A Tribute To A Wall Street Nostradamus

Dow down 34, Nasdaq down 3. Hilarious. Looks like continued piss-poor performance out of the markets. Todays action came hot off the prediction wire from last week and left little, if any movement. I still remain bearish...but monitoring the markets as if my week depended on it. It will for sure ruin my week to be on the wrong side of a rally. Here is the snapshot...as you can see nothing to get aroused about.

VIP AUG 45 calls $2.00 trading at $3.50
LRCX Aug 40 Puts $1.60 trading at $1.00
RYL Aug 40 puts @ $1.40 trading at $1.15
WHR Aug 75 puts @ $1.05 trading at $1.15
AZO Aug 85 puts @ $.95 trading at $.75
RHAT Aug 22.5 puts @ .60 trading at $.40

Here are a few price patterns I planned on presenting tomorrow morning...

THE- Descending Triangle
CTSH- Emerging Ascending Triangle
IFIN- Double Bottom

For those who want to participate in an experiment, I am seeing a lot of Ascending Triangles happening at the bottom of intermediate downtrends. Take UPL, BUCY, LUFK, and WIRE to name a few. Im too picky to trade them, but I'll track them to see how location of a pattern can affect the probability of a profitable outcome.

See you tomorrow

Monday Morning

What a great weekend! Hopefully everyone feels the same. One of the highlights of my weekend is that I got to spend time with my daugther Kaylee. She wanted to go golfing with me on Saturday, so I let her drive the cart and hit a few balls along the way. Now she wants a set of clubs and wants to take lessons. She's only 6, but I think this will be a great opportunity to spend more time with her. We must have been on the course for about 3 hours total between the driving range, and playing the back 9 , and never mentioned how boring it was or complained at any time. We had a few laughs and spend some quality time together. Great times.

I like to start the week off on a positive note. Reflecting on positives puts my mind in a positive energy environment. When I am thinking positive, I am feeling positive. This takes my mind off of the fear of what I do for a living. Everyone has a slight fear of trading. Perhaps not trading itself, but a consequence of trading. Take losing money for example. People fear more from a dollar lost, than joy from a dollar gained. If you can find a way to re-wire this thought process, trading will become more of a discipline and a non-emotional approach for you. This is why I try to start off positive and be in a positive state of mind.

This morning I bank rolled a few puts on Redhat (RHAT). It might be premature, but if I am wrong it will be very small. The market has remained down just a few points all morning. Not a huge drop, but I am still riding the bear-mobile.

Stay tuned...


Mark Cuban is my hero

If anyone wants an outstanding idea for hedge funds, read this article...


In this article, he mentions..."I have learned that despite all the claims and books written about efficient markets, the trading of individual stocks are not efficient. There are always people trading on better or worse information. There are always people trading on emotion rather than logic. There are always people trading on hopes of the big hit. What Peter Lynch would call the “10 Bagger”. They were gambling. Nothing more. Nothing less."

Anyone care to disagree? Have you ever stopped to think about who is on the other side of that trade you place? You are thinking one thing, while the otherside of that trade disagrees. Which of you have the best information on the probability of the outcome?

He brings up a very interesting comparison I must say. The question is, do the geniuses punch in on Wall Street, or do they live in Las Vegas?

Bear Trap

Today does not change my opinion on the market in the least. In fact I hope this is not causing traders to close bearish positions. None of the bearish trades I am in have triggered my exit signals, so I just take a deep breath and realize that in order to get to tomorrow, I need to make it through today. Earlier in the week I mentioned there was the potential for the Dow to make an equivalent high at around 11200. Notice how todays action takes us right to this level. If the Dow breaks higher and closes there, then I might reconsider my posture. Here is a snapshot of the Dow....

We'll take another look as of the close today, but I still feel comfortable anticipating the retracement at the moment. The advance/declines today is also not in my favor, but by the close I bet it looks quite a bit better. RHAT is hesitating, and will likely hop in on Monday morning before the market crash. I found a few others to watch for puts...BRL, COH, and RTI. Beautiful downtrends, and almost right for the taking.


This week in a nutshell

I tool a few off this chin this week. I am a better man for coming out with it and getting it off my chest. I take it in stride and embrance losing like it was a distant relative. Most of my trades were closed this week, and all I am left with is VIP, LRCX, RYL, WHR, AZO, and a mountain of unread e-mails.

Here is the lineup in case you were wondering...

VIP AUG 45 calls $2.00
LRCX Aug 40 Puts $1.60
RYL Aug 40 puts @ $1.40
WHR Aug 75 puts @ $1.05
AZO Aug 85 puts @ $.95

Now that we have cleared that up...I am still watching RHAT and I will find more prospects in the morning. After I sleep this day off, I will provide a more interesting post tomorrow.

Today's Campaign: INDECISION

I must say I am quickly shifting from short term bullish, to short term bearish. Most indicies are nearing levels of resistance, and this ends up being two days now of indecision and still waiting for a short term directional confirmation. As I watch the market move slowly from positive to negative, am am slowly closing out a few bullish trades, and entering bearish trades.

As of last night, I discussed bearish plays such as RHAT, AZO, WHR, and RYL. They each looklike decent potential set-ups, and I took positions in all but RHAT...still waiting for a better looking entry.

I'll post again after the close.


Master Talk Presents...William Eckhardt!

“One adage that is completely wrongheaded is that you can't go broke taking profits. That's precisely how many traders do go broke. While amateurs go broke taking large losses, professionals go broke by taking small profits. What feels good is often the wrong thing to do. Human nature does not operate to maximize gain but rather to maximize the chance of a gain. The desire to maximize the number of winning trades (or minimize the number of losing trades) works against the trader. The success rate of trades is the least important performance statistic and may even be inversely related to performance. Two of the cardinal sins of trading - giving losses too much rope and taking profits prematurely - are both attempts to make current positions more likely to succeed, to the severe detriment of long-term performance. Don't think about what the market's going to do; you have absolutely no control over that. Think about what you're going to do if it gets there. It is a common notion that after you have profits from your original equity, you can start taking even greater risks because now you are playing with "their money". We are sure you have heard this. Once you have profit, you're playing with "their money". It's a comforting thought. It certainly can't be as bad to lose "their money" as "yours"? Right? Wrong. Why should it matter whom the money used to belong to? What matters is who it belongs to now and what to do about it. And in this case it all belongs to you.”

If you are not familiar with who this gentleman is, hurry and find out. A small wager between two traders back in the early 80's (William Eckhardt & Richard Dennis) started an amazing adventure that would change how the make-up of a trader was viewed. They started a group known as the "Turtles." The Turtle experiment proved that you did not need a doctoral degree in mathematical logic to win. In fact, it proved anyone can become a trader.

The quote here ought to lead to an eye opening event in tonights presentation. I myself have always said that it is VERY possible to "go broke taking profits." Tonight I have an exercise you can all participate in to prove this point.

See you then!

When All Else Fails....Buy Oil

It seems the Oil Index & the Pharmaceutical Index are the only things currently on the rise. It looks like that bull run is coming to a hault here soon. If you are bullish on the market keep a close eye on drugs and oil. It appers most of the major indicies are nearing resistance levels.

As I head into my weekly Master Talk presentation tonight, I will have a little more of a bearish posture on the market. There are a ton of bearish set-ups that I came across only in about 20 minutes of searching. A few I am going to research a little further are...Homebuilders (again), RHAT, CECO, BBBY, IDXX, THE, RYI, AZO, and WHR. Not a ton of Bullish set-ups...EZPW & CRDN may be interesting... and HANS just became optionable (finally). Im adding it to my watchlist.

I'll be back in a minute...


A Daytraders Dream, A Trend Traders NIGHTMARE!

Does anyone out there happen to be a daytrader?

Not me. I could never hack it as a daytrader. If you have not already, outline your strengths and weaknesses. Not just as a trader, but as a person as well. This will really help you understand what type of a trader you should be. Years ago when I was trying to define how I should trade, I went through a similar exercise. I found out I was an agressive personality, impatient, liked to see results quickly, and thrived off variety. So I defined myself as a short term (as short as a couple days to as long as a couple weeks) aggressive trader. Aggressive, meaning I prefer to swing for the fences with my option trades. They are usually low probability but high reward trades. This also means I strike out a lot. With a solid money management approach, I am able to balance bigger winners, against many smaller losers.

Where am I going with this? Today's market action was interesting to say the least. I watch the guys around me that daytrade, and see how they are loving the opportunities...then compare them to the longer term traders who are breaking out in a sweat because they are not able to make heads or tails of it.

Are you the person sweating, or the person going hog wild today?

If you watched the market today, you saw a lot of volatility. Intra-day movements like this that are out of the norm, offer great trades for someone scalping points on an index or high priced equities. Looking at the 1 day chart of the S&P, you can see some pretty big swings.

If watching the market move on a day like today causes emotional reactions, stay away! Don't feel compelled to watch the market during the day. We all know that intra-day moves mean very little compared to where a stock closes on the day. However, if you see potential in days like today, or think you have an eye for moves like this, why not practice day trading?


A Tribute To Market Wizards

I have always been under the assumption that if you are trying to learn a new skill, or really want to accel in a subject, that you surround yourself with individuals who have mastered this skill. Since we are all trying to learn how to become better traders, each week I read a quote from someone who is considered to be a master of this skill. Jack Schwager is the author of a series of books (Market Wizards, New Market Wizards, Stock Market Wizards, etc.) in which he conducts interviews with these "Market Wizards." Here is a running list of the quotes I have used in my "Master Talk" presentations every Wednesday night and their respective authors.

“You have to be willing to make mistakes regularly; there is nothing wrong with it. Michael Marcus taught me about making your best judgment, being wrong, making your next best judgment, being wrong, making your third best judgment, and then doubling your money.”
“Whenever I enter a position, I have a predetermined stop. That is the only way I can sleep. I know where I'm getting out before I get in. The position size on a trade is determined by the stop, and the stop is determined on a technical basis. I never think about other people who may be using the same stop, because the market shouldn't go there if I am right.”
“Place your stops at a point that, if reached, will reasonably indicate that the trade is wrong, not at a point determined primarily by the maximum dollar amount you are willing to lose.”
“If you personalize losses, you can't trade.”

~ Bruce Kovner

“The word 'trading' is not the way I think of things. I may be a trader in the sense that my frequency of transactions is relatively high, but the word 'investing' would apply just as much, if not more. In my mind, trading implies an anticipation of a sale at the time of purchase. Good trading is a peculiar balance between the conviction to follow your ideas and the flexibility to recognize when you have made a mistake. The balance between confidence and humility is best learned through extensive experience and mistakes. There should always be respect for the person on the other side of the trade. Always ask yourself: Why does he want to sell? What does he know that I don't? All great traders are seekers of truth. The markets are always changing, and the successful trader needs to adapt to these changes.”

~Michael Steinhardt

6.15.06 (AIT)
“If you can't take a small loss, sooner or later you will take the mother of all losses. There are old traders and there are bold traders, but there are very few old, bold traders. Dramatic and emotional trading experiences tend to be negative. Pride is a great banana peel, as are hope, fear, and greed. My biggest slip-ups occurred shortly after I got emotionally involved with positions. I prefer not to dwell on past situations. I tend to cut bad trades as soon as possible, forget them, and then move on to new opportunities. The elements of good trading are: 1. Cutting losses, 2. Cutting losses, and 3. Cutting losses. If you can follow these three rules, you may have a chance. Trying to trade during a losing streak is emotionally devastating. Trying to play "catch up" is lethal. I set protective stops at the same time I enter a trade. I normally move these stops in to lock in a profit as the trend continues. One evening, while having dinner with a fundamentalist, I accidentally knocked a sharp knife off the edge of the table. He watched the knife twirl through the air, as it came to rest with the pointed end sticking into his shoe. "Why didn't you move your foot?" I exclaimed. "I was waiting for it to come back up," he replied. Losing a position is aggravating, whereas losing your nerve is devastating.”

~Ed Seykota

“Throughout my financial career, I have continually witnessed examples of other people that I have known being ruined by a failure to respect risk. If you don't take a hard look at risk, it will take you. If you argue with the market, you will lose. It is incredible how rich you can get by not being perfect. Never risk more than 1% of your total equity in any one trade. By risking 1%, I am indifferent to any individual trade. Keeping your risk small and constant is absolutely critical. I have two basic rules about winning in trading as well as in life: 1. If you don't bet, you can't win. 2. If you lose all your chips, you can't bet. Frankly, I don't see markets. I see risks, rewards, and money.”

~ Larry Hite

“I realized that every time I had a loss, I needed to learn something from the experience and view the loss as tuition at the College of Trading. As long as you learn something from a loss, it's not really a loss. Stop looking at losses as problems and start viewing them as opportunities to elevate yourself to the next plateau. Develop the concept of never taking a trade that would jeopardize your ability to continue trading. I manage to stay composed because I know that the risk and volatility in my portfolio is exactly the same as it was yesterday, last week, and last month. So why should I let my emotions go up and down if I'm in exactly the same exposure all the time? Think of each trade as one of the next one thousand trades you are going to make. If you start thinking in terms of the next one thousand trades, all of a sudden you've made any single trade seem very inconsequential. Who cares if a particular trade is a winner or a loser? It's just another trade. I think investment psychology is by far the more important element, followed by risk control, with the least important consideration being the question of where you buy and sell.”

~Tom Basso

“I turned from a loser to a winner when I was able to separate my ego needs from making money. When I was able to accept being wrong. Before that, admitting I was wrong was more upsetting than losing the money. When I became a winner I went from 'I figured it out, therefore it can't be wrong' to 'I figured it out, but if I'm wrong, I'm getting the hell out, because I want to save my money and go on to the next trade.' By living the philosophy that my winners are always in front of me, it is not so painful to take a loss. If I make a mistake, so what! My attitude is: Never risk your family's security. Whenever you get hit, you are very upset emotionally. Most traders try to make it back immediately; they try to play bigger. Whenever you try to get all your losses back at once, you are most often doomed to fail. After a devastating loss, I always play very small and try to get black ink, black ink. It's not how much money I make, but just getting my rhythm and confidence back. Before taking a position always know the amount you are willing to lose. The most important thing is money management, money management, money management. Anybody who is successful will tell you the same thing. I always take my losses quickly. That is probably the key to my success. The best advice I can give to the ordinary guy trying to become a better trader is learn to take losses. The most important thing in making money is not letting your losses get out of hand.”

~Marty Schwartz

It would appear that the market held it's gains today. What is most interesting about today is the market breadth. Today's advance/declines on the NYSE was nearly 5:1!!! I still feel the market is trendless, however watch this week for the market to test prior highs (Hence the predominant bullish positioning this week.)

Im updating my positions. I closed RHAT at the bell for .40 per contract (thanks for the sweet reco Kelly!), and entered VIP 45's for $2. Here is an updated list...

VIP AUG 45 calls $2.00 --------closed at $2.10
FTO Aug 32.50 calls $2.00 -----closed at $2.40
MNI AUG 40 Puts $1.00 ---------closed at $0.90
LVS Aug 75 calls $2.10 --------closed at $1.95
LRCX Aug 40 Puts $1.60 --------closed at $2.40
GRMN Aug 90 calls $8.50 -------closed at $12.20

Thanks for listening.

A Modest Comment by a Modest Man

I was right.

Thus far the market is rallying strong. Could this be another head fake? We'll see. Whatever this movement is, I am glad to see the position in GRMN up $5.50 this afternoon, since today was going to be a day we might have gotten out. Here is another trade I placed this morning...

Symbol: FTO
Trend: Uptrend, support bounce.
Target: Earnings Announcement on 8/7
Trade: Aug 32.5 @ $2
Why?: Ride a little price & volatility move up to earnings.

I'll be in touch...


As I hose down my office from an interesting week, I wish to leave a few thoughts behind before I sleep them off. Extreme markets call for extreme measures, so I had to dig deep into my goodie bag in preparation for next week. Here are a few things I am considering...

Stock: GOOG
Trend: Symmetrical Triangle reversal
Target: ???
Trade: OTM puts....Aug 350's perhaps? If it remains above it's 200 day, perhaps calls?
Why: Why is volatility increasing AFTER an earnings announcement? Have you seen this monster triangle pattern that is forming, or should I say that has finally broken. I'm not going to aim for an unrealistic target price, but there should be some residual continuation to catch as the stock falls. If you are not so sure, wait for a re-test! After all, there is a little hesitation as it attempts to break it's 200 day average.

Stock: VIP
Trend: Symmetrical Triangle Pattern
Target: $13 move upon a breakout
Trade: OTM calls or put depending on which way it breaks
Why: The pattern looks too pretty to ignore. This stock has amazing fundamentals and an awesome PE...Did I say that out loud?

Stock: RHAT
Trend: Downtrend, resistance bounce
Target: $20ish
Trade: Aug $22.50's @ $.70
Why: Nice risk reward if the stock makes a lower low.

Stock: MNI
Trend: Downtrend, resistance bounce
Target: $36ish
Trade: Aug $40's @ $1.00
Why: I normally don't trade ATM, but if this stock makes my predicted move, this option is too cheap to pass on.

Other considerations: I closed out of LVS for a nice loss today. It triggered a mental stop as it plowed through support. I will give GRMN until Monday to get right, and if not Im closing it also. LRCX is still doing well and still on it's way to our target. Also keep an eye on BBI as it continues to work that lovely channel, watch OIH to stay above $130 for a nice bounce, and BA in case it breaks support.

I have a feeling the market will rally next week....

Until then, have a coke and a smile!


"Two For The Money" How gamblers and traders can relate to one another

My therapist tells me to take random things and relate them to trading. Yes, I have a therapist...mind your own business. I was watching this movie titled "Two for the money," and there was a scene in the movie I was fascinated by. I got a copy of the script and here is the scene I am referring to (I edited the language).

WALTER: We're here for the gambler's anonymous meeting...
INT. MANHATTAN APARTMENT - DAY The GROUP sits in a circle, listens as a BUSINESSMAN, near tears, gives his testimony.

BUSINESSMAN...I mean you'd think with two mortgages out, repo guys staking out my car, my job on the line and my wife threatening to leave, you'd think I'd have the brains to stop, instead of staying in the chase, doubling down, which of course is what I did...I know I'm sick because I keep thinking if I just pulled that game out then I got a lock on the parlay and I'm flush going into Monday night and-- (breaking down, unable to continue)

MEMBER #1... It's a disease, Leon.

MEMBER #2 Admitting you have a problem is the first step.

BUSINESSMAN/LEON Then I guess I'm doing pretty good because I got one big $@#%* problem. Someone claps. Everyone joins in. LEON smiles. Warm beat. WALTER suddenly stands. BRANDON watches, concerned.

WALTER: My name's Walter. I'm new to the group. (various "hellos") Hi. I've been going to meetings like this for 18 years. Once a week, every Friday night, for 18 years. This, my friends, is my 936th consecutive meeting. (enthusiastic applause) Thank you. Thanks. And my hand to God, I haven't been to a track, casino or bet a game that whole time. Not a cent. (murmurs of approval) I've listened to thousands of sob stories by people like Leon here, and I gotta say, Leon -- if I learned one thing it's that gambling is not your problem.

LEON: It's not?

WALTER: Not even close. You're a lemon. Like a bad car, there's something inherently defective in you. And you. And me! All of us here-- we're lemons! Big, juicy, acidic, ice-tea flavoring lemons! We look like everyone else but we're defective because when most people make a bet they want to win, while we, the degenerate gamblers of the world, we're subconsciously playing to lose. All humans like going to the edge of the abyss, but what makes us different is we go all the way and hurl ourselves off into the void! And we like doing it so much we do it time after time after time! Me? I always felt most alive when they were raking away the chips, and every one here knows what I'm talking about. People like us, even when we win, it's just a matter of time before we give it all back. But when we lose, and I mean the kind of loss that makes your ^%$& pucker to the size of a decimal point, there's a moment when you're standing there and you've just recreated the worst possible nightmare this side of malignant cancer for the 20th damn time and you suddenly realize -- hey, I'm still here, I'm still breathing, I'm still alive! In order to really live you have to be aware of your own mortality -- and a losing bet of a certain size is one of the best ways. I know of getting that feeling. When you win, you defy death,but when you lose, you survive it, and that's remarkable! Us lemons, we mess things up on purpose! We need to constantly remind ourselves that we're alive! Gambling's not the problem, Leon, your messed up need to feel something, to convince yourself you exist, to test what's really real, that's the problem!

BICYCLE MESSENGER: Hey! You're the guy I see on tv every weekend selling bettingpicks!

WALTER... Yeah. So?

BICYCLE MESSENGER: This guy peddles a tout service on tv.

WALTER: Check the charter, buddy, we all left our jobs at the door.You gonna toss an ex-alcoholic bartender out of an AA meeting? WALTER(handing out business cards) -- Here's my card -- we're topping 80 percent this season -- put it in your wallet, in case you fall off the wagon --

"Walter" is played by none other than Mr. Al Pachino. What fascinated me about this scene was how it applies to trading psychology. In my opinion, the hardest part about trading is not learning all the technical analysis, it's not learning all the different markets, nor the little nuances about the business. It is dealing with your emotions. Staying motivated, keeping a healthy mind, coping with losses, staying focused, avoiding self-doubt, etc. (Now you can see why I consult a professional) This is hard work! In the script above when Walter mentions that it's not Gambling (Trading) that is the problem, but that it is something on the inside that is inherently wrong with us, something inside me said "Ah-Ha!" I can recall all the bad losses I've taken like they happened yesterday, and how I felt afterwards. Why do we feel more pain from a dollar lost than joy from a dollar gained?

I guess the reason I felt compelled to share this is to preach about trading psychology. We are all going to lose money. You might want to expect this going in, plan for it, that way it never gets to the point of wiping you out. The next time you approach that bet, and you lose, remind yourself why you trade. What made you get into this business? Why do you put yourself through this?

Think of that loss as one loss out of the next thousand trades. Seems inconsequential doesn't it? I preach about a 285% year last year. Seems amazing doesn't it? What most people don't know is I only made money 35% of the time I traded. Imagine having to cope with that mentally, knowing that the probability of sucess on this trade is slim. My advice to you would be to continuously work on coping with handling losses. Stay positive! None of us have a crystal ball, but some of us manage to stay in the game when others don't. There are plenty of resources on trading psychology. I suggest you put a lot of effort into bringing a positive attitude to the table, and shrugg off a loss as if you knew it would happen, and it was all a part of your learning experience and your greater plan of becoming a better trader.

Looking to take a stance on the market? Me neither.

I must say I do not trade the market (typically). There are times when it is a no-brainer to buy calls or puts on a trend, but how often do you see a no brainer trend? As I fell out of bed this morning to turn on CNBC, the awakening results made me laugh. What a nice follow up to what could have been a nice reversal in the market. I must admit, the double bottom formation blinded me from the reality of my surroundings. We are still in earnings season! So this is a great example of why it is so rare to find index positions in my account. Is there any rationale to the way the market moves? Like I mentioned earlier, this is why I wait for the no-brainers.

I mentioned yesterday that I was watching a few stocks that came out of my search. All of them bullish. So I added a few trades...

Symbol: LVS
Trend: Uptrend, Bull Flag Pattern
Target: $77
Trade: Bought Aug $75's @ $2.10
Why: Earnings on the 31st, IV increasing, anticipating a break of this flag. I doubt this one hits my target by the 31st, but a good surge of Implied Volatility and a decent move upward ought to yield a decent profit.

Symbol: LRCX
Trend: H&S Reversal Pattern
Target: $32ish
Trade: Aug 40's @ $1.60
Why?: Enormous volume confirmation on todays support break.

I also closed out of my position in GOOG today. I was riding the volatility wave up to earnings. My wave ended up being less than a ripple. However, my Sept 450's closed out at $8.80, when I purchased them at $8.20 about three weeks ago. What is even more interesting is that the stock has dropped about $12 from when I purchased these calls. This is why I love options!


Creating Trading Rules & Trading Systems

This is an article I posted on the INVESTools site last week. It helps an entry level trader know what to take into consideration when deciding on what your "rules" or "apporach" will be. Take a look!

Creating a Trading System & Trading Rules

By Jeff Kohler
PHD Coach / Master Talk & Trading Rooms Instructor

In this weeks article I want to tackle the topic of developing trading systems and trading rules. Before we start this journey, I want to remind everyone that if you have not had success trading the initial system you purchased from INVESTools, you might want to review all of its rules and signals to make sure there were no misunderstandings along the way, and keep practicing with it until you get positive results. If you were not able to follow a system successfully, should you be trying to create one? Many of you have benefited from the INVESTools method, and based on your experiences, you have ideas of how to optimize its performance and produce better results. This is where the process of building a system and personalizing trading rules begins. You must arrive at an idea or a concept to get started. Through this article, I want to use a few examples and create a set of “mock rules” to give you an idea of how the process works.

General Principles
When coming up with a system or trading rules some of the elements you need to consider are…

A simple yet robust system- Come up with something easy to follow that generates good results.
Risk- understanding how risk plays a role in this, and determining how much you will risk per trade.
Longevity- Find something that will work no matter what the market encounters over the years.
Stock Selection/Diversification- Create a system that can apply to any stock, or only the specific stocks you trade.
Entry & Exit Signals- Create specifics to enter & exit. Test these methods to ensure their results.
Stop placement- Have exits planned for any scenario.
Record Keeping- Keep records of what you trade and why. This will also help create new rules and modify existing rules when needed.

Depending on how far you want to take this, you can add on as many topics to the list above that you wish. The more thorough your list is, the more systematic your trading becomes, and the more reliable your results can be.

What do you want to risk?
Most traders will confess that this concept is more important than the system itself. You need to develop an easy to use method for managing your risk in your trading. If you are not applying risk management now in your trading, do not delay this any further. Let me give you an example you might have read in your materials.

We teach our students to use a fixed percent of risk when they trade. Most will agree that 1-2% is an acceptable range to use. Let’s assume we have a $100,000 account value to trade with. Using a fixed percentage of risk would mean putting 1% ($1000) at risk per trade. This means that even if the trade goes completely against me, I would only lose $1000 per loss. (This does not mean I spend only $1000, this can mean I spend $5000, but set my stop so that I only lose $1000.) If you keep your losses small, you will give your winners a chance to outpace those losing trades.

Let’s translate this into a trading rule! Determine your risk management plan and follow it. Here are some examples. These might not apply to you, so when creating your own, make sure your rules follow your personal risk management plan.

Only put 1% of my account value at risk in an entire trade.
Only use 10% of my account to trade riskier investments such as options.

What types of stocks do you want to trade?
To some this is a very vague question, however a very important one. You need to establish guidelines of the quality of stocks you will select to hopefully lower your risk in a trade. This encompasses the fundamental quality of the stock, the industry group quality, the trend, etc. Some of the categories may or may not be important in your eyes, but focus on the ones that are. Here is a sample of items you might want to consider when answering this question.

Fundamental quality- Does the fundamental quality of the company matter to me? How do the scores look, do they meet my minimum criteria? (Ex. MG-Zacks of 3.25 or higher)
Technical quality- Is this stock in the right trend? Where does the price fall in relation to support & resistance?
Industry group quality- How does the stock measure to the industry? How does the industry measure against the market?
News & upcoming events- Are there any upcoming earnings announcements or news events that might affect the trade?
Diversification- How do I diversify myself? Do I trade similar stocks? Should I have trades in multiple groups? Should I consider ETF’s? Can I be both bullish & bearish in my account at the same time?

Let’s translate these criteria into rules! Here are a few examples.

Look for a Phase 1 score of 5 or better, and an MG-Zacks score of 3.25 or higher.
Stock must be in an established uptrend for the last two months, and have at least two touches each on a rising support and resistance line.
I must inspect the trend on a 5-year chart, then on a 1-year chart to see the bigger picture.
The stocks industry group must be in an uptrend.
I must inspect news and check when upcoming earnings announcements are scheduled.
Do not trade stocks that are too highly correlated. Consider ETF’s as an alternative to trading many stocks in a group generating the same trading signal.

Remember, these are only examples. When creating your rules they can be more specific, or less specific. They can be more restrictive, or less restrictive. Consider that the more restrictive you are, the less trades you will find. The more specific you are, the more systematic you will become.

Entry & Exit Signals

This can be a daunting task. There are many combinations you can use, various indicators to utilize, etc. Keep in mind the objective in this task. You are trying to find an entry point in the stocks you are watching, and you are trying to determine where you will get out of the trade. Before you start on the specifics, you need to come to terms with the type of trader you want to be. Are you going to trade the trend of a stock, and stay with that trend until the trend fails, or are you the short term trader who wants to trade short term movements in the overall trend? Once answered, this will be one of the more important questions you will answer about your trading approach. As we determine our rules, consider the following:

Anticipate or confirm? - Am I anticipating a movement from the stock, or do I wait until the move happens, and is confirmed by my indicators? Do remember that waiting for confirmation from your signals is conservative, has a higher probability of success, yet lower reward potential. Anticipating movements is more aggressive, has a lower probability of success, yet a higher reward potential.
Establishing a trend? - Does the trend matter in this trade? If so, should this trend be established over a minimum period of time?
Support & Resistance- Do I get in as the stock bounces off support, or breaks above resistance?
Indicators- What indicators should I use to generate buy & sell signals? Should I use the indicators conservatively (confirmation) or aggressively (anticipate)?

Let’s create some sample rules based on the topic above! Here are a few examples:

Make sure I am trading with the direction of the trend. The trend must consist of at least two higher highs, and two higher lows.
Wait for the stock to bounce off a recent support level. Determine the distance between support & resistance and make sure the distance is enough to justify the trade.
Using a MACD and Stochastic, wait for both indicators to be low and turning upward. As they change direction and the stock confirms support, take a position with the prevailing trend.
Aim for upper resistance as my target price. Plan for an exit at my target price, however if the MACD and Stochastic start to head down before reaching my target take profits at this time.
Upon entry, if the stock breaks support at any time, exit the trade.

Where should I set my stops?

Bruce Kovner, a very successful trader who was interviewed in the book “Market Wizards” says, “Place your stops at a point that, if reached, will reasonably indicate that the trade is wrong, not at a point determined primarily by the maximum dollar amount you are willing to lose.” Some traders use support and resistance lines to know where to extent stop orders, some use technical indicators such as an ATR or a parabolic SAR, some use fixed percentages based on the price of the stock or option. There are many ways to do this, so pick one! Here is an example of a trading rule for setting stops.
1. Identify support, and set a stop order 3% below (to allow for intra-day fluctuations.)
2. Set an initial trailing stop order to follow the trade by 10%. For example, if my option premium increases $1.00, my stop order tightens by 10% locking in a portion of the gain.

Final Thoughts

This is a crucial step in your trading. The 15 rules we created here today are basic ideas you might consider as you formulate your own rules. Like I mentioned earlier, these rules can be more specific, or less specific. They can be more restrictive, or less restrictive. Consider that the more restrictive you are, the less trades you will find. The more specific you are, the more systematic you will become. Try to cover most of the elements you will encounter in a trade. I also want you to keep in mind that in order to make sure your system/rules work; they will likely require some backtesting. This means you should take a few stocks going back a few years, and test your rules. For instance if your signal to buy was three green arrows, and your signal to sell was three red arrows, go back on these stocks and see if your approach would have been profitable or not. Your rules may need some adjustments along the way, but these rules are not to be broken. Make sure you know the difference.

MasterTalk follow up from 7/12

Since tonight is my night off from Master Talk, I figured I would review the three trades we took last week to discuss how to handle the trades from here. Last week we made three trades...SHLD, GS, GRMN. Here are the details...
Symbol: SHLD
Trend: H&S Reversal Pattern
Target: $135ish
Trade: Bought Aug 150's @ 7.20
Why: Bear market, bear pattern, beautiful confirmation of the H&S on 7/12, amazing Risk/Reward!

The option hit our target range yesterday pushing this contract to it's high of the day at $15 per contract. If you have not gotten out of this trade as of yet, you might want to reconsider riding the correction here with the market. You'll likely give the majority of those gains back.

Symbol: GS
Trend: Downtrend
Target: $138ish
Trade: Bought Aug 150 puts for $7.50
Why?: Resistance Bounce, bear market, nice risk/reward

GS hit our target price on 7/14. The option would have sold for roughly $12 on that exit we discussed last week. If you are still in this trade and did not get out on the 14th when our stock hit it's target, I would watch how resistance holds up. If it breaks out of the downward channel it is in, I would take the loss at that point.

Symbol: GRMN
Trend: Uptrend
Target: $109
Trade: Bought Aug 90's for $8.50
Why?: Nice re-test of an old resistance level as new support (50 MA as support also). Strong stock, good movements.

The stock has moved nicely in our favor, but I am concerned about the lack of movement on the markets rally today. Everything was up strong today, except this already bullish stock. Sign of weakness? Perhaps. Keep a close eye on this one, this doji may show a sign of weakness and a reason to take our profits. Aug 90's are@ $11.80.

A very nice position to be in going 3 of 3 last week. What is very important in the analysis of these trades is exits. Entry points are easy, but it is closing the trade that most struggle with. Pay close attention to target prices. Use easy to reach support/resistance levels, or average movements to create target prices. This provides a blueprint to follow, and if you do not follow your plans, it is easy to know where to place the blame.

Consider this a rally?

Okay, this time I really mean it. Now that the schedule has lightened quite a bit, I plan on regular postings from here on out. Let's start with a quick outline of what is going on in the market today...

While it is still early in the day, as you look at the graphic on the left, you can see the market is rallying strong. Earlier in the day, Fed Chairman Bernake stated that inflation appears to be somewhat contained and that rate hikes might be reaching their end. Corporate profits from IBM, UNH, BAC, and JPM caused stocks to rally as well while advances vs. declines at the moment are nearly 5:1!!!

I ran my "Anticipating the Bounce" search today and came up with a few watchlist stocks to keep an eye on that look tradeable... CME, LVS, JCOM, TK, PFG, FRO, DSW, and NSS, I'm running these through the system right now and will likely post some trades before the close today.


About me

  • I'm Option Addict
  • From Saratoga Springs, Utah, United States
  • I am a professional trader and an instructor for Investools. I've had relations with the markets for 9 years. Born in Concord, CA, but reside in Saratoga Springs, Utah. Father of THREE, Husband of one.
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