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Thursday, April 15, 2010

TRADING STYLE REVIEW PART II

Before I get to todays topic, some housekeeping on a trade I mentioned the other day


Here is that Sugar trade and it's completion. I have to admit that I had intended on holding this a bit longer, but as per usual, the market threw me a bit of a curve ball. We went up 4 straight days off the lows instead of making a higher short term low first. Often but not always, this will result in a retracement move back down testing the lows. I don't like riding those retracements after I have had a large paper profit like this. I do not mind if they happen right away where the trade had never really gone anywhere first. Sincee I prefer this to happen early, when it does not, and I am trading against a trend this strong, I tend to take profits faster.

As you can see it was $14,200 so not a bad tally for a few days work here. There was another trade I made in Natural Gas that I got some money out of that I did not post when I entered it, but it added to this sum above. Overall a decent chunk to take out of the market during a 3 day span. This exit and the logic of it leads into today's topic, which is Discretionary Trading.

DISCRETIONARY TRADING

I like to refer to this as Caddyshack Trading. The reason for this is at times it reminds me of the scene when the Caddies get loose at the pool in the movie Caddyshack. It is just total pandemonium. It is wild completely random unpredictable activity. This is how Discretionary Trading can feel at times, especially when you are on a losing streak. This style of trading basically means that you are using your discretion in applying whatever techniques you use to make your trading decisions. The progression in my career has been that initially I was a mostly mechanical trader than used some discretion. This was when I was just learning how to trade, and was studying various techniques to see what worked best for me. After doing it that way for awhile, I then decided that systematic trading would work best for me and be a better fit to my personality. I stayed with that approach for quite some time.

Eventually for some of the reasons I mentioned yesterday that are drawbacks to systematic trading, I decided that I could make more money using more discretion. I felt that I was just missing too much opportunity. Most of the worlds greatest traders are discretionary traders. It is kind of the old adage of playing chess against a machine. I don't recall the details exactly, but I remember a series of chess games between a computer and one of the worlds great chess players. The human as I recall won 2 out of 3, which should have been impossible. The bottom line is that you have to do some thinking in life, you cannot just blindly follow rules that may or may not always conform to the changing times.

I thought I would be able to make more money trading with discretion than mechanically, and that has turned out to be the case. In all honesty though, the transition was very painful, and it was during that transition that I came up with Caddyshack. At times it felt like I had no idea what the hell I was doing and also that I would never get the consistency in my results that I was used to. Trading systematically I had several years where 80% of my trades were profitable. It is very easy to be confident and click the mouse when you know that 8 out of every 10 trades will make a profit. It is another thing to have that same confidence when you are going through a period where 4 or 5 trades in a row lose.

When I define discretionary trading as just using your discretion with your decisions, that does not mean you just randomly buy and sell. I do have friends that do that and they have no consistency at all and just lose money month in month out. Trading in this fashion just means you develop and or apply techniques to trade  the markets using your best judgement as to when to do so. In the above example of the Sugar trade this is how I did that.

First, I judged that based on several factors including momentum indicators, accumulation distribution indicators, and cyclical and seasonal patterns, that the Sugar market was setup for a rally. Next I had to make a judgement as to how I was going to get long that market. I watched bar patterns until I saw a few that I thought supported a rally if certain levels on the high side were taken out. I placed orders for a few days with none of them being filled, until finally the one shown above was. My plan was initially to use a target of 18.39 to exit. I know from experience my best trades go right away, and this one did. I use my judgement on profit targets in different ways. In this case since we are still in a very strong downtrend, I was not going to be greedy and try and be a hero and pick the bottom of the whole move. Once we went up 4 consecutive days and did not get to my target I went to plan B of the exit strategy. That is basically to try and exit if I don't reach my target at a 2 to 1 ratio of what I risked. Once we had exceeded that and it was clear we were not going to reach the target yesterday, Plan B called for an exit close to the close.

The biggest drawbacks to this approach are as follows. First, you are open to making a wide variety of variable decisions that can lead to random results or worse. Second, emotions are completely in the open and can often influence what decisions get made. Third, it is very hard to go back and review a decision after the fact to determine what you could have done differently to avoid a bad result. It is just impossible to re- create that identical mindset that you would have had at the time of the decision.

The best way to get around some of these obstacles, is to develop an approach that is reasonably fixed and impart some discretion as to how to apply it. This is what I do. I know when I "stay home" meaning stick to my core setups, I consistently am a very good trader. When I get away from that core and start forcing marginal trades in an attempt to broaden myself, I often get burned. I think trading systematically first, then transitioning into discretionary trading is the best path. This way you will have a base of sound disciplined logic in your approach, then can use your experience to enhance the results.

This has been my path, and it is the one I recommend. I did not do it that way by design, but I think it is the best way to develop the best of both.

4 comments:

Flip flop flow said...

Ahah! Fewer trades because you don’t just mechanically open them.

jg said...

Makes sense, Chris. Thanks!

And, congrats on your nice wins.

robert said...

re: Sugar trade

I thought I recall you saying that you always put your "buy stops" above the market - namely above the high of the last bar.

According to your entry shown on the chart, it looks like you didn't do that.

Please explain.

Chris Johnston said...

robert

stop was 2 ticks above high of bar the day before the last bar. This is a specific bar pattern entry
i use at times