.

#4 (10). Markets can do anything.  When majority expects it to go one direction, it can go the other way.  When majority expects it to be volatile, it can stay quiet, and vice versa.

#5 (10). If it moves, markets can only go up or down.  It is possible to get 10 wins in a row due to randomness.  Don't confuse a small winning streak with skill.  

#6 (10). To trade in this environment long term without an edge is foolish.   All successful traders know their edges.   If you don't know your edge, you are the patzer and you will lose money long term.  As a rough rule of thumb, edges typically takes at least 30-100 trades to come through.

#7 (10). Edges are not certainties - see Rule 1.  Edges only tilts the odds to the trader's favour, either improving win rate, or increase win size, or both.

#8 (9-10). TA assumes Price is the only reality and that Price discounts all information, including all fundamental, business, insider and every other information. 

#9 (7). Other things equal, TA works better when there is a larger number of participants (higher volume, higher liquidity).  However, Rules #1, #2, #3 and #4 supercedes this rule.

#10 (9).  Majority loses majority of the time.  A small minority consistently takes all the winnings.

#11 (9-10). Because of rules #1, #2, #3, #4, the only way to win the trading game over the long term is to trade like a casino or the insurance company - the house, not the player, the insurer, not the policyholder.  The casino and the insurer always has the edge.  The casino and the insurer doesn't care who wins, or if the current trade is a win or a loss.   The casino and the insurer knows that after a large number of trades, it will win.

#12 (10). If the trader expects to make 20 trades a month, and has a trading system with 60% win rate, 40% lose rate, then he expects 40% x 20 x 12 = 96 losses.   In this case, the Trader better get used to losing nearly 100 trades a year.   Most new traders cannot stand losing so many trades and gives up.

#13 (9-10). In #12, the Trader's only choice is not how to avoid these losses - that is impossible and inevitable.  The Trader's only choice is how much he wants to lose.   How much to lose is under the Trader's control.

#14 (9-10). All big losses starts with small losses first.   The professional trader keeps his losses to 1R.

#15 (9-10). All big losses are position size mistakes (those that ruins capital).

#16 (9-10). Because of #1, #2, #3 and #4, all "too big" trades are gambles, not professional trading.   Not all gambles are losses - but over the long term, repeated gambling leads to losses and ruin.

#17 (10). Smart casinos limit the table size to a maximum size relative to their capital, because they are a business.  They are not gamblers.

#18 (10). Prudent insurance companies limit their risks that they accept (relative to their capital), because they are a business.   If they accept bigger sizes, they will reinsure away some of the risk outside their tolerance.  They are not gamblers.

#19 (9). Trade outcomes are not always what they appear - rule #4 comes into mind.   A trade can appear losing, but end up winning, and vice versa.

#20 (7-10). In a trend, a losing trade is more likely to lose more.  Rules #1, #2, #3 and #4 supercedes.

#21 (7). In an uptrending/sideways trading range buy at bounce from Strong Support, a temporarily dip to above Support is more likely to be a winner.  Rules #1, #2, #3 and #4 supercedes.

#22 (10). No one can consistently and accurately predict in advance if a trend or a trading range will continue or reverse.  This is part of #2.

#23 (10).  The professional trader always trade with a Trade Plan.  The Trade Plan specifies in advance his entry points, support, stops, resistance, targets, risk, reward, $ risk per trade, position size.  He knows where to exit before he even enters the trade.  After the trade, he journals and compares the outcome with his Plan and Trading rules.   The amateur relies on hope.

#24 (10).  The professional trader follows his trading rules on Position Sizing and keeps his greed in check.   The amateur who gambles big has lost the trade even before he enters, as his greed overrides him. 

#25 (10).  The professional trader follows his trading rules on Exits, and keeps his fear in check.   The amateur who gambles big is more likely to lose big when price turns, as he will not be able to control his fear at the break-point.

#26 (10).  The professional trader follows his trading rules on Entries, and keeps both his greed and fear in check.  The amateur who doesn't have entry rules is always confused, vascillating between greed and fear.

#27 (10).  The professional trader knows that there are many successful trading system, and Adam's methods is only a tiny drop in a vast ocean of successful systems.   But all these systems trades the same markets, and so, these rules apply to all successful trading systems.

#28 (10).  A trade without a Trade Plan is a mistake, even before the trade is entered, and regardless of trade outcome.   For the amateur, a trade without a written Trade Plan is a mistake.   Trade long enough without trade plans, and it will eventually lead to long term losses or ruin.

#29 (10).  The professional trader makes a lot of money with 100 losses a year, because these losses are planned, limited to 1R and necessary business losses.   The amateur loses a lot of money with 10 losses a year, because these losses are unplanned and unnecessary losses.   If you can't tell which is necessary loss and which is unnecessary loss, stop trading with real monies, and learn how to construct a Trade Plan.  Re-read all the rules above.

#30 (10).  Trends are a minority, but when they occur, sometimes, they can last a lot longer than you can stay solvent.

#31 (7-9).  The Golden Rule of Trading is Cut your Losses short, let your Profits run. (this assumes a 50/50 win/lose rate;  If the win rate is high enough, it doesn't apply).

#32 (7-9).  Never take a trade unless RRR > 3.  If you must, make sure it is at least 2 times.  When you're in a trade, make sure the RRR is at least 1 times.   No reason to stay in a trade, if the RRR < 1.   For Swing Trading, it is acceptable to exit mostly/completely when RRR > 2.

#33 (7-9).  When evaluating Risk (= Entry Price - Stops), evaluate carefully presence of Strong Supports.   Know how supports alters lose rates.

#34 (7-9).  When evaluating Reward (=Target Price - Entry Price), evaluate carefully presence of Strong Resistances.  Know how resistance alters win rates.

#35 (7-9).  When evaluating Win / Lose rates, evaluate carefully momentum, especially broader trend, current momentum and short term momentum.   In addition to S+R above, consider chart patterns and market psychology.  Consider candlesticks patterns and market psychology.  Consider tandem stocks, sector and general market drivers.

#36 (7-9).  Know the Big Picture, the market drivers and catalysts, whether Risk is "On" or "Off" in extremes.  This means understanding everything about the market, from US vs International stocks, Large caps vs Small caps, Stocks vs Treasuries, Treasuries vs TIPs for inflationary expectations, Treasuries vs Junk Bonds, Currencies, Consumer Staples vs Discretionaries, Commodities vs Stocks, Volatility/Quiet, etc.  Know Rule #3.  Note catalysts in Trade Plan.

#37 (9). Markets are fairly efficient majority of the times, especially when times are calm.   It gives you high Rewards with a low win rate.   It gives you high Losses in a similarly low loss rate.  It gives you smaller Rewards with a higher win rate, but it also gives you small Losses with an equally high loss rates. 

#38 (10).  Markets becomes inefficient when there is extreme fear, either during times of panic or euphoria.  The amateur joins the crowd, letting emotions control his actions.  The professional trader trades independently, his trading rules control his emotions and governs his actions.

#39 (9).  Always be inflexibly flexible.  The professional trader knows why it is important to follow the rules, and follows them the vast majority of the time.  He also knows when it doesn't apply in the minority of the times, and breaks them.  Agak-agak (being approximately right) is much more important than precision (especially precisely wrong).

#40 (10).  The Trader alone is responsible for his own results.  Blaming markets, manipulators, spouse, friends, or any other person other than themselves misses the point. 

#41 (7).  Everyone gets what they want from markets, even losses.

#42 (10).  Much of successful trading is invisible and unseen.  The order execution is only 0.1% and easiest to learn. 

#43 (9-10). Long term successful trading is a business and a profession, just like any other business and profession.  A business and a profession like engineer, doctor, actuary is not a hobby.  Those who attempt to engage trading as a hobby is more likely to lose monies over the long term.  Business makes monies.  Hobby costs monies.  Businesses made monies off hobbyist.  (some serious hobbyist do make money - their "hobby" is actually their primary profession).

#44 (10).  You do not become a top professional from attending a few days seminar like Wealth Investors Academy, or reading a workbook.  It takes 10,000 hours of good quality study and practice to be a top professional in any profession.  Only a small minority wins - see Rule #10.

#45 (9-10). You can only trade your beliefs about the market.  There are as many different beliefs as there are unique individuals.  Decide which beliefs are useful to you and adopt.  Discard the useless beliefs or beliefs that doesn't suit you.  Keep refining and simplify your beliefs.  Know yourself.

#46 (7).  One belief is that when markets cannot make a new high, the path of least resistance is down, but you won't know in advance how far it will go.  When it can't make a new low, the path of least resistance is up.  

#47 (9). Trading mistakes are costly.  It is a fine line between a profitable system, and a losing system.  Edges are small and mistakes can turn a winning system into a losing system.  Markets are dynamic, mostly efficient and seek to eliminate the vast majority of edges over time.   The biggest weakness of any trading system is the trader himself.

#48 (9). There are as many objectives as there are traders.  Your objective must fit who you are.  Not necessarily what you want, but what you can commit to.   Higher objectives require higher commitments.  Trading Objective is not just a number by year end.   A large objective like that needs to be broken down into mini-objectives under the Trader's control.  At the end of the year, the Trader still need to let go of the result.

#49 (10).  Good entries and exits alone does not ensure that you meet objectives. 

#50 (10).  % return earned on a stock doesn't ensure that you meet objectives.   Always think in R-multiples.   Earning 2% on a stock and gaining +2R brings you closer to your objective than earning 20% on a stock and earning 0.5R.   The latter will take you 4 times longer than the first case.

#51 (10).  For systems like Adam's, you meet objectives through Position Sizing and number of Trades.   Your system and position sizing defines the performance parameters of your system including winning/losing streaks, drawdowns, volatility, besides expected returns.   If you don't know what is normal performance parameters, you are more likely to abandon a good trading system / make unnecessary adjustments.

#52 (9-10).  Strongly connect your objectives with your life mission.

#53 (9-10).  No single system works well in all market types (bull, bear, range, volatile, quiet).  However, systems can work like Holy Grail in pre-defined / single market types.  

#54 (9-10).  To trade for a living over one's lifetime, one must be able to trade multiple, uncorrelated systems, that takes advantage of the changing nature of markets during Bull, Sideways and Bear markets, and during Quiet, Normal and Volatile markets.

#55 (7-9).  A small win is better than no win.   A scratch (no wins) is better than a loss.   (10) A small loss is always better than a big loss. 

#56 (10).  Markets always provide you with Opportunities.  If the Market has just turned from Bull to Bear stopping you out, and you didn't manage to short, just be patient, because it will then eventually provide you with the opportunity to Buy the Dip based on the bounce for example.   If that was not a good enough RRR and you pass that, then, Market will eventually provide you with another Opportunity to Sell the Rally. All good things take time.  And Market ALWAYS provide you with the opportunity.  If not the current instrument, there is ALWAYS another instrument somewhere else.  There is NEVER a need to "force" a trade.

Quadruple Witching, AAPL, Positive Expectancy Idea?

Last Friday (20 March) was Quadruple Witching Day.  Quad Witch happens on the 3rd Friday of every March, June, September and December.  This date is important because this is the day when Index Options, Index Futures, Single Stock Options and Single Stock Futures all expires on the same day.  On this day, volatility can be expected to be higher than normal.

On this day, AAPL (along with many other optionable stocks) experienced substantial increase in volatility, as follows:

Note that 45 minutes before closing, AAPL was trading above $128, following a short term uptrend a few days prior. 
- Last 15 minutes to closing, AAPL dropped like a brick, and closed $125.90 with 13 million shares trade. 
- Next 15 minutes After Hours, 14 million shares were traded and it bounced back all the way up. 
- Then, volume dropped dramatically after hours, and prices were made to hover around $126.4-$126.6.

What happened?

The coincidence with Quadruple Witching is too great to ignore.  My personal belief (no proof, just trails left by the manipulators from price action, volume and open interest) is manipulation.  AAPL dropped more than $2, who would gain?  From stock perspective, heavy selling 13 million shares and heavy buckback of 14 million shares suggest very little price difference in the underlying stocks, perhaps less than 50 cents difference.

For a start, we note:

1. A $2 fall in closing price (from above $128 down to below $126) makes a massive difference in the value of all the ITM APPL calls.   The number of Open Interest of all ITM Calls is massive, and I believe is very similar in size to 130,000 contracts (equivalent to 13 million shares).   Even if the manipulators lost 50 cents in the stock market, they would gain $2 in the Options market in this segment alone.  

2. In addition to the gain from the ITM calls sold, there are 3 specific Call Contracts that would expire worthless - the $128, $127 and $126 strikes, since AAPL managed to close just 10 cents below $126.  Total Open Interest is sizeable, around 78,000 contracts at the start of the day.   In just 1 day, volume traded = 132,000 contracts (equivalent to 13.2 million shares).   Again, the Call Options Seller has a financial interest to see the price drop like a brick.

3. Don't just look at the Calls, consider the Puts too.   Puts trading volume tend to be smaller than Calls when the stock has been rising for months.   This is reflected in the smaller Open Interest.   However, look at the massive Put Volume from just 1 day at the $128, $127 and $126 strike that would benefit from the underlying manipulation - the total volume there is 113,000 contracts (equivalent to $11.3 million shares).   These Puts would normally be worth almost nothing in the quiet noon, but suddenly in the last 45 minutes, would have had a massive explosion in value at the close.   The $128 strike with the largest volume of 56,000 contract is worth at least $2 extra, from a few cents - these are very likely high 3 digit or 4 digit absolute % returns within 1 hour.

Of course, I have no proof of manipulation.  All I have is just the trail of stock prices, option prices, stock volume and Put/Call Option volume and Open Interest.

Do you think AAPL stock price action 15 minutes before and after closing was a coincidence?

Future Lottery Idea?

Is it possible to take advantage of Quadruple Witching?  Could you design a positive expectancy trade from this?

Consider the $128 Put.  It was probably worth a few cents a couple of days ago when the stock ran up to nearly $129.  You might not want to buy all OTM puts with 1 day expiry, but perhaps you could filter it with volume, to follow the smart money - at that may point to $128, $127 strikes, which would look like it would expire worthless a few hours prior to closing.   The win rate may only be very low, possibly 10%, but if you only do this during Quad Witch days, and follow the "smart money", could you have a positive expectancy system?   For example, at $0.10, each contract is only worth $10 - you could speculate using $100 and the payoff may be in thousands $.  In this situation, what is losing 2 to 4 trades of $100 each, if one win nets you $1,000 or more?  

It would be a bit like buying lottery tickets - most would expire worthless, except here, instead of negative expectancy from lottery tickets, you may actually get positive expectancies.

Think about it ... why play lotteries when you can play the OTM options once a quarter with positive expectancy? *smile*

Designing Trade Plan with Positive Expectancy

Van Tharp likes to say that one of the primary jobs of a trader is to find and trade "low risk ideas" or find trades with "high R-multiples".   It may be phrased in different ways, but the central concept from all these various explanations is that your job as an independent trader is to find and design trades with Positive Expectancy.

What is Positive Expectancy?
This is a important concept that all Van Tharp students knows by heart and second nature.  They no longer thinks about it consciously.  Every trade is assessed against this Positive Expectancy framework during the Trade Planning process. 

"Expectancy" refers to the Expectancy Per Trade, which is simply calculated as follows:

Expectancy = Win % x Win Size + Lose % x Lose Size, where:

1. Win % = expected win rate over a number of trades.   For example, if you are able to find 10 similar trades and win 6 times, lose 4 times, then, your Win% = 60% and your Lose% = 40%.

2. Win Size = this is the win size expressed as R-multiples.   For example, if the Reward per trade = 2R, then, Win Size = 2R.

3. Lose% = 1 - Win%.

4. Lose Size = expected lose size, which is usually 1R.   1R is basically how much $$$ you plan to lose in that 1 trade, if losses were to occur.

Note that these are simple statistical concepts.  The critical underlying belief is that trading has uncertain outcomes.  No one knows (not even Adam) how a trade taken today will turn out in the future.  If you don't accept this belief, then, it is unlikely that you'll be able to trade Adam's (and pretty much every other trading coach) methods over the long term.  All reasonable coaches will tell you that trading is always about PROBABILITY and never certainty.

Once you've accepted that trading is about probabilities, then, every trade that you plan should consider the Win % and Lose %.   Initially, you may not have an idea on how to assess Win %, but over time, with more experience and practice, you will be able to have a reasonably good guess.

A simple yardstick is this. 

1. Assuming a random Entry Price, where the Profit Target is equal distance away from the Stop Price, then, the Win % should be roughly equal to the Lose %, since both are equally far away and random.  Here, the Win % can be roughly 50%, and Lose % roughly 50% also.

2. The Win % is a function of many things, one of which is the relative distance from the Entry Price to Profit Target vs Stop Price.   Imagine if the Profit Target is $10 away, but the Stop Price is only $0.01 away.   The odds of hitting the Stop Price, even if it is buying on the strongest Uptrend with strongest Support is near certainty. 

This has important implications.  If your Entry Price was truly random, and you have a Profit Target of 2R and risking 1R, then, your Win% can drop to below 50%.   In a truly random situation, the Win % may only be 33%, and the Lose % twice that since the Reward distance is also double the Risk distance.

3. In real life trading, price movements may appear random, but is not truly random all the time.   There are concepts like momentum.   Momentum tends to drive prices in the same direction than against it.  So, if you take the entry with the momentum, odds of achieving the Profit Target tend to be better than 50% even if the distances are the same.    Not every trade has the same momentum strength - and differentiating one from another is a lifelong learning journey of studying tens of thousands of different charts.

4. Prices also tend to behave in a non-random fashion near Support & Resistance, but not always.   If there is very Strong Support nearby with a confluence of strong supports, then, it is less likely for price to be able to successfully penetrate that strong Support Zone.  Conversely, a stock making new high in the early stages of a bull market can run very, very far, as there are no prior resistance.   So, the presence or absence of Support and Resistance can alter the Win %.  Again, learning and differentiating various Support and Resistance and combining that with Momentum to assess win rates can be a very interesting lifelong learning journey.

5. One of the best ways to learn is to make as many practice trades as possible in your Demo accounts, using methods taught by your coach such as Adam, and sharing / discussing the specific trades in a group setting with others for different perspectives.   If your entries follows the setups identified here, then, you can develop experience to assess win % for various RRR.  

The Relationship between Win % and RRR

RRR = Reward to Risk Ratio = Reward / Risk.
Simplistically, if the Reward = 2R and the Risk = 1R, then, RRR = 2R / 1R = 2 times.

In a random trading system, there is a trade-off relationship between Win % and RRR.   A system that generates large RRR basically has a larger distance to Profit Target, compared to the Stop Loss.  As implied in point 2 above, the larger RRR tends to have a lower Win%, if the trading system was truly random.

Most new traders tend to favour large win %.   Actually, the easiest way to achieve a high win% is to constantly take profits when it appears, even if it's just a few cents.   You may achieve 99% win% with this strategy.  Unfortunately, when you have losses, a single loss can undo the work of 10 profitable trades or even more.   Many, many traders have tried this method on and off over the history of trading, and it is extremely difficult to grow one's equity over the long term using this method.  The exceptions are extremely few, done by full time professional scalpers with special equipments, special training, incredible discipline, lots of practice, mentoring, etc. and special commission rates that provides them with edges over 99.9% of the market participants.   HFT (High Frequency Trading) Traders are in this category, and one study I've seen is that they hardly ever lose at all.  But to you and me, we simply do not have this edge that the HFT traders have.

A low win % like 33% isn't necessarily a bad trading system.   If you study Van Tharp's books and materials and also study performance results of Trend Following traders, there are actually many Trend Followers with win rates around 35% but have equity growth that are very, very profitable over the long term.   This is because when they lose, they lose 1R, but when they win, they are in that winning trade for a very long time and the strong trend that they've found enable them to have RRR that is very large.  The average R-multiple is 3 times, and sometimes, they can have 5, 10 or even 20 R multiple outcomes.   This enables them to have a very decent trading system.   Financial markets are not truly random.   There are many studies that shows that trends tend to persist longer than what statistical models predicts.   Hence the typical saying that the "Trend can last longer than you can stay solvent".  Many of the famous bankruptcies like LTCM occurs because they failed to understand that financial markets are not random all the time, even if they appear random most of the time.  The 1% exception can deliver massive returns to the Trend Followers offsetting all the prior small losses.  This is especially so in the Commodity Futures, and also appear in single theme stocks.

The Trader's First Job is to Design Trades with Positive Expectancy

In general, if you can find trades with an Expectancy of 0.2R, 0.25R or higher, you should do very well if you utilized the right Position Sizing strategies.

For example, the various systems below with various win rates have very decent Positive Expectancies:

For example, with 50% win rate, and RRR of 1.5 times (called Win Lose Size Ratio or WLSR), the Expectancy of the Trade = 50% x 1.5R + 50% x (-1R) = 0.25R or 25%.

Similarly, if your win rate is lower at 40%, but your RRR = 2 times, then, you still have a fairly good trading system with an average Expectancy of 0.2R.

Conversely, if your RRR = 1, but your win rate is higher at 60%, then, your Trade Expectancy = 0.2R as well.

In short, your job as a Trader is to find Trades with Positive Expectancy, at least 0.2R to 0.25R or even higher.  

For example, using Entry Method #1 (called Buy the Dips), this type of trade tend to have good RRR if you bought the bounce off Support, since the Risk is just below Support and the Reward tends to be higher than the new High.   In addition, as you are trading with the broader trend, your win rate can be 50%.   In this case, you can afford to be safe and wait for a higher bounce off Support before jumping in, and still have RRR = 1.5 times.   With 50% win rate, your trade can have at least 0.25R.   So, Entry Method #1 is a system with Positive Expectancy.

Similarly for all the Entry Methods taught by Adam.   If you just follow these trades, you will have found trades with Positive Expectancy.

The Table Above are Minimums, your Trade Plan should aim higher

For example, in a 50% win rate situation, it is usually better to aim for RRR of 2 times or more.  Then, if you must take profits at 1.5R, then, you will still have a decent Trade Expectancy.   Trade Plans should have decent Margin of Safety.

The Difference between a Positive Expectancy Trade and a Zero Expectancy Trade is a fine one

Now, imagine you are using Entry Method #1, which is Buy the Dips.   Imagine that you only planned the Trade with RRR = 1.5 times instead of 2 times.   You entered the trade.   Half way through the trade, the stock paused, showing a "Harami" candlestick pattern.  Your gain is only 1R so far.  You are tempted to sell and lock in a sure 1R gain.   Should you always do this?

Granted, occasionally, you should if there are extremely good reasons.  However, in this case, the Harami candlestick pattern is not a very strong reversal signal.  This pattern requires confirmation first.   Also, you are still trading in the broader uptrend.  What happens if you always take profits earlier, instead of following the Trade Plan?

The following illustrates the situation if your RRR (or WLSR) is 2/3rd of the above.  

 

Note that the result of taking profits prematurely is that Expectancy has become negative, zero, or an extremely small amount.

In short, you the Trader, have just turned a great trading system, into a lousy system!  

If you trade the first table systems, you can grow your equity extremely well.  However, if you have a tendency to take profits too soon, you turn a good system into a mediocre / a losing system.   You may not be aware, but if you trade like this over the long term, you will not be able to consistently grow your equity.

The Trader's Second Job is to Trade the Plan

Once you have found a good trade, a trade with Positive Expectancy (like Buying the Dips), and you have planned the trade in terms of Entry Price, Support, Stop Price, Resistance, Target Price, and have assessed the win rate to be 50% with RRR = 2 times, you have a good Trade Plan in hand.

Your next job then is to Trade that Plan.  Try as best as you can to execute it faithfully.  If your stop is hit, accept the loss as pre-defined, and move on.   If it feels like it takes a long time to get to 1R, be patient, and let the trade unfold itself.   However, once the trade has earned a significant profit (like 1R), it is time to be diligent and not allow this profit to become a loss.  A trailing Stop to Entry Price, and subsequently revising it upwards to Pivot Lows may be one good way of allowing the Trade to reach its full potential / 2R and not be tempted to take profits prematurely.   Hence, the popular saying "Plan the Trade and Trade the Plan".

Other Thoughts
Trading is not so simple unfortunately.  Daily, in our existing trade positions, we are confronted with the temptation to take profits when it is there, before they disappear.

One common solution is to take partial profits.   Imagine if the position is up 1R, and you decide to take 50% off.   What do you have to do to make that trade produce an overall 1.5R winner?

The answer is that you now need to hang on to that trade even longer, until it reaches 2R.   This is so that 50% x 1R + 50%  x 2R = 100% x 1.5R or a 1.5R winner, as you planned.

In general, it is not always a good thing to take 50% profits off.  If you are unable to hold on to the winning position up to 1R, odds are even poorer that you will be able to hold the same position until it reaches 2R.   In other words, premature profit taking tend to begets even more premature selling, that effectively, you, the Trader have turned a great system into a losing system.   Hence the popular saying that "The biggest weakness in any Trading System is the Trader himself".

If you find yourself constantly in this situation, one way to overcome that is in the Trade Plan itself.  Look only for the strongest trade.   Know yourself.  Plan for the fact that even though you are targeting 1.5R, look only for trades with 2R, 3R or even 4R multiples, so that should you need to take profits early, your RRR is still quite decent with good expectancies.   Of course, it is better to also work on your tendency to profit take often, but self work is hard when it is built into our nature, and so, we try to find other easier ways to overcome it like the Trade Plan.   Hence, the importance of the Trade Plan, and Know Yourself.   Unfortunately, you cannot know yourself until you have taken hundreds of trades and journal them.  It's Catch 22.  

Conclusion

The Trader's First Job is to design and find trades with Positive Expectancy.   If the expectancy is negative, zero or extremely small, do not take the trade.  Throw it away, and look for a new idea.

If in doubt, assume a lower win rate in the Trade Plan.   This invariably leads to finding trades with high RRR.   The safe way is to look for trades with RRR of at least 3 times, or more, when the win rate is in doubt.

The Trade Plan is the most important arsenal in the professional Trader's tool kit.  It is what gives him the Edge over 99% of amateurs.  The Trade Plan forces the Trader to plan in advance, all possible outcomes.  It prepares the Trader mentally on how to act when losses occur, and what targets to aim for, when the trade moves his way.   It is a map that the Trader has drawn up in advance to guide him on his daily journey of monitoring his trades.   Yet, most amateurs still do not utilize the Trade Plan - they often do not know Risk vs Rewards before entering the trade.  Is it a wonder that their results are mediocre?

Hence Van Tharp's saying, that the Primary Job of the Trader is to design trades with high R-multiples.   When designing the Plan, know yourself.   The more you know yourself in terms of how you manage the trades on a real life day to day basis, the better it is for you to design plans that fits you.   As with all plans, you should build sufficient Safety Margins, so that if the expected and unexpected happens, you still have high odds of success.  The easiest way is to look for trades with very high R multiples, even if you cannot assess the win rate.

Designing Trade Plans does not have to be elaborate.  With repeated practice, Trade Plans can be constructed within 10 minutes, some even much faster.  Hence, do not engage in Intra-day Trading when you first start off trading.  Intra-day Trading tend to encourage the Trader to skip Trade Plans and do the wrong things.  Once the habit is ingrained, it is extremely hard to shake it off - it is always easier to learn trading the right way, than to unlearn old established habits.

And once you've designed your Trade Plan, the next job is to execute it unfailingly.  Imagine there is another side of you called the Executor.  This Executor's job is to simply execute the Trade Plan.  It doesn't question the Trade Plan.  It just does, and it doesn't care about the outcome of the Trade, except to follow the Trade Plan.   The trader who can automatically, effortlessly and happily execute the Trade Plan with discipline, and have designed a superior Trade Plan with Positive Expectancy is one (large) step ahead than the majority of the market participants.   He has an Edge in Trading.

In short, design trades with positive expectancy / plan the trade.  Then, Trade the Plan.

Good luck in planning your trades.

Typical Questions

Question:  I am surprised why you think 50% win rate is a good thing.   In the recent dip, I put in 10 trades without a Trade Plan, and the next day, 9 out of that 10 trades turned positive - don't I have a 90% win rate here that easily beats the professionals?

Answer:   The win rate above is not necessarily the number of trades that turned green the next day.  Green can be meaningless, if the gain the next day is only 1 or a few cents.  Odds are you can't sell the trade and be positive after deduction commissions & fees.

Rather it is the probability of the trade entered yesterday reaching the profit target, which may be $4 away, if your Risk is $2 away on the other side, assuming RRR of 2 times.   The further the distance to profit target, the more challenging it is to get a 50% win rate over many trades entered.

Imagine this extreme case where the trader is complacent.   Let say he got onto a good trade.  The trade is correct right from the start.  Over days, the unrealized gain is now $3.90, just 10 cent shy of $4 profit target.  He decides to hang on for that extra 10 cents.  But the extra 10 cent never happened.  Instead the trade turned south ... over days, it keeps going down.   The trader stares at the screen in disbelief.   He refused to sell at +1.5R.  He refused to sell at +1R, +0.5R.  0R, ....  Eventually, it hit his stop loss and he lost 1R.   Did this trader has a win or a loss?   The obvious answer is that he has a loss.  If this is the only trade he made, the win rate is zero and the lose rate 100%.  Therefore win rates doesn't care about the trajectory of the price.   All it cares about is whether the trade reaches the Profit Target (or closed at a profit) or the Stop Loss (and closed at a loss).   The Win Rate is a different concept than Win Size.  If the Trader closed the trade when the price falls to +1.5R, then, his win size is no longer +2R but +1.5R.  However, at +1.5R, he does have a Win and if this is the only trade he makes, then, his Win Rate = 1/1 = 100%.

Of course, in the example where the Trader didn't close the trade at a profit, the Trader has made numerous trading mistakes, but that is a different issue altogether.  The key point is that the win rate is not necessarily green trades the next day, but relative to profit targets and stop loss, which for the typical trader trading Adam's systems.  Typically, stop losses tend to get hit first, due to the nearer distance, and it could take days/weeks to reach the Profit Target. 


Best wishes,
SH

Entry Method #8: Special Bounce Strategy

Here, Strong Support is defined as 50, 100, 150 or 200-day SMA.
Conceptually, there is no reason why we cannot use Other very strong support as well (e.g. confluence of Fibonacci Supports with Horizontal Supports, etc.).
Supporting momentum indicators helps.  Broader trend momentum helps. 

Click here for Adam's 2 postings on this topic - Special Bounce Strategy and Examples of Special Bounce Setups.

Entry Method #7: Trading Divergences & Chart Patterns from Steve Burns

Trading Divergences

Divergence is a powerful concept in Technical Analysis.  Adam's workbook covers this topic from pages 122-127 inclusive.  A sample of the pages is shown below.

 



 

Whilst Adam's materials focuses on the indicators that he teach, in theory, the divergence concept can also be applied to other popular technical indicators.  Like other technical tools, the longer the divergence period or the clearer the divergence signal, the more powerful the signal in general.

In my April and May 2015 presentation to the WAI, I shared the trading results of a real life trader ("Yong Liang"), where one of his key systems is actually trading divergences.  You can review his trade results here in this posting - http://waiicpenang.blogspot.my/2015/05/waiic-slides-515-ideas-to-trades-real.html.  Go to page 8 of my slide.   During the period covered, he made 9 "divergence" trades, winning 5, losing 4, with a Net win of +3.6R.   As he risked approximately 2% capital, his portfolio gained over 7.2% capital alone from these 9 divergence trades.

In short, powerful stuff, and you don't need too many entry methods to grow your capital.  The key is to predefine your entry, stops, profit targets, risk the same % capital for every trade and control your portfolio heat.  Be disciplined.

Chart Patterns from Steve Burns
Once you understood the common principles of Adam's entry methods, you can extend the same underlying principles to other chart patterns.   Today, I saw Steve Burns tweet, and took this snapshot of the popular chart patterns that he tweeted out:

The "Rectangular Formation" is the same as Adam's Horizontal Breakout trade.
The "Inverse Head and Shoulders" is very similar to Adam's 1-2-3 Change in Trend.
These are more than enough patterns to generate 20 trades a month, either on Daily or on Hourly charts.   The key is not necessarily knowing more patterns, but know extremely well the few core ones so that you can quickly identify them whenever you look at a chart.  In time, anticipating various patterns will be 2nd nature to you.

Entry Method #6: Earnings Probability Game

Click here for Adam's original blog article on this technique.   Do click here for his excellent write-up in April, as well as expanding the original EPG from Zacks to include Dow stocks reporting Earnings on an Uptrend.  

More than just an Entry Method
IMHO, these 2 trading systems are complete, with long term positive expectancies.  

A complete Trading System with Entry, Exit and Position Size Rules
Over the years, I've seen many so called "trading systems" over the Internet, but they are really just "entry methods" or "indicators" - e.g. "Buy the Dip", or "1-2-3 Change in Trend" or "RSI2 indicator".   But EPG is more than just an Entry Method - it is a complete trading system that covers very specific Entry Rules, Exit Rules (on Stops and Profit Takes) and the Position Sizing rules.   It doesn't get better than this!   Make sure you fully understand what he has taught on these 3 rules first.

Positive Expectancy Systems
Without even looking at the results that Adam showed, just based on his trade criteria, we should be able to see that the system have positive expectancy.  We only go long on an uptrend which other things equal, typically improves our win rate to above 50%.   We consistently cut our losses to 1R, and let our winners to 2R or more, which ensures that our Win/Lose Size Ratio (WLSR) is greater than 1.   Furthermore, we tilt the win rate to our favour further, by employing Zacks Buy Rank and Zacks positive earnings surprise (ESP) with 70% Zacks claimed accuracy.   With a higher win rate and an RRR (Reward to Risk Ratio or WLSR) greater than 1, we can only have a positive expectancy system.   The Dow system may have a slightly lower win rate as it hasn't got the Zacks edge (but should still be positive expectancy).

Positive Long Term Results
IMHO, the key to get consistently positive trading results over the long term is to make sure that you adhere to these 4 things:

1. Always follow the Position Sizing rules - never deviate.   Decide in advance how much you want to risk per trade (whether 1% capital or 2% capital), and consistently apply this, even when you feel afraid or uncertain.   For example, if you are unsure, then, start smaller than normal, perhaps with 0.5% capital for every trade (if you previously traded 1% capital), regardless of trade outcome.   Do this consistently for every trade.   Only then, will you have the chance to get consistent results.   If not, you guarantee inconsistent results over the long term.   Worse, you might get unlucky to lose big when you decide to bet big, but win small when you decide to bet small.

2. Always follow the Entry rules - never deviate.   In particular always look for the Uptrend in the list of stocks given.  Only enter within 24 hours (nearer safer) of Earnings announcement and not prior, otherwise, your 1 ATR stop may be triggered unnecessarily - for "morning" announcements, enter the prior day, and for "afternoon" announcements, enter on the same day.

3. Always follow the Exit rules - never deviate.   Key in both Stop Loss and Profit Take orders.  Keep losses to 1R, Take Profits at 2R, and consider the 2-day Time Stop to free up capital for other trades.

4. Take as many valid trades as possible - don't stop with just 3 or 5 trades, aim for 100 trades.

Note that these 4 principles are the same exact success principles that TOMIC and TOMC adheres to constantly every day.

Don't give up too soon, commit to making 30, 40 or even 100 trades!
There is no positive long term results for you, if you don't take action and commit to making many trades like 30, 40 or even 100 trades.   I understand there may be some of you who have tried EPG before, but stopped.

As Adam explained in the April article, we cannot predict whether losses or profits will occur first.   In the example given, depending on when you start the EPG system, you might be lucky and experience winning streaks first.   Conversely, you might be unlucky and suffer a series of losses first.

If the latter applied to you, then, don't give up, but commit to make 100 trades for as long as it takes.   If you toss a loaded coin long enough, the positive bias will eventually come through.

Don't be greedy!
WHEN you experience winning streaks (not if - since if you trade long enough, you WILL experience winning streaks), don't be greedy and increase the % risk per trade.   If you do this, you guarantee yourself to get inconsistent results, as the law of averages kicks in and revert your 100% win rate back to 55%-60% say, by hitting you with losses when you start to bet bigger.   Always keep your % risk per trade constant.   If you haven't experienced a 55% win rate with a RRR > 1 over 100 trades before, start small and commit to get that experience, even if it takes a couple of years.  Once you have personally experienced this over a long period of time, you will have found for yourself the Holy Grail to trading.

Don't be fearful!
WHEN you experience losing streaks, don't stop and don't reduce the % risk per trade.   Instead, commit to make 100 trades for as long as it takes.

Don't judge by outcome, but by how well you followed the process
Until you get 30, 40 or 100 trades, don't judge the system by the outcome/equity results.   Instead, judge yourself by these 4 criteria:

1. Position Sizing rules - have you followed the rules?
2. Entry rules - have you followed the rules?
3. Exit rules - have you followed the rules?
4. Take as many trades as possible - have you done this?

If you have taken 100 trades, and every one of the 100 trades checked Yes, Yes, and Yes to Questions 1, 2, and 3, then, give yourself Top Marks - you are the True Trader and after 100 trades, it will be virtually impossible for you to lose money - you might surprise yourself by making quite a lot of money instead!