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Trading Multiple Instruments: Maximizing Your Profits

We've all been taught to diversify our stock investments for safety-the appropriate saying is "Don't put all your eggs in one basket". But should traders follow this same advice or should they focus on one instrument? And if they trade more than one thing, how much of each do they trade? How do professional money managers measure and balance risk when they trade a portfolio of instruments?

Some traders should focus on one type of instrument. Like anything else in life, some people are best suited for doing one thing well and just that one thing. Some other traders find that as they mature as traders, they are able to trade more instruments and they begin to branch out to trade new things.

Let's imagine a trader that starts out trading E-mini S&P futures on the Chicago Mercantile Exchange and when corn and soybean futures pick up in volatility and begin to trend day after day, they find themselves watching and then trying to trade these new interesting markets.This trader usually trades one E-mini S&P future, and they have been making money consistently in this market, but how many corn futures should they trade? One? Three? Ten? Does it matter?

In general, there are two schools of trading: discretionary traders and systems traders. Pure systems traders run statistics on their system and they follow the signals put out by their models religiously. Discretionary traders make decisions about their entries and exits based on their internal knowledge of the trading tools they use. But discretionary traders can be very systematic-and in my opinion should be very systematic in their decision-making and trading practices. Discretionary traders should have realistic expectations about the probability of success of their entry and exit methods and be very disciplined about following their own trading plans. When discretionary traders learn to approach the markets in a consistent manner, their profits generally improve quite a bit. In essence, these profitable traders arediscretionary traders that approach the markets in a systematic manner. They find what works and then do it over and over again.

How do these traders maximize their profits if they trade more than one instrument? Let me start with a general statement: it doesn't make any sense if you spend a specific amount of time and energy successfully trading the E-mini S&P futures market and on one contract,average $600 net profit per trade and then spend that same amount of time and energy to trade one contract of corn and on average,make $75 per trade. As a trader, you have a limited amount of time, energy, emotion, and capital. One of the most important lessons a trader must learn is to maximize their return on each of these. So how can a corn futures contract be compared to an E-mini S&P contract?

My experience in this area began as the head of risk management at a major US bank and was refined when I began managing large amounts of an investment fund in the early 1990s for Commodities Corporation. At the bank, all risk was compared to the United States 30-day Treasury Bills. The largest one-day range from the prior day's close to the current day's close [Average True Range] over a three-year period was used as the general measurement of that instrument's volatility. By taking that measurement and multiplying it by the value of the contract, it's easy to calculate a measuring stick for each 'thing' you want to compare: a futures contract, foreign debt instruments, stocks, real estate, mortgages, plane leases-literally anything you can invest in or trade can be compared using this method.

Why would you want two positions that are equally risky? If you have a finite amount of time, energy, emotion, and capital, you will maximize your returns if you risk the same amount of these things each time you trade. It makes no sense to make a successful corn futures trade that nets you $75 and use the same amount of your limited resources when you could have made a trade in the E-mini S&P futures, used the same amount of these limited resources, and netted $500 on that trade. If you were too busy trading the corn position to take an E-mini S&P position when it appeared, you just cost yourself $425 in potential profits by not making your risk equal.

Once you understand the concept, the calculations are simple. First, I start out by picking out an instrument to act as my default 'risk point' default. That means I make it my standard to set all other position sizing in all other instruments. I list all the instruments I'm going to trade in a spreadsheet. Then I gather the daily average true range for each instrument going back at least five years. The largest average true range found in that period multiplied by the value of the contract gives me the largest risk in dollar terms I would have faced in each instrument over that time period. Remember: Risk is a two-edged sword. If I had the right position, I would have made that amount or some portion of it-if I had the wrong position, I would have lost that amount or some portion of it.

Now that I have a list of instruments, and I know the largest risk in dollar terms for each instrument, I add in the stop loss sizes I use for each instrument. Then I simply set my spreadsheet to show me how many of each instrument I need to trade to face the same risk, right or wrong, so that each time I trade any of these instruments if I am right, I'll be averaging about the same amount of profit per trade. And when I'm wrong, I'll be losing about the same amount. This is called equivalent risk and if you trade more than one thing, using this methodology will help maximize your profitability.

Let's look at a simplified example of my equivalent risk spreadsheet:

In this example, my spreadsheet only shows US futures contracts. And by default, the portfolio size or amount of capital available is $100million US dollars. Using those settings and using the CME euro FX currency futures as the standard measuring instrument, I would trade 750 euro FX currency futures. And when I trade corn futures, I would trade 3,534 contracts to have an equivalent risk. In the E-mini S&P futures, I would trade 1,875 contracts. You can see it's simple to know just how many contracts of each instrument to trade to achieve equivalent risk once you set up this simple spreadsheet. And if you look at the very top of this spreadsheet, there's a row named 'Portfolio in Millions of $US Dollars' and after it, you'll see the number 100. If you simply replace 100 with 1, the spreadsheet will recalculate all sizes to an account that has a value of one million US Dollars. Replace it with 0.1 and the portfolio will reflect an account of $100,000. Or put in 0.01 and it will reflect an account of $10,000. You may find that at $10,000, this spreadsheet gives you a contract size of less than one. Remember, these numbers are based on the most extreme range over the past five years, so that means an account of that size wouldhave been wiped out if you took a position larger than the one suggested by the spreadsheet and were wrong for the entire range of that day. This is a tool and you'll have to work with it to decide how best to include it in your trading. If you are a very short-term trader, these position sizes may seem very conservative. They are meant as a way for you to be able to compare 'apples to oranges.'

I hope this spreadsheet is interesting to you. Just as I made the Market Maps Trade Entry sheet available to anyone that would like to try using it, if you drop me an e-mail at , I'll be glad to send you a copy of this spreadsheet. And if you have questions, by all means don't hesitate to e-mail me and ask them! PLEASE don't use these calculations blindly. Make sure you understand what the spreadsheet does and then double check the average true ranges in this spreadsheet, as well as the standard measurements like the value of a one point move. NEVER use a tool until you have researched it and thoroughly understand it.



Vow to Be a Winning Trader!

This is the time of the year that many people make resolutions to lose weight, stop smoking, be better husbands or wives or parents-well, you get the idea. For those of you that are just learning to trade, or are early in your trading careers, I suggest you consider making a New Year's resolution to be a winning trader. But don't make that vow without knowing what it entails! It's not just saying the words or wanting to be a winning trader that makes it so. What do I mean? Read on.

I recently did a live trading session at the Las Vegas Traders Expo. In fact, I was one of five traders or educators that traded live for about an hour. At the end of the day, there was a panel discussion featuring the five of us and the audience could ask us questions. One mentioned that he had brought up a member of the audience during his session and after pointing out one of his trading set ups unfolding in real time, he let her place the trade entry order while the rest of the audience watched. She ended up making a small profitable trade. He said that he wanted to show the audience that he could teach anyone to be a winning trader.

The rest of us on the panel looked at him skeptically and then we all began asking him questions. Suffice it to say that although we all felt some trading skills could be taught to most people, we disagreed with him that everyone could be taught to be a successful trader. Did he budge from his statement? Not a bit. Did we change our minds? Not one of us.

To me, this discussion got to the very heart of what makes a successful trader. While running one of the largest institutional trading desks in the US, I taught literally thousands of traders over a 15-year period. And recently, I have been mentoring well over 350 professional traders at the Chicago Board of Trade and Chicago Mercantile Exchange. I have watched some of the most talented traders fail miserably and leave the business, while others with much less talent flourished and are still successful traders to this day. I have taught people 'right off the street' that truly did not have a clue what it took to be a winning trader and watched them blossom before my eyes. So trading can indeed be taught. But to steal a line from one of the panelists that day in Las Vegas, 'it's called trading, not winning, just like it's called fishing, not catching!.'

I can teach just about anyone how to spot repeatable trade set ups. I can teach them about the importance of using stops and taking trades that have a high probability of being successful, with good risk-reward ratios. I can preach to them about the necessity of keeping a trading journal and taking images of each of their trades so they can review their trades for strengths and weakness in their own trading. But all of those things do not make anyone a winning trader.There is an aspect within each of us that probably determines whether any one of us will be a winning trader: are we willing to do the work and exhibit the discipline needed to become a winning trader? If you are not, nothing I show you or teach you-and nothing anyone else shows you or teaches you-will make a difference in the end. If you cannot master yourself, you will not be a winning trader in the long run.

Trading is not about looking at an indictor and deciding if the price of what you are watching is going to go up or down.Trading is about knowing how to recognize what is happening in that market, how to take advantage of it, and having the discipline to follow your plan. And getting to that point as a trader takes education, practice, and dedication.

I use a charting package that allows me to replay up to four days of data, tick by tick, at any speed from normal up to 300 times faster than normal. That allows me to pick days from the past in any futures contract, currency, or individual stock and then practice trading on a random day, over and over, honing my skills. I have taught hundreds of professional traders that now use this software; yet I can count on one hand the number of them that take the time to practice and hone their skills once the market closes, even though they know it will make them more successful traders.

So let me revise the statement made by the one panelist from the Las Vegas Expo in my own words: almost anyone can be taught some of the tools used when trading. But to be a long-term winning trader, you have to find the desire and discipline to practice, learn your trade, and then follow the rules you set up for yourself. Then you must take the time to review your trades on a regular basis with brutal honesty and work on improving your weaknesses while playing to your strengths as a trader.

Now is a good time for you to consider making a New Year's resolution to find the discipline and drive you'll need to become a winning trader. The sooner you start down that road, the quicker your journey will begin.

This is why my motto has always been: "Master Your Tools, Master Your Self!"



Making Choices That Put You in a Position of Strength

I have often compared successful professional traders as workmen that have mastered their tools, doing their job; infact, the term I often use when describing my own trading is 'making the donuts.' Another very successful trader withmore than 40 years of professional trading experience describes his trading as 'slicing sausage'. Most people scratch their heads when they hear us say such things, wondering why we are not as excited about making a trade as they areor as the people they see waving their arms on talk shows or selling 'can't miss' systems. After all, don't we enjoy trading?

Of course I enjoy trading! I enjoy the feeling of accomplishment of a job well done. And honestly, it took me years tounderstand that the choices made in the 'thrill of the moment' are not always the best choices. The best choices I canmake as a trader are the ones that give me a position that is grounded in the strength of my research and experience. Too many traders trade for the sake of the thrill of making a trade and find after the fact that they rushed their entry. Or they began with an opinion about where the market was going and then went in search of an entry, no matter what the market was trying to tell them in real time. Remember this always: there are always consequences to your choices. If you choose quickly, with little thought, you might 'catch the ride', but it might not be the ride you are looking for. It costs you no capital to miss an opportunity-and any capital lost must be remade if you are to grow your account! Commit your capital only when you see a high probability entry set up you recognize and are confident you are capable of executing.

Let me show you two sides of the same coin, so to speak: this is the same market and two potential entry points. In fact,both of these entries were taken in my own prop room. One was a small loser and one was a nice winner. Let's examinethem up close:

On the entry set up on the left, you can see that though price 'tested' the up sloping Lower Median Line, it closed verynear this line, leaving no 'separation'. There is no sign of strength present here, nothing yet to lead you to believe priceis about to stop and turn higher. But the trader chose to view this as a valid test of the Lower Median Line Parallel,because his 'view' was that this market was going to move higher on the day. He entered a limit buy order at the area where price would intersect with the same up sloping line and was filled on the very next bar. And note that that verynext bar closed on its lows, a tick or two below the up sloping Lower Median Line Parallel. These weak closes led thetrader to lose confidence in his entry and although he had placed his initial stop below what were now triple bottoms by about 1 ? S&P points, this close made him tighten up his stop loss closer to the action. And of course, he was quickly stopped out on the opening of the next bar.

It is important to note he did not lose a significant amount of capital on this trade. In fact, he lost less than he had originally been willing to risk on taking this trade entry. But he lost several things that are much more difficult to quantify and to regain: focus and confidence. While it is certainly true that when your account is empty of trading capital, you are done trading, it is equally true that if you have lost your focus, you will not see the high probability trade entries you spent so much time and energy mastering as clearly-if you see them at all-until your head clears. And worse, even if you do see the next high probability trade entry set up, will you have the emotional 'capital' to step up and take the trade?

In the same prop room, several minutes later, one of the other prop traders saw the second high probability trade set up. He pointed out to the rest of the room that this second test had everything the first test and re-test lacked: Price had now shown a sign of strength by climbing well back above the up sloping Lower Median Line immediately following the first test. Price had peeked below the same up sloping line this time, leaving good down side separation and probably running any down side stop orders that were resting in that area and yet had managed to close back above the upsloping line with good up side separation, another sign of strength. And there were multiple market formations below the entry area that should act as buffers, drawing in fresh limit buy orders that could be used to hide an initial stop loss order underneath. If price came back to re-test this up sloping line, this would be a classic high probability test and re-test trade entry set up.

The second trader put limit buy orders and initial stop loss orders in the market, waiting for price to come back down and re-test the up sloping line. If his limit orders were filled, he would have a position rooted in the strength of preparation and patience. The first trader did not have the emotional capital to take the second trade set up, even though he acknowledged it had all the markings of a classic high probability long trade set up. And remember, his view was that this market was heading higher on the day. But his lack of focus and the emotional costs from the first poorly planned trade entry stopped him from taking the second trade.

Both traders got a ride that day. They were using the same charts. Their entries were five bars apart and in the same direction. They were sitting so close their knees were nearly touching. And knowing them as only a mentor knows his students I'd say they were about equal in abilities and experience. But on this day, one fell for the thrill of catching a ride while the other waited until he saw the set up he felt comfortable risking his capital on. And as you can see, one lost money on the day and one had a very nice trading day.

There should be no mystery why I am known for my motto 'Master Your Tools, Master Yourself'. I truly believe becoming a trader is all about finding a handful of high probability trade set ups you can see and identify on a regular basis and then learning them inside out. Then you have to learn to master your own weaknesses and harness your strengths and couple these trade entries with solid money management. One thing is certain: if you trade for 50 years, you will have days when the human element present in all of us clouds your judgment and you will rush a trade or miss a trade or make a trade because you were chasing 'phantoms.' But if you keep it as simple as possible and make it repeatable, while it may seem trading has become like 'making donuts' or 'slicing sausage', you'll find these judgment clouded days come less and less frequently.