Tuesday, April 16, 2013

Trading Example

A Simple Trading Set-Up

I know that people of all sorts of experience and aptitude visit a site like this. Those who are experienced have their own methods that (hopefully) work for them. Here, I wish to show a simple trading example. It is one of an infinite range of possibilities, which range from pure guesswork/gambling to using sophisticated algorithms to make your decisions for you. This is a simple chart method that may give you some ideas for your own trading.

I did not cherry-pick these charts. I simply decided on the fly that this might be an easily understood example, without knowing how it would turn out. I was talking about this at the time online where I trade. I'm sure you may have better methods and be ten times the trader I am, but this is one way to trade.

The futures cross over

The chart is a five-minute chart of the S&P 500 futures, which we call $ES_F. You have three indicators on here: volume bars, candlesticks and a thirty-period trend line. There's nothing magical about any of these, they just happen to be what I was using today. I use them because they help me visualize what is happening. What helps you may be completely different. If you are experienced, you really don't need much more than this.

When the futures behave on a typical day, the trend line is what you want to focus on. It was a trending day, making the trend line particularly useful, without a lot of misleading crossovers. Crossovers are what we look for, because they suggest waxing/waning buying enthusiasm. The longer you trade, the more you will realize that the market moves in pulses of enthusiasm about owning equities.

So, we are watching the trend line. Notice how the candlesticks remain on the left side on the way up (disregard the bottom left for this example, though it works the same way). We stay long while the candlesticks stay to the left of the trend line.

Surge to the downside

Notice the crossover. The idea is to sell when the move below the trend line is confirmed. If you are quick on the trigger, you enter short early and incur more risk and more potential profit. Exactly where you pull the trigger depends on your own disposition, how the market has been acting that day, and so forth. It was helpful that the volume spikes began to show to the downside, so pulling the trigger and selling/going short was easy to decide early on. I don't like to be piggish, and am willing to give up occasional potential huge gains for many more smaller gains, though I've tried both ways and both strategies have terrific arguments in their favor. Anyway, that big volume spike on the big, ugly red candle is a tip that you have a blowoff bottom.

We do get a false mini-crossover right before the big down move. This is where judgment comes into play. You want some kind of confirmation that the down move is over, not just a statistical artifact. Nobody said this was easy, there is judgment involved, always. Let me emphasize: every trading method requires judgment calls, is far from fool-proof, will give you occasional losses, and will put you on the wrong side of a move a certain percentage of the time. Anybody who tells you differently is fooling you.

The longer you stay in a trade, the higher your event risk, so you pay for that time you are holding, even though you don't realize it. Anyway, once you see the crossover, that's when you start thinking about ending the old (long) trade and entering the new (short) trade. End it either on the next crossover to the upside, or as early as makes you comfortable. You won't go broke taking a quick profit.

The bottom and the next cross-over

We get the hoped-for downside surge, and nice potential profit on a short. If you want to stick in the trade, you again exchange greater risk for greater potential reward. Most would cover on that big, ugly red candlestick, walk away with nice profits, and prepare for the next setup, given that this generally has been an up market. In an up trending market, it makes less sense to hold short than to hold long, so you close your shorts out quicker than longs, on average.

The next set-up, in fact, came quickly, with the crossover to the upside in the middle of all those lovely green candles. You buy at the crossover (closing any shorts if you haven't already, obviously) and enjoy the ride higher. You then could either sell on one of the pops with a nice profit, or hold. That is where the day ended.

It doesn't always end this nicely. You can get whipsawed doing this, too. You have to judge the market conditions every day to decide if this market strategy will work.

This isn't an attempt to prove anything. I just want to give a typical example of how things work in real trading. Exactly where you buy and sell is completely discretionary, and you won't necessarily make a profit even with these kinds of set-ups. The cross-overs, though, give you your signals, how you follow them is up to you. The above should show that you don't need fancy charting studies or much guess-work to help you make your trading decisions. Simple trend lines and volume bars will do.

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