Online Forex Trading

10 Steps To Professional Day Trading

2008-02-03T14:10:00.000-08:00

Everyone trades a little differently. The trading method outlined below is MY personal approach to trading. This method has worked for me for the last 20 years, and has helped me to avoid big draw downs since the mid 1980's. My trading strategy has helped me to make a good living trading.

Here is my 10 Step Approach to Learning My Style of Trading:

1. Practice exiting trades at break-even, using a one-tick target, a two or three tick soft stop (mental stop) and a 1.5 point hard stop. Never *allow* the market hit your hard stop. Exit by moving your target toward your hard stop, not by moving your hard stop towards your target. With time, all of this must become a reflex. You won't always be able to keep your losses down to 2 ticks, but only on rare occasions should you find yourself letting the market hit your hard stop. ("Rarely" means only about once every 50-100 trades after you get the hang of it.)

Even though your entries won't be good enough in the beginning to make a profit trading these tight soft stops, your entries will gradually improve until you turn the corner and become profitable.

Learn exits and entries separately. Don't let the one influence the other.

Taking losses this way takes dedication and discipline, so stick with it. It's the key to confident trading. If you never take large losses (and rarely medium size ones), the fear of loss pretty much goes away, and your confidence grows. Especially after your entries improve enough to support a "scalping" type exit strategy.

2. Every trade *in all market conditions* begins as a scalp. Let me clarify this: if you're in a choppy market and you're looking to get small gains, like a point or so, manage your initial hard and soft stops *exactly* the same way you would in a quick trend or any other type of market. That means keeping losses as close to 2 ticks as possible, taking lots of break even trades and exiting every time the market doesn't give you *instant gratification* (within a minute or so).

No matter what the market is doing, you must demand that it moves in your favor right after you enter, otherwise you get out as close to break even as possible. This means you'll be closing a lot of trades near break-even within the first minute. This is the foundation of learning to trade for consistent gains.

3. Don't worry about the commissions on break-even trades. If you do, you'll hold on to losing positions, begging them to turn around for you. This is called *hoping.* In this business, this type of *hoping* is the kiss of death. Your money-making trades must move your way in the first minute or less. When trades don't act right in the first minute, most of them will hit your hard stops.

So don't get hung up on the fact that your broker loves you. Who cares if he/she makes a living?

Your concern is *limiting losses*. I care more about this than anything else in trading. (Well-timed entries make my tight soft stops possible, so they're almost as important as the exits.)

4. Practice your entries until your timing is so good that you can *reasonably expect* the market to go your way immediately, before it goes more than 2 ticks against you. This is not easy at first, but if you stick with it, you'll get it.

5. Practice fading the emotional extremes on your entries. (Fading means entering in the opposite direction of the market's last move.) When an extreme NYSE-Tick (often above 1000 or below -1000) occurs at the same time the market accelerates into a support or resistance area, look for a price stall or reversal and fade the move. Fade the emotion.

6. Rarely, if ever, *chase* the market on your entries. Wait for a pullback to get onboard a trend.

I favor shorts over longs... I can get out of a short position quicker than I can get out of a long position. I don't know why. I like to say that I "see gravity better than helium." In the rare strong-trending markets where I may chase an entry, it's going to be a down trend, not an uptrend. I don't trust up trends enough to chase them. Maybe it's just a personal quirk and maybe not. I honestly don't know.

But it's interesting to note that most (not all) professional traders I've met are Bears and prefer short positions over longs. You should give it some thought and find out which direction works better for you. Are your losses bigger on shorts or longs? Specialize in one direction and trade the other direction only when things are looking real good.

7. Never let a gain turn into a loss. This will mean getting out of most trades a little (or a lot) too soon. You just have to live with it. Swing for home runs (greed) will ruin your trading. There is no mechanical formula that I know of, (such as, "move your stop to break even after you get 3 ticks gain") that will work. You have to develop a feel for how the market is acting at the moment, and use your feel to reduce your target or advance your hard stop. This comes with experience.

8. Develop a feel for the big picture movements of the market, not just the intraday action. Use the end-of-day market internals to analyze the market's mood and develop a daily bias.

9. Practice does *not* make perfect. Only *perfect practice* makes perfect. I learned this in my younger years, pursuing a professional
baseball career. Perfect practice will keep your losses smaller than your gains in the trading business.

There are a lot of things involved in perfect practice. When you get tired, or when the phone rings, or whatnot, *don't trade*. Always, *always* exit trades exactly the way I've outlined above on every trade in every market condition. Always *wait* for your pitch, the well-timed setup for entering. Don't practice sloppy entries just because you're bored. Only perfect practice will help you. Anything else just amounts to practicing bad habits.

10. Get a mentor. I traded for 6 years before I learned to keep my losses small. My trading turned around immediately after I met my mentor and talked to him on the phone for one week. Is there any serious profession that you can learn without a mentor? Maybe there is, but I don't know of any. It's certainly not trading.

Six Reasons Why You Need a Trading System

2008-02-03T09:39:00.004-08:00

Every minute more than 150 Million Dollars change hands in the electronic index futures markets like the e-mini S&P and e-mini NQ. You can win or lose thousands of dollars in a few minutes; the futures markets can make you rich in a few weeks or months or wipe out your account with no mercy.If you want to compete in the game of games and play against the best traders in the world, then you need to get ready. Too many gamblers are entering the arena without any plan or strategy, completely unprepared, and that's why they lose.Trading a system will dramatically increase your chances to succeed in trading, because it eliminates five of the top six reasons why unprepared traders fail.

Here are the top six reasons why traders fail,
and how a trading system eliminates them

Let's take a look at the reasons why traders lose money:

1. Lack of a Trading Plan
2. Lack of Discipline to Follow the Plan
3. Failure to Control Emotions
4. Failure to Accept and Limit Losses
5. Lack of Commitment
6. Over-Trading

By all means you have to avoid these mistakes if you want to win.Here's how a trading system eliminates 5 of the 6 top reasons why traders fail:

Solution #1: Having a trading plan

Having a trading system means having a pre-defined set of rules you have developed to guide your trading. Therefore you HAVE a trading plan, eliminating the No.1 cause for failure.

Solution #2: Following the trading plan

The easiest way to follow a trading plan is to automate it. Almost every trading system can be automated, and you could let the computer trade for you. You won't have to worry about your discipline any longer, as the computer mechanically trades every setup for you.

Solution #3: Controlling emotions

Trading with a system removes emotions from trading. If you don't have a strategy and you try to make decisions when the market is moving, you are liable to become emotionally attached to positions. You may experience panic and indecision when the market does not move in your favor, as you do not have a prepared response. That's when most traders lose their money. If you follow a system you will know what to do no matter what the market does.

Solution #4: Controlling your losses

You probably have heard the saying Let your profits run. Unfortunately most traders let their losses run. A trading system will get you out of a position when the predefined stop is hit. Unless you override the system to give the trade a little bit more room it will stop the loss and therefore limit your losses.

Solution #5: Commitment

You won't believe how many traders show a lack of commitment and therefore lose money. Lack of commitment means that they stop trading after the first loss, and don't give their system a chance to make back the money they lost. Trading is not a one-way street, and losses are part of our business. If you can't accept the fact that there will be losses, you shouldn't trade. Fortunately a trading system can help you to overcome this problem; an automated trading system continues trading according to the rules, and therefore adds much more consistency to your trading.

As you can see, Five of the six top reasons why traders lose money in the markets are simply eliminated when you start trading with a system.Without any guarantee, your chances of making money rise incredibly when starting with a profitable trading system.

How to Find a Day Trading System that Works

2008-02-03T09:39:00.003-08:00

Day Trading with a system will dramatically improve your chances of making money in the markets.

The next challenge is to find a day-trading system that works. Today you have the chance to choose from more than 300 daytrading systems available. Unfortunately just 10% of them are trading profitably.

In the next three minutes I will present you the 10 Power Principles for Successful Day Trading Systems, which will help and support you in your research.

Principle #1: Few rules - easy to understand

It may surprise you that the best trading systems have less than 10 rules. The more rules you have, the more likely you "curve-fitted" your trading system to the past, and such an over-optimized system is very unlikely to produce profits in real markets.

It's important that your rules are easy to understand and execute. The markets can behave very wild and move fast, and you won't have the time to calculate complicated formulas in order to make a trading decision. Think about successful floor traders: The only tool they use is a calculator, and they make thousands of dollars every day.

Principle #2: Trade electronic and liquid markets

We strongly recommend that you trade electronic markets because the commissions are lower and you receive instant fills. You need to know as fast as possible if your order was filled and at what price, because based on this information you plan your exit.

You should never place an exit order before you know that your entry order is filled. When you trade open outcry markets (non-electronic) you might have to wait awhile before you receive your fill. By that time, the market might have already turned and your profitable trade has turned into a loss!

When trading electronic markets you receive your fills in less than one second and can immediately place your exit orders. Trading liquid markets you can avoid slippage, which will save you hundreds or even thousands of dollars.

Principle #3: Make consistent profits

You should always look for a daytrading system that produces a nice and smooth equity curve, even if in the long run the net profit is slightly smaller. Most professional traders prefer to take small profits every day instead of big profits every now and then. If you trade for a living, you need to pay your bills from your trading profits, and therefore you should regularly deposit profits into your trading account.

Making consistent profits is the secret of successful traders!

Principle #4: Maintain a healthy balance between risk and reward

Let me give you an example: If you go to a casino and bet everything you have on "red", then you have a 49% chance of doubling your money and a 51% chance of losing everything. The same applies to day trading: You can make a lot of money if you are risking a lot, but then risk of ruin is very high. You need to find a healthy balance between risk and reward.

Let's say you define "ruin" as losing 20% of your account, and you define "success" as making 20% profits. Having a trading system with past performance results let you calculate the "risk of ruin" and "chance of success".

Your risk of ruin should be always less than 5%, and your chance of success should be 5-10 times higher, e.g. if your risk of ruin is 4%, then your chance of success should be 40% or higher.

Principle #5: Find a system that produces at least five trades per week

The higher the trading frequency the smaller the chances of having a losing month. If you have a day trading system that has a winning percentage of 70%, but only produces 1 trade per month, then 1 loser is enough to have a losing month. In this example, you could have several losing months in a row before you finally start making profits. In the meantime, how do you pay for your bills?

If your day trading system produces five trades per week, then you have on average 20 trades per month. Having a winning percentage of 70% - your chances of a winning month are extremely high.
That's the goal of all traders: Having as many winning months as possible!

Principle #6: Start small - grow big

Your day trading system should allow you to start small and grow big. A good day trading system allows you to start with one or two contracts, and then increases your position as your trading account grows. This is in contrast to many "martingale" trading systems that require increasing position sizes when you are in a losing streak.

You probably heard about this strategy: Double your contracts every time you lose, and one winner will win back all the money you previously lost. It's not unusual to have 4-5 losing trades in a row, and this would already require to trade 16 contracts after just 4 losses! Trading the e-mini S&P you would then need an account size of at least $63,200, just to meet the margin requirement. That's why martingale systems don't work.

Principle #7: Automate your day trading

Therefore you should automate your trading and look for a day trading system that either already is or can be automated. Automating your trading makes it free of human emotion. The buy and sell operations are all automatic, hands-free, with no manual interventions and you can be sure that you make profits when you should according to your plan.

Principle #8: Have a high percentage of winning trades

Your day trading strategy should produce more than 50% winners. There's no doubt that trading systems with smaller winning percentages can be profitable, too, but the psychological pressure is enormous. Taking 7 losers out of 10 trades and not doubting the system takes great discipline, and many traders can't stand the pressure. After the sixth loser they start "improving" the system or stop trading it completely.

Especially for beginners it is a big help to gain confidence in your trading and your system if you have a high winning percentage of more than 65%.

Principle #9: Look for a system that is tested on at least 200 trades

The more trades you use in your backtesting (without curve-fitting), the higher the probabilities that your day trading system will succeed in the future. Look at the following table:

Number of Trades	50	100	200	300	500
Margin of Error	14%	10%	7%	6%	4%

The more trades you have in your backtesting, the smaller the margin of error, and the higher the probability of producing profits in the future.

Principle #10: Chose a valid backtesting period

I recently saw the following ad: "Since 1994 I've taught thousands of traders worldwide a Simple and Reliable E-Mini trading methodology".

That's very interesting, because the e-mini S&P was introduced in September 1997, and the e-mini Nasdaq in June 1999, therefore, none of these contracts existed before 1997. What kind of e-mini trading did this vendor teach from 1994-1997???

The same applies to your backtesting: If you developed an e-mini S&P trading strategy, then you should backtest it only for the past 2-4 years, because even though the contract has existed since 1997, there was practically nobody trading it (see chart below):

Now you know how to separate the scam from good working day trading systems. By applying this checklist you will easily identify day trading systems that work and those that will never make it.

Making sure your trading plan works

2008-02-03T09:39:00.002-08:00

In our article "Define your Goals and Make a Plan" you learned:

How to define your financial and trading goals.
How to select the right market for your trading goals.
What timeframe you should trade in.
The difference between trading styles and how to find the right one for you.
How to create a basic trading plan.

Now that you defined your goals and created your trading plan, you need to make sure it really works. Thus far everything might look great, but how can you be sure that the system works when you start trading it with real money?

Evaluating a trading system is easier than you think. Below you'll find 10 Principles of Successful Trading Systems that we developed and refined over the last couple of years.You should use these Power Principles to evaluate your trading system, whether you developed it on your own or think about purchasing one. By checking a system against these principles you can dramatically increase the chances of being successful.

Here we go:

Principle #1: Few rules - easy to understand

I strongly recommend that you trade electronic markets because commissions are lower and you receive instant fills. You need to know as fast as possible if your order was filled and at what price, because based on this information you plan your exit.

You should never place an exit order before you know that your entry order is filled. When you trade open outcry markets (non-electronic) you might have to wait a while before you receive your fill. By that time, the market might have already turned and your profitable trade has turned into a loss!

Principle #3: Realistic expectations

Losses are part of our business. A trading system that doesn't have losses is "too good to be true". Recently I ran into a trading system with a whopping winning percentage of 91% and a drawdown of less than $500. WOW!

When looking at the details it turned out that the system was only tested on 87 trades and - of course - curvefitted. If you run across a trading systems with numbers too good to be true, then it's probably exactly THAT: Too good to be true.

Usually you can expect the following from a robust trading system:

A winning percentage of 60-80%
A profit factor of 1.3 - 2.5
A maximum drawdown of 10-20% of the yearly profit.

Use these numbers as a rough guideline, and you will easily identify curvefitted systems.

Principle #4: Maintain a healthy balance between risk and reward

Let me give you an example:

If you go to a casino and bet everything you have on "red", then you have a 49% chance of doubling your money and a 51% chance of losing everything. The same applies to trading: You can make a lot of money if you are risking a lot, but then risk of ruin is very high. You need to find a healthy balance between risk and reward.

Your risk of ruin should be always less than 5%, and your chance of success should be 5-10 times higher, e.g. if your risk of ruin is 4%, then your chance of success should be 40% or higher.

Principle #5: Find a system that produces at least five trades per week

The higher the trading frequency the smaller the chances of having a losing month. If you have a trading system that has a winning percentage of 70%, but only produces 1 trade per month, then 1 loser is enough to have a losing month. In this example, you could have several losing months in a row before you finally start making profits. In the meantime, how do you pay for your bills?

If your trading system produces five trades per week, then you have on average 20 trades per month. Having a winning percentage of 70% - your chances of a winning month are extremely high.

And that's the goal of all traders: Having as many winning months as possible!

Principle #6: Start small - grow big

Your trading system should allow you to start small and grow big. A good trading system allows you to start with one or two contracts, and then increase your position as your trading account grows. This is in contrast to many "martingale" trading systems that require increasing position sizes when you are in a losing streak.

Principle #7: Automate your trading

Therefore you should automate your trading and look for a trading system that either already is or can be automated. Automating your trading makes it free of human emotion. The buy and sell operations are all automatic, hands-free, with no manual interventions and you can be sure that you make profits when you should according to your plan.

Principle #8: Have a high percentage of winning trades

Your trading strategy should produce more than 50% winners. There's no doubt that trading systems with smaller winning percentages can be profitable, too, but the psychological pressure is enormous. Taking 7 losers out of 10 trades and not doubting the system takes great discipline, and many traders can't stand the pressure. After the sixth loser they start "improving" the system or stop trading it completely.

Especially for beginners it is a big help to gain confidence in your trading and your system if you have a high winning percentage of more than 65%.

Principle #9: Look for a system that is tested on at least 200 trades

The more trades you use in your backtesting (without curve-fitting), the higher the probabilities that your trading system will succeed in the future. Look at the following table:

Number of Trades 50 100 200 300 500 Margin of Error 14% 10% 7% 6% 4%

The more trades you have in your backtesting, the smaller the margin of error, and the higher the probability of producing profits in the future.

Principle #10: Chose a valid backtesting period

I recently saw the following ad: "Since 1994 I've taught thousands of traders worldwide a Simple and Reliable E-Mini trading methodology".

The same applies to your backtesting: If you developed an e-mini S&P trading strategy, then you should backtest it only for the past 3-4 years, because even though the contract has existed since 1997, there was practically nobody trading it (see chart below):

As you can see, it's rather easy to find a trading system that works. By applying this checklist you will easily identify trading systems that work and those that will never make it.

How to Develop a Profitable Trading System

2008-02-03T09:37:00.009-08:00

In this article I will explain to you how to develop a profitable trading system in five steps:

Step 1: Select a market and a timeframe
Step 2: Define entry rules
Step 3: Define exit rules
Step 4: Evaluate your system
Step 5: Improving the system

Let’s take a closer look at these steps.

Step 1: Select a market and a timeframe

Every market and every timeframe can be traded with a system. But if you want to look at 50 different futures markets and 6 major timeframes (e.g. 5min, 10min, 15min, 30min, 60min and daily), then you need to evaluate 300 possible options. Here are some hints on how to limit your choices:

Though you can trade every futures markets, we recommend that you stick to the electronic markets (e.g. e-mini S&P and other indices, Treasury Bonds and Notes, Currencies, etc). Usually these markets are very liquid, and you won’t have a problem entering and exiting a trade. Another advantage of electronic markets is lower commissions: Expect to pay at least half the commissions you pay on non-electronic markets. Sometimes the difference can be as high as 75%.
When you select a smaller timeframes (less than 60min) your average profit per trade is usually comparably low. On the other hand you get more trading opportunities. When trading on a larger timeframe your profits per trade will be bigger, but you will have less trading opportunities. It’s up to you to decide which timeframe suits you best.
Smaller timeframes mean smaller profits, but usually smaller risk, too. When you are starting with a small trading account, then you might want to select a small timeframe to make sure that you are not overtrading your account.

Most profitable trading systems use larger timeframes like daily and weekly. These system work, too, but be prepared for less trading action and bigger drawdowns.

Step 2: Define entry rules

Let’s simplify the myths of “entry rules”:

Basically there are 2 different kinds of entry setups:

Trend-following
When prices are moving up, you buy, and when prices are going down, you sell.
Trend-fading
When prices are trading at an extreme (e.g. upper band of a channel), you sell, and you try to catch the small move while prices are moving back into “normalcy”. The same applies for selling.

In my opinion swing trading is actually one of the best trading styles for the beginning trader to get his or her feet wet. By contrast, trend trading offers greater profit potential if a trader is able to catch a major market trend of weeks or months, but few are the traders with sufficient discipline to hold a position for that period of time without getting distracted.

Most indicators that you will find in your charting software belong to one of these two categories: You have either indicators for identifying trends (e.g. Moving Averages) or indicators that define overbought or oversold situations and therefore offer you a trade setup for a short term swing trade.

So don’t become confused by all the possibilities of entering a trade. Just make sure that you understand why you are using a certain indicator or what the indicator is measuring. An example of a simple swing trading strategy can be found in the next chapter.

Step 3: Define exit rules

Let’s keep it simple here, too: There are two different exit rules you want to apply:

Stop Loss Rules to protect your capital and
Profit Taking Exits to realize your profits

Both exit rules can be expressed in four ways:

A fixed dollar amount (e.g. $1,000)
A percentage of the current price (e.g. 1% of the entry price)
A percentage of the volatility (e.g. 50% of the average daily movement) or
A time stop (e.g. exit after 3 days)

We don’t recommend using a fixed dollar amount, because markets are too different. For example, natural gas changes an average of a few thousand dollars per day per contract; however, Eurodollars change an average of a few hundred dollars a day per contract. You need to balance and normalize this difference when developing a trading system and testing it on different markets. That’s why you should always use percentages for stops and profit targets (e.g. 1% stop) or a volatility stop instead of a fixed dollar amount.

A time stop gets you out of a trade if it is not moving in any direction, therefore freeing your capital for other trades.

Step 4: Evaluate your system

The first figure to look for is the net profit. Obviously you want your system to generate profits. But don’t be frustrated when during the development stage your trading system shows a loss; try to reverse your entry signals. On our website www.rockwelltrading.com you already learned that trading is a zero sum game: So if you are going long at a certain price level, and you lose, then try to go short instead. Many times this is the easiest way to turn a losing system into a winning one.

The next figure you want to look at is the average profit per trade. Make sure this number is greater than slippage and commissions, and that it makes your trading worthwhile. Trading is all about risk and reward, and you want to make sure you get a decent reward for your risk.

Take a look at the Profit Factor (Gross Profit / Gross Loss). This will tell you how many dollars you are likely to win for every dollar you lose. The higher the profit factor the better the system. A system should have a profit factor of 1.5 or more, but watch out when you see profit factors above 3.0, because it might be that you over-optimized the system.

Here are some more characteristics you might want to consider besides the net profit of a system:

Winning percentage
Many profitable trading systems achieve a nice net profit with a rather small winning percentage, sometimes even below 30%. These systems follow the principle “Cut your losses short and let your profits run”. However, YOU need to decide whether you can stand 7 losers and only 3 winners in 10 trades. If you want to be “right” most of the time, then you should pick a system with a high winning percentage.
Number of Trades per Month
Do you need daily action? If you want to see something happening every day, then you should pick a trading system with a high number of trades per month. Many profitable trading systems generate only 2-3 trades per month, but if you are not patient enough to wait for it, then you should select a system with a higher trading frequency.
Average Time in Trade
Some people get really nervous when they are in a trade. I have heard of people who can’t even sleep at night when they have an open position. If that’s you, then you should make sure that the average time in a trade is as short as possible. You might want to choose a system that does not hold any positions overnight.
Maximum Drawdown
A famous trader once said: “If you want your system to double or triple your account, you should expect a drawdown of up to 30% on your way to trading riches.” Not every trader can stand a 30% drawdown. Look at the maximum drawdown the system produced so far, and double it. If you can stand this drawdown, then you found the right system. Why doubling? Remember: your worst drawdown is always ahead of you.
Most consecutive losses
The amount of most consecutive losses has a huge impact on your trading, especially when you are using certain types of money management techniques. Five or six consecutive losses can cause you a lot of trouble when using an aggressive money management.
In addition this number will help you to determine whether you have enough discipline to trade the system: Will you still trade the system after you have experienced 10 losses in a row? It’s not unusual for a profitable trading system to have 10-12 losses in a row.

Step 5: Improving your system

There is a difference between “improving” and “curve-fitting” a system. You can improve your system by testing different exit methods: If you are using a fixed stop, try a trailing stop instead. Add a time stop and evaluate the results again. Don’t look at the net profit only; look also at the profit factor, average profit per trade and maximum drawdown. Many times you will see that the net profit slightly decreases when you add different stops, but the other figures might improve dramatically.

Don’t fall into the trap of over-optimizing: You can eliminate almost all losers by adding enough rules. Simple example: If you see that on Tuesdays you had more losers than on the other weekdays, you might be tempted to add a “filter” that prevents your system from entering trades on Tuesdays. Next you find that in January you had much worse results than in other months, so you add a filter that enters trades only from February – December. You add more and more filters to avoid losses, and eventually you end up with a trading rule that I saw recently:

IF FVE > -1 And Regression Slope (Close , 35) / Close.35 * 100 > -.35 And Regression Slope (Close , 35) / Close.35 * 100 < .4 And Regression Slope (Close , 70) / Close.70 * 100 > -.4 And Regression Slope (Close , 70) / Close.70 * 100 < .4 And Regression Slope (Close , 170) / Close.170 * 100 > -.2 And MACD Diff (Close , 12 , 26 , 9) > -.003 And Not Tuesday And Not DayOfMonth = 12 and not Month = August and Time > 9:30 ...

Though you eliminated all possibilities of losing (in the past) and this trading system is now producing fantastic profits, it’s very unlikely that it will continue to do so when it hits reality.

Conclusion

Developing a trading system can be tricky, but it’s by far not as complicated as many vendors make you think. In the following we will present you a simple trading system that we developed using these steps.

How to optimize a trading system without curve-fitting it

2008-02-03T09:37:00.008-08:00

There’s a fine line between “optimizing” and “curve-fitting”.
You have to make sure that your don’t over-optimize.

In the following example I’ll show you how to determined the “best” parameter without curve-fitting a system.

The underlying system is a simple breakout system. The system contains a parameter called TF_Param.

In the following I will explain how we optimized the parameter and why we selected 0.7 as the current value for the parameter.

First I run the optimization and look at the net profit, since that’s one of the most important figures.

As you can see, any parameter between 0.35 and 0.8 produces robust results.

Next I am looking at the max drawdown.

Any parameter above 0.4 produces a rather low drawdown, so using the combined information I would pick a TF_Param between 0.4 and 0.8.

Now I am looking at the average profit per trade:

The parameter range between 0.45 and1.2 looks promising, so I am limiting the TF_param to 0.45-0.8.

Now I am looking at the winning percentage. The higher, the better:

Anything above 0.5 produces a quite robust winning percentage above 50%.
As it seems, anything above 0.6 is quite good.
Combining all the previous results we should look for a TF_Param between 0.6 and 0.8

As a last test we look at the number of trades. Again: The higher, the better:

No surprises here: The lower the parameter, the more trades we get.

By combining all the above findings we see that a TF_Param between 0.6 and 0.8 produces best results.
That’s why 0.7 is definitely a good choice. Even if the market changes slightly, the system would still produce excellent results.

How long should I backtest a trading system?

2008-02-03T09:37:00.006-08:00

I am frequently asked how long one should backtest a trading system. Though there's no easy answer, I will provide you with some guidelines. There are a few factors that you need to consider when determining the period for backtesting your trading system:

Trade frequency

How many trades per day does your trading system generate? It's not important how long you backtest a trading system; it's important that you receive enough trades to make statistically valid assumptions*: If your trading system generates three trades per day, i.e. 600 trades per year, then a year of testing gives you enough data to make reliable assumptions*. But if your trading system generates only three trades per month, i.e. 36 trades per year, then you should backtest a couple of years to receive reliable data.

Underlying contract

You must consider the characteristics of the underlying contract. The chart below shows the average daily volume of the e-mini S&P:

It doesn't make sense to backtest a trading system for the e-mini S&P before 1999, because the contract simply didn't exist! In my opnion it doesn't make sense to backtest an e-mini trading system before 2002 because at that time the market was completely different; less liquidity and different market participants. I believe that a reliable testing period for the e-mini S&P are the years 2002 - 2004.

What account size do I need? How much money can I make?

2008-02-03T09:37:00.005-08:00

These questions are the most frequently asked questions. In this article we will try to answer these questions.

First of all, let's clarify a common misunderstanding:

You never risk your full account size. You always have a "catastrophic stop", and it is important to define the "ruin" before you start trading. Let's say you start with a $10,000 account, and you decide to stop trading if you lost $2,000. In this example you are "ruined" if your account decreases to $8,000. Though you invest $10,000, you only risk $2,000.

Back to the first question: "What account size do I need?"
The first factor is the margin required by the exchanges. The margin is the "security deposit" that you need to have in your account if you want to trade. This margin varies depending on the contract you want to trade, e.g. $3,938 for the e-mini S&P and $1,688 for the 30 year Treasury Bonds. Many brokers offer a 50% (a 50% deposit? I'm not sure what noun is needed here.) on this margin requirement if you daytrade, i.e. you open and close the position on the same day.

If your trading system requires trading 1 contract of the e-mini S&P, and you hold the position overnight, then you need at least $4,000 in your trading account.

The next factor is the expected drawdown.
If you would only deposit $4,000 in your trading account, the first trade moves against you by more than $62, and the value of your account falls below the margin requirement of $3,938, then you receive a "margin call". Many electronic platforms automatically liquidate your open positions, and don't let you trade any longer. Therefore, you need to know the maximum drawdown of your trading system in the past. Let's say your trading system had a maximum drawdown of $2,200 in the past, then you need at least $6,200 in your trading account: $4,000 margin requirement plus $2,200 "buffer" for a possible drawdown. A safe approach is to double the maximum drawdown, because usually the worst drawdown is still to come.

Let's say that based on these calculations you decide to fund your account with $8,000, and you define your "ruin" as $6,000, i.e. you are willing to risk $2,000 for your trading adventure.

How likely is it that you lose the $2,000 you are willing to risk?

Assuming you have a well tested and robust trading system that is likely to achieve similar results in the future as in the past, then you can use the log-normal distribution to calculate the risk of ruin. In the following example we will use the values of our e-mini S&P Trading System "Coin Collector":

The profit factor of this system is 1.42, i.e. for every dollar you lose you earn $1.42. The winning percentage is 70.5%, and the average winner is $129. Using these figures and the results of the past trades, you can calculate the "risk of ruin" for our system:

The probability of losing the whole $2,000 that you are willing to risk in the next 30 trades only is 1.4%. That's very low. If you decide to risk $3,000, then the probability of losing all the money in the next 30 trades decreases to 0.07%.

Let's talk about the next question: "How much money can I make"?

You first need to calculate the average profit per trade by dividing the overall profit by the amount of trades you made. In our example the "Coin Collector" produces an average profit of $37. Next you need to multiply this number by the trading frequency. The "Coin Collector" produces in average three trading signals per day, i.e. you can expect $111 per day per contract.

An average week produces 15 trades and $555 profits. Deducting commissions and slippage you can expect $842 in two weeks (=30 trades).

If you catch a lucky streak you could even make more. So how likely is it to MAKE $2,000 within the next 30 trades? The probability of making $2,000 is 20.4%.

Trading is about risk and reward: you want to get a decent reward for your risk. In our example the probability of losing $2,000 is 1.4%, and the probability of making $2,000 is 20.4%. That's an excellent ratio!

Conclusion:

Your account size is determined by the margin requirement set by the exchanges and the "buffer" you should have for an expected drawdown.

The question "How much money can I make?" can be answered using the performance report of the past results of the system. Keep in mind that these figures are only valid if you developed a robust (and not a curve-fitted) trading system.

Using some statistical functions, you can then determine the "risk of ruin" and the probability of making a certain amount of money.

That's what trading is all about:

risk and reward.

How do I backtest the right way?

2008-02-03T09:37:00.004-08:00

In my opnion backtesting can be a very powerful tool if used correctly.

The problem is that many trader over-use the functions provided by the different backtesting software packages and think more is better. Many so-called system developers try to imply that the longer you backtest the better and more robust your system will be. That's not always true.

Let me use the e-mini S&P as an example. In 2000 the average daily range was 100-150 ticks per day; in 2004 it was only 40-60 ticks per day. If you backtest any trend-following daytrading system in the e-mini S&P you will see that it worked perfectly until 2002 and then suddenly falls apart. It seems that there are no more intraday trends. That's not surprising as the daily range of the e-mini S&P decreased by more than 50%.

What happened?

There are a couple of reasons. Probably the most important one is the introduction of the Pattern Day Trading Rule in August and September 2001by the NYSE and NASD: If a trader executes four or more day trades within a five business day period then he must maintain a minimum equity of $25,000 in his margin account at all times. Because of this rule made traders stopped daytrading equities and started trading the e-mini S&P future instead.

Look at the sudden increase in volume in the e-mini S&P in the beginning of 2001:

Many of these stock daytraders used methods to scalp the market for a few penny. Using the e-mini S&P they suddenly had a much higher leverage, paying less commissions, and their methods were extremely profitable.

Unfortunately these scalping methods kill an intraday trend almost instantly, making almost every trend-following approach fail.

Another reason for the dramatic change of the market was the introduction of the automated strategy execution in TradeStation. In 2002 TradeStation's customers who were using this feature increased by 268%. Overbought/Oversold strategies became very popular and when the market made an attempt to trend these strategies immediately established a contrary position.

Conclusion

When backtesting you need to know these things. It's not enough to just run a system on as much data as possible; it's important to know the underlying market conditions.

In non-trending markets like the e-mini S&P you need to use trend-fading systems, and in trending markets like commodities you should use trend-follwing methods.

And that's when clever backtesting helps you:

If your backtesting tells you that a trend-following method worked in 2000-2002, but doesn't work in 2003 and 2004 then you should not use this strategy right now.And vice versa: When you see that a trend-fading method produced nice profits in 2003, 2004 and 2005, then trade it.

I haven't yet seen a strategy that works in all market conditions: trending and non-trending. Usually a strategy works very well in ONE market condition (e.g. trending) and produces small losses in the OTHER market condition. That's why you need to alter trading strategies.

And THAT'S where backtesting can help you.

What you can expect when trading a system

2008-02-03T09:37:00.002-08:00

If you think about trading a system then this lesson is of highest importance to you.

Especially if you are new to trading systems you need to know what to expect when trading a system. System trading can be very rewarding but you need to know how to avoid the pitfalls of system trading if you want to be successful in the long run.

The performance report of our e-mini S&Trading System CoinCollector shows an average profit per trade of $36 over the past 733 trades:

Four weeks ago we achieved excellent results with the CoinCollector: Between March, 14 and March, 21 we realized $963 profits with 17 trades. This yields to an average profit per trade of $57, way above the "expected" average profit of $36 (see below):

When trading a system you have to keein mind that you are working with averages:

If your backtesting shows an average profit per trade of $36 then you can be almost sure that the system will not suddenly jumuto $57 average profit per trade.

In trading we have good weeks and bad weeks. Losses are part of our business. After an extraordinary week there will be a slow week. After a winning streak we will realize a loss.

Looking at the performance of that week a correction was inevitable. And it happened: Tuesday, March 22nd, we realized a loss of $712.50.

Such a loss hurts. You quickly forget all the nice profits of the past week and focus on the loss. You may start questioning your system and think that it stopped working, and so you stotrading. You start looking around for the next system. You don't give the system a chance to come back to "normal". You see an extraordinary week like the week from March 14 - 21, 2005 and think that you will continue making profits like this forever.

When reality hits you, you stop believing. But take a look what happened after the loss.

Here's the performance report of the 2 weeks combined: The "good" week and the "bad" week with the loss of $712.50:

Now take a look at the first graphic with the performance the system promised you.

We are right on target!

The average profit is back to normal, and so is the winning percentage and the profit factor.

Within two weeks the system normalized itself. That's exactly what we expect from a robust trading system.

Maintain Your Perspective

2008-02-03T09:37:00.001-08:00

System trading can be very rewarding but you need to know how to avoid the pitfalls of system trading if you want to be successful in the long run. You need to know what to expect when trading a system.

Many traders think that when trading a system their equity curve will consistently going up, like having an ATM in your front yard.

In reality you'll have some days and weeks when the system outperforms and a period when the system underperforms.

When trading a system you need to maintain a long term perspective.

Trading a system means playing a number's game:

You need to place at least 40 trades before you can look at the performance of the system. Most traders only evaluate their performance once a month and try to have as many profitable months as possible. Hedge Funds evaluate their performances quarterly or yearly. If you look daily at the results of a trading system it will drive you crazy.

Sure, nobody likes going through a drawdown. But losses are part of our business and you need to deal with them. The famous Richard Dennis once said: "It is totally counterproductive to get wrapped up in the results. You have to maintain your perspective. Being emotionally deflated would mean lacking confidence in what I am doing. I avoid that because I have always felt that it is misleading to focus on short-term results."

Many traders focus on short term results and lose their perspective. That's why they fail: They experience a loss or a bad week and shop around for the next system. And while the trading system they just abandoned is recovering from the drawdown, the new trading system might produce first losses, and they start looking for the next system.

They are like the dog chasing many rabbits: At the end of the day he's totally exhausted and didn't catch a single one.

Maintain your perspective!

When Should You Override a Trading Strategy?

2008-02-03T09:37:00.000-08:00

Let's use the following example for trading the e-mini S&P:

Your system establishes a long position at 1190.00 and the profit target order was placed at 1192.25 ($112.50 profit per contract). Prices moved up to 1192.00 and reversed. One hour later the system tries to reverse at 1191.00. Again prices moved up to 1190.75 and reversed. Two times the system missed the profit target by one tick.

Should you change the strategy?
or
Should you manually override the strategy when something like this happens?

Doing any of this is like opening Pandorra's Box: Let's say you start lowering your profit goal by one tick. Of course you will be instantly rewarded, because the number of winners would increase. Next week you might experience the following situation: Your stop is hit and you are taken out of the trade, but then the market turns and takes off and you are missing a nice winner. What now? You start moving your stop a little bit further away and again you are instantly rewarded: The number of losers decrease.

One week later you experience a similar situation and you continue "finetuning" your system by slightly moving down your profit goal and minimally increasing your stop loss. And very soon the winning system that you once had turns into a losing one, because your losses are much bigger than your profits.

I have seen it many times: A trader backtests his system over 700 or maybe even 1,000 trades and then "finetunes" it after the first 5 trades. This doesn't make sense: If you have a sound logic why your system should work then it won't need "finetuning" after 5 trades.

You should evaluate your system periodically, but instead of curve-fitting your system's parameters you should ask yourself: "Does the logic of the system still apply?"

If you have a trend-following system and markets are trading sideways, then "optimizing" the system parameters won't help: It's the wrong market condition and the market is just not right for your system.

Exercise discipline:

If your system worked well over 1,000 trades, and you have a sound logic and didn't curve-fit the system, then you should not override the system or "finetune" it after only a few trades.

Understanding Winning Percentage

2008-02-03T09:36:00.007-08:00

Let's say you purchased or developed a system that has a winning percentage of 70%.

What exactly does that mean?

It means that the probability of having a winning trade is 70%, i.e. it is more likely that the trade you are currently in turns out to be a winner than a loser.

Does that mean that when you trade 10 times you will have 7 winners? - No!

It means that if you trade long enough (i.e. at least 40 trades) then you will have more winners than losers, but it does not guarantee that after 3 losers in a row you will have a winner.

Let me give you an example:

If you toss a coin then you have 2 possible outcomes: head or tail. Probabilities are 50%, i.e. when you toss the coin 4x then you should get 2x head and 2x tail.

But what if you tossed the coin 3 times and you got 3 times 'head'?
What are the probabilities of 'head' on the next coin toss?
50% or less?

If you answered 'less' than you fell for a common misconception. The probabilities of getting another 'head' is still 50%. No more and no less. But many traders think that the probabilities of 'tail' are higher now because the three previous coin tosses resulted in 'head'. Some traders might even increase their bet because they are convinced that now 'tail is overdue'. Statistically this assumption is nonsense and a dangerous and many times costly misconception.

Let's get back to our trading example:

If you have a winning percentage of 70% and you had 9 losers in a row, what are the probabilities of having a winner now? - It's still 70% (and therefore there's still a 30% chance of a loser).

It's important that you understand this concept!

Let's say you purchased or developed a system that has a winning percentage of 70%.

What exactly does that mean?

It means that the probability of having a winning trade is 70%, i.e. it is more likely that the trade you are currently in turns out to be a winner than a loser.

Does that mean that when you trade 10 times you will have 7 winners? - No!

It means that if you trade long enough (i.e. at least 40 trades) then you will have more winners than losers, but it does not guarantee that after 3 losers in a row you will have a winner.

Let me give you an example:

If you toss a coin then you have 2 possible outcomes: head or tail. Probabilities are 50%, i.e. when you toss the coin 4x then you should get 2x head and 2x tail.

But what if you tossed the coin 3 times and you got 3 times 'head'?
What are the probabilities of 'head' on the next coin toss?
50% or less?

Let's get back to our trading example: If you have a winning percentage of 70% and you had 9 losers in a row, what are the probabilities of having a winner now? - It's still 70% (and therefore there's still a 30% chance of a loser).

It's important that you understand this concept!

What's the deal with hypothetical results?

2008-02-03T09:36:00.006-08:00

Question:
I recently read about your e-mini S&P Trading System. The fact that your system is based on hypothetical results has made me a bit skeptical. Does it mean that the system won't work in real time?

Answer:
Published results should always be marked as hypothetical, even if they have been achieved in "real" trading. Here's why:

It is impossible to predict the slippage when using stop or market orders. Two traders, let's say YOU and John, place an order at the same time, and John might experience 1 tick slippage, while you are filled right on your specified entry price.
You don't know whether a limit order will be filled or not. If your trading system requires the use of limit orders, you might experience the following situation: your order is filled, John's isn't, and the market retraces. While you took some profits using a limit order, John is still in the trade and sees his profits shrinking, and in the worst case turning into a loss.
Another factor is the account size: If John is trading a rather small account, then his broker might liquidate his position because he experiences an intra-day drawdown that issues a margin call. Many electronic platforms are set up in such a way that they immediately liquidate a position, even if the market turns around and he would end the trade with a profit. John then experiences a loss, while you might realize profits on the same trade.
What about the ability to withstand losses and your discipline to follow the trading strategy no matter what? Let's say that after a couple of losses John decides not to follow the system any longer, and that's exactly when the system produces some winners. You strictly followed the system and realized these profits, while John is missing them.
Published results are always PAST results. If more traders would have been trading the system, the prices might have behaved differently. There could be a difference in price movement when 100 traders try to enter the market at a certain price point instead of only 1 trader. And what if 1000 traders placed a 2-lot order at a certain entry signal?

All these factors cannot be fully accounted for when publishing the results. That's why every serious vendor should mark his results as being hypothetical.

Back to your question: "Does this mean that the system won't work in real time?"

No. It just means that you should be aware of the limitations of past performance results.

No serious vendor can guarantee that a trading system will make profits in the future, but professional development and thorough testing of a system increase your chances of making money dramatically.

Paper Trading Resuts vs. Real Trading Results

2008-02-03T09:36:00.005-08:00

Whether you purchased a trading strategy or developed your own system or trading ideas:
You should *always* paper trade the new system first.

There are several reasons why paper trading can save you thousands of dollars. Trading your strategy on a paper trading account is risk-less, and it will show you pretty fast whether your trading strategy will be profitable or now.

The big question is: Will you achieve similar results when trading real money?

You already know that there’s a difference between hypothetical and real trading results for various reasons.
(see http://www.rockwelltrading.com/rockwell-trading-articles/Whats-the-deal-with-hypothetical-results.htm ).

But what about paper trading results?

Answer: Yes, you will achieve similar results, but they won’t be exactly the same.

Here’s why:
Every strategy uses either stop, market, market-if-touched or limit orders.
To date no paper trading account can exactly determine at what price you would have been filled.

Let’s discuss this topic using limit orders as an example:
Limit orders are filled according to the FIFO-principle: First In – First Out.
Example: If you and I are placing a limit order at exactly the same price, but you are placing it 1 second before I do, then YOUR limit order is filled first.

If there are more sellers than buyers at a certain price point, then some limit orders are not getting filled.
And of course MARKET-orders have priority, i.e. first all market orders are getting filled and THEN limit-orders according to the FIFO-principle.

As you can see, there are five variables that influence the fill of a limit order:

Number of buyers at a certain price
Number of sellers
Number of traders using market orders
Number of traders using limit orders
Speed of transferring your order, which determines your place in the queue

All these factors make it impossible to simulate whether you would have been filled at a certain price or not.

The currently available software packages try to simulate a fill in one of the following three ways:

They assume that a limit order is filled if prices are touching the specified limit price.
They assume that a limit order is filled if prices are trading THROUGH the limit price.
They assume that a limit order is filled when prices touch the limit price X times

None of these approaches correctly reflects the “real” fill of limit orders.

Based on the approach that your paper trading account chooses, you will achieve more or less the same results.
Option 1 is the least accurate,
Option 2 is the most conservative (but not accurate either),
and Option 3 usually reflects the “real” market behavior best (based on the settings).

Using a software that uses Option 3 to determine fills ensures that your real trading results
will be similar to your paper trading results, but not exactly the same.

Five Tips For Choosing an Automated Trading Software

2008-02-03T09:36:00.004-08:00

Emotions and human errors are the most common mistakes that traders make. By all means you have to avoid these mistakes. Especially during fast markets, it is crucial that you determine the entry and exit points fast and accurately; otherwise, you might miss a trade or find yourself in a losing position.

Therefore you should automate your trading. Automating your trading makes it free of human emotion. The buy and sell operations are all automatic, hands-free, with no manual interventions and you can be sure that you make profits when you should according to your plan.

Here are five steps to choose a great trading software to automate your trading.

1. Hands-free execution of trading signals

Your trading software must allow a complete hand-free execution of trading signals. You don't gain anything if your software requires you to confirm each trading signal. The trading software must place and cancel ALL orders automatically according to the rules you established.

2. Robust, high-quality execution of trading strategies

Your best bet is a server-based solution. Many online trading software packages reside on YOUR computer and send the signals to your broker. This causes a big problem: If YOUR computer freezes or your internet connection is interrupted, the trading signals are not submitted. That's why you want a server-based solution: In this case the strategy is executed directly on the server at your broker's office. This provides a high level of security and reliability, since your broker's servers are usually more reliable than your private computer.

3. Real-Time transparency of strategy performance

At any time you need to know when and at what price you entered a trade, when and where you want to exit it and of course you current profit and loss. Make sure that your online trading software provides you with these important information in REAL-TIME. Especially when trading "old" information is useless information. You need to know your current position and profit and loss NOW, not 10min delayed.

4. Full control over strategy execution and the ability to modify or cancel orders

There might be situations when you have to override your trading strategy. Just think about unusual events like 9/11. Or maybe you have a family emergency and need to stop your trading and take care of personal matters. Your trading software must allow you to stop a trading strategy at any time and modify or cancel existing orders. Stay away from trading software packages that don't let you fully control your trading strategies.

5. Ease of diversification and re-balancing of your trading portfolio

As your account grows you will diverify your trading. You then need a trading software that allows you to add, delete, run, and stop systems as desired. Make sure that there are plenty of systems available for the trading software of your choice. Stay away from products that allow you to run only ONE proprietary strategy. Think ahead: As soon as your account allows you to trade multiple strategies, start diversifying. This will smoothen your equity curve and accelerate your success.

I've been testing dozens of products for automating my trading systems, and currently I am using Strategy Runner. Though there are still some minor flaws I found it very reliable and accurate. As far as I know Strategy Runner is the only server-based trading software available, which makes it an obvious choice for professional traders.

Should I Incorporate Fundamental Analysis When Trading a System?

2008-02-03T09:36:00.003-08:00

There's a common misconception about "Fundamental Analysis": People tend to think that the market should react in a certain way to news. Example: "Unemployment Rate goes down", which means that the economy is doing better, therefore companies should make more profits and stock prices will move up. Conclusion: If the unemployment report is positive, the market moves up.

But in reality the markets are driven by greed and fear, and not by supply and demand or anything like this. A report itself is meaningless: It's the traders reaction to the report that moves the market.

Here's a perfect example: On Friday, April 7th 2006 the unemployment rate for March was published. The market expected an unemployment rate of 4.8%, and the numbers came in better than expected: Only 4.7% (for details see http://biz.yahoo.com/c/ec/200614.html). That's good news, isn't it? The market should move up, right?

WRONG! On that day the e-mini S&P dropped 20 points. Why?

Well. here are some comments I got from a news-service:

"Not surprisingly, Friday’s equity trade was dictated by the March employment report. More specifically, it was the Treasury market’s reaction to it that set the stage for stocks." ...
"A lack of negative surprise caused the stock market to breathe a sigh of relief."...
"The Treasury market had a very divergent reaction to the data, and it took the stock market down with it. For Treasury traders, the in-line data essentially provided no evidence that the Fed will be inclined to soon end its monetary tightening cycle."

Oups. So the stock traders thought it's good news and the market was moving up, but the treasury trader in the other room thought it's bad data. So treasury instruments were rallying, causing the stock market to drop like a rock. But don't stocks lead the treasuries? Or do treasuries lead stocks? ...

As I am writing these lines another news hits the ticker:

Oil prices trading above $69 per barrel. But what does it mean? Should the stock market move up or down? Here's a discussion that I heard this morning: "As crude oil prices continue to plug higher the debate over what it all really means will begin again. The questions that will be batted back & forth are "Are sky-high oil prices indicative of a coming economic slowdown or looming inflation?" And more important: How will the Fed react? Will they cease increasing interest rates or even lower the rates again? This would provide a boost for the stock market. Or will traders fear that there's an economic slowdown which might result in lower company earnings? This would move the market down.

As you can see, it's not the news that move the market; it's the reaction of the traders to news that let prices jump up and down.

Now, how should a computer model take these emotions into consideration?
In my opinion there's no way, and I haven't seen any models (incl. artificial intelligence) that is coming somewhat close to this (sometimes really weird) human behavior.

That's why I for one don't incorporate Fundamental Analysis into my trading systems.

Fundamental vs. Technical Analysis - Which one is better

2008-02-03T09:36:00.002-08:00

There are two general schools of analysis: Fundamental and technical.

Which one is better?
Which one should YOU use?

Let’s take a look at the definition of fundamental analysis:

"Fundamental stock analysis requires, among other things, a close examination of the financial statements for the company to determine its current financial strength, future growth and profitability prospects, and current management skills, in order to estimate whether the stock's price is undervalued or overvalued. A good deal of reliance is placed on annual and quarterly earnings reports, the economic, political and competitive environment facing the company, as well as any current news items or rumors relating to the company's operations"

Wow. Sounds like a lot of work. But is it worth it?

Let’s see how technical analysis is defined:

The basic foundations or premises of technical analysis are that a stock's current price discounts all information available in the market, that price movements are not random, and that patterns in price movements, in very many cases, tend to repeat themselves or trend in some direction.
Therefore technical analysis involves the study of a stock's trading patterns through the use of charts, trend lines, support and resistance levels, and many other mathematical analysis tools, in order to predict future movements in a stock's price, and to help identify trading opportunities.

I believe in technical analysis for a couple of reasons:

The markets are driven by greed and fear, and not by supply and demand or anything like this.
An economic report itself is meaningless: It's the traders reaction to the report that moves the market.
I’ll give you an example in a couple of minutes.
Price data are more “objective”. You can interpret financial data and economic reports any way you want, but support levels are support levels, and a weekly high is a weekly high. It’s easier to interpret hard facts than financial statements, because many times they might be misleading.
Example: IBM announces that it will meet the projected sales targets, and the shares drop like a rock, because traders hoped that they will exceed their goals. Another day DELL announces that they will meet their targets, and the shares jump up, because traders didn’t believe that they will make it due to the “difficult economic environment”.
It’s easier (and therefore faster) to learn technical analysis. You can learn the basics by reading a couple of book, while you need to study micro- and macro-economics to interpret economic reports. And even then you might be fooled by the market.

Here’s an example that happened towards the end of April 2006:
Oil prices were trading at record highs above $70 a barrel. This increases the costs of energy for companies and assuming stable price levels for most goods corporations make smaller profits. Smaller profits lead to smaller earnings, and therefore the shares of a company should move down.
But look at the market: On the day oil prices hit a record high the e-mini S&P jumped up 20 points, and the Dow was trading at the year’s high.
The reason for this strange behavior: On that morning the Core PPI was release and rose only 0.1%. This led traders to the conclusion that higher energy costs have less influence on prices than expected. That spurred optimism, and prices rallied. Just looking at fundamental the market should have moved down, but the trader’s reaction to a certain report moved the market up.

For these reasons I recommend that you take a close look at technical analysis. Keep in mind that big trading companies like Goldman Sachs are employing analysts with PhDs in economics, and you shouldn’t expect to be smarter than them.

Top Five Reasons Why You Should Consider Index Futures Trading

2008-02-03T09:36:00.000-08:00

You can trade stocks, forex and futures.

Depending on your account size "stocks" might not be an option for you, since you need at least $25,000 in your account to daytrade stocks.

Forex trading is very popular, but if you are new to trading I must warn you:

The Forex markets are extremely volatile, and you can easily make (or lose) thousands of dollars in a day. Many Forex brokers offer "free quotes and charts" and "no commissions", but keep in mind that nothing is for free: You are paying a spread, i.e. you can NOT buy a currency and immediately sell it for the same amount. It's like at the exchange booths that you know from your holidays: You exchange $100 into 80 Euro, but when you change the 80 Euro back into dollars, you only receive $96.

Same when trading Forex: You are paying at least 2 "pips". This amounts approx. $20, depending on the currency pair you're trading. Another disadvantage of Forex trading is that you are NOT trading at an exchange: There is no "Foreign Exchange". You are trading against your broker: If you are selling, then your broker is buying from you and vice versa. And that's why your broker is giving you the quotes for free: He can basically give you *any* quote since there are no regulations. Scary, isn't it?

So let's talk about futures trading, and why you should definitely consider index futures trading:

1. Electronic Trading

Index Futures are traded electronically and you can enter the orders through your computer, without ever calling a broker. You will receive fills within less than two seconds. That's extremely important since you should ONLY place a stop loss and profit target order AFTER you received your fill.

2. Low Commissions

When trading index futures you pay very low commissions, sometimes as cheap as $5 to $8 per round turn. Compare this to $18 to $25 commissions when trading "open outcry" markets, or a $20 to $30 spread when trading Forex. Low commissions are important to keep your costs down and increase your bottom line.

3. High Leverage

When trading index futures you only have to deposit a small amount as a margin requirement with your brokers. The margin requirement is determined by the exchange, and if you are daytrading your broker can reduce the margin requirement even further. Let's say you want to trade the e-mini S&P index future. The current value of the contract is $55,000, but you only need to deposit $3,900 margin to trade one contract. When daytrading your broker can reduce the margin requirement to $500, giving you more than 100:1 leverage.

4. Liquid Markets

When trading index futures you are trading some of the most liquid and popular markets in the world, hence you will experience little or no slippage. As an example: There are 1,000,000 contracts traded per day in the e-mini S&P index future.

5. Free Quotes and Charts

When trading index futures, your broker might give you access to quotes and charts for free. Most brokerage firms offer trading platforms that include charts and quotes, and if you open an account you'll get access for free.

Don't fall for all the hype and do your research. If you're new to trading I strongly recommend trading index futures. Index futures trading offers many advantages over stock and forex trading, and it's easier than you might think.