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The Art of Trading #3

                                                                               

Paul King, March 23rd 2006

 

The Five Factors continued

 

iv By command I mean the general’s qualities of wisdom, sincerity, humanity, courage, and strictness.

 

You are the one who is in control of your trading account, trading systems, and every decision made that makes or loses money.  Creating a system or method which, if traded accurately, will make money is difficult, but not impossible.  What is much more difficult is having the qualities to trade it accurately – taking every single trade entry, and exit without making any implementation errors.  You have to have the mental strength to command your trading environment effectively, and this is one of the main barriers to successful trading.

 

There are 2 aspects to trading a system successfully.  One is having a complete system and trading plan and the other is implementing it accurately.

 

A complete trading system has rules which specify the following things with no ambiguity:

 

• Market selection – which markets to trade
• Instrument filter – which instruments within the market are considered tradable
• Trade setup – what conditions signal a potential trade
• Entry signal – what rules determine a position should be taken
• Position sizing algorithm – how much to trade
• Exit rules – when to exit the trade

 

If you do not have pre-defined answers to all these questions before you enter a position, you do not have a complete trading system or plan and it does not matter how much mental discipline you have, you will not be able to trade consistently or accurately because you have not defined what this means.

 

Once you have a detailed plan, you can easily spot deviations from it (trading implementation errors) and work on your self-discipline to correct the errors and put rules in place to make sure they do not recur.  One definition of stupidity is ‘making the same mistake twice and expecting different results’.  We all make mistakes, but what differentiates successful traders from the rest is that they can identify the mistake and take action to prevent it happening again.

 

More coming soon even if nobody sends me any feedback…

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Web Site Review: MarketClub

 

Paul King, March 20th 2006

 

MarketClub is a web site that has some nice features to help you become a better trader.

 

The site is split into 4 main sections:

• Chart Portfolios
• Smart Scan
• Trade School
• Data Central

Chart Portfolios

Chart Portfolios is where you can create, manage and chart the instruments you are interested in.  Equities, Forex, Futures, and Mutual Funds are included.  The charting is a nice implementation using Java-based charts and has all the features you would normally need (trendlines, studies, different timeframes, etc.).  The unique feature is the 'Giant Footprint' button that shows good entry and exit points on each chart in different timeframes.  It is a simple concept that uses the highest-high, or lowest-low of the last 3 periods, but is surprisingly effective.

Smart Scan

Smart Scan is a useful scanning technology that finds instruments that are making new highs or lows, and have strong or weak Displaced Moving Average (DMA).  Again all the instrument types are supported and you can use this scan to quickly find good trade setups.

Trade School

Trade School is a series of audio workshops and workbooks that cover many aspects of good trading.  A few of them are a little dated (1996), but they mainly cover topics that are 'classic' and can never really go out of date.

Data Center

Data Center is where you can download 1 minute, 5 minute, 15 minute, 1 hour, or daily data in tab-separated, comma-separated, or MetaStock format for any of the instruments supported by MarketClub.  Great for doing your own analysis.  There is no limit to the amount or frequency of the downloads you can perform.

Overall this is a handy, useful, and informative site, and the additional movies that demonstrate how to effectively use all the features of the service are excellent.

Visit MarketClub

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Book Review: Blink by Malcolm Gladwell

 

Paul King, March 15th 2006

 

In this short, concise, and to-the-point book, Gladwell delves into the subconscious mind and just how much it actually affects our personality, opinions, and decision-making in ways that are not immediately apparent.  The example short stories used have significant relevance to trading and here are a few of the main ones:

 

Immediately ‘knowing’ a Greek Statue is a Fake

 

Even after months of scientific study and evidence that a particular statue was genuine, key people kept getting a ‘negative’ feeling when they first saw it; their hunches turned out to be correct.  In trading, before I enter a position I take a quick look at a 1-minute chart of the last 5 days and I immediately get a feeling that says ‘Not liquid enough for my position size’.  This is ‘thin-slicing’ and Blink demonstrates how it can be a useful and interesting phenomenon that one can consciously use.

 

Red Deck/Blue Deck

 

In an experiment where a game was played with 2 separate decks of cards, one of the decks had a much higher expectancy in the game than the other.  It was shown that after about 50 cards were played, people normally learned to avoid the bad deck.  Professional gamblers, however, started to avoid the bad deck after 10 cards without consciously knowing why.  This is an example where feelings can be telling you something important much quicker than any rational analysis of the situation can.  It would be a good idea to develop and incorporate these kinds of feelings into your trading.

 

Priming Yourself

 

Throughout the book there are many examples where priming radically affects our decision process and even our actions in ways we would not even think of.  Being given a word game to play that simply has words that are associated with ‘old’ can make people walk slower and more stiffly after finishing the game!  Priming oneself to be an accurate and successful trader can be an effective, but simple technique that can have immediate and tangible results.

 

Simple is Best

 

Studies have shown that a simple set of rules can be a more accurate predictor of whether someone is having a severe cardiac episode than an expert opinion using a large array of factors.  In trading, Occham’s Razor should always be applied to cut through to the minimum set of important factors that determine whether a trade is low risk/high reward or not.  Including ‘everything but the kitchen sink’ in your trading system or method is actually counter-productive and less effective than a simple but elegant solution.

 

The Sip Test

 

It has been shown that people prefer one kind of cola over another much more often in a simple sip test.  This, however, has little relationship to market share, and how people enjoy each product in real life drinking a whole can or case.  We use a completely different part of our brain to evaluate a sip than we do to drink a whole can of a product.  In trading, the first few minutes of a trade are irrelevant to the final outcome – it is the closed trade results that matter, not what the ‘first sip’ tastes like.

 

I could go on, and on, with more trading examples from this book, but why don’t you just read it and determine the applicability for yourself.

 

Blink is #8 on our Non-Trading Recommended Reading List here.

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An eBay Arbitrage System

                                                                               

Paul King, March 9th 2006

 

eBaytrage, noun, buying and then re-selling an eBay auction item for different prices and making a profit equal to the difference between the purchase and selling price.

 

Why some eBay items are incorrectly priced

 

In order for an arbitrage to be successful we must be able to identify items for sale that are under-priced relative to the 'normal' market price.  On eBay some items are under-priced because they cannot easily be found due to spelling errors, and therefore attract fewer bids than they should. 

 

The Hypothesis

 

Popular 'commodity' items that are misspelled on eBay will ultimately sell for less than the prevailing market value for the item if it was listed correctly.  Therefore it should be possible to 'low-ball' these items, purchase them, and relist them for a significant profit.

 

Examples of misspelled eBay items are listed below: (you can click on them to perform current Ebay searches)

 

"Sony Vio" instead of "Sony Vaio"

 

"Micro Soft" instead of "Microsoft"

 

Trade Setup

 

The item for sale must have a history of selling for a high price (based on a completed auction search) and be a commodity, rather than a 'difficult-to-value' item.  Examples of commoditized items include electronics, software, and books.

 

Trade Filter

 

Not every item will be a good candidate.  It is important to check the seller profile to ensure they have sold a reasonable number of items and have a high positive feedback number.

 

Risk/Reward

 

Not every trade will offer a good risk/reward.  It is important that the item has a high historical sale price compared to the anticipated sale price for the misspelled auction.  Using a maximum bid that is half of the historical ending auction price for the item gives a good margin of safety.

 

Implementation Costs

 

The implementation costs for the arbitrage are the shipping and handling costs to buy the item, and the eBay listing fee to sell the item.  The potential profit should be a reasonable multiple of the implementation costs to make the trade worthwhile.

 

Position Sizing

 

As with any trading system, position-sizing is a key concept.  Never allocate more than a few percent of available capital to any one trade even if it is possible to simultaneously buy and sell the same item.  It is always possible for something to go wrong (for example you end up with an item that doesn't function and you can't relist it and may lose the entire cost of the item).

 

Contact Us if you have any interesting comments about this system.

 

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The Art of Trading #2

                                                                               

Paul King, March 7th 2006

 

The Five Factors continued

 

ii By weather I mean the interaction of natural forces; the effects of winter’s cold and summer’s heat and the conduct of military operation in accordance with the seasons.

 

All markets have cycles, seasons, and prevailing temperaments and it is important that your trading system or method adapts to the current market conditions.  At a minimum you should identify the different types of market your system performs well in and then only trade when conditions are favorable.  The main classifications of a market that effect trading are volatility and trend.  Volatility can be lower than normal, normal, or higher than normal.  Trend can be downwards, sideways, or upwards.  Combining the two parameters gives us 9 different market types that your system must be able to perform well in, or it should be suspended during times when conditions are not good.

 

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Product Review: Business Planning for Traders and Investors by Van K Tharp   

                                                                       

Paul King, March 1st 2006

 

This set of CDs (8 audio, and 1 supporting data) from the Van Tharp Institute is a recording of a series of telephone conferences that Van Tharp held, which includes guest speakers from each area of expertise.  The CDs deal with the difficult and sometimes intimidating subject of effective business planning for success.  If you have been trying to trade without a business plan (and probably losing money) this course can help you get on the right track and actually set and reach your goals for your trading.

 

Here is a special point that I learned from each CD.  I’m sure that when I listen to them a second time I will pick up even more information.

 

Disc 1 - Commitment

 

Treating oneself as a 'business entity' and addressing each personal issue this bring up is a powerful way to find out how you can operate efficiently.

 

Disc 2 - The Big Picture

 

Global and macro-economic factors will affect any business, and trading is no exception.  Inflation, real estate, gold, interest rates and the overall stock market are all important to how you trade.

 

Disc 3 - Discipline

 

Listing all the tasks you need to do in the context of a purpose, vision and goals, and then categorizing them by roles that create results is a great way to know you are working on what is important.

 

Disc 4 - Basic Trading Knowledge

 

Using expectancy to estimate the value of other business transactions is a useful concept.

 

Disc 5 - Personal and Business Finances

 

Conceiving and planning for the largest business you can imagine is a great way to set your sights high from the start and have a better chance at success.

 

Disc 6 - Personal Edges

 

Paying yourself with 'mental dollars' for achieving planned important tasks is a clever way to avoid disappointment for a losing month/quarter/year.

  

Disc 7 - How Systems Work Under Various Conditions

 

No trading system works all the time, and knowing when your system is broken is a useful thing to understand and have rules in place for.

 

Disc 8 - Review of Example Business Plans

 

Goals should always be matched to actions so that you know what you are working on will bring tangible results.

 

Disc 9 - Data CD

 

Some very useful additional material that includes example business plans to help you see the level of detail that should be aimed for.

 

Visit the Van Tharp Institute for more information about this excellent CD series.

 

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