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TECHNICAL ANALYSIS FOR IDIOTS

  
  Education
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The outline of the book is very simple and well designed, consisting of four parts: Introduction to Technical Analysis, Tools For Technical Analysis, Time to Trade, and Trading Mechanics.  There is a wealth of information here so let’s look at a few nuggets.

INTRODUCTION TO TECHNICAL ANALYSIS

Arps does a good job of explaining the purpose of technical analysis as a way to “help you anticipate potential changes in the direction of market prices resulting from crowd behavior driven by the emotions of greed and fear” and not as a “business of absolute predictions.”  All too often the new trader considers technical analysis to be the answer to predicting future price action; Arps tempers this expectation with a good analogy:  “Like weather forecasting, technical analysis doesn’t result in absolute predictions about the future.  Instead, technical analysis can help investors anticipate what is “likely” to happen to prices over time.”  After laying the foundation Arps begins to build a firm structure by covering topics that include market structure, charting, and various swing patterns.

TOOLS FOR TECHNICAL ANALYSIS

Part 2 covers the technical of technical analysis.  Here Arps dissects just about every tool available to traders from trendlines to moving averages; oscillators to point and figure charts; and price to support and resistance.  These tools help the trader better  anticipate future price direction by considering recent price support/resistance areas, overbought/oversold areas, trending/consolidation conditions, divergence, etc.  “Answers to these questions can alert you in advance as to when prices are likely to change direction and thus provide you with powerful information that can significantly improve your trading profits.”  Much of what is covered here is your traditional meat and potatoes but there is a little extra gravy, such as Arps’ own Fear-Greed Index, a chapter on Volume Float analysis, made popular by Steve Woods, and the Jackson Probability Zones, a method named after J.T. Jackson.

TIME TO TRADE

Understanding the basics of technical analysis is one thing: applying it to current market conditions is quite another.  In part 3, Arps discusses how to use technical analysis for building the skills necessary to become a successful trader.  What is of particular interest to me is Arps discussion of developing a trading plan, which, he says, consist of four parts:  rules for entry, rules for exit, money management rules, and the selection of a strategy.  Anyone who has traded for any length of time will quickly point out that the trader may have more degrees in technical analysis than a thermostat but if he does not have a plan for using that knowledge it will be worthless.  In fact, it could be dangerous.  Arps does a great job of cautioning the would be trader who believes that technical analysis knowledge is key when it is not.  “There are several reasons to have a trading plan, but probably the biggest is the way it simplifies things.  Decision making becomes very clear cut.  The trading plan defines what is supposed to be done, when, and how.  Just follow the plan.  The plan serves as a roadmap to entering and holding, profit taking, or cutting losses.  Writing down your plan gives you an immediate edge over most traders and investors.”  Bottom line: the trader’s edge is following a plan; not the plan itself.

TRADING MECHANICS

In part 4, Arps takes the trader through the (more…)

6 Stages Of A Trader

  
  Education
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Very interesting description of how traders evolve over time. The pieces of advice Bo Yoder andVadym Graifer give at the end of the article are spot on. Definitely worth reading as every trader worth his salt can relate to all the different stages. Enjoy.
Stages of a Trader
Stage One: The Mystification Stage (by Bo Yoder)
This is where the neophyte trader begins. He has little or no understanding of market structure. He has no concept of the interrelationship among markets, much less between markets and the economy. Price charts are a meaningless mish-mash of colored lines and squiggles that look more like a painting from the MOMA than anything that contains information. Anyone who can make even a guess about price direction based on this tangle must be using black magic, or voodoo.
However, as one begins to observe, read, study, the mess may begin to resolve itself into something that may make sense. Sort of.
Stage Two: The Hot Pot Stage
You scan the markets every day. After a while (sometimes a good long while), you notice a particular phenomenon which pops up regularly and seems to “work” pretty well. You focus on this pattern. You begin to find more and more instances of it and all of them work! Your confidence in the pattern grows and you decide to take it the very next time it appears. You take it, and almost immediately your stop is hit, and you’re underwater for the total amount of your stop-loss.
So you back off and study this pattern further. And the very next time it appears, it works. And again. And yet again. So you decide to try again. And you take the full hit on your stoploss.
Practically everyone goes through this, but few understand that this is all part of the win-lose cycle. They do not yet understand that loss is an inevitable part of any system/strategy/method/whathaveyou, that is, there is no such thing as a 100% win approach. When they gauge the success of a particular pattern or setup, they get caught up in the win cycle. They don’t wait for the “lose” cycle to see how long it lasts or what the win/lose pattern is. Instead, they keep touching the pot and getting burned, never understanding that it’s not the pot (pattern/setup) that’s the problem, but a failure on their part to understand that it’s the heat from the stove (the market) that they’re paying no attention to whatsoever. So instead of trying to understand the nature of thermal transfer (the market), they avoid the pot (the pattern), moving on to another pattern/setup without bothering to find out whether or not the stove is on. (more…)

A Few Notes From Adam Grimes

  
  Education
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Adam Grimes (Chief Investment Officer of Waverly Advisors) prefaces his 2012 book, The Art and Science of Technical Analysis: Market Structure, Price Action, and Trading Strategies, by stating: “This book…offers a comprehensive approach to the problems of technically motivated, directional trading. …Trading is hard. Markets are extremely competitive. They are usually very close to efficient and most observed price movements are random. It is therefore exceedingly difficult to derive a method that makes superior risk-adjusted returns, and it is even more difficult to successfully apply such a method in actual practice. Last, it is essential to have a verifiable edge in the markets–otherwise no consistent profits are possible. This approach sets this work apart from the majority of trading books published, which suggest that simple patterns and proper psychology can lead a trader to impressive profits. Perhaps this is possible, but I have never seen it work in actual practice. …The self-directed trader will find many sections specifically addressed to the struggles he or she faces, and to the errors he or she is likely to make along the way. …[Institutional] traders will also find new perspectives on risk management, position sizing, and pattern analysis that may be able to inform their work in different areas.” Using example charts for many assets from different times over different time frames and from different markets, he concludes that:

From Chapter 1, “The Trader’s Edge” (Page 7): “Every edge we have, as technical traders, comes from an imbalance of buying and selling pressure. …we do not trade patterns in the market–we trade the underlying imbalances that create those patterns.”

From Chapter 2, “The Market Cycle and the Four Trades” (Page 45): “When buying pressure seems to be strongest, the end of the uptrend is often near. When the sellers seem to be decisively winning the battle, the stage is set for a reversal into an uptrend. This is why it is so important for traders to learn to stand apart from the crowd, and the only way to do this is to understand the actions and emotions of that market crowd.”

From Chapter 3, “On Trends” (Page 95): “…many outstanding trades come in trending environments. Market structure in trends is often driven by a strong imbalance of buying and selling pressure, it is often easy to define risk points for trades, and some of the cleanest, easiest trades come from trends. However, markets do not always trend.” (more…)

Dalton, Jones, & Dalton, Mind Over Markets

  
  Education
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Mind Over Markets, the book that popularized (and expanded on) Peter Steidlmayer’s Market Profile, was first published in 1990. Anyone who bought the book expecting a self-help manual would have been sorely disappointed because what they got instead was a pretty complicated alphabetic model for organizing the distribution of market data along price and time axes. Twenty-three years later James F. Dalton, Eric T. Jones, and Robert B. Dalton are back with an updated edition of their text, Mind Over Markets: Power Trading with Market Generated Information (Wiley, 2013).

The book itself is organized according to the Market Profile trader’s achievement level—novice, advanced beginner, competent, proficient, and expert—with the greatest time spent on the competent level. The expert trader gets a mere two pages. (more…)

6 Types of Traders

  
  Education
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  • Pretrader. Everything is new at this stage, and everything is difficult. This is the point where the trader is learning the very basics of charting and of market structure and is also just starting to explore the marketplace.
  • Novice trader. At this stage, traders are not trading to make money; they are trading for experience and to begin to deal with the emotional challenges of trading. One of the main signs of progress in this stage is that the trader will start lose money more slowly than before—still losing, but losing less often and less consistently.
  • Early competent trader. The first step toward making money is to stop losing money. A trader whose wins and losses balance out (before commissions) has taken the first steps to competence. (At this stage, the trader is still losing money due to transaction costs and other fees.)
  • Competent trader. The first stage of real competence is achieved when the trader is able to cover transaction costs with trading profits. Reaching this stage may take a year and a half to two years, or more. Consider this carefully—two years into the journey a realistic expectation is to finally have accomplished the goal of being able to pay for your transaction costs. This may not seem like much, but very few individual traders ever survive to this stage.
  • Proficient trader. Here the trader starts making money. Errors and mistakes are far less frequent, but, when they do happen, they are corrected and reviewed, and the lessons are quickly assimilated. The trader has been exposed to the stressors of trading so many times that they have now lost most of their emotional charge and is able to approach the markets in an open, receptive state. As competence grows, the trader can look to manage more money; developing the skills of trading larger size and risk becomes a focus.
  • Experienced trader. It is difficult to imagine a trader becoming a true veteran without living through a complete bull/bear market cycle—about a decade in most cases. This trader has finally seen it all and has also become cognizant of the unknown and unknowable risks that accompany all market activity. It is possible for developing traders to gain much of this veteran trader’s knowledge through study at earlier stages of development, but there is no substitute for experience and seeing events unfold in the market in real time.

Typical Trading Errors

  
  Education
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1.  Refusing to define a loss.
2.  Not getting rid of a losing trade when it is obviously a loser.
3.  Getting locked into a bullheaded opinion about market direction.
4.  Focusing on monetary value of trade instead of market structure.
5.  Revenge trading to recoup a loss.
6.  Not reversing a position when the market is clearly changing direction.
7.  Not following the rules of your strategy.
8.  Planning for a trade and then not taking it.
9.  Not acting on your intuition.
10.  Giving back recent gains due to overtrading or inconsistency.

How would you classify trading errors?

  
  Education
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TRADINGERROR

  • Improper analysis, categorized as inadequate preparation or incorrect interpretation
  • Improper entry (early or out of sync with market and sector action)
  • Improper execution (inappropriate position size, failure to adhere to proper trading principles, e.g. momentum resumption)
  • Failed exit, e.g. profit turns into a loss, failure to recognize ‘windfalls’, etc.

So what ‘rules’ must we have.

  1. Identify your edge (specific market, specific techniques)…if making money on the short (long) side isn’t working, why persist at that which isn’t making it happen? Strive to do more of what is working and less of what is not.
  2. Trade with the market. Intraday ‘tells’ are huge. If breadth is negative and the dollar is positive, going long equities is going to be tough sledding.
  3. See the market as it is. If we’re wrong, having missed the exit ramp, are we going to stay on the highway into the next state, or get off?
  4. Understand the market structure. Is the market trending, detrending, breaking out of consolidation, bouncing off support or resistance, consolidating?
  5. Know how volatility is behaving…rising, falling, at extremes.

TRADING ERRORS

  
  Education
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1.  Refusing to define a loss.

2.  Not getting rid of a losing trade when it is obviously a loser.

3.  Getting locked into a bullheaded opinion about market direction.

4.  Focusing on monetary value of trade instead of market structure.

5.  Revenge trading to recoup a loss.

6.  Not reversing a position when the market is clearly changing direction.

7.  Not following the rules of your strategy.

8.  Planning for a trade and then not taking it.

9.  Not acting on your intuition.

10.  Giving back recent gains due to overtrading or inconsistency.

We can learn a lot from the market, and from ourselves, if we would only listen.

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