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THE CLIFFS NOTES VERSION OF MY APPROACH TO TRADING


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THE CLIFFS NOTES VERSION OF MY APPROACH TO TRADING

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  #1 (permalink)
Legendary Market Wizard
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This article is intended for the edification of all who are interested, but is especially intended for those who are just starting out. There is not any information in this text that experienced traders haven’t seen before. In fact, everything that is mentioned here is in the public domain, and has probably been discussed at one time or another in this forum and/or practiced by it’s participants. However, this is the routine that I follow, the charts and indicators that I look at, and the thought process and philosophy I employ, so in that sense it is proprietary.

While I look at and consider a multitude of factors, my overriding determinant for initiating and exiting a trade is what I have always referred to as my “feel”. Feel is an intuitive sense a trader develops about the direction of the market, after continuously having watched and studied price action and market behavior. It is not an end state but a dynamic goal, always adapting to changing and evolving market conditions and drivers of price.

For the most part, my trading is not mechanical in nature, although there are certain rule based trades that I take because of their high probability of success. I would like to think that the majority of my trades are still predicated on thoughtful analysis and feel, even though I pay serious attention to the signals generated by my charts and indicators. At times visceral input may generate a trade while the technicals confirm, and at times the converse may be true.

In the most general way, I classify market action as either trending or range bound and my trades as either proactive or reactive, and as either breakout, continuation, or reversal trades.

Algorithmic and high frequency trading has forced traders to transform from “momentum chasers” to “mean reversion” traders. Buying new highs, and selling new lows, rarely works now as passive algorithms are programmed to buy the new low and sell the new high. Even before AT and HFT, the markets traded in ranges about 80% of the time while trending only 20% of the time.

Due to these factors I find myself making a lot of reactive, reversal trades. When I traded at the CBOT, I always felt more comfortable taking the other side of retail stops and fading the rest of the pit, rather than trading with the market, and being the same way as the rest of the locals.

This contrarian strategy is perfectly suited for today’s algo driven and range bound markets, and is luckily already in my trading DNA. The 4 days or so a month that the markets have a trend day, I will adjust my hold times and position sizing upward, but I will still initiate my trades by buying weakness and selling strength, although they will be in the direction of the prevailing trend.

I do make proactive trades based on leading indicators, such as pivots, trendlines, support/resistance, pattern set-ups, etc. which may be also be continuation or breakout trades, but it is far more natural to me to fade extreme moves.

My trade/risk management and position sizing is not mechanical, but is predicated on my on-the-fly assessment of price action and volatility. The broad risk reward parameters and trade plan is outlined, but the final draft has not been finished. Price action is dynamic,and so is my decision process. However, I hope to know within a relatively short amount of time, if the market has me by the balls, or I have the market by the balls, or if it’s just a ring-the-register kind of trade.

What I am very adamant about, and what I feel is a very overlooked topic, is position sizing. Especially on trend days, I am looking to add to good trades. It is critical that you press on these days, because there are so few of them. Adding to, and milking your winners is one of the most, if not the most, important techniques you can employ for making money.

While the opening has progressively become less of a factor and the it’s importance continues to become increasingly diminished, I will use it as a general reference point for this article.

FIRST THING IN THE MORNING

I break out the journal and begin to make entries. They begin with cognitive or psychological remarks that continue to the trading session where commentaries about the markets are added. Educational entries are usually made after trading hours as they are made evident.

The idea is to use the cognitive journal to keep a real time record of what I’m thinking and feeling while I’m trading, so that I can become a better self-observer. This helps me to identify problems as they occur, so that I can keep them from affecting my trading. The sooner in the day I begin to assess my emotional status, the better. Therefore, my best practice calls for writing in my journal, first thing in the morning. This initiates the process of clearing my mind for the remainder of the day, and better prepares me for the trading session.

MORNING CALL

This where I bring myself up to speed on overnight developments in Europe, Asia, and the U.S., check the financial calendar for upcoming reports, and try to get a feel for what the market will be focusing on today. As a rule I always have charts up for the Bonds and Dollar, but if something else is in play or is being emphasized that correlates to the e-minis, it will need to be added. Barchart.com has a very good morning call newsletter which summarizes all of the above.

I then begin to make my:

INITIAL APPRAISAL OF TRADING DAY PRIOR TO OPENING

Where is the market trading relative to:
  • VWAP
  • Overnight Range
  • Previous Day’s Range
  • Value
  • Developing Value
  • 200 MA
  • Pivots


As it gets closer to the opening, I start to formulate an opinion about what kind of opening it’s going to be:

OPENING STRUCTURE
  • Opening Range relative to price benchmarks above
  • First Bar and Second Bar - Range (doji) or Trend ( big body)
  • Opening’s Structure

a) Open Drive
b) Open Test Drive
c) Open Rejection Drive
d) Open auction

INDICATORS

I am checking the following indicators for reference:

● VIX
● SPX Cash
● Cumulative Adjusted Tick
● Cumulative Delta
● Advances/Declines
● Relative Volume
Delta Volume

I am now starting to formulate an idea of the potential structure of the day and after the first hour(initial balance) I am getting a better idea of the probabilities for the size of the day’s range, what kind of day it will be.

Range Day - The market will oscillate around an average price value with relatively low volatility through the day, likely ending the day not far from its opening price level and/or its volume-weighted average price (VWAP);

● Upside Trend Day - The market will open near its low price for the day session
and build its way higher through the day, closing near its high price. The market will tend to stay above its VWAP for most of the day;

● Downside Trend Day - The market will open near its high price for the day
session and work its way lower through the day, closing near its low price. The market will tend to stay below its VWAP for most of the day;

Upside Breakout Day - The market will open within a range, but will build volume and attract participation at the upper end of that range, leading to a price break above the range, and further acceptance of price above the range with solid volume. An upside breakout represents a transition from range to upside trending conditions.

Downside Breakout Day - The market will open within a range, but will build
volume and attract participation at the lower end of that range, leading to a price break below the range, and further acceptance of price below the range with solid volume. A downside breakout represents a transition from range to downside trending conditions.

False Upside Breakout Day - The market opens within a range and moves
above the range, usually with limited participation and volume that wanes with higher prices, only to fall back into the range and return toward VWAP. A false upside breakout represents an extension of range trading conditions.

False Downside Breakout Day - The market opens within a range and moves
below the range, usually with limited participation and volume that wanes with lower prices, only to bounce back into the range and return toward VWAP. A false downside breakout represents an extension of range trading conditions.

TYPES OF TRADING DAYS - MARKET PROFILE STYLE

CONSOLIDATION 80%
● Normal
● Non Trend
● Normal Variation
● Neutral

TREND 20%
● Trend
a) Trend from Open - open, trend
b) Spike and Channel - spike, channel, reverse to prior range
c) Trending Trading Ranges - trend, range, trend, range, trend
d) Trend Resumption - trend, range, fbo, trend-symmetrical
● Double Distribution

Concurrently, I am checking various charts that give me a macro-economic perspective of the markets:

INDICES
● SPX
● COMP
● DJIA
● RUT

MACRO ETF INDICATORS
VIX - Volitility Index
● UUP - Dollar
● TLT- 30yr bond
● GLD - Gold
● DBA - Commodities
● USO - Crude Oil

GLOBAL MARKETS
● VGK - Europe
● FXI - China
● EWZ - Brazil
● EPI- India
● RSX - Russia
● EWJ - Japan

BONDS
● TLT - 30YR
● IEF - 10YR
● SHY - 2YR
● LQD - IN. GR.
● AGG - AGGR.
● TIP- INFL.ADJ.

STOCKS
● NFLX
● GE
● BIDU
● GOOG
● AMZN
● RIMM
● AAPL
● CME

This is how I break down the trading day, and intra day tendencies I’m looking for

9:30 AM -10:30AM Opening - Initial balance 10:00-12:00 Contra- trend
reversal- Fed open market operations

10:30 AM -12:00PM Morning - The !0am move may continue till Noon

12:00PM - 2:00PM New York Lunch Hour 12: 00 - (1:00 - 2:00)
Consolidation or slight contra- trend move

2:00PM - 3:30PM Afternoon 1:00 - 2:00 - 3:00 ABC Move

3:30PM - 4:00PM Close 3:30 Linear Move

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Do you have anything important to add or take away from this list 4+ years later? The markets are always changing, and we must change to stay adaptive right? But most points in your plan seem to still apply today.

Thanks for your insight!

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lovetotrade View Post
Do you have anything important to add or take away from this list 4+ years later? The markets are always changing, and we must change to stay adaptive right? But most points in your plan seem to still apply today.

Thanks for your insight!

@tigertrader

I concur with the quote - how has your mentality shifted since you first wrote this?

-Jimmy
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