Thursday, June 13, 2013

The big market moves of Wednesday and today are a great illustration of how deceptively easy the market appears along with the potential for stellar gains and/or losses.

The chart above is  ES market activity for Tuesday, Wednesday, and Thursday of this week. I included Tuesday to show you a typical trading range for the market - about 15 - 17 points in a day. The market moves on Wednesday and Today were more than double that with a 40+ point range - giant moves!!
Viewing the completed chart makes it look fairly orderly and straight forward- market drifts, then dives sharply, then recovers. You might even be tempted to think the movement looks pretty predictable and easy to forecast. Ah, but things aren't as easy as they appear. Cover up the 3/4 of the right side of the chart, and slowly move the paper to the right, and try to predict where the market is headed. Not as easy or predictable now, is it? =) That's what traders face trading real-time - trying to gauge where the market is headed with only past data/charts as a reference/guide. They key to being successful is trying to map out in one's head what the "end of day" chart looks like long before it actually takes shape on the chart.

The majority of traders were fooled by the Wed/Thurs big swings. These are people who are seasoned traders, not beginners.

Before I describe the events on the chart, I need to define two terms. The ES futures market runs nearly 24 hours/day and is composed of two parts:
1) Cash ("Live") Market - This is the time floor traders at the exchange actively trade the market, 9:30am - 4:15pm EST.
2) Globex Market - The time outside of Cash Market hours - from the afternoon through the next morning until the Cash Market reopens.

Okay, so looking at the chart, Tuesday was a normal day and ended down. During the Globex session, the market rose slowly but steadily. Then we get to the Cash Open on Wednesday, and the market starts moving down. During this time all the Twitter message traffic shows traders are going long, buying as the market is dropping, thinking that the market is going to resume moving up. The market keeps drifting lower, but people still keep buying. At this time there is hardly anyone mentioning going short (selling).
As the chart shows, the market was basically a one way trip down and those who bought now had to get rid of their positions with losses, then they would buy in again at a lower level, only to exit that position with losses as well. They never considered reversing and going short instead.
Some who bought at the start of the day and held their position, starting feeling lots of pain later in the day with mounting losses until finally, they close their position with a big loss. This is why you should use stop loss orders to keep small losses from becoming big losses. Unfortunately traders including me don't like using stops because the market tends to seek them out before continuing in the planned direction. But big market moves like on Wednesday/Thursday show why not using stops poses such a big risk.
So the cash market closes and continues to drop during Globex before slowly starting to rise before Thursday's cash open. At this point Bulls are very jittery and Bears are licking their chops to short more when the market moves up. A lot of the same people who were trying to "buy the dip" on Wednesday are now shorting the market rally, expecting it to fall back down. As the really continues, they exit with losses, and short again higher, only to close with losses as the market moves higher.  The Twitter traffic is the reverse from the day before - lots of people selling, very few buyers. Instead of reversing their mindset to buy, they keep selling. Towards the end of the day the market climbs at a faster pace, giving enough pain to sellers to force them to close, which adds pressure for other sellers to close, otherwise known as a "short squeeze". The market zooms up and makes up all the ground it lost the day before, as if Wednesday never happened. shocked

Wednesday: Market falls but majority is tricked to thinking it will go up and wind up losing. Bears are giddy with delight, and think market will be falling further the next day.
Thursday: Market roars back, but the folks who lost money on Wednesday are not likely participating because they are too nervous and wounded. The Bears who stayed in thinking the market would keep falling lost all their profit. New Bears who shorted today and stayed in lost their shirts with big losses.

You should find it fascinating that so many seasoned traders were tricked into doing the opposite of what they should be doing. This is what makes trading difficult - the market send out signals that are meant to confuse the majority of traders, despite their preparation.

How did I do? Well, I successfully got the bulk of Wednesday's down move, but even though I expected Thursday to be an up day, I got left watching since it never pulled back to what I was expecting as a low risk entry point. I can live with that, and I'm all kinds of glad I wasn't lured into trying to short this market was a beast in the up direction!

In terms of the potential gains or losses made by traders - they were amplified by the big size of the swings: a 40+ point range! So for example, 1 ES contract gives you a $50 gain/loss with every point move up or down respectively. So a 40 point swing represents a $2000 gain/loss depending if the trader had a winning or losing trade- and that's just 1 contract. So you can see if a trader had many contracts and was wrong, things could get ugly fast.
In a worst case scenario a trader would be long on Wednesday and stay long, getting big losses. Then they would try shorting the market Thursday and wind up with huge losses again. The size of these swings could easily break an account - which is the risk all traders face. On the other hand, the trader who is on the right side can get tremendous gains. Therein lies the risk and reward of trading. It's not easy, you can lose big if not careful, but the potential is also there to make life changing wealth.

Thursday, February 28, 2013

Automated Vs Discretionary Vs System Trading

In the world of trading, there are two main schools of thought- programmed/automated and discretionary methods of trading.

Discretionary trading is when one is making decisions on what to do real time based on market activity. Automated trading removes the human decision making element out of the process and does pre-programmed responses based on market activity.

For computer automated trading - ideally the biggest pro would be that you'd be able to turn it on and just sit back and let the cash roll in while it does its thing. No thinking required- just a simple flip of the switch to make money. No faulty human interaction to mess things up...

It's the Holy Grail that every trader has thought about at some point and would love to have- who wouldn't? cool

On the opposite end, you have discretionary trading, where people decide whether to buy or sell based on what they see going on in the market. This is what the majority of non professional retail traders do.
The region of space both types can share is systematic trading - where you trade according to a defined set of trading rules and methods. The automatic traders will have these rules programmed in while the discretionary trader manually operates his system. My trading style falls into the category of discretionary system trader.

Which method is better? People working on automated systems swear by them and condemn discretionary traders as giving their money away to the market. Discretionary traders scoff at automated traders as trying to perform an impossible task resulting in a big waste of time and money.
In the professional world of Wall Street, automated trading machines exist but they only look to make pennies per trade- the key for them is performing thousands of transactions per second so they can make big profits on mass volume. You need big bucks to have such a machine and a big outlay of capital to be able to afford to trade on such a large scale. In other words, this is not available to non professional private traders like myself that trade on a far smaller scale.
On the smaller scale,  an automated system would have to place fewer trades that would last longer. To date, while I have "heard" of automated systems that are successful for the retail trader, I have yet to see a bonafide proven system that one would say is successful if your goal is to keep risk low and live off the income.

The Kryptonite of discretionary traders are their emotions. The market is geared to induce an emotional response that will lead you to doing the opposite of the right things to do. One of the first things a competent trader has to master is the control of their emotions and ego- it's the cause for most discretionary trading losses.
Purely discretionary traders treat the market like an extension of a Vegas casino and make "bets" based on gut feelings. As you move towards more organization and control, you have "system" traders who have a defined method/strategy of making trades, but it's not automated and instead done manually.

This is the biggest "pro" of automated trading - removing the human chaotic human emotional factor from the equation.

However, as a discretionary system trader, my answer may be biased, but I think "organized/system" discretionary trading is superior to automated trading for the following reasons:

1) The market is comprised of living/thinking traders, which makes the market a living entity of sorts composed of the summation of human actions. Trying to code that type of random behavior analysis into a working program is incredibly challenging and perhaps beyond the scope of the technology that currently exists for it to perform consistently well for retail traders.
2) It's said that the market never repeats but often rhymes- making it difficult to program in those subtle variances.

3) The learned response: being able to learn/adapt from past mistakes favors discretionary over automated trading.

From the above, I think #3 is the biggest reason against automated system trading. When market conditions cause a trader to lose money, they know they need to make changes to their methods. A discretionary system trader likely has a better feel for the market than an automated trader who just plugs in market variables. As a result, the discretionary trader will have a better chance at pinpointing the exact problems while the automated trader only knows the current running programs need changing, but no specifics on which variables or rules to change.
Running automating trades comes at the price of not having a hands-on feel of the market, so detailed knowledge of market behavior and nuance is not as developed as those with their hands continually on the driving wheel such as discretionary traders are.
I can point to my own trading growth from being able to do analysis on my trading logic and figure out what improvements to make to adjust for the market.