Online Trading Education

Successfully Trading the Middle Ground

Years ago in college, I remember reading Greek mythology.  These were wondrous stories of adventure, courage, exploration and searching.  Yet there is one principle that stands out from these many great tales that has served to guide my life in business and most especially trading.  It is the Greek word “sophrosene” or “balance.”  It teaches that in all human endeavors, true success is attained when one learns to achieve the middle way.

Learning this lesson is, in my judgment, the first critical step to becoming a successful trader.  It is key to overcoming a natural obstacle all traders face.  I call it the “greed/fear syndrome” or the “going to the moon/going below ground” tendency.

Greed is a natural human emotion.  But for traders, it can be toxic—you get in a trade, it starts going your way and you see no reason to get out.  Suddenly you find yourself shooting for the moon.  Greed blinds you – but, the next thing you know, the market reverses and instead of making money, you are down.

Greed’s opposite side may also consume you: fear.  The realization grips you that you really don’t ever have certainty about which direction the market is going to move. You sense that you can lose your capital if you are wrong.  Indecision paralyzes you.  You go below ground and huddle there trembling in despair.

The truth is that both of these extremes can destroy a beginning trader.  It is equally true that both are completely natural.  The key to overcoming them is to learn how to find the middle ground, how to balance greed and fear. This is probably the most valuable lesson for the trader to learn:  understand that it’s not all wins and no losses.  Aspire for success but know that there will also be failure.  Remember that hogs get fat but pigs get slaughtered.  And remember, too, that he who hesitates is lost.

Learning how to balance these two natural and highly dangerous human emotions is among the most important lessons I have tried to teach.  Indeed, its importance to my own trading was one of the reasons I started the school in the beginning.  I found that by teaching others, I constantly force myself to remember what I know to be true, but which all traders find so hard to master: the art of balance; overcoming fear but avoiding greed.

The method I teach to accomplish this goal is the product of years of making mistakes as a trader, as well as all the successes I thankfully have had.  I try to learn from the mistakes as well as the wins, and I teach my students to do the same.

TRADING THE S&P

The search begins with choosing a market to trade where elements that contribute to the balance can be found.  I have been day trading the S&P 500 market since the early 1980’s.  The S&P 500 is a futures contract that trades on the Chicago Mercantile Exchange, and offers several important features that can contribute to the trader’s ability to find success in day trading:

Liquidity:  The market for the S&P 500 futures contract has become sufficiently large that there is substantial daily trading volume, an ample supply of both buyers and sellers, and therefore reduced risk that a trader will be unable to get in or out of a trade when he or she wants at a chosen price (which is called a “limit price”).

Volatility:  The S&P futures market exhibits relatively greater price volatility—alternating upward and lower movements in short time intervals—so that opportunities exist to take both long and short positions throughout most trading days, and correspondingly, opportunities to make profit.

Accessibility:  The S&P 500 futures market operates 24 hour/day, and is accessible via electronic trading platforms offering ease of trade placement.

Leverage:  With the S&P 500 futures market the cost of admission is reasonable—one can control approximately $250,000 worth of stock value for a margin requirement that is typically only 1% or 2%, and enter and exit a position for less than $25 in commissions.

Risk Management:  It is easy to place stop loss orders to hedge every position a trader takes.  This permits prudent risk management to contain losses to affordable levels in order to allow the trader the chance to be wrong on a trade, but still preserve his or her trading capital.

Each of these features makes the S&P 500 futures contract the ideal trading vehicle, and contributes to the equation for finding the balance in trading which is the key to becoming a successful day trader.  At the DTI, I teach a method of forming a comprehensive trading approach that puts the odds in your favor, thus maximizing the probability of success.  I also teach students that every trader must develop a plan of approaching the market that is understandable, accessible, and adaptable to changes in the market.

I suggest that the student start off every day at the same time and gather certain basic information. This includes price data, timing of scheduled news events, trade volume information, and the status of certain markets.  I also teach that the trader should reserve time to review the previous day’s trades, analyzing what went right, what went wrong, and why.

One of the lessons I have learned is that one does not have time to do a doctoral thesis on the true value of what you are trading.  Therefore, the successful trader must assemble his/her tools and indicators in advance of the trading day, and develop a comfortable method that is facile enough to quickly answer the most basic question which must be constantly asked throughout the trading day:  whether to be long, short, or out of the market.

METHOD FOR TRADING

The method I teach for integrating the various elements previously discussed consists of three main parts:

Key Numbers:  Key numbers are price levels that most traders call support (where the market has buyers stepping in supporting the price) and resistance (where sellers are stepping in and offering the market.)

Time of Day:  I have identified certain time zones for trading.  Since the market is a combination of people’s beliefs and how they vote those beliefs (either by being a buyer or a seller), it is very important to have a good understanding of people.  I have observed that people are creatures of habit, and that people generally do the same thing – whether it is good or bad – every day.  I have also observed that the market reacts to people’s daily habits such as:  when they rise in the morning, the time they go to lunch, and the time in which they go home for the day.  Since we are part of a global economy and the S&P 500 is a world market, one can watch the behavior of the markets, and see very discernible time-based trends that can be used in combination with key numbers in the balancing act of trading.

RoadMap™ Indicators: The RoadMap™ to the MarketÔ is a proprietary software program we have developed based on more than 20 years of observing the market that allows us to track the market 24 hours/day.   We have made this software available to traders to provide a constant watch of the indicators that make up the direction of the market.  It is an analytical tool that we use to evaluate the market and answer that basic question of whether to be long or short or out of the market.  It is the heart of the method I teach and draws together in one easy-to-grasp location each of the indicators that combine with the key numbers and time zones to bring us the tools to achieve balance in our trading.

In addition to developing a structured method and finding the right balance to fear and greed, becoming a successful trader also requires one to be able to take a disciplined-approach to the market.  When I first started in this business I spent about 90% of my time trading and 10% thinking.  Over the years, the percentages have reversed such that now I spend 10% of my time trading and 90% thinking.  Do not overtrade.  Failure is due to fear, greed, and/or a lack of understanding/training of how to trade.  A successful trader has the ability to overcome the push-pull of greed and fear through balanced trading, and balanced trading comes from knowledge of the markets, understanding of the importance of a disciplined method that combines key numbers, trading psychology, time, market indicators, and managing both risk and the trade itself.

In addition to the above methods, I also teach to always trade with a stop.  Pre-plan your trade.  It is always good to have a target or target area in mind.  While in the trade, use a stop and add an adjustment to that stop, moving it up or down, as you approach your target.  I am a firm believer in allowing the market to take me out of a trade.

THE GAME PLAN FOR SUCCESS

For traders to succeed, they must have a game plan, specific strategies and tactics to approach the market, and achieve a balance in their trading.  Defining a game plan provides preparation and knowledge.  Specific strategies and tactics that work, yield the consistency traders must develop.  In addition, a trader must find a balance with which he is comfortable.  Balance keeps the trader on a steady path that provides the ability to diverge when necessary.  It is important to examine all three of these elements traders must implement before being able to attain long term trading success.

GAME PLAN

“Know thyself.” – Socrates

It is vitally important to know yourself as you approach the trading arena.   Are you the individual trader, or an institutional investor?  Institutional investors have enough weight to make their own waves in the market, while the individual trader is best served by riding the waves made by others.  Many new individual traders tend to get carried away, thinking they can shape market consequences like larger investors.  In reality most traders are miniscule in relation to the markets.  Only when a trader accepts his place in the market and sets his own course can he benefit from the ride provided.

Know your risk potential.

Can you afford to lose?  It is a harsh question, yet one that must be asked.  The term risk capital applies to the balance of your account.  It is the money you can afford to risk.  Being in financial positions where the loss of money impinges on your financial well-being is not advisable.  If you cannot afford to lose, then the overriding factor becomes the money, which can cloud a trader’s judgment and cause anxiety.  Trade numbers, not money.  Market analysis needs to be pure, untainted by financial concerns.

Managing risk capital is another area of concern.  The entire balance of a trading account should never be on the line.  An “all-or-nothing” approach will make for either a very short or a very costly trading career.  If the market is going against you, don’t lose all of your risk capital trying to force it into going with you.  Understand when it is not in your favor, and get out.  It is very important to come to this conclusion before your risk capital has been depleted.

Understand your goals.

While everyone would like to make a quick fortune, a trader’s goals should be attainable.  You need to start at the bottom and build yourself up.  IBM is not going to hire a recent college graduate to be their CEO.  Gradually build up risk potential by gradually increasing the size of profits.  The more you have, the more you can afford to risk.  Unless a trader approaches his trading career as a building process, early losses aimed at unrealistic goals will end a trading career before it ever begins.

STRATEGIES AND TACTICS

Time

[Important Note:  Throughout this document all times are presented on the 24 hour clock and all times are Central.]

There are times during the day when the market tends to move in patterns.  Knowing these patterns and adhering to them can make all the difference in the world.  A smart sea captain would not try to navigate through a shallow reef during low tide.  A trader should demonstrate that same constraint.  If you were trading during a time where the market traditionally rises, it would be unwise to be taking a short position, or vice versa.  The key is to recognize these patterns and ride them to profits.

Be cautious of times zones when a churning market can play havoc on a trend trader.  The first half hour and the last half hour of the day market are extremely dangerous and can pull the unwary trader under.  Other times to beware are between 13:30 and 14:00, and occasionally 10:30 thru 11:00.  Position traders are best served by avoiding these time periods.

As a trader, you may find that there are certain times during the day where it sometimes seems that you can’t help but be right, and there may also be those times when you can’t win for losing.  Identify these times quickly, and make advantageous use of these zones.  In my history of trading, I have found four time frames that are most profitable for me, including the early morning, the morning, the noontime, and the afternoon.  While the best of these time frames to trade may vary greatly from person to person, each trader must learn to identify their own “prime times” and stick to them.

Indicators

Time can only do so much.  It puts you in the right place, but knowing where to go from there is the real measure of talent.  The primary determination that must be made before trading any market is whether be long, short, or out of the market.

Long: Trade positioned with an expectation of rising market prices (buy low & sell high).
Short: Trade positioned with an expectation of falling market prices (sell high & buy low).
Out: No trade positioned due to no expectation of movement, or no understanding of the fundamental reasons for a market move.

This is sometimes referred to as LSO – long, short, or out of the market.

In the early morning trading I have found the best indicators to be found in the foreign markets, specifically the European markets, as they are the active markets for the early day.  We generally look for alignment.  If the major European markets (the FTSE, the DAX, and the CAC), are all moving higher, it can be expected that the S&P, my primary trading vehicle, will follow.

As the day takes us from the early morning shadow of the European markets to the bright lights of New York City, we look for other indicators.  At the beginning of New York’s trade day, all eyes are focused on the NYSE, and its many indicators including statistics like the TRIN and the TICK.  As the clock continues to turn, examine the Futures Markets in Chicago.  At the Chicago Mercantile Exchange, (CME), you can track the NASDAQ 100 Futures and our trading vehicle, the S&P 500 Futures.  In addition, just down the street is the Chicago Board of Trade, (CBOT), where you can follow the Dow futures and the ever influential bond market.

Key Numbers

Learning when (the Trade Zones) it is best for you to trade puts the market in front of you, but you trade only when indicators show market direction.  However, trend traders must complete the picture, knowing not only where a market is, but also where it is moving and at what point a chosen direction is proven wrong.  This is how key numbers come into play.  Key numbers are those numbers that bear the greatest import on the markets.  They can be breaking points, pivots, or targets.  We determine key numbers through three means: common focal points, previous day’s action, and historical data.

Common Focal Points

Common focal points are those numbers that hold obvious significance.  Examples are Dow 10,000, S&P 1200.00, or NASDAQ 1600.  These numbers are often referred to as “round” numbers.  They are typically fifties, or hundreds, and can sometimes be thousands.  On rare occasions, as seen in the Dow, these “Round” numbers are in the 10,000’s.  As the power of ten rises, so does the significance of the number.

Previous Day’s Action

Finding the numbers that were important in the previous days trading can often help a trader’s knowledge of their immediate surroundings.  If the market approaches the previous day’s low, you can expect the number to either provide support, causing a directional change; or to fail, spurring a quick run at new lows.  Other numbers of importance aside from the Open, High, Low, and Close include time based numbers that I feel are important.  Among these are the 12:30 number and the 03:30 number.  The RoadMap™ is a tool we use to capture these numbers.

Historical Data

Historical data consists of the compiled information from previous days.  The numbers that bear notice in the forefront are those that continually show up.  For instance, the number 1212.00 on the S&P futures contract has been a 03:30 number, a 12:30 number, a high, a low, an open, and a close.  All have occurred more than once, and all on varying days.  Thus it has earned the distinction of being considered a historically significant number.

BALANCE

Greed/Fear
The Courage to Act

Knowing what is happening, and getting involved do not always fall under the same category.  Once the decision has been made as to what direction the market is going, where protective stops need to be placed, and what your likely target is, you must quickly make the transition from analyst to trader.  Making the transition from an effective paper trader to that of an actual trader is a stumbling block for most.  If you have a sound methodology, you need to have faith in it.  If you do not fully believe in the method you are using, your emotions will take over your trade decisions, resulting in financial disaster.

The Fear of staying too long

Often traders will enter a trade, but then start to doubt their analysis.  This voids the time spent identifying the risk and possible reward.  It is a fact that the market may change, but if your methodology is proven to be accurate, you need to give it the opportunity to succeed.  Quick profits are nice, but the old axiom of the market is cut losers quick, and let the winners run.  The quick cut is determined through key numbers with the use of a protective stop.  If your stop gets hit, then you were wrong.  If it doesn’t take you out, then you may still have a winning trade in your hands.  Take your losses with a grain of salt and wait for the next opportunity.

The Greed of not taking profits soon enough

On the opposite end of the spectrum is greed.  Greed has the capacity to nullify decisions made through a methodology.  If the target price has been reached, some acknowledgment of that fact needs to occur, whether profit taking, or tightening of stops.  The worst kind of loss is when your analysis was correct and your target was reached, only to find your desire for more leaving you in a falling trade that becomes a loser.  Accept your goals and acknowledge a “win” by taking your profits and/or tightening your stop.

Confidence/Humility
The confidence to trust in your own judgment

If you have a method that works, use it and do so with confidence.  In order to be successful, you must be confident and believe in yourself.  Without confidence in your own ability, you will not succeed.

The humility to listen to the market

Try not to let confidence go to your head.  No matter how successful a trader may be, the market can always prove a trader wrong.  A trader needs to let the market tell him what to do.  A good trader does not get caught up in the frustration of attempting to tell the market what to do.

The judgment to know the difference

Balancing confidence and humility is perhaps the greatest feat any trader will face.  There is no black and white.  Traders must be able to admit when they are wrong. Without admission of error, the best trader can wipe out an account that took months to build in a matter of days, if not minutes.  The use of stop orders will force traders to adhere to this principle.  If one is long in the market, a sell stop will protect the trader both from a market change in direction and from himself.  DTI rejects the proposition of mental stops. In the heat of trading, mental stops can be discarded, or even forgotten.  If stops are moved, they should not be moved away from the market, but towards it.  The name of the game is elimination of risk and protection of profits.  Becoming an investor just to prove that eventually the market will listen to you will only result in losses.

Repetition/Innovation
Consistency

If you have a method that works, then diverging from it because of short-term pitfalls could take you out of the next great trade.  Don’t change to suit the moment.  A moment is just an instant in time, it does not define a pattern. If you start changing things on a whim, you will not be able to settle into the subtle pace of confidence.

The flexibility to change and the maturity to be consistent

A trader needs to understand that what worked last year may not work this year.  You need to be open to the prospect of change, but not too quick to embrace it.  Change should not occur by the actions of one day, or even one week.  The key here is consistency.  If your method is consistently not working then you need to improve it.

Review

In the world of the trader, one must combine knowledge of self with knowledge of the markets.  Understand and appreciate your goals and risk potential and be able to approach the market with a concise strategy.  Strive to achieve the balance necessary for success.  Don’t let either greed or fear influence your decision making process.  Be consistent while allowing yourself the flexibility to adapt to the ever-changing market. Confidence is the hallmark of a good trader.  The ability to temper that confidence with humility is the sign of great trader.

For more information on trading or formulating a trading plan, please contact DTI Partners, Inc. at:

DTI Partners, Inc.
1555 University Blvd. S.
Mobile, AL 36609
800.745.7444
251.652.1555
www.dtitrader.com

Tom Busby is the founder, President and Chief Instructor of the Day Trading Institute in Mobile, Alabama. Tom has traded the S&P 500 every day (but six) since its inception in 1982, and is well known throughout the trading community. In 1996, he founded the Day Trading Institute to teach others his unique method of using the S&P 500 as the market leader for trading futures, options, equities and other securities. The Day Trading Institute teaches its students how to approach the market using technical analysis combined with risk management techniques. More information about Tom Busby and the educational and informational services of the Day Trading Institute may be obtained by calling toll-free 800.745.7444 or by email to info@dtitrader.com. Visit their web site at http://www.dtitrader.com.