Nextleveltrading's Weblog

Managing your Trading Risk

nextleveltrading — Tue, 18 Mar 2008 21:30:14 +0000

Basically, the best traders know when to get in and when to get out. They usually look for a 3:1 risk/reward ratio. The downside risk must be less than the upside potential. While there are several levels of success on the upside, there is only one level of risk on the downside. There are never multipliers on the downside.

Great traders decide on their exit points on the upside as well as the downside in advance of their trades. They establish an exit point based on the amount of profitability they want from a trade, taking into consideration commission and slippage costs. Then they get out of a trade before it reverses. They realize that when they get bigger and stay longer, they are increasing their risk, especially in highly volatile and illiquid markets. However, at times they also press the bet and add to their positions before the exit target is reached. But they are careful not to get too greedy.

In highly volatile markets, successful traders are particularly cautious in managing their positions. They are quick to adapt to changing circumstances and don’t remain wedded to positions. They are continually moving stocks, mentally and physically, reviewing and renewing their choices. Successful traders get bigger in their winners and kick out their losers. They diversify when they get a chance to do so, recognizing that they lose the most money when they are too loaded up in one area of the market.

They evaluate each position on its own merits and never justify being in one stock by the fact that they are ahead in another stock. They are not always looking to recoup losses or to hit home runs. In fact, they are very clear about closing down their trading for the day once they reach a certain amount of loss.

Next Level Trading

Who are the Analysts?

nextleveltrading — Sat, 23 Feb 2008 00:19:21 +0000

Stock analysts come in two varieties: buy-side and sell-side. Investment bankers, including most full-service brokerages, hire sell-side analysts to research stocks of interest. Originally, brokerages derived most of their income from commissions on stock sales, hence the term, sell-side analysts. These days, investment banking accounts for the lion’s share of full-service brokerage income, but the sell-side label is still applied.

Brokerages employ scores of analysts. Each typically covers a specific industry such as semiconductor equipment or restaurants. Analysts write research reports on their industry as a whole, and on specific companies within the industry. The analysts devise sales and earnings forecasts, buy, hold, or sell recommendations, and target prices for companies they follow. They update their forecasts and recommendations after each company’s quarterly report is released and at other times as events warrant. Sell-side analysts’ ratings and reports are widely distributed, and third parties such as Thomson Financial, Zacks Research, and Reuters tabulate their ratings and estimates and publish them in the form of analysts’ consensus ratings and forecasts.

Mutual funds, pension plans and other institutional players read the sell-side analysts’ reports, but many also employ their own analysts. These buy-side analysts do their own research and arrive at their own opinions about a company’s future prospects. The buy-side analysts’ reports are rarely publicized.

All of the ratings and forecasts that we hear about or see complied come from sell-side analysts. Analysts publish an in-depth report describing the business model, industry, and competitive situation when they begin coverage of a new company. After that, most analysts’ reports are short updates, typically responding to an earnings report or other news affecting the company’s outlook. Each report or update includes the analysts’ current buy/sell recommendation, as well as earnings forecasts for upcoming quarters and for the current and next fiscal years. The report also provides background information justifying changes in the ratings or forecasts.

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Keeping a Trade Journal

nextleveltrading — Tue, 12 Feb 2008 22:40:09 +0000

If there is a single factor that is common to those who fail in trading, it is the failure to keep and make use of an adequate trade journal. Many traders have the idea that the purpose of a trade journal is accounting or bookkeeping, and given this notion, they quickly become bored and abandon the trade journal completely. Of course, this not the purpose of a trade journal. The primary purpose of the trade journal is one of discovery: discovery about one-self and discovery in relation to the market.

Self-deception is an ever-present factor in trader psychology. Part of this stems from a common operating belief that “things go wrong” not because of one’s own actions, but because of the actions of others. In addition to this factor, problems of selective memory are so rampant, particularly in relation to emotion-based traders, that the only cure is accurate and precise use of the trade journal. Many traders lose partly because the factors they are trading on amount to a desire to lose. Traders become inhibited in writing out precisely what is operating because in their experience, these factors operate best when they are hidden. Even when the trader is engaged in hiding them from her or himself. Self-delusion is a major occupational hazard in the business of trading and investing.

In general, the first step toward the alleviation of trading problems is the revelation of “secrets”. Any trader will profit from a “telling” of the results of the day’s activities. There are two parts to this. The first is to tell oneself. Here, in addition to making the trade journal entries, one must always know the state of one’s performance. This should always be current, and one should know it without fail. The second is to tell someone else how you did today-someone who is important to you. It is astonishing how frequently traders refuse to track their performance and fall into secrecy. This is the beginning of many levels of self defeating activity that finally lead to a common plight: not only the risk of ruin, but the reality of ruin as well.

Trading journal entries must include the price and basis for each entry, target, and stop. In addition, context variables should be noted, and the trade should be tracked as it unfolds. The more focused on the chart one can be, the more focused will be the important observations that will prove beneficial. The most difficult part of the journal entry is recording what happens once one is in the trade. Being in a trade always produces experience factors that are not present otherwise. It is always a challenge to record these factors honestly and accurately. This is where most traders begin to fail: by refusing to write down the contents of one’s actual experience- the fantasies, then fears, the wishes, the upsets, the enthusiasms, and so on. The “outer” context factors must be recorded as well: listening to the news or the commentator, the play caller in the chat room or others of any kind or description.

This sounds like a terrible chore, and indeed it is a chore, but the potential for learning about oneself and about the market that comes from this is available nowhere else. Only in your own experience can you find your interface with the financial markets. That is your individual space that no one else knows. Your obligation as a trader and investor is to know that space as well as you are able to and to become as responsible as you can be for what takes place there. The trading journal is instrumental in accomplishing. Consider it an essential and never ending tool in your education as a trader.

Next Level Trading

Reasons why not to chase a stock

nextleveltrading — Tue, 05 Feb 2008 18:10:17 +0000

Knowing how to enter into a position is just as important as knowing how not to enter into one. The two most common ways of botching an entry are chasing a stock past year ideal entry point and anticipating a move to an entry point too early.

When you decide to enter into a position, refrain from chasing stock too far past your ideal entry target range. This does not mean that you cannot get into the stock; it simply means that instead of paying an immediate premium for it, you are waiting for it to pull back before getting in. You can get in on a pullback as long as the stock does not move excessively past your entry point. If it does move too far past your entry point and then falls back (a fallen star), it should be avoided.

Most market markers are unwilling to chase a stock too far past an entry range in order to execute a customer’s retail order. They prefer to short a stock to a retail buyer if the stock moves up excessively, rather than pay up for it. This is because stocks tend to pull back in a steplike fashion after moving higher.

Traders usually chase stocks because they get emotional about having missed a move, and they want in at all costs. Buying a stock you are better off letting it go. The chances are that another opportunity will materialize. Remember, missed money is better than lost money. Chasing stocks is the most common way to lose money when entering into positions.

Another common mistake made by professionals and novice traders alike is to anticipate a move into your entry zone before it gets there, with the motive of getting a cheaper price. When prices do not move to your level, there is usually a good reason. By anticipating the move, you are nullifying the reason for getting in. Always wait for the price to enter into a sweet spot before acting. Use caution and refrain from anticipation. Anticipation is a dangerous quality to possess as a trade. Regardless of how tempting it may be to get onto the wave early, when you anticipate you are projecting your will onto the market. Allow the market to open the door for you before you act. Read the market’s will and refrain from imposing your own.

The problem with anticipating a move through support or resistance is that these levels are called so for a reason. The buyers or sellers of yesterday usually fortify those levels with increased resolve. The bulls or bears may be waiting in the wings to protect their territory. The very reason you are entering into the position in the first place is because of the evidence that the selling resistance or buying support has been nullified by today’s stronger action. Anticipating a move to these levels is wishful thinking and has no basis in reality.

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Gap Openings

nextleveltrading — Wed, 30 Jan 2008 15:50:35 +0000

In the event of a gap up opening where the futures gap above fair value and stocks open higher than the prior day’s close, the rule to remember is that the 5- and 15-period moving averages need to catch up. Shorting gaps up is naturally countertrend. This sets up opportunities to place shorts off existing pivots or 200-period moving average resistances at least until the 5-period moving average catches up. Gap openings should be considered to be like short squeezes, so it’s important to make sure that the 1-minute stochastic gives 80-band crosses down or mini inverse pip slips through the 80 band before taking shorts. The Achilles heel of a short squeeze is an 80-band stochastic slip on either the 1-minute or the 3-minute chart.

The first 15 minutes of the opening should be traded only by experienced traders, since this period is fast and frenetic. The 13- and 60-minute noodles reading should be done after 9:45 a.m. If you take a position overnight to play the gap down or up and it gaps against you, it is important to make sure that you give it 10 to 15 minutes after the open and mark the highs and lows of that opening period. If the high in that period breaks, then keep a stop. If the low breaks, then manage to pare and lip the gapper.

In the event of a gap down opening where the futures gap below fair value and stocks open lower than the prior day’s close, the same rule concerning the 5- and 15-period moving averages needing to catch down to the gaps applies. This means that the countertrend move to go long off a pivot or 200-period moving average support can be played. The upside on the bounce is the 5-period resistance overshoots for the scalps. Getting a good stochastic 20-band crossover on both your 1-minute stochastic and the futures 1- and 3- minute stochastic is the key to assuring a clearer move.

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Intraday Traders should start out as a Scalper

nextleveltrading — Wed, 23 Jan 2008 01:09:35 +0000

Every trader needs to start off as a scalper. A scalper is a trader who expects a move from point A to point B in a relatively straight line. The scalper’s aim is to get in and out with the least amount of wiggles and noises. Scalpers will tend to actually be the most risk-averse because their understanding is that the longer one is in a position, the more risk is inherent in the trade. Therefore, a scalper wants to enter and exit in the shortest time possible. The scalper style is most effective in an environment with high volume and wide channels. Volume gives the scalper liquidity and the opportunity to exit into the buyers on longs and to buy into the sellers on short covering. Scalpers love to play panics and wider-channel trends and ranges. Scalpers will always get out early, which is just an indication of their innate ability to exit without disturbing a stock’s momentum. Scalpers will mainly use the 1-minute and 3-minute charts, with a background view of the 10 or 13-minute charts.

A scalper is an expert at selling into the buyers and buying into the sellers. Excellence of timing and execution is the forte of a good scalpers. Scalpers are either taking profits or trimming losses. When supports overshoot, a scalper will be there to take advantage of the overshoots and scalp out their short covers into the sellers without thinking twice. When a pivot resistance overshoots, a scalper will take that opportunity to sell into the buyers without thinking twice because he knows that the pivot is a resistance and that the result is likely to be a backfill and a short-term peak. Scalpers are aware at all times, and this is their strength. They leave little to chance. This is an absolute foundation that every trader must start off with, for better or worse.

After being successful with scalping, a trader will eventually realize he may have quite a lot of money on the table by getting out on the shorter time frame signals. When the 1-minute stochastic peak, a scalper will take his profits before the inevitable retracement. However, after the retracement, the stock will continue to move with the trend. Eventually, a pure scalper may realize this. He will then try to use his ability to scalp by cashing out the majority of his shares based on a 1-minute chart but keeping a small number of shares to move with the 3-minuter trend, with stops in place if the 3-minute premises warrant it. This way, he gets the immediate gain from the scalp and also gets to take advantage of the trend along the way because he has pared some shares out to lock in profits but also maintained a smaller position for a longer time frame to take advantage of the trend. This trader is now moving to the stage of being a combination trader, which is a trader who can scalp and pare initial gains while riding a smaller number of shares for a larger gain.

Next Level Trading

Protecting your capital with Stop-Losses

nextleveltrading — Tue, 15 Jan 2008 22:50:12 +0000

Enter into trades only when you have established a sensible game plan, with a stop-loss exit strategy mapped out in case the trade is a loser. A stop-loss is your only insurance if the stock does not perform the way you hoped. If and when that initial stop-loss point is reached, it is crucial to get out of the position without thinking about it.

Managing loss is what risk control is all about. Losing correctly requires inner strength and strict discipline. It takes control to set a stop before you enter a trade. Setting a stop before trading means that you are considering the risk before going after the reward. The only way to last in trading is by preserving capital and adhering to predetermined stops will allow you to do this.

After you determined a stop, do not adjust it to give yourself more leeway if the trade is not working out. Why a trade is not working doesn’t matter. You can always find rationalizations and excuses for loss later. The sooner your stop announces to you that your position is faulty, the better off you will be. Traders without discipline will move stops or ignoring them can’t last long in this business. Your first choice for a stop-loss is probably the best, and you should adhere it.

There are different strategies for placing stops. With practice, most traders develop their own stop-loss strategies based on their own risk/reward ratio.

Another type of stop-loss is one used to protect your profits. This is used when your position is working well and has moved to or passed your predetermined exit price. It is time to preserve some of your gains. Locking in some profits using a stop-loss strategy is an effective way to trade without worrying about losing your gains. It helps a trader to let profits run longer while not missing out on a solid gain. Depending on the trader’s style and the type of stock traded, the stop-loss level used to lock in some gains could be adjusted. More aggressive traders may use wider stops to protect profits, while less aggressive traders would use narrower ones.

Developing a comfort level when using stops takes practice and discipline. Each stock has its own personality and reacts differently throughout the day. Some stocks advance and pull back quickly, while others may creep along steadily. After becoming familiar with the stock you’re trading, you will be able to place stops more effectively.

Next Level Trading

Active Traders’ Mind Management

nextleveltrading — Fri, 11 Jan 2008 20:05:48 +0000

Traders need to maintain a clear focus, and that comes only with a clear head.

Learn to pace yourself. A word of caution: good times can still be dangerous. When almost every trade you put in works and your account is growing rapidly, slow down. You don’t have the Midas touch. The risk now is overtrading. Jumping into higher-risk trades because you are doing so well is common and a mistake. You need to take a cold shower and review every trade based on the rules you have developed for yourself. That is one of the big reasons you must put your daily plans on paper so that you can go back and make sure you are doing what you are supposed to be doing. I know arrogance and overconfidence usually lead to a lesson in humility.

This understanding of your own psychology will teach you to follow your instincts. Nobody can fully explain what is in your head. When trading, you are attempting to foretell the future. This is obviously impossible. This is what makes your instincts such an important tool, your sixth sense. Find out early on if you have good instincts for the market or not. That is important because it is your instincts that you will often rely most heavily on.

Learn to be honest with yourself. When your instincts work in your favor, imprint those feelings in your mind. When you feel the groove, you must imprint it in your mind so that you can repeat it. On the other hand, if you take a profit totally by accident, be able to separate this feeling from the feeling you had when you honestly followed your instincts. Accidental incidents are not repeatable, but instinctual ones are. Instincts are ever changing and evolving attributes that you should not ignore, but rather embrace. Instincts are developed over time and through experience, and surviving the market first will allow you to thrive in it later.

Find your own game or recipe for success. A sound financial and educational base is imperative and makes for a great beginning, but thats all it is. At some point, the more you divert yourself from finding that understanding of yourself. Learning from others is imperative, but relying on others is a mistake. There a difference.

As you develop your own unique trading style, you also must consider a reality for all traders. The mind has a low acceptance rate but remember, the best traders are in minority, and the best traders, learn to lose. Day trading is pushing the envelope of your capability. The most aggressive and exciting realm of market engagement.

Because active day trading is on the edge, one of the truly difficult psychological barriers to accept is learning to accept losses. It is a major component of active trade and simply part of endeavor. With the acceptance of this fact, traders see losses differently, knowing that every loss has a lesson within it. Traders must embrace losses and see them as a cleansing process to rid them of the mental anguish that losses bring. The deeper the lose, the greater the burden, and the losses can weigh on you like useless cargo that has no value or upside. You have to learn to train your emotions and your mind to cut them quickly, moving you ever closer to understanding trading.

Next Level Trading

Do Not Buy a Stock Because the Price is Low

nextleveltrading — Tue, 08 Jan 2008 16:46:23 +0000

Buying a stock just because the price is low is often a risky strategy. However, there are situations where a lower price can be one of the selection factors. The term “oversold” can refer to a technical condition with an individual stock, or it can refer to a situation which causes a stock to drop lower in price due to the release of information regarding the earnings potential of a company. Actually the stock becomes “undervalued,” meaning that the price is lower than the current value based on current earnings. When a company which has been established with consistent earnings over several years comes out with negative information, price will likely drop. An “oversold” or “undervalued” situation can be an ideal time to buy any stock, but it is important to know more than just the price of the stock and its current P/E ratio.

At times a drop in the stock price brings even more sellers to the market, which causes the price to drop even further. Many times the selling momentum will force the price lower than the implications of the bad news. This can create a temporary oversold situation.Buying oversold stocks is a strategy used by many investors in which they buy recently depressed stocks with which they are familiar. The key is to buy the stock in relation to its earnings, rather than buying stock because it has a low price. Many stocks with low prices are actually expensive in relation to earnings. Investors buying oversold stocks might have a short-term gain objective and an alternate long-term objective if the stock takes a longer time to recover. This can be an effective strategy in a bull market, but can be very disappointing in a bearish market, where downward market pressure is contributing to lowering of prices.

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Never Fight The Fed

nextleveltrading — Mon, 07 Jan 2008 23:56:25 +0000

Interest rates go up, stock prices go down. Interest rates go down, stock prices go up. These are simple facts. Most stock prices tend to go to opposite direction of interest rates. Most corporations have to borrow some money; when they borrow money, they have to pay interest.The interest they must pay comes from the earnings they hope to increase by borrowing the money. If they have to pay out more dollars in interest on loans, they obviously have less money in the form of earnings. Consequently, earnings have a direct relationship to the price of the stock: Higher earnings, the stock price goes up. Lower earnings, the stock price goes down.The only other actions which affect the price of a stock are speculation, which can drive the price higher, or lack of investor interest, which can drive the price lower.

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