Markets are inherently chaotic. To an external observer and newbie trader the counter intuitive movements of markets creates a vacuum that makes rational decisions difficult. This is the sole reason why many traders fail and blow out their accounts. They believe all the false moves as changes in the direction of trend and get caught out in a counter move.
Furthermore at lot of the market gurus advocate an over dependence on lagging indicators and short-term trading. Anyone that has followed short-term movements in prices knows how chaotic that is. Throw in the behaviour of banks and market makers in taking out stops and creating false breakouts and we have a very volatile cocktail.
So how does one manage expectations in this turmoil. Firstly even chaos theory recognises that at some level, even micro, there is inherent order in a system. An airport might look like a manic place to most observers but it is a highly organised complex place with every person following a definite route and timeline. One has to acknowledge that within chaos there is a point where perfection exists.
In markets this point is difficult to find as so much of market movements are based on psychology and sentiment.
If you break down the movements you see a tug of war between the traders going up and the traders going down. In a micro and short-term time-frame it seems like it goes both ways all the time but on a longer and medium time-frame the charts look quite ordered.
The challenge for most traders is to follow the long-term sentiment yet trade regularly in the short-term. The rapid and chaotic movements in the short-term stops out many people if the entry points are not chosen correctly.
If we revisit the airport analogy the people who arrive early have a long wait and the people who arrive late often rush and miss their plane but there is a point right before it gets too busy about 1 and half hours before departure when the momentum gains and most people arrive at the check in counters.
This is when the lines can be longest, but the system is working at maximum efficiency to get the people on that plane. The deadline starts to loom and the authorities want to ensure that everything runs smoothly. This is the moment any accomplished trader should be getting into the market.
Early signs of a buildup of momentum.
Most traders get there too early, get nervous and sell out or get there too late and miss the plane. There is a case for getting there early but this is wasted time as the plane may be delayed and the move may not happen for hours, days, or weeks.
The problem with most systems is that they bring you to the extremes. They are either lagging or get there too early. How many times have people made a trade based on the RSI only to realise it has floated up in the extremes for weeks. And how many times have people made a decision based on a moving average, just to see it swing back.
So the only indicator you really need are the key points and blockages. These are normally the pivot points where congestion starts to happen and markets get choppy and some indication that prices are moving and momentum is happening in a particular direction. If you use candlesticks this is when the small candles become long and solid in a particular direction. If you look at numbers you will see numbers start moving fast but predominantly in the same direction 4 forward 2 back 6 forward 3 back, that kind of thing. This is the moment to trade.
Be mindful of the longer term trend and realise you are on the edge of chaos. Things will start moving rapidly but the momentum has started the lines are building up and the people are moving. Just like in the airport. Go with the flow, don’t fight it. You will get there in the end.
Showing posts with label trading system. Show all posts
Showing posts with label trading system. Show all posts
Sunday, 22 June 2014
Thursday, 19 June 2014
Trader Dyanamics Toolkit: Asymmetric trading
History is full of battles with victories for the underdog. Whether it is David and Goliath, Alexander the Great, or Mao Tse Tung, humanity has a habit of routing for the weaker competitor. Markets, are not the same. There are no cheerleaders for bad traders. They tend to get wiped out pretty quickly. That is why you see so many sites comparing trading to battling a vastly superior enemy.
In battle a great leader with a good strategy and well trained and bold followers can achieve more than a great army with no cohesive structure or strategy. This theory can be applied to trading as well. During the financial crisis, it was the giant face less banks with their armies of employees and vast resources that went broke. The smaller hedge funds run by great traders like Paulson or Soros made lots of money.
This is an Asymmetric battle.
Asymmetric warfare is war between belligerents whose relative military power differs significantly, or whose strategy or tactics differ significantly.
Independent traders often think they are at a disadvantage because of the resources available to big banks and funds. However, trading on your own with small lots can be quite an advantage in this fast paced world. As we have seen after the multitude of bank failures financial institutions are placing layer after layer of risk management in their trading models.
Understandably, the high frequency traders make money in milliseconds from slight changes in the market, but we are not competing with them anyway. Most independent traders these days have access to as much information online as a corporate trader.
Most technical analysis packages have all the signals needed and so much news and so many pundits can be easily followed on Twitter. All this can have negative implications, the fog of war.
New traders depend on too much information to make a decision. This multitude of information channels makes rapid decision-making difficult and takes out the edge of being a private trader. This is a problem the majors are faced with, the analysts, program trades, risk managers, hedging strategies, and compliance and regulatory issues makes information sharing and trading quite a challenge for larger funds. Funds spend most of their time trying to put together exotic products to circumvent complex financial regulations.
The principle of asymmetric warfare is to move fast with stealth without the enemy knowing your actions. Private traders can do that. Smaller traders trade smaller contracts so don’t need to worry about moving markets and don’t have risk managers and compliance officers monitoring all our moves.
Use these advantages to level the playing field. You make rapid decisions, pounce and ambush trades and leave quickly if necessary. That is the edge of a mercenary.
It’s the only way to survive in the market and consistently take on the big players. Every day, with every trading decision.
That point must be clearly established based on your money management criteria.
Signal contagion
To make all this easy you need a well-defined system and entry and exit points. Often traders need the comfort of having lots and lots of signals (MACD, RSI, Stochastics, MA, Bollinger), you know what I mean.
All these signals come from the same information, price, they just present it differently. It gives people comfort when they see numbers they are familiar with or colours going from red to blue, but just like the mercenary that is aware of every single noise or movement and quickly decides whether it is hostile or not, the trader should be cautious about his signals.
Lagging signals should predominantly be used for confirming a particular trading hypothesis. There is too much noise in the markets and too many unknowns to rely entirely on signals. Furthermore, many traders like numbers and lines and pivots to predetermine entry and exit points. Therefore you should always be wary of congestion areas on a chart where traders are stop hunting and testing the will of their opponents.
Last night was a great example of this. Federal Reserve Chair says stocks are not overvalued. Promptly a new record for the S&P. Prior to that the market was going down stop hunting. Very few lagging signals would have seen this coming but a careful analysis of the readily available information, your trading signal and rapid action would have got you on the right side of the trade.
In battle a great leader with a good strategy and well trained and bold followers can achieve more than a great army with no cohesive structure or strategy. This theory can be applied to trading as well. During the financial crisis, it was the giant face less banks with their armies of employees and vast resources that went broke. The smaller hedge funds run by great traders like Paulson or Soros made lots of money.
This is an Asymmetric battle.
Asymmetric warfare is war between belligerents whose relative military power differs significantly, or whose strategy or tactics differ significantly.
Independent traders often think they are at a disadvantage because of the resources available to big banks and funds. However, trading on your own with small lots can be quite an advantage in this fast paced world. As we have seen after the multitude of bank failures financial institutions are placing layer after layer of risk management in their trading models.
Understandably, the high frequency traders make money in milliseconds from slight changes in the market, but we are not competing with them anyway. Most independent traders these days have access to as much information online as a corporate trader.
Most technical analysis packages have all the signals needed and so much news and so many pundits can be easily followed on Twitter. All this can have negative implications, the fog of war.
New traders depend on too much information to make a decision. This multitude of information channels makes rapid decision-making difficult and takes out the edge of being a private trader. This is a problem the majors are faced with, the analysts, program trades, risk managers, hedging strategies, and compliance and regulatory issues makes information sharing and trading quite a challenge for larger funds. Funds spend most of their time trying to put together exotic products to circumvent complex financial regulations.
The principle of asymmetric warfare is to move fast with stealth without the enemy knowing your actions. Private traders can do that. Smaller traders trade smaller contracts so don’t need to worry about moving markets and don’t have risk managers and compliance officers monitoring all our moves.
Use these advantages to level the playing field. You make rapid decisions, pounce and ambush trades and leave quickly if necessary. That is the edge of a mercenary.
It’s the only way to survive in the market and consistently take on the big players. Every day, with every trading decision.
- Analyze information rapidly
- Make quick decisions based on available information
- Act.
That point must be clearly established based on your money management criteria.
Signal contagion
To make all this easy you need a well-defined system and entry and exit points. Often traders need the comfort of having lots and lots of signals (MACD, RSI, Stochastics, MA, Bollinger), you know what I mean.
All these signals come from the same information, price, they just present it differently. It gives people comfort when they see numbers they are familiar with or colours going from red to blue, but just like the mercenary that is aware of every single noise or movement and quickly decides whether it is hostile or not, the trader should be cautious about his signals.
Lagging signals should predominantly be used for confirming a particular trading hypothesis. There is too much noise in the markets and too many unknowns to rely entirely on signals. Furthermore, many traders like numbers and lines and pivots to predetermine entry and exit points. Therefore you should always be wary of congestion areas on a chart where traders are stop hunting and testing the will of their opponents.
Last night was a great example of this. Federal Reserve Chair says stocks are not overvalued. Promptly a new record for the S&P. Prior to that the market was going down stop hunting. Very few lagging signals would have seen this coming but a careful analysis of the readily available information, your trading signal and rapid action would have got you on the right side of the trade.
Friday, 13 June 2014
Trader Dynamics Toolkit: Noise trading
The massive moves in oil in the past days made me wonder why loads of people sit and stare at the multitude of indicators on their screen all day. If you look a bit further back you will see oil has been moving for a couple of weeks, quite significantly. If you search in Google you will notice that there were stories about ISIS and Iraq and the impeding crisis around the same time. Suddenly, you have a neural trading system, which would normally cost, you an arm and a leg. But this kind of trading based on noise is age old. Even Edwin Leferve read the ticker and made quick trading decisions based on it in the 1920's
There are all sorts of labels for Traders based on what time-frame and system they use to trade. Everyone has heard of the swing trader and day trader or position trader. In my many searches on the web I discovered a label for a trader I had never seen before. Noise Trader. Actually, it was coined in a report written by Andrei Shleifer and the famous Lawrence H Summer titled “The Noise Trader Approach to Finance” . Link at the bottom of the page for your information.
Many of you think I am mad to think that a 21-year-old document has any relevance to modern-day trading. I agree its all pretty boring until you get to page 28 and positive feedback trading. “The key to success, says Soros, was not to counter the irrational wave of enthusiasm, about conglomerates, but rather to ride this wave for a while and sell out much later.” It goes on to say that this could lead to a bubble but can make you very rich in the short-term. Even back then they were scared of the noise traders as they suggest taxing them to the hilt. Well 20 years later and after a series of bubbles nothing much has really changed.
I guess that means all great traders are noise traders. Now to me that makes perfect sense. The false prophets and market Gurus that peddle indicators and mechanical systems inherently dismiss the one real mover of markets, Sentiment. Yes, some people say much of this is built into the market and I totally agree, if you are a high frequency trader, but most of us are not. For them lagging means a millisecond for us it could be hours or days. It is not bad if you want to make a few great trades, but to be a real trader you need consistency. That means trading well, most days for years. The only way to do that is to follow the successfull crowd, and follow it as perfectly, as you can.
So the question comes down to how one measures noise and sentiment in the markets. Most of trading these days is done by machines and even in dark pools where there is no transparency. The few indicators for momentum are based on the price anyway and are pretty much useless. A friend was following sentiment based on his Twitter posts. That is not a bad idea but its a bit like standing outside a football stadium and predicting the results based on the crowd cheering. You will get it right sometimes but you would be blind, literally.
The answer to all this is very much in built in the strategy. There are a host of analogies traders use, riding the wave, jumping on the bandwagon,and buy low, sell high. The implication for these statements is a fundamental shift in a market, towards a certain direction. Too many traders, these days want to know the whys and the how's. None of that is relevant.
The real questions are ”is the market moving ?” and “why aren’t you in it ?”
The Noise Trader Approach to Finance
http://scholar.harvard.edu/shleifer/files/noise_trader_approach_finance.pdf
There are all sorts of labels for Traders based on what time-frame and system they use to trade. Everyone has heard of the swing trader and day trader or position trader. In my many searches on the web I discovered a label for a trader I had never seen before. Noise Trader. Actually, it was coined in a report written by Andrei Shleifer and the famous Lawrence H Summer titled “The Noise Trader Approach to Finance” . Link at the bottom of the page for your information.
Many of you think I am mad to think that a 21-year-old document has any relevance to modern-day trading. I agree its all pretty boring until you get to page 28 and positive feedback trading. “The key to success, says Soros, was not to counter the irrational wave of enthusiasm, about conglomerates, but rather to ride this wave for a while and sell out much later.” It goes on to say that this could lead to a bubble but can make you very rich in the short-term. Even back then they were scared of the noise traders as they suggest taxing them to the hilt. Well 20 years later and after a series of bubbles nothing much has really changed.
I guess that means all great traders are noise traders. Now to me that makes perfect sense. The false prophets and market Gurus that peddle indicators and mechanical systems inherently dismiss the one real mover of markets, Sentiment. Yes, some people say much of this is built into the market and I totally agree, if you are a high frequency trader, but most of us are not. For them lagging means a millisecond for us it could be hours or days. It is not bad if you want to make a few great trades, but to be a real trader you need consistency. That means trading well, most days for years. The only way to do that is to follow the successfull crowd, and follow it as perfectly, as you can.
So the question comes down to how one measures noise and sentiment in the markets. Most of trading these days is done by machines and even in dark pools where there is no transparency. The few indicators for momentum are based on the price anyway and are pretty much useless. A friend was following sentiment based on his Twitter posts. That is not a bad idea but its a bit like standing outside a football stadium and predicting the results based on the crowd cheering. You will get it right sometimes but you would be blind, literally.
The answer to all this is very much in built in the strategy. There are a host of analogies traders use, riding the wave, jumping on the bandwagon,and buy low, sell high. The implication for these statements is a fundamental shift in a market, towards a certain direction. Too many traders, these days want to know the whys and the how's. None of that is relevant.
The real questions are ”is the market moving ?” and “why aren’t you in it ?”
The Noise Trader Approach to Finance
http://scholar.harvard.edu/shleifer/files/noise_trader_approach_finance.pdf
Sunday, 8 June 2014
Contrarian Trading: Where perception meets reality
The moves in the market, now, reflect an interesting market dynamics. The Euro-zone continues under performing and the US economy is sputtering to life. The hype surrounding economic recovery is based on a market perception that has been fed with European and Japanese financial stimulus and US Quantitative Easing. As the US starts to taper the Euro-zone picks up the baton and runs the printing presses at maximum speed. Things are not right economically , but we follow the traders not the economists. Economists and politicians love a nice bull run. Traders don't care as long as something, somewhere is moving.
Markets are about perception, much of it is not real or connected to reality. The futures market is exactly that, a perception of the future. There are many perceptions of the future. Which is why people bet against each-other. You cannot compete with someone else’s perception of the future, you have to create your own. Furthermore, even though individually people tend to be rational we have seen, in history, as a group they become completely whimsical. The psychological make-up of the market is more akin to a panicky impulsive 4-year-old then a grown up.
If you follow the US market all you have to do is look at the S & P or Dow. The Dow regularly falls over 100 points and regains it based on the flimsiest pieces of news and conjecture. In the modern era where 60 % of trades tend to be through computers and neural networks trading has become much easier. People may pretend that these algorithms are super complex but the reality is that most of them just look at the prices of a few different instruments and some key Twitter accounts. They look at correlations between certain markets and also filter out key keywords from news sources and then place trades automatically.
They react. They are not really neural and clearly cannot predict much. In fact their power of prediction is far worse then human traders. However, they trade better because all the emotions associated with human traders have been taken out of the equation.
It is true, there are the High Frequency Traders and some people who are privy to inside information, but that is nothing new. If anything, inside information is pretty useless as one cannot predict how the market will react to it. Good news can be bad market and so forth. So how does one trade against these mechanical monsters ?
It is pretty clear if you are a regular market follower. The old adage about trends being your friend is great if you are trading on the daily, weekly and monthly charts. A yearly chart of the US/Yen looks very tradeable but on the smaller time frames this is madness.
High Frequency algorithms, neural networks are inherently linked to the human psyche but magnify our emotional problems. They panic buy and panic sell based on a few keywords. They muddle up correlations between currencies because the people who design them hide behind formulas and equations not the truth about markets. It is for this reason that, after the sub prime crisis, the human traders in hedge funds have a habit of turning them off and trading manually when things heat up.
Do your research, and use your system but when the market goes crazy don’t blame it on the computers, dust off one of your nice contrarian strategies and make money. There are many effective strategies based on divergence. Once you start using them you will see divergence everywhere.
Trading divergence is the modern betting against the panic. It is a tough call and not for the faint hearted but as Hyman Roth said in the Godfather II when his associate Moe Greene got a bullet in the eyeball: And I said to myself, this is the business we've chosen.
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