The Right Tools for the Right Market

As a drywall contractor you don't show up to a drywall job with concrete cutting tools. As a trader we need to be congnizant of what tools we use on what market. And because in trading, as in construction, the tools often define the trader/contractor, it is important that you bid on the right job (i.e. participate in the right market).

A few years ago a fellow trader asked me what I was doing. He saw me using overbought/oversold indicators and other reversion to mean oscillators. And I was trading Forex. He told me "you gotta fit the right tool to the right market". If those were the tools I preferred then I was trading the wrong thing.

Needless to say that conversation prompted me to investigate the emini Futures (S&P 500, Dow, and Russell 2000). These markets respond well to reversion-to-mean indicators. Another lesson I learned is that what timeframe you trade also determines the right tools for the job. When you're scalping the Russell on a 52 tick chart (about 35 s - 1 m depending on the speed of the market) you need to have the 610 tick (about 5 m) chart up to keep you on the right side of the trend. Just cause you are reverting to the mean doesn't mean you want to ignore the big picture.

Today, whether I'm trading futures, forex or something else I know that I need to fit the right tool to the right market.

LT

Cut Your Losses and Add to Your Winners

You've heard it a thousand times before from experienced traders or even from yourself. Cut your losses short. It's hackneyed and frankly most traders feel they do cut their losses short. I certainly did. I use stop losses (and I don't move them away from my entry). I'm not a crazy man - or am I?

There is a great little ebook I read recently by the "Phantom of the Pits" that talks about this concept. Although there is a lot of fluff in my opinion there are several key points not to be missed:

1) Use a clock when you trade. In other words if you are in a trade you aren't waiting for the market to do "something" (usually take you out at your stop loss) but you are actively looking to exit the market if your trade idea doesn't immediately "prove it" to you. In other words don't sit there and wait until the market does something. Either your trade idea is a "winner" and it moves immediately and significantly in your favor or it is a "loser" and it either moves against you or doesn't move immediately and significantly in your favor. Every minute, hour, day you are in a trade that goes "nowhere" is just that much more likely to hit your stop loss. Don't wait for it - just get out.

2) There is a great quote in "Market Wizards" where Soroes says something to the effect of "when you're right you gotta be a pig - you can't own enough". The second major point of the Phantom of the Pits is that you need to add to a winning position when you are right. You gotta punish the market when you are right because otherwise you won't achieve much beyond break-even.

I have to admit when I originally heard the concepts of cutting your losses and adding to winners I didn't get it. I use a stop loss - isn't that cutting your losers? And adding to winners sounded dangerous - if I was making money the last thing I wanted to do was let it ride. I wanted to grab those profits quickly! So if you are looking for some ideas to increase your trading edge I strongly suggest looking into these. Especially for those folks who are trend traders this can really make or break you.

LT

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ER2 Migration and Re-defining the Edge

If any of you have read "Who Moved My Cheese" by Spencer Johnson then you'll have a bit of an idea of what it's been like for me over the past couple months (and incidentally why I haven't been posting in the blog much).

The long and the short of it is the emini-Russell contract or ER2 is moving exchanges from the CME to the ICE. So what you ask? Well the problem is several fold: 1) I'm not the only one abandoning the Russell and volume is down significantly, 2) the new exchange doesn't support limit orders. And the last CME contract of the ER2 is September 2008. So needless to say I have re-tweaking my short-term futures trading systems to work more effectively on markets that won't be undergoing such drastic measures - the emini-Dow and the emini-MidCap 400.

So what does all this have to do with the price of cheese? Well let's just say that it has reminded me of how traders must not only be able to find one market edge and exploit it but that they must be able to redefine their edge when market changes occur - such as this one. Brett Steinbarger of Trader's Feed has done an excellent job of describing this in his books and on his blog. Basically it means you have to always be hungry and never satisfied with yourself in the market. Never get too comfortable.

Back to re-defining myself.

LT

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