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Profitable ETF Trading Strategies: trading the morning gaps

April 30, 2009 Leave a comment

There are many trading books from excellent traders that described their particular techniques for trading the morning gaps. If you look carefully at their ideas see that in many cases we are in complete disagreement about an appropriate strategy for the gap. This sounds stranger than it really is. 

The morning gaps is so volatile that there are a number of short-term strategies that can make money if execute effectively. 

For me, however, the morning gap is so volatile that I like to wait approximately 20 to 30 minutes to get a read on the morning price action before I commit my money.

 I conducted several daily analyses concerning the gap, however, that shapes my strategy for the following day. 

First, I analyze statistics concerning the science and direction of the morning gap in the market in my target of interest the past 200 days. I uses information to establish normal and abnormal gap, in order to increase my understanding of the current context of the market and the trade. I actually use this information to help me manage my exit decision near the end of the day regarding the size of the overnight risk I am prepared to take. 

There are some times when the correlation between the gap and the subsequent follow-through is so strong that you can use the strategy of linear forecasting to estimate the size of the follow-through based on the morning gap. This only happens 10-20% of the time, but when it does it can help you very carefully engineer a good reward to risk ratio trade. 

A persistent finding is that the size of the gap correlates strongly to the size of the follow-through. Unfortunately this will not predict the direction of follow-through reliably. 

In terms of standard practices and intraday battle drills, I look for a morning hook or a bungee trade in the direction of closing the morning gap when it’s large. 

The morning will normally takes the form of a large gap down, the sharp see selloff, intraday support established at the low of the day, followed by a reversal to at least close the morning gap. There are a number of sub strategies with the morning hook but the basic idea is pretty simple. 

The bungee trade occurs on exceptionally sharp selloff that begins to immediately rebound on an upward trending day the broader market. In many cases this strategy allows us to front run a mechanical entry price that we have established during our preparation phase.

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Profitable ETF Trading Strategies: efficiently developing an effective trading plan

April 30, 2009 Leave a comment

Every day after the market closes I prepare a trading plan for the following day. Every Friday night, I analyze the market conditions on a weekly basis to develop a week long trading strategy that will last entire week. My combined daily trading plan then incorporates both the weekly and daily preparation.

I use a number of methods  to generate system signals efficiently for both the daily and weekly trading plans.

Standard stock screens@stockcharts.com: I have about a dozen standard screens that I can quickly run on a standard set of trading baskets. Because I have named these baskets and named the screens, I can link them together to build more complex screens as needed.

Excel macros: I use defined ranges and standard formatting in combination with Excel macros to automate the production of 30 different reports in various spreadsheets. I hotlink the summary action tables of the various spreadsheets into a Microsoft Word document to generate automatically but daily and weekend reports. The macros include a linked set of sorting routines and report printing procedures to standardize repetitive tasks. This saves time, energy and improved accuracy a lot.

Excel visual conditional formatting: by defining the correct area which makes certain conditions highlighted I am able to rapidly source and identify trading targets to meet my requirements.

Maintaining your trading Journal: many of tomorrow’s setups and trade frames for a result continuation patterns from today’s setups and trades. Developing familiarity with stocks and ETFs that behave well is a very efficient way to generate trading ideas for tomorrow.

Mastermind sharing: by having a group of like-minded traders who share ideas and a common framework for trading the market, we are able to very efficiently generate a lot of trading ideas from various members

Staying alert in the moment: since an important part of my trading strategy on an intraday basis is to respond to existing market conditions as they change, I can say that my is an efficient way to generate trading ideas as well. My mindfulness practice includes maintaining a watch list of all my favorite stocks and ETFs sorted by daily percent gain and loss, which allows me to focus on the extreme winners and losers in order to ride momentum intraday.

I find that having about 10 tradable ideas in mind that are related to market conditions broad indexes favorite stocks and ETFs is more than sufficient to prepare me for the day ahead. Having the automatically generated daily and weekly reports adds rigor and discipline to my preparation.

Profitable ETF Trading Strategies: a reflection on trend following

April 30, 2009 Leave a comment

Trend following is one of the most powerful practical trading strategies available to you as an individual trader. It is suitable for multiple time frames and multiple markets. In a very real sense, all trading strategies regardless of time frame incorporate some aspect trend following except for purely random entry systems.

In my own personal strategy I employ trend following in several ways:

On a weekly basis I analyze market conditions to determine what percent exposure to the markets for the following week I should have. If market conditions permit me to expose money for the week ahead, I will then allocate the appropriate amount of money into the strongest trending ETF sectors. I will use a trailing stop from the highest high  while in the trade in order to preserve profits and perfect capital.

I defined the strongest of the strong ETF’s with a composite measurement of strength, consistency and volatility lesson blended into a single metric.

This exit strategy will certainly give back some profits but is a disciplined way of ensuring that I don’t exit positions too soon. It also waits to see the far side of the hill before it sells to preserve profits.

In a longer term passive asset allocation strategy, I am fully invested in a diverse set of low correlation asset classes as long as the market trend is positive, as defined by the relationship between price and the 200 day moving average. In a sense, this is trend following related to the markets overall trend. When that trend is negative, defined by price less than 200 day moving average, then I am out of a position and fully in cash.

The strategy could incorporate going short the market once the bearish trend is established on price weakness. In my personal strategy, however, I go after profits on the short side in a different manner.

In the shortest time frames strategies for trading, I am looking to capitalize on intraday trading prices in high probability setups in order to make more reward than risk in the shortest possible time.

It is fair to say that I am really looking to trend follow in all time frames that I trade.

Michael Covel’s book on trend following is the best single resource I have found on this topic. I also like Dr. Elders triple screen pattern to find high probability, high payoff opportunities in strong trends.

Profitable ETF Trading Strategies: four sources of traders insight into self

April 29, 2009 Leave a comment

There are a number of ways to trader can go about gaining self-knowledge. I want to describe four important sources in this article: assessment instruments, reflective journals, traders mastermind and a trading coach. Each of these can offer important insights into your trading practice, and I recommend that traders use each of these for their self-development.

Assessment instruments: while there are many different kinds of pseudoscientific instruments out there, a couple strongly scientific instruments come to mind. The Myers-Briggs type indicator is one of the most well-known instruments self evaluated personality profiles. While there are many who dispute its claims to scientific knowledge, there is no doubt that it offers powerful insights into preferences and learning styles even if treated as a metaphorical tool. Another odd other instrument that I am fond of using is the learning styles indicator which I find particularly useful since I consider trading the markets to be an educational process of focused inquiry. Appreciating the cold learning style model will give you many useful points of departure for self discovery.

Reflective journals: I strongly recommend every trader maintain a comprehensive trade journal that can be used as evidence were behavior during the act of trading. There’s nothing more powerful than physical evidence in establishing exactly what it is that you do as a trader as opposed to what you believe you do or think you do or say you do. A reflective journal can be short annotations of standard trades patterns or can be expanded to include recordings of how you feel, what you see, with letter grades and editorial comments included. Journals offer double loop learning, which is learning about the trade as well as learning about yourself in the trade.

Traders mastermind: by having a trading tribe of like-minded practitioners who are open to observation and giving quality feedback you will be able to triangulate your behavior and performance through the eyes of respected others. In addition to being 80 high-quality social support network, you want access to excellent feedback. It is good for you to give feedback to others and not just received. That is being a good citizen.

Trading coach: this is a powerful text me for supercharging your performance by putting yourself under the watchful eyes of a coach who can help you focus on the important elements of planning, preparation and execution of your trading plan. A good coach will help us see ourselves clearly and move us to those areas where he modes need improvement. If Tiger Woods and Michael Jordan pay money for personal coaches, there must be something to it.

By incorporating some or all of these sources of insight a trader can dramatically improve his personal performance.

Profitable ETF Trading Strategies: can I make a living as a mechanical trader?

April 29, 2009 Leave a comment

The short answer is: no, you cannot make a living as a mechanical trader.

In fact, you cannot make a living as any kind of trader, mechanical or otherwise.

This doesn’t mean that you are a bad person or stupid or somehow lack the qualities needed to be a success in life. It is simply a realistic appraisal of the statistics of success regarding the trading profession.

Thousands and possibly millions of people around the world have all decided one time or another to try their hand trading profession as a way of life.

They have done what you have done, which is to list their strengths and weaknesses, have some kind of market feedback to suggest to them that they could actually do this for a living, developed a plan and put it into action.

They may have received the encouragement of friends and the advice of professionals.

They may have equipped themselves with the finest hardware and software available to give them an edge.

They may have sufficiently capitalized their effort so that they can participate in markets for extended periods of time.

They researched systems that are appropriate for their personality and the kind of markets they propose to trade.

They have written business plans, rehearsed their trading strategy through simulations and prototyping with real money small position sizes.

They may have aligned themselves with a tribe of like-minded people for mutual support and multiple perspectives.

They may have equipped themselves with market insights from recognize longevity and above-average results.

They have done all of these things, and like you they have failed.

These people were not stupid, naïve, or unprofessional. They are all generally good and decent people just trying to make a living.

It’s just that the market is hard and unforgiving.

It will crush you without blinking an eye.

The guy on the other side of the trade take your money without blinking an eye no matter how unfair you feel it isor how professional you are.

He is trying to feed his family just like you were.

But you failed and he didn’t. T

he reason they succeeded and you fail, you ask?

If you fail to perform any of the good ideas earlier in this article the answer is easy. You were a naïve child unprepared for the world.

But if you were well-prepared as noted above and still feel, the answer is harder to find, and sometimes we can’t find it at all.

The market is not only stranger than we know, it’s probably stranger than we can know.

And just when you think you have it figured out after a long winning streak, and have taken on more risk than you realize because you’re hot, the new kid in town who was luckier or faster than you will take all your money and leave you crying in the street.

But maybe you are different.

Your plan is better. You are smarter. You are faster. Keep telling yourself that.

All I know is that everyone I have met who makes a living as a trader has a ruthless commitment to performance and preparation and specialization in their niche.

They are driven to succeed by an inner fire that cannot be extinguished.

They are relentless  about exploiting their edge every time they see the opportunity and they do not quit until they have the prize in hand. and then they guard it as if their life depends on it.

That is who you are trading against. 

Do yourself a favor and find an easier way to make a living.

Take care of your long-term investment through passive asset allocation.

But if you must trade, prepare yourself well and remember that you have been told.

Your results are entirely your responsibility.

Don’t ever forget that.

Now go trade.

Profitable ETF Trading Strategies: is mechanical trading right for me?

April 29, 2009 Leave a comment

Clearly, when you are considering whether or not a particular trading strategy is appropriate for you it comes down to bottom line performance. Can you, in fact, execute the trading strategy according to the rule sets as defined?

In this sense it doesn’t matter whether your system is purely mechanical or discretionary or combination of both. You can either follow the rules or not, and the rule set makes money for you according to plan or doesn’t.

It would be nice to know, however, if a certain style is appropriate for your personality type or not before we commit a lot of time and money to the effort.

There are a lot of people who believe they can trade a mechanical system until they actually have a good one and try to do it. They discover that they cannot stop themselves from tinkering with it by bending the rules or otherwise adding discretion.
Here’s an example from my own trading practice.

I have a mechanical system that is in the market only 10 to 15% of the time in a given year. It waits for specific high probability conditions to arise in the market and then takes a position that is clearly against the mass psychology. It aims to capitalize on the markets tendency to revert to the mean after extreme moves.
This rule set guarantees that you will enter the market in a direction completely opposite of what your human psychological tendencies suggests is about to happen.
Even though I have back tested the system extensively in the past 15 years in multiple markets and am satisfied with my rational brain that it has a high probability of success and reliable results, and have traded it successfully with real money for more than four years, I still find it uncomfortable to enter the positions because of my psychology.

I can now manage my psychology to enter the position at appropriate risk levels when signals are generated and have had to learn how to accept the uncomfortable feeling as a positive sign of a good trade.

In a larger sense, I think what is necessary for someone to be pure mechanical trader is that they have the confidence in their analytical judgments, confirmed the reliability of the  confirmedand have identified the risk level that allows them trading system without danger of blowing up.

They are  committed to periodic performance review and can approach the entire situation with analytical mind and rigor.

These would be unusual qualities for most people, but they are ideal for someone who has a good mechanical system and wants to exploit it. 

Profitable ETF Trading Strategies: appreciating the power of rehearsals

April 28, 2009 Leave a comment

Rehearals are considered to be one of the highest payoff practices in the military planning process. It’s where units develop and reinforce the patterns of action and decision-making that make all the difference in combat.  Rehearsals  will improve your trading practice as well, if you understand how to do them well.

There are 4 main reasons why rehearsals can improve your trading practice:

1. Practice essential tasks.  By identifying the critical tasks in your systems, you can focus on the ones that contribute the most  to success or failure

 2. Identify weaknesses or problems in the plan. You often will not discover  gaps in your logic or problems with the concept until you have “driven the route ” from start to finish from the perspective of the operator. This is especially true if you have built your plan out of component pieces, each which are individually sound, but have not yet been linked together before.

 3. Coordinate subordinate element actions.  When you use a building block approach to trading system development, sometimes  you will discover that the sum of the parts is different than the whole. This means that there are unknown or unintended consequences of piecing things together which are not revealed until you put the plan into operation, or better yet, have a decent rehearsal to test the seams.

 4. Improve understanding of the concept of operations. Once you have driven the entire plan, you will develop a sense of completeness and appreciation for its qualities or problems areas from the top down. You will be able to see the seams, where pieces come together in utual support or in sequence.

By paying close attention to your rehearsals, and making them as realistic as possible, you will be able to dramatically improve your trading practice.

Taken together with effective After Action Reviews, rehersals are an important part of your preparation phase. Time spent here will add directly to your bottom line.