Techniques And Guidelines For Futures Traders


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Techniques And Guidelines For Futures Traders

  1. 1. Techniques And Guidelines For The Futures Trader Characteristics of a Successful Trader Importance of a Trading Strategy Guidelines for Successful Trading Fundamental vs Technical - A Trading Example The Nature of the Markets, Contrary Trading and Self Awareness Why is Successful Trading so Difficult Introduction Futures markets are a highly leveraged form of investment, where price movements can be rapid and extensive. This makes futures a particularly attractive investment medium for the individual with sufficient capital to risk and the temperament to trade. Margin deposits to trade futures contracts are often less than 5 per cent of the full value of the underlying contract, which means that it is possible to make substantial profits. By the same token, it is also possible to sustain substantial losses. For more than a century, futures markets have attracted individuals who have been willing to risk their capital with the aim of profiting by correctly judging short, medium or long-term trends in prices. But consistently profiting from the futures markets is certainly not easy. In fact it is often quoted that around 80 per cent of inexperienced traders lose money in the futures markets. This statistic in itself is most valuable. It suggests that in order to be successful, the trader not only has to have a well planned strategy and an enormous amount of self-discipline, but that trader must also behave, think and act differently to the manner in which the majority of inexperienced traders behave, think and act. One thing you will hopefully learn as a trader is that the mental resources you use in every day life, will most likely not work in the trading environment. This means you may have to change your own attitudes and your own way of thinking. After years of trading, experienced traders often realise that the battle to become a successful and profitable trader is not external, but rather internal. The difficulty is changing ones own attitudes towards the structure of the markets, the trading environment and towards winning and losing. This pamphlet or any other publication will not turn you into a profitable trader. But it should draw your attention to the most common mistakes made by traders and the most important areas for you to focus on. Characteristics of a Successful Trader The Turtles In the early 1980’s, Richard Dennis - a very successful trader in the US who had amassed many millions of dollars trading the futures markets - had a disagreement with his partner. Dennis believed that successful trading could be taught to almost anyone while his partner, William Eckhart believed that profitable traders were born, not bred. Either you have it or you don’t, said Eckhart. To settle their disagreement, the two men decided to test their views by training a selected group of individuals to trade. An ad was placed in the Wall Street Journal, seeking applicants to become trainee traders, which attracted thousands of applicants. Thirteen individuals were selected - all with varying backgrounds and professions. Some of them had basic knowledge and experience of the financial markets, but most had no knowledge or previous experience at all. Dennis named the group the Turtles, as the exercise reminded him of turtles being reared on a turtle farm he visited during one of his holidays. After several weeks of extensive training where both Dennis and Eckhart passed their knowledge and trading strategies to the group, each trader was given a sum of money to trade on their own. The results were so spectacular that the experiment was repreated. The Turtles soon became renowned as a group of the most profitable and successful traders in the world.
  2. 2. While the experiment proved that almost anyone can become a successful trader, there are certain things the trader must learn in order to be successful. And although the Turtles klearnt some specific trading techniques, which are still secret today, they also developed a number of essential characteristics which helped them to achieve their success. Some of these characteristics are as follows: An objective, open-minded approach to trading This would have to be one of the most important attributes of the successful trader, but also one of the most difficult to learn and develop. A trader must learn detachment from the markets and from trading positions taken, so that a completely unbiased, objective and open-minded attitude is maintained. This characteristic alone usually takes years for the average person to learn as it goes against natural psychological tendencies. Ability to accept that the market is always right This goes hand in hand with objectivity and flexibility in that the trader must accept that the markets will move in an infinite variety of ways, without any regard whatsoever for that trader. Any one individual cannot control a market and therefore the trader must accept that the market will do what it wants to do regardless of a trader’s expectations, hopes or desires. The markets therefore, irrespective of the trader’s position, are always right. Ability to admit your mistakes and take a loss. It is often said that a trader’s attitude toward losses rather than profits, is what distinguishes the trader as successful or not. Any trader that can’t admit a mistake and be prepared to take a loss, will not last long in the trading environment. Even the most successful traders have losing trades, in fact it is estimated that around 65 of every 100 trades made by professional or experienced traders are losing trades. This indicates the winning trades are substantially larger than the losing trades. The biggest mistake novice traders make is not cutting their losses. If you don’t have the humility to admit you are wrong and you can’t take a loss then DON’T TRADE! Losses are a normal part of trading and the sooner a trader can accept this and learn from past losses, the sooner the trader will be successful. Self-discipline Self discipline is always high on the list of essential characteristics of the successful futures trader. Traders will naturally tend towards impulsive and erratic behaviour - reacting to emotions as prices fluctuate. The trader must therefore learn to adhere to a reasonably well defined strategy - both in terms of trade entry and exist, and money management. There are times when for example, irrespective of the traders expectations or beliefs, that a position must be closed - simply because it has reached a certain pre-defined limit. The whole concept of self-discipline is tantamount to the trader’s methodical and structured strategy. Dedication If you expect to become a successful futures trader overnight or believe that trading is easy, then perhaps you should put your money in a secure, high-interest account and save yourself from learning the hard way. Trading is one of the most difficult professions in the world - the statistics prove that. If you are committed to becoming a successful and profitable trader then you must be committed to a reasonable amount of work, study and research.
  3. 3. Absence and Fear of Greed It is said that fear and greed are the trader’s two worst enemies. If you are afraid of losing or are greedy to win, you have a huge handicap as a trader. These emotions will most certainly erode or remove your objectivity, lead to poor decision making and a lack of self-discipline. If a trader finds himself hoping or wishing for the market to move or behave in a certain way, then at least one of these harmful emotions is present. Learn to be free of these emotions or you will without doubt, give your money to other traders who can learn this. In fact, if you are aware that you continue to experience feelings of fear or greed, as most traders do, then you should question the motives behind your trading. Don’t think about what you want the market to do, think about what YOU will do if the market behaves in an unexpected way. Be prepared for anything. Ability to go against the crowd If the majority of inexperienced futures traders lose money, then it is obvious that in order to make money, you have to learn to do what the majority are not doing. This in itself, is extremely difficult. While following the majority and being amongst a common consensus gives the trader a warm sense of security, it will probably give the trader empty pockets. Learning to go against the crowd is very important. This alone takes strength and courage, but it should not be a fight. If you find yourself making contrary views or taking contrary positions to prove something, then again your ego is involved and you are likely to lose money. Many traders like to think they are contrary investors, but without even knowing it, they are just following the crowd. Self awareness. Without self-awareness, a trader will not be able to learn or develop any of the above characteristics. In order to change and learn from past mistakes, the trader must be able to look at him or herself in a clear, objective way. Watching ones own feelings, thoughts and emotions in an impartial and detached manner, will without doubt, help the trader to become successful. Importance of a Trading Strategy The importance of a well defined trading strategy, cannot be over emphasised. If an individual was starting a business of some kind and risking hard-earned cash in doing so, it is highly likely that the individual would attempt to reduce the risk being taken by conducting extensive research, study and preparation into the nature of the business and all the circumstances affecting it. The individual would not commence business until a strategy or plan had been devised and all the possibilities had been covered. Why then would a futures trader, entering into one of the most difficult professions in the world, commence trading without a well defined plan or strategy? A trading strategy is a means by which a trader makes decisions to both enter and exit a trade. The most profitable traders usually have a well-defined strategy, so that if the markets act in a particular way for example, the trader would buy. If the markets move to such a price or an indicator reaches a specific level for example, the trader would sell. There should be some kind of mechanical action, whether it is a function of technical or fundamental indicators or simply a particular behaviour of the market itself, to indicate to the trader to buy or sell. In addition, the trader should also have a well-defined money management strategy, so that losses can be controlled quickly and profits can be protected. This money management strategy will become part of the trader’s overall system. The more reliance placed on this system, the more objective an approach the trader will have towards the markets and trading. Before even entering into a trade, the amount of capital that the trader is willing to risk on that particular trade, should be decided. This means a disciplined use of actual or mental stop-loss orders.
  4. 4. Additionally, you should be prepared to protect your profits to some extent, but that will depend on your time-frame and trading style. A long-term trader for example, will usually be more prepared to give back profits in order to remain in the longer price trends. Short-term traders however, may use tight stop-loss orders to prevent erosion of profits. Guidelines for Successful Trading Following are some additional guidelines that may help traders to avoid obvious mistakes: 1. Use money you can afford to lose. If you are undercapitalised or are trading with money you can’t afford to lose, it will be very difficult for you to maintain an objective view of the markets. The first step towards a non-attached trading method is not to be in a situation where you must win. 2. Don’t over trade. Inexperienced traders can easily become over-confident after a number of winning trades. This can lead to over trading, which is particularly dangerous. Learn to be patient and to wait for the most extreme overbought and oversold situations within your trading time- frame. 3. Trust your system No system will give you the ability to trade profitably 100 per cent of the time. But the main thing is that you devise a trading system you are happy with and then stick to it. Changing from one system to another and continually changing the rules and boundaries of your system, will only lead to a complete lack of confidence. 4. Don’t try to pick market tops and bottoms Your aim as a trader, should be to pick the major movements, rather than the absolute tops and bottoms. Trying to pick these extremes can often mean going against trends, which makes you vulnerable. Wait for confirmation that a market has turned. 5. Cut your losses, let your profits run As difficult as it may be, you have to learn to be very impatient with losing positions and to resist the temptation of taking your profits too early. Novice traders often lose money hanging on to a losing position and yet are quick to take profits - afraid that they will disappear. 6. If you get into a losing streak, take a breather When things just aren’t working, scale down your trading or even take time out to regain your confidence and an objective view. A period of time away from the markets can be refreshing and recharging. 7. Build a pyramid when adding to a profitable trade It is easy to get over-confident and double up on a profitable trade. Instead, you should reduce the number of contracts each time you add to a position. If the first trade was ten contracts for example, the second should not be more than 8 contracts and the third, no more than 6 contracts. An upside-down pyramid is likely to fall over. 8. Never add to a losing position Adding to a losing position or averaging down is very dangerous. It occurs sometimes when traders refuse to admit their mistake. 9. Never reverse your position Reversing a position immediately is also dangerous. Take some time to review the situation without an open position before you jump back in. 10. The trend is your friend As obvious as this seems, many traders will watch a market trend in one direction and then when it stops trending and enters a sideways pattern, they will open a trade. 11. Don’t risk your entire trading capital on one trade If you intend buying ten contracts for example, you may buy five and then add to the position with another five after the market has moved in your favour. 12. Making money is more important than being right Many traders seem to get more satisfaction from correctly predicting the markets than they do making money. If you find yourself regularly
  5. 5. imparting market predictions, telling everyone your views and your positions then you should ask yourself if you are trading to make money, or to be seen as a market guru. If you are a trader, then no one needs to know your views or your positions. Your profits alone are the best measure of how successful you are. 13. Maximise the size of profitable trades rather than the number of profitable trades The size of a trader’s profits is far more important than the success rate. Even a trader that makes 60% losing trades and 40% winning trades, should be profitable if strict money management is adhered to. 14. Avoid market orders Traders should aim to enter orders with specific price limits to encourage a disciplined trading strategy. This will depend however, on the time-frame a trader chooses. 15. Always use stop-loss orders, but use them carefully. The disciplined use of stop-loss orders, whether they are actual orders placed with your broker or self-imposed limits where you cut your losses, is an essential part of any successful trader’s system. But it is important not to place stops to close to the market volatility. Deriving a stop level that is not too large and yet is not too easily hit, is difficult and will need to be related to your own individual system. 16. Don’t favour the long position Don’t get into the habit of favouring either long or short trades. Markets often fall faster and stronger downwards than they do upwards, so always be prepared to go short. 17. Find or develop a system that suits your personality The type of system you use should depend on your own personality and the type of trading that suits you. Some systems will require large stop- losses and therefore are better suited to the longer-term trader. A purely mechanical system, where no judgment is involved, may suit the trader who finds it difficult to maintain objectivity. 18. Learn to be responsible for your actions You must learn to be full responsible for your actions as a trader. If your system is based on a market newsletter or your broker’s advice for example, you must accept responsibility for losses that may occur. 19. Learn to treat trading and the Markets with detachment One common characteristic amongst successful traders, is that they are often emotionally detached from trading and the markets. Fundamental vs Technical - A Trading Example Technical and fundamental analysis are considered the two main methods used by traders and market analysts as a means of predicting the future direction of prices. Technical analysis involves the use of charts which graphically portrays prices, volumes, open interest and other relevant indicators concerning a market. There are several different methods of technical analysis including the study of chart patterns, moving averages, strength/weakness indicators, Elliott Wave analysis, Gann analysis etc. There are many books available on these specific topics. Fundamental analysis on the other hand, involves the study of basic underlying factors which affect the supply and demand and therefore prices in a market. A trader using fundamental analysis may look at average price/earnings ratios, dividend yields, fiscal and monetary policy and other economic indicators. A basic example of a technical system may be the use of moving averages. A trader may use daily closing prices of the Share Price Index contract for example, to construct two moving averages - a 15 day moving average and a 20 day moving average. These two figures are then overlayed on the daily SPI price chart. In the event of the 15 day moving average crossing above the 20 day moving average, the trader may buy. If the entry price was say 1750, a stop loss order would then immediately be placed at say 1735 so that if the market were then to fall to this level, the losing position would be closed automatically by the broker. If the market were to rise however, the trader could then use the moving averages as a means of exiting the trade. If for example, the 15 day moving average crossed below the 20 day moving aerage, the trader may sell and thereby close the profitable position. Stop loss orders can also effectively be used to exit a profitable trade or prevent profits from eroding. In the
  6. 6. above example, if the price were to rise to 1790, the trader may place a stop-loss sell order at say 1775, to protect unrealised profits and also allow the market to move higher. This basic example provides the essential ingredients for a successful trading strategy; a well defined method that indicates when to open or close a trade, along with disciplined money management that includes the use of stop-loss orders to limit the size of losses and protect unrealised profits. The Nature of the Markets, Contrary Trading and Self Awareness There is a common observation in stock and futures markets that is relied upon by many successful traders. This observation is that markets will form major tops when the surrounding news, outlook and consensus is most optimistic or bullish and major bottoms when the news and consensus is most pessimistic or bearish. An explanation for this is that at these extreme levels, the chance of a reverse in direction is far greater than a continuation in the existing trend. In terms of supply and demand, you might say that at the top of a bull market, everyone who can be long, already is. As a result, there is an insufficient weight of funds to significantly add to the long side of the market. Some traders explain this principle by saying that the markets travel the path of ‘least resistance’, which is usually (but not always) contrary to the general consensus. Accepting this observation of course is one thing, but learning to objectively measure consensus and act contrarily is far more difficult. Often the trader believes he is acting contrary to the general consensus, when in fact he is just doing what everyone else believes is contrary. This again comes back to being objective, open-minded and detached from your trading. Detached that is, in terms of your emotions and ego. If you are trying too hard to be contrary or to trade at all, then you will probably loose your objectivity. It is well known that most traders are wrong most of the time. Yet it is difficult to accept that if you are a member of the trading community, then chances are that most of the time, your judgments are going to be mostly wrong. But if you learn to be aware of your emotions, feelings and thoughts when you are trading, you can actually use this to your advantage. This doesn’t mean that every time you are bullish, you do the opposite and go short. But it does mean that you need to watch your own feelings and thought process as your trade. Some traders describe this as if they were outside themselves, watching their own mind work as they trade. This is detached, open-minded and objective. Why is Successful Trading so Difficult Ultimately, an experienced trader should be aiming towards an absence of emotions such as fear and anxiety. But initially, these emotions can be used to the trader’s advantage, if the trader is self-aware. Often these negative feelings can be associated with the most profitable trades - hence the saying: “If it feels wrong, do it”. In the case of trading, if an intended action feels wrong, it can often be the best thing to do. What really makes trading so difficulat therefore, is that it contradicts our normal or typical way of thinking. In many respects the trading environment is different to our normal life in that in order to succeed in most things, we must be in full control. To gain that control, we force something outside of ourselves to conform to our expectations, ideals or ways of thinking. This attitude for trading however, can be quite disastrous. A trader cannot fully control prices or the direction of the markets and will nearly always lose if a fight or battle against the market is involved. The solution is simply to let the markets do what they want to do and to take full advantage of price trends as they occur. If the trader is fighting or trying too hard, there is something wrong. Finally, as Mark Douglas says in his book “The Disciplined Trader: Developing Winning Attitudes”, your degree of success and profitability as a trader will be directly related to your own self-esteem and self-judgment, based on a value system you have learnt or acquired during your life. Traders must therefore concentrate on building self-esteem and self-confidence.
  7. 7. Traders often begin their trading career believing that the battle is against the markets. But gradually they realise the battle in fact, exists within themselves.