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Thanks again to all those who took the time to respond to the quiz. I have received some positive feedback on the quiz format so I'll plan to continue that method going forward.
Here's my take on the charts from Quiz #2. The bar highlighted in the quiz is noted with an arrow in the charts below.
I view all three of these as valid entry signals. Each corresponds with one of the trade types I identified earlier in the thread:
My specific comments can be found in the charts below. One general comment that applies to all three is that these setups in real time are often fuzzy and not as glaringly obvious as we'd like them to be. I chose the examples that I did with that concept in mind. All represent legitimate entries but pinpointing the exact entry point is tricky, and there's usually some "overshoot" that will test your resolve (and your stops).
As to chart #1, some of you viewed this as choppy or unclear rather than as a with-trend trade. This one comes off the second touch of the SMA, and so is admittedly an early entry of an as-yet unconfirmed trend. I take these trades sometimes, other times I don't, depending on how the market's been acting. In this case, note that right before the entry there is a doji, and then the next bar (the entry bar) was kind of hard to see on the original pic. This is a red bar that breaks below the low of the doji. This would be my specific entry signal, the break below the low of the prior bar.
I would welcome comments or questions on any of these charts.
Today I'd like to address how this tick chart setup can provide clues about the character of the trading day.
Today (until the last half hour at least) was a "trend up" day in equities. In other words, a day with a single dominant trend direction. Trend days present some great opportunities for low-risk, high-reward trades if you can recognize them and adjust your trading plan accordingly.
A typical trend day will start, like today, with a large overnight gap and then a continuation in the same direction of the gap in the morning session. Throughout the trading day, selloffs/bounces in the opposite direction of the dominant trend will tend to be shallow.
This tick chart setup can help spot trend days, particularly if you use multiple envelopes. On a trend day, a move down to the opposite side of the SMA (against the trend) will tend to reverse before the outer envelope is hit. See the attached chart, which highlights all of the points in the day when the lower envelope was approached. Until the selloff in the last half hour, all of these moves reversed course after touching the inner envelope, but before touching the outer envelope. This is indicative of weak selling interest.
If the normal plan for entering trend trades is to wait for a bounce off the SMA in the direction of the trend, an alternative method may prove more profitable on trend days: instead of entering at the SMA, enter on any dip to the opposite, inner envelope. Don't expect overbought/oversold conditions to develop in the opposite direction of the trend. Pullbacks will be fleeting and may not look like promising entries in the heat of the moment. The key is recognizing the day as a trend day, which should be possible if the day is shaping up appropriately after the morning session and the first test of the opposite envelope.
So far in this thread I've discussed entries but haven't said much about exits.
In truth, entries are the easy part. Exits are hard. My general advice about exits:
1. Stops should be used on every trade, and should be inserted automatically along with your entry order.
2. The size of the stop should be determined by two factors:
a. The stop should be placed at the first point where it is clear that the instrument is not acting in line with your expectations when you entered the trade; and
b. The stop should be no further away from the entry than the initial profit target, in order to ensure that the risk:reward ratio is not working against you.
For purposes of this system in particular, I would generally advise the following stops:
With-trend entry (enter at SMA): Inner envelope on opposite side of SMA
Chop entry (enter at envelope): A few ticks beyond the outer envelope, preferably beyond a recent swing high/low
Countertrend trade: No more than 12-15 ticks, as this will generally be the distance from the entry to the profit target (the SMA)
3. As to profit targets, the goal is to hold a trade until a point when it is likely to reverse based on the analysis discussed in this thread. This generally means:
With-trend entry (enter at SMA): Outer envelope
Chop entry (enter at envelope): Inner envelope on opposite side
Countertrend trade: SMA, or for trend reversal setups, outer envelope on opposite side.
Note that these are moving targets. The SMA moves as the trade develops, pulling the envelopes along with it. You may find that frequent adjustment of exit orders is necessary as the trade develops, which is fine. I would advise against moving the stop outward, however, as risk should be fixed at the time of the trade.
To illustrate, I've attached pics showing exit points for the three setups above.
Where exactly did you enter on that short? What made you decide to exit early?
On a chop trade like that, I will usually start with a stop a set number of ticks above the entry based on my risk tolerance (6 ticks here it sounds like). Then if the trade starts moving in my direction, I will move the stop to just above the high, thus cutting the risk down a bit. If you have a good entry sometimes this will allow you to get the risk down to 1 or 2 ticks. At that point I don't see much benefit to exiting early; since the risk is so small, might as well keep the trade open and see if it develops into a larger move.
I used to have a problem with "breakeven stops." I would reset the stop to breakeven (or +1 tick to cover commissions) too early, and this stop would almost always seem to get hit. I don't advise doing that. The stop should remain beyond the swing high/low, or else it's begging to get hit.
I sure agree with exit being the hard part, both technically and psychologically. I read some material on random entry (don't recall the sources) and did a lot of SIM on random entry to help me better understand the importance and methods of exit. Does any of the random entry work inform your exit methods?
____________________________________________________
If it is to be, it is up to me.
All I Know About Trading Options I Learned in Flight School
Thanks for your answer. The magenta triangle on the left side of the wick shows the entry (1.4115, it was exactly the high of the candle), the blue triangle on the right side of the wick shows the exit (1.4113). Why did I exit early? Hmh, I donīt really know, itīs more a psychological aspect. I thought it could go up again and decided to lock in profits before it turns against me. I know, I should trade what I see and not what I think.
The best would have been if I had entered again some minutes later (the red down arrow marker on my chart) with the divergence in my favour and the peak above the upper envelope.
Thanks for your advice to move the stop just above the high and cut the risk down to 1 or 2 ticks. With such a small stop itīs easier to follow how the trade develops. I will try this.
I have thought a bit about random entries over the years but haven't read much on the subject. I remember an article in Active Trader magazine but can't recall having read anything else on it. I should look into that further.
I suspect that it would be possible to make money using random entries, along with a disciplined exit approach that kept losses small and winners large. I haven't tested this idea but I definitely agree that exits are more important than entries.
It might help to take a step back and look at the forest rather than the trees for a second. Imagine that you come across a herd of trades milling around on the prairie like wild animals. The trades are all different sizes, some large as elephants, some small as a mouse. Your job is to separate the trades into two separate pens: one for winning trades, and one for losing trades.
What you want to do to succeed in trading is to herd all the largest trades into the winning category, and all the smallest ones into the losing category. If you do that over time, you will make money. If you do the reverse, you will fail.
If you are looking at a trade where you got in at the absolute high of the chop range as you did here, by placing the stop just 1 tick above your entry, you can guarantee that if the trade is a loser, it will be a small one. To return to the analogy above, that trade is a mouse. You want that trade to go into the losing category. I will take a one tick loss every time it's offered, if that stop is at a logical place (like beyond a swing high at the top of a chop zone) that can be expected to serve as support/resistance. If the trade goes your way, you might wind up with 10, 20+ ticks of profit. If it goes against you, you lost 1 tick; big deal. That's a great bet.
It sounds like what you did in this case was deliberately herd a mouse into your winning trade pen. You saw the 2 tick profit and didn't want to see it turn into a loss (even a small one), so you booked the profit before it could run away. This could be a problematic habit over time, as I can guarantee you that the average loss (the average size of the trades in your losing pen) will be larger than 2 ticks. By booking a 2 tick profit, you're dragging down the average size of your winners instead, which is a no-no in my view.
This is a common tendency that all traders have to overcome at some point. The root cause is a fear of loss. Our natural instinct when herding the trades is to get as many trades as possible into the winning pen, regardless of size. That's the wrong metric and in fact makes it very difficult to get ahead over time, especially after subtracting commissions.
In case anyone wants to do this exercise in SIM, here was the experiment I did, using end or day data.
Stage 1
Choose a trading instrument at random from among your candidates. I used the S&P 100.
Choose an entry date at random.
Choose a direction at random, i.e. long or short.
At exit, go back to step 1.1 for a thousand trades per run, for 100 runs.
Evaluate variance among runs, tweak exit rules and try again until no improvement or bored.
Stage 2
For each instrument
Choose random entry within first 10% of data
For each instrument, trade with 5 years of data until data exhausted. Delete open trade.
If results promising (positive with acceptable variance) from 100 runs, forward trade with one year of unseen data.
I was shocked at how poorly some common exit strategies worked without categorizing the market condition. Were I to do this again, I would add a method to characterize the market similar to how you have and select my exit tactics for each category.
It was a long time ago and a fun exercise. It taught me a lot about trailing stops. If anyone does similar work, it would be interesting to have a thread on it.
____________________________________________________
If it is to be, it is up to me.
All I Know About Trading Options I Learned in Flight School
