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Thursday
Aug202009

 Do You Have a Love Hate Relationship With Stops?

Money management is the most important part of your trading, like it or not. If you are weak on money management skills, no entry system or set up will be profitable over a long period of time. Correct stop loss placement, order management and risk reward selectivity are rarely the topics of popular seminars, because many traders go out of their way to ignore these important topics!

Let's cut the list down to make this discussion more manageable: How do you feel about your own use of stop loss orders? Do you dread placing stop loss orders because you just know that the market will 'run your order' and then head back in the original direction of the trend, leaving you with a loss while the market does exactly what you thought it would do?

Let me tell you about the very first seminar I gave for professional traders making the transition from floor traders to 'screen' or 'off-floor' traders at the Chicago Mercantile Exchange: A high profile floor trader from the S&P futures pit interrupted my explanation of where I was placing my stop loss order during a live trading demonstration by saying, "Stops are for losers." There was a nervous laugh around the room and I looked at him to try to judge if he was being serious. I asked him if he used stops in his trading. He said, quite proud, "I never use stops. I know when it's time to get out. But leaving stops in the market, that's just stupid. The stop will get run! That's giving money away!"

I gave three live trade examples during that seminar and each time, I'd ask him after I placed my stop loss order if he'd use a stop and if so, where? Each time, he said the same thing: "Stops are for losers!" I finally said to him that he should take all the money in his trading account and give it to his wife-or if he wasn't married, give it to me, so someone would still love him when he went bankrupt. There was another nervous laugh around the room and he gave me a blink and then a glaring look. You can guess the end of this story: He started trading 'off floor' and within three months, he had lost his entire trading account.

Here's a simple method I use to determine where to place my stops: Using thorough statistical analysis, I've gone back and tested each commodity, cash currency, futures contract and stock to find out just how 'noisy' each is. I want to know just how far price can move against the current trend and yet still 'return' to the direction of the trend. More important, I want to know on average, how far does price violate important areas like swing highs and lows and then return to the trend? Look at the following chart. You can see price is in a strong up trend and I have marked the swing lows with blue dots.

Now look closely at the swing lows and note that price rarely violates a major swing low. This is a day session only 15-minute chart of the S&P 500 futures market. You can see that by simply trading with the trend, finding a repeatable entry set up and most important, placing your stops underneath the swing lows in the case of an up trending market, your stops will protect you, not hinder you! If you keep moving the stops up under the next swing low as it is confirmed by new highs, you'll soon be 'boxing in profits' and find yourself working stop profit orders on a consistent basis. Let's see that chart again, in a trade context:

Let's not forget the 'noise' factor, though. My statistical testing tells me that in the E-Mini S&P futures market, for example, I need to place my orders at least three ticks below a swing low to stay away from the noise at those key levels. If I place my stop loss orders closer than that to the swing low, they are more likely to get 'run' and then price may return to the direction of the trend. I want my stop loss orders to protect me, but I also want to give the trade enough room to develop and mature as it unfolds.

Here's the 'noise factor' from some other popular markets:

US 30 year Bond Futures: 3 ticks
Euro Currency Futures: 5 ticks
E-Mini Russell Futures: 10 ticks [One full point]

It's time to embrace stops. Don't cringe when you place a stop loss order into the marketplace! Just use stop loss orders more effectively by hiding them underneath swing lows or above swing highs by an amount equal to or greater than the noise factor in that market. If you follow this simple idea for placing stops, you'll be in the market when it is trending and your stops will protect you when the trend has been truly violated.

Thursday
May212009

SFO - Article By Timothy Morge

X Marks The Trading Spot:
Identify Price Targets With Intersecting Median Lines
By Timothy Morge

If only there was a map that led us along the road to riches. Mapquest won't provide specific trading directions, but charts can point out general directions.

There's a growing group of veteran floor traders in Chicago that have switched to looking and trading the markets in a whole new light. They're what other locals are calling the forkers, traders that use pitchforks or median lines as their principal trading tool. The group has grown large enough that they've begun proudly wearing buttons reading, I'm a forker! Now the Chicago Mercantile Exchange (CME) co-sponsors seminars that teach this simple but powerful tool that is so effective when used to day trade markets in an off-floor environment.

In the CME trading pits, these were veterans of daily battles, where each local had to fight, tooth and nail, for profits. In my seminar, I begin by reminding them of two of their favorite childhood games: hunting for buried treasure and hide and seek. To find out how remembering these childhood games can translate into making consistent profits in the currency markets, read on.

Median lines can be used to find high-probability trade setups that repeat over and over again. These tools work across the board in all timeframes and on all tradable instruments including stock index, interest rate and currency futures, and individual stocks and their ETF cousins once you learn some basic methodology.

My first rule when taking a trade is no edge, no trade! I see too many traders simply selling or buying each time price approaches the median line or one of its median line parallels. Dr. Alan Andrews, the inventor of median lines, taught that three things could occur at the median line or at its parallels. Price will reverse, gap through the line or will congest. Do the math and see that simply buying or selling at each test of the lines has about a 50-percent probability of being profitable. However, there are ways to use these tools that give reliable, repeatable results.

Starting Out

Median lines are simple to draw. Choose a high, low and high pivot or choose a low, high and low pivot. It's best to start with what looks to be an important swing high or low. (See Figure 1 for points labeled A, B and C for an example. Look at the blue lines for this explanation.)

Once you have chosen three points (a high, a low and a high), connect the last two points with a line [B-C]. Find the mid-point of the line connecting the two [B-C] points. Then draw a line from the first [A] through the mid-point of the connecting line between the two [B-C] points. Extend this line (now called a median line) out in space. Similarly, draw lines parallel to the median line that begins at the [B] point and then the [C] point. You now should have what many call a pitchfork. The line that starts at the upper pivot and runs parallel to the median line is called the upper median line; the line that starts at the lower pivot is called the lower median line.

Finding Treasure

To teach traders how to find high-probability trade setups, I speak about the market in terms of the energy that price carries as it moves forward. 0Median lines and their parallels are areas where price may run out of energy, so I begin with these areas as my starting point when looking for trade setups. Just thinking that price may run out of energy isn't enough for me, however; I want to see more before I put any of my money on the line.

One of the easiest high-probability trade setups to identify are areas where two median lines [or their parallels] cross; a zone called confluence. It's best if these crossing lines oppose, meaning one has an upward slope and one has a downward slope. In essence, once you find the dominant median lines or pitchforks for a given chart, it's just like reading a childhood treasure map: X marks the spot!

Another way to form confluence is to use major Fibonacci retracements or projections if one of these areas is close to an area where price will likely intersect with the median line or its parallels. Of course, if I can identify an area where I have opposing lines crossing, along with a major Fibonacci retracement or projection, I like the trade setup even better. If all of this sounds as if I set very high standards for acceptable trade entry setups, it's because I want my trade entries to have a probability of success of seventy percent or higher.

Figure 1 shows an area of confluence, where X marks the spot. Let's see how this could be used to set up a potential trade in the euro currency. The euro made a nice run higher before selling off to test the 61.8-percent retracement from the high at Pivot B to the low at pivot A. Once prices held at this level leaving a double bottom they climbed higher, retesting the prior high at pivot B. During the first 15 minutes of the CME day pit session, prices tried to test the prior highs a third time but found good sellers, and that bar closed near its lows. As this first bar of the day session closes, I draw in a new red down-sloping median line or pitchfork, which shows me the probable direction of price if the euro had just seen a change in trend or direction. The slope of this red down-sloping median line also tells me just how fast price should travel, if indeed the trend has changed.

The Trade Entry Spot

Now look to the right of the last bar on Figure 1 and you'll see two lines that intersect, one a blue up-sloping median line and the other, a red down-sloping upper median line parallel. If price tests the area of confluence where these opposing lines cross at 129.56, it's highly likely that price will be contained. Price should run out of directional energy at this area roughly 75 to 80 percent of the time, if price gets there. It doesn't take much imagination to see the X that marks the spot here! The treasure comes in the form of a high-probability trade setup.

The area of confluence, where these two opposing lines intersect, occurs at 129.56, and it also has a time element to it: If price tests this area two bars from now, it will be running into opposing forces right at the time both lines predict it should run out of directional energy, and that would further enhance the probable outcome of this trade. Because this is such a high-probability trade setup, I'll be willing to get short the euro at three ticks below this area of confluence, instead of right at the confluence. So my limit sell order will go at 129.53.

Transmit Both Orders Simultaneously

Here is the second rule: Never enter a trade without entering a stop-loss order at the same time you enter your limit entry order. The last thing I want to do is put in a limit sell order, and just as I type it in, watch the market zoom through where I would put in my stop loss order before I can even enter it. So when using an electronic platform, type in both orders, hold each until both are ready to go, and then transmit them at the same time.

Hiding Stops

Where should the stop-loss order be placed? Well, I've already showed you how I play hunting for buried treasure. Now let's remember how to play hide and seek. In this game, you go hide while someone else counts to 25, and then he/she tries to find you.

In many senses, this is a good way to think about your stop-loss placement. There are going to be people looking for your stop, so rather than using arbitrary or cash-amount stops, always try to find a market formation behind which you can hide your stop-loss order. In this case, there will be sellers at or near the area of confluence that we are trying to sell. If price gets above this area of opposing median lines, the next area to hide stops would be the high at Pivot B, which was just re-tested on the opening. So if price manages to get back up there, this area will provide some protection for us to hide behind in the form of sellers looking to sell the test of the prior highs, as well as the high of this morning's session. I'll hide' my initial stop loss order at 129.66, three ticks above the morning high and retest of the prior swing high.

What's the Target?

The last important piece of an initial trade setup plan is the risk/reward ratio. I personally don't take a trade unless I am making a minimum of two dollars for every dollar I risk. To find the risk reward/ratio of this trade, I first must identify a profit target. The most logical profit target is a test of the red down-sloping lower median line parallel. I expect price will test and break through the up-sloping blue median line because it retested the prior swing high on the opening, and if the high of the day holds, a major move to the downside should unfold.

To calculate where price would intersect with the red down-sloping lower median line parallel, I look at the recent size of average bars, and then overlapping them about 30 percent, I use my cursor to see how far price will likely move to the right as it travels low enough to intersect with the red lower median line parallel. That comes out to roughly 128.70.

Doing the Math

Now let's calculate the risk/reward ratio. I'm willing to sell at three ticks above the intersection of opposing lines, at 129.53. My initial stop loss is at 129.66, so I am willing to risk 13 ticks on this trade. If I get filled, my initial profit target is at 128.70. I am looking to make 83 ticks on this trade. That means my risk/reward ratio works out to 83/13, which is roughly 6.4, a more-than-acceptable ratio. I enter my limit sell order at 129.53 and my initial stop loss order at 129.66 at the same time. Note that I do not enter my profit order, because I have no position yet.

The Trade Unfolds

Two bars later, price rallies to and stops right where X marks the spot, getting me short euro at 129.53 (see Figure 2). Price runs out of directional energy right where it should and turns lower, closing on its low. As soon as I confirm that I am short euro, I put in my profit order, a limit buy order at 128.70. Price makes a narrow range bar and then spikes lower. It is testing the red down-sloping median line, which is a potential area for price to run out of downside directional energy, but not the area where I think price will run out of energy. But when price then makes two bars that are well above this area, with about the same range and alternating closes, I sit up and take a closer look at the chart. Can I move my initial stop-loss order closer to the current price action without getting too close to the inherent noise of this market?

note that the last bar formed the second of two bars with the same high at 129.47, something chartists call double tops. Double tops also are areas where new traders will likely have sell orders resting in the market, because this area is seen as an area of overhead resistance. There also is overhead resistance at the red down-sloping median line parallel. Because price closed on its low during the last bar, I am going to hide my stop-profit order three ticks above the just formed double tops, at 129.50 (marked Cancel Profit Stop 1 on Figure 2). I now am playing with the market's money, and that's always the first goal once I identify and enter an acceptable trade. I must work my way to break even or better stop-loss orders as quickly as possible without getting too near the noise inherent in the market.

Price again spikes lower, testing the down-sloping red median line, but so far it is unable to close below this line. Price then consolidates, forming an energy coil, which indicates that price is restoring energy. Then, price did run out of energy right where the upper median line parallel predicted it would.

The next bar is a narrow range bar that closes below the low of the wide range bar that just tested the red upper median line parallel. Because a narrow range bar is a warning sign that price is again restoring energy, I reevaluate my stop-profit order. Now that price has tested the upper median line parallel once, I am willing to hide behind the 129.40 high of that wide range bar, so I move my stop-profit order down to three ticks above this high, to 129.43 (Cancel Profit Stop 2). If price climbs above the just-tested red upper median line parallel, I'm more than willing to exit this trade via a stop-profit order and keep the potential ten ticks of profit I'll still have in this trade.

Locking in More Profit

Price then makes two very wide-range spike bars lower. The first wide-range bar tests the red median line again, and the second wide-range bar spikes through the red median line and closes well below it. Once this second wide-range bar closes, I immediately move my stop-profit order to three ticks above the 129.05 high of the just-closed wide-range bar (Cancel Profit Stop 3 at 129.08). Why? I now have more than 60 ticks of potential profit in this trade, and price has made the majority of the move in two spike bars.

If price retraces higher just as fast, I must protect some of these profits. Readers can see that price tested the red down-sloping median line three times before finally breaking and closing below it. So I think I can hide just above this median line, which comes in at 129.01. I am boxing in profit, using market formations to hide my stop orders, working my way towards my profit target at 128.70.

Two bars later, price tests the red down-sloping lower median line parallel, in the process filling my profit order at 128.70. Once I confirm that my profit order has been filled, I cancel my stop-profit order and double check that I am flat. I net 83 ticks on this trade, which is $1,037.50 per contract before brokerage fees.

Putting the Trade Together

The keys to this trade are easy as one, two, three: 1) Identify a high-probability trade setup (X marks the spot!) 2) Find market formations to hide initial stop behind and 3) Make certain that the trade setup is above minimum acceptable risk/reward ratio of 2:1. Also, make sure the size of the potential loss per contract will not wipe you out.

These trade setups repeat over and over across various markets. Once you learn to identify them and also exhibit the patience for them to unfold, you will see just how powerful these simple trading tools are. Just ask the forkers, and I'm sure they'll send you a button reading, I'm a forker!

Thursday
May212009

Trend Dynamics - Article By Timothy Morge

Published Bimonthly For Graduates Of The Trend Dynamics Course
Strategies :: Tactics :: Analysis
May/June 2001

With this issue, we continue our exploration inside the minds and trading rooms of professional traders in the Trend Dynamics trading community. In this installment we visit Timothy Morge at Blackthorns Capital in Chicago, Illinois where he manages a private fund and trades stock indices as a private speculator. Over the past twenty-five years Morge has been immersed in price action as a floor trader on the CME (Chicago Mercantile Exchange), a cash FOREX trader, an institutional arbitrageur, a professional offshore fund manager, and private speculator.

In the interview that follows, Morge shares his experiences as a trader and reveals how he trades in today's markets.-Ed.

Ed: Tim, tell us how you first became interested in trading?

Timothy Morge:
My father was a welder and a self-taught engineer. One of his business acquaintances was a wonderful guy who ran a large scrap-metal operation. He traded copper futures and that fascinated me. He gave me access to his extensive trading library that featured rare courses and manuscripts from the pioneer trading technicians of the 1930-1950 era. I love the technical analysis research of that period-one of my friends aptly calls it the "golden age of technical analysis." That was when I first came across Dr. Andrew's Median Line concepts.

I spent whatever time I could watching him update his charts, talking with him about what he thought about the Copper market or what he was doing with his positions. That was in 1974, and I was just turning 16. I graduated from high school a year early, and enrolled at the University of Chicago as a math/physics major in 1975.

Because I was a math/physics major, I had large blocks of time available to me on the university's mainframe computers. In fact, I had more time allotted to me than I could use, so friends would barter with me for my excess time on the mainframe. One of my dorm buddies came to me one night and told me he needed some time on the computer because his father wanted to build a predictive model for U.S. T-Bill prices. I offered my buddy some time blocks and volunteered to pitch in with the project. I spent a great deal of time constructing a database of historical raw commodity prices for them and a Fed-action database (with information such as weekly Fed actions such as regulating the money supply, discount window activity and changes in Fed funds/ discount rate) and then wrote a model that made a prediction for three month interest rates. It was a great learning experience, but when the computer model's predictions differed from the father's hunch about where interest rates were heading, he chose to ignore the model and proceeded to lose some $4 million dollars in margin. [This illustrates an object lesson about how a trader can be blind to evidence contradictory to his position or expectations.- Ed.]

Right after college, I was hired as a junior economist for the Harris Bank in Chicago. My department was charged with managing and developing a model that forecast the federal budget for Harris. At the time, Harris' Chief Economist was Dr. Beryl Sprinkel. Ronald Reagan was just beginning his run for the Presidency and many of his economic facts and figures concerning monetarist economic policy came out of our department. After he became the President-elect, Dr. Sprinkel was chosen to join his Treasury cabinet; shortly thereafter the bank's heavy funding of the economic department came to a close.

What did you learn by developing these two econometric models, the interest rate model and the federal budget model?

The faculty at top Business Schools like the University of Chicago and MIT spend a great deal of time teaching that markets are random, that trying to model them is useless. I found that false - that markets do have repetitive patterns; and it was not a great leap to take the data management skills I had developed in building econometric models and turn them toward evaluating and exploiting trading opportunities in the markets.

In 1980, I was offered a new job trading T-bills. For my training they sent me to their Foreign Exchange (FX) area and I seized an opportunity to become a cash FX trader. I traded mostly cash FX from 1980 through late 1988 for Harris, Bank of America, and First National Bank of Chicago in late 1985. First Chicago hired me as their chief dealer and by late 1988, I was put on their risk management committee, which was a part of their Board of Directors. I was in charge of executing and monitoring the bank's risk in their multi-billion dollar portfolio of proprietary trading positions that included: cash FX positions, cash bond and note positions; and even stock index and cash stock positions.

What important lessons or attitudes did you learn from that vantage point?

The realization that all traders are created equal in the eyes of the markets. I had several clients that held huge currency positions. They would constantly speak about how the normal trading rules didn't really apply to them because their portfolio was several billions to $50 billion (in U.S. dollars). They really believed that their portfolios were important and were subject to a different set of trading rules. This became more glaring when it came to taking losses. I would hear they weren't taking their losses at a certain price level, which was their initial stop loss area, because the market was just too thin; or, because they wanted to see how the Asian or European or U.S. markets reacted to these so-called "ridiculous" new price levels.

When I started managing other traders as part of my responsibility, I'd hear similar justifications for exceeding stop-loss limits. And finally, I'd have to take over their position, pick up the phone and liquidate it for them. There's always a price for getting flat-you may not like the price, but there's always a price if the market is trading. And chances are, if you blink at the first price and choose to wait for the next price, the first price was cheap.

So, I learned that markets treat all traders in like fashion. We may think the tried and true rules of trading don't apply to us for one reason or another, we may think we are bigger or faster or stronger or better prepared or smarter, but in the end game we are all traders, and all the same in the eyes of the market we are trading-its the market itself that wields the ultimate scale of justice.

I left the bank in 1991 to form a CTA. I managed offshore money for a large commodity pool until 1994. In 1995, I took a break for a few months, then leased a seat on the CME. I had always wanted to try trading on the floor, and now with the pits disappearing, I'm glad I took the time to try it. It was a fascinating experience and I am still amazed how much work it takes to stand in the pit jammed among several thousand other traders looking to ply their edges. Besides quick thinking and discipline, it takes a great deal of physical stamina. After five months, I found I was trading as much off-floor as I was in the pits, so I did not renew my lease and I returned to my trading office at home.

"If you blink at the first price and choose to wait for the next price, the first price was cheap."

"It's amazing how well prepared the great traders are before they step into that pit each morning."


What did you learn on the floor that helps you trade off-floor today?

The first thing I learned was the value of preparation and just how outstanding some of the floor traders really are. It's amazing how well prepared the great traders are before they step into that pit each morning.

Something else I learned is the importance of becoming content with what the market has to offer. For example, the first trading manager I worked for got a huge bonus and left to go trade on the floor in the currency pits. He was there for about 18 months, eventually leaving to work for Morgan Stanley in New York. The next time I saw him, I asked him why he went back to the institutional world. I didn't really understand his answer until I traded on the floor myself.

He said, for the first few months on the floor, he was making a great living by "finding dollar bills on the floor all day long." And after three or four months, he would start to "find a few five dollar bills and even a ten dollar bill here and there on the floor." Life was great. After 9 months, he started to "find five and tens more often."

After the first year, he didn't even bother looking at the one dollar bills, and just spent all his time looking for fives and tens. And then he quit looking for fives. Soon, thereafter his trading had deteriorated to the point where he wasn't effective as a floor trader any longer.

In other words, traders often get bored or dissatisfied with what the market has to offer. As an example, if I can take a few patterns and trade the E-mini S&Ps every day as a speculator and make $2K a day, that's more than $500K a year - ah, but that's only if I have the discipline to trade only those patterns and I am happy with just `printing the money every day.'

Another thing, when I worked for institutions, I thought of myself as a purist -and had some mystical idea that I could lose money on a trade and still have performed great because I lost money but performed as well as I could on that trade set up. So if I was long, and the market broke and I did a great job cutting my losses, I'd take solace and perhaps even pride in knowing I did a great job cutting the loss. That's just nonsense. To me, a losing day is a losing day. Everyone has them, but there's nothing good about them, other than their utility as learning experiences. Each day I try to remember that the exercise is to make money. I'm not there to entertain myself or amaze my clients. I'm there to keep adding to the trading kitty.

Where did you go after you left the floor?


I visited some of my institutional contacts and landed some offshore unregulated money to manage again. I continue to manage institutional money, as well as trade my own capital. Lately, my trading has focused on trading the U.S. stock index futures, though I still take swing positions in U.S. T-Bonds and currencies.

What's the physical layout of your trading room?


I have a large "L" shaped trading desk configured with three main stations. One component, is a Dell twin-Pentium III with a single 21" monitor that serves as my on-line/ internet computer. This is where I retrieve e-mail, do research using MS-Excel and other math-crunching tools. I also create charts using Advanced GET Real-time and maintain a Fibonnaci retracements and projections database. This station also has a real-time version of TradeStation 4.0 running using a Quote.com data feed.

A second workstation is comprised of a Dell server with twin 21" monitors. This machine runs E-Signal and Tradestation 4.0 and is my main data server. Its function is to capture data in TradeStation 4.0 and run TradeStation charting and a proprietary model I use to trade.

My third workstation, a Dell Pentium IV with twin 21" monitors, runs TradeStation 4.0 and CQG (Commodity-Quote Graphics) from a dedicated phone line feed. This is my back-up data and quote source. The proprietary model is also mirrored here in case the main server has a data problem. I also run several MS-Excel spreadsheets that crank out real-time indicators from this machine.

While trading, I am usually sitting in front of the first workstation, watching and charting using Advanced GET RealTime. I generally move back and forth between the 13"and 39" day-session only charts of E-mini Nasdaq and E-mini S&P 500 futures. My electronic execution platform is also on this first machine. The second machine is on the same desk to my right and I usually have a window with a set of quotes updating on the screen closest to me and a cash NDX (Nasdaq 100) chart up with the model's current position and statistics on the second screen.

The third station is on a second desk. I generally have a second quote screen on one of its twin monitors and a few of the spreadsheet generated applications on the second screen. These applications provide information like a real-time Nasdaq 100 cash index generated tick-by-tick from each stock's real-time tick activity, my own version of advances and declines, etc.

How do you prepare for a typical trading day?

My data collection and charting regimen is quite rigorous. Immediately after the T-Bonds and currencies close on the International Monetary Market (IMM exchange) at 2:00 PM CST, I begin to update charts.

I keep hand-posted daily, weekly and monthly charts for the following: U.S. T-Bond futures, a 30-year U.S. yield chart, cash and futures Dollar/ Yen, cash and futures Dollar/Swiss, cash and futures Sterling and cash and futures Dollar/EuroFX. I've been keeping these charts by hand since the early 1980's.

I also update a database on each of these instruments with swing highs and/or lows that may have been made that day, as well as upcoming daily, weekly and monthly support and resistance. I use a simple tool, FibNodes developed by Joe DiNapoli, that calculates a range of Fib relationships. I feed it minor and major swing highs and swing lows and it generates a sheet for me for the next day's trading. I use this to locate areas where there is a confluence (multiple counts of) support or resistance.

"There is something that happens as your eye processes the bar data and then your brain transmits that into a signal to draw a bar on paper."

It's rare to run across a trader who hand-charts anymore. How does hand charting make you a better trader?

There is something that happens as your eye processes the bar data and then your brain transmits that into a signal to draw a bar on paper. There's a certain intimacy that comes from hand charting many commodities. I do not find this holds true for all markets. The S&P and NDX futures, for example, are noisy to the point of being painful for me to hand chart! But for bonds, currencies and copper, for example, I really feel I trade much better because I'm in tune with some markets that are a part of the entire market. And, in those markets I hand chart, I am much more patient with entering and exiting positions-I am just a better trader because of hand charting.

How about intraday timeframes?

During the last hour of index trading, if trading permits, I update intraday charts (13", 39", 55") for the Nasdaq 100 futures and S&P futures, as well as cash Dow Industrials, Nasdaq Composite, Nasdaq _ and S&P 500 index.

Is 13" the smallest timeframe you look at?

Yes. I then go back to all of my intraday charts and re-work S/R (support & resistance) lines that I draw and use to identify what I call "trading energy areas". I draw Andrews Median Line sets, multi-pivot lines,' and simple trend lines. These lines identify S/R areas.

From each day's trading activity I note which lines "described" price. I highlight those lines while deleting lines that are either no longer relevant or that price simply ignored.'

What do you mean by "describing" price?

I see the simple lines I draw as price attractors. I expect the majority of Andrews lines I draw to be tested. On the other hand if price never interacts with the lines, they are useless, and I'm quick to jettison them. By "describing price" I mean that price moves to support and then bounces higher; or price tests support, bounces or pauses there and then plunges through and the break is a meaningful break. The longer you work with these lines, the easier it is to tell, early on, whether a line you just put on the chart is working or is useless.

Once I have finished updating all the charts, I go back to the database for each instrument, and I look for areas of confluence. I look to see where Fib numbers, S/R lines, swing tops or bottoms highs/lows are clustering. These are the energy areas I look for, areas price will generally be attracted to, but will also tend to be where failures and changes occur. Timeframe is not important for these numbers or areas. But the more these areas have been tested and survived without being violated, the more I pay attention to them. It's really less confusing than it may sound. The majority of the swing highs and lows will show up in most, if not all, timeframes and a confluence involving lines tend to be repeated in most timeframes.

Finally, its back for one last crack at the charts to add whatever energy points or confluence areas may have popped out from the updates. Recently, I have been trying to keep a web site updated regularly so I try to translate a small portion of my thoughts to the charts and commentary posted there. I find it always helps to write out my thoughts and so the web site is a good resource in that it forces me to write down some of my immediate thoughts once I finish updating the database and charts.

Multi-pivot lines are horizontal or diagonal trendlines that intersect multiple swing tops or bottoms.

This is a good example of what it means to attain formlessness and stay flexible in your analysis. - Ed. Do more of what is working, and less of what's not- J. Hart.


What do you do pre-opening?

Right after the alarm goes off in the morning, right before I shower, I go into my trading room and eyeball the charts for new highs or lows that occurred overnight in the Globex session and do new Fib calculations, projections and retracements. This allows me to let what's happened overnight "roll around in my skull" while I shower. I then -,,down to breakfast with the little ones and my wife. I don't listen to nr before or after trading. Most days, my wife will tell me that such and such happened this morning, and I won't have a clue until she tells me. I do note the days of important releases and decide beforehand whether I want a position into the numbers. There are many where I go into the major economic numbers flat.

Can we review a few trades based on the aforementioned regimen you just outlined for us?


Sure, the charts that follow illustrate my basic tactical approach to trading. Chart 145,opposite top, is a 39" S&P 500 futures chart (day session only, Globex price action is omitted)

I saw a well-defined swing from the 1143.75 low on 03/29 to the 1178.75 high on 4/02. Using the Median line technique, I bisected that swing with a line drawn from the high at 1194.50 on 3/27.

As price sagged down from the 1178.75 high, I noticed a congestion holding in the last few hours on 4/2/01 at A.

I dismissed buying that congestion because the Median lines are sloping downward, an expression of selling pressure. In a downward sloping median line structure like this I'm looking to sell short, not go long.'

As price held above the Median line during the afternoon of 4/2/01, was the formation of the congestion, to the left of Y on Chart 145, an example of price describing an energy level?

Yes. Early on 4/3/01, price gaps slightly lower on the opening of and then the bar develops into a "zoom bar" at B below the downward sloping Median Line. This is a term Dr. Andrews used to describe what Trend Dynamics calls a wide range, or thrusting price action. S&P Energy Coils and Median LInes The high of the first bar is 1148.25, the low is 1132.75. The second bar is a rally to re-test the down-sloping Median Line at 1141, see B on Chart 145,above. I shorted into the high of that second bar which was 1141.25. Once short at 1141, I could place a stop at 1149.00, three (E-mini S&P 500) ticks above the high of the day. To me, this was great trade location, as my stop was above a number of supply areas: the high of a wide-range period, above the down-sloping median line, above the high of the day, and above the swing bottom (old demand/new supply area) on the left at 1143.75.

I saw a logical profit objective in the form of a test of the lower down sloping ML, roughly 1100 to 1102 area, which was reached on 4/4/01 at C, where I exited at 1102.50.

Note that a down-sloping Median line incorporates a lower top swing structure which is either a deviation in trend if the structure was previously up; or an affirmation of lower tops in a downtrend - Ed.

Were the re-tests of the center median line, the re-test you shorted and the bounce off the lower line at C examples of price describing an energy level?

Yes. Keep in mind I don't assume these price levels will be respected, but wait for evidence that the lines I'm looking at are being proven by price action, before I consider initiating a trade.

The risk-reward on this trade was about 5:1. Did you make a risk/reward calculation prior to entering that trade?


No, I used to, but now I'm more focused on just executing the trade at points where I find the trade location attractive and I like the character of the market, then managing the trade. If the risk to a logical stop is excessive I just reduce size or pass on the trade.

How do you manage a trade like this if price approaches your objective but falls short, then starts to rally back against you?

Certainly if it moves in my favor and then starts to rally abruptly 10, 12, 15 handles against my short I'm stripping off contracts on that rally, on the other hand as it approaches my objective and I see structure (swing tops) or retracement levels to lean against I start lowering stops to lock in profits above these points of resistance.

Do you use the same rules for re-entry, do you look for a re-test of an energy area perhaps a bit higher or lower then the original level, because time has elapsed and then re-enter just as you'd enter an original position?

Right. If price breaks below an energy area or congestion area, once I have taken partial profits, I maybe interested in adding or selling the retest of the lowest part of that congestion area. Obviously, it depends on many variables, and how a market is trading on any given day, but there are often re-tests of these areas, so even if you miss it once and perhaps even twice, you will find opportunities to get back in.

If I re-enter, the stops stand alone for that new position-I don't feel as if I have an extra cushion because I have already taken X number of dollars out of the market on this move before entering this new trade. The merits of a re-entry must be strong enough that it stands on it's own, or I won't take the trade.

What if price fails to hit your limit price, you're not in, and begins to reverse in the direction you want to be positioned?

I tend to enter trades at a price of my choosing, when possible, which means when I see a trade that I identify that has several degrees of confluence I usually have limit orders in the market before price even gets to those areas. I don't wait for a bounce or reversal to get in. I like to have good trade location. Having good trade location can cover many sins. When that isn't possible, I'll have a stop order working below or above the market to stop me into the market with smaller size, at least on trades that I feel are high probability trades. If I can't enter with good trade location, I usually reduce position size.

In the case of a setup that's slipping away, I may look for some type of Fib retracement to go in, but I try to balance this against chasing a market which I consider to be a breech of my trading rules.

The first trade, just below A on Chart 145, p. 289, looks like you're selling a breakout (the zoom period), you are selling a re-test but in the local context of that breakout. I've never thought of the S&P as a high-probability breakout trading market, but more of a choppy market, breakouts probably reverse more than they continue in the S&P. Would you agree?

Yes. In general, I am not a "breakout trader." It was the context of the breakout that made that first trade compelling. The breakout itself was not attractive to me as a trader. The multiple signs of weakness are what lit me up for the first trade.

The second trade (see D on Chart 145,p. 289). I consider the second trade a "lay-up." Price will often make that run to re-test the down sloping Median Line after testing the lower ML-and the trade is a very high percentage trade. You just have to take that trade. When you are wrong, it is very inexpensive and you just let the move above the Median Line and the prior swing high take you out and you then know you are back to assessing the state and context of the market going forward. If nothing else, wait for the market to begin to range and then coil again.

In any case, price re-tested the down-sloping Median Line at 1126.25 on 4/4, at D. I had sell orders at 1125.50. My stop was 1133, above the high of this rally and above the prior minor swing top and minor congestion on the left at E, which was at 1131.50 on 4/3/01. In this case I had two objectives, the first was a 61.8% retracement of the day's range, which was at 1109. My second objective was a re-test of the down sloping outer ML down in the 1088-90 are at F, which would also be a re-test of the prior major low made 3/2/01.1 took half of myposition off at 1109 and then began working a stop profit order one tick above the prior 39" bar's highs to lock in the balance of the profit. First stop profit order was at 1117.75, then I moved it to 1116.25; and, I moved it again to 1112.25, where I got stopped out and flat.

Why did you take partial profits on a 61.8% retracement of the C-to-D swing in Chart 145, the day's range on 4/4/01, yet you let the prior trade run on 4/3/01? There was a higher timeframe 61.8% retracement of the 3/22/01 to 3/27/01 swing at 1129? What was different about the contexts that encouraged you?

I think the difference lies in how I see markets in terms of expressions of energy: "spent energy" vs. "stored energy". The first trade came right after the market had been in a trading range and had stored energy in the coiling range (A-to-Y on Chart 145, p. 289). The second trade came after the market had spent a great deal of energy (Y-to-C) and had little or no motion that would indicate it was re-storing energy. Once price tested the lower down-sloping ML, there was a strong rally. The price action appeared to act more like a two-way trading range day as opposed to a one-way trend day. I decided to emphasize taking quick profits, especially if price was unable to break below the early morning low of 1098.50 at C.

In a way, your style of trading seems remarkable simple.

Part of it is that simple. I determined the macro-direction of the market, which in my mind was clearly down; assessed the current state, heeding the overhead gap above that it could not fill. It had been in a trading range for three days and on the fourth day, price retested the top of that trading range at Z, and the bottom of the open gap and failed causing a sell off, which terminated in a tight energy coil for the second half of the day, right at the low of the trading range (A-to-Y) and just above both the current Median Line and the Major Median Line something had to give, and when it did, the market had a tremendous amount of energy stored, both from the three day trading range and the tight energy coil from the second half of the fourth day. Likely conclusion: On the morning of the fifth day [4l3],1 saw every indication that the state of the market was changing: Price had broken out of the energy coil and the trading range and zoomed below two important Median Lines-and I can't stress this enough, the market had the energy stored to make a dramatic move. So I was eager to enter this market short, everything was in place for a major move.

I see, but these trades occur in a larger context where we had multiple large timeframes in running moves to the downside. How might you trade markets with a different character, like Copper, or Bonds, or a context that is choppier?

Well, I trade every market based on the state and context of that market at the time I am trading it. For example, I have a good set of tools for range trading. I call those tools "hand-to-hand combat tools." One example would be what I call trading a "rolling chop," which is often found in Copper, for example (see Chart 146 below). This type of market doesn't coil or store energy, and it doesn't range trade, per se. Instead, in a downward sloping rolling chop, price sells off for three or four days, stopping out any bottom picking long positions and getting many position traders short on the move to new lows.

Well, I trade every market based on the state and context of that market at the time I am trading it. For example, I have a good set of tools for range trading. I call those tools "hand-to-hand combat tools." One example would be what I call trading a "rolling chop," which is often found in Copper, for example (see Chart 146 below). This type of market doesn't coil or store energy, and it doesn't range trade, per se. Instead, in a downward sloping rolling chop, price sells off for three or four days, stopping out any bottom picking long positions and getting many position traders short on the move to new lows.

How discretionary is your trading?

I am a discretionary trader, but I would say that I am also a fairly regimented trader. Over the years, I have refined my trading style so that I know my trading tools very well. I think a lot of traders make a big mistake in jumping from one tool to another in a ceaseless search for the Holy Grail. They never really master the tools they have and finally bust out. My advice is to spend those years getting to know your tools really well. There are no single magical set of tools. I know many professional traders and it's often uncanny how we end up initiating trades in the same general area, even though we're using different tool sets.

"My advice is to spend those years getting to know your tools really well."

How would you describe your money management guidelines?

I always have a stop in place. I usually start with a disaster stop. I rarely risk more than 2 percent of capital on a position and that disaster stop is rarely hit. I like to take money off of the table and once trades become profitable and I have some time invested in them, I am careful to keep the trades from turning into losses. If I violate my trading rules, I always take a minimum of three trading days away from the markets-to clear my mind. I would always rather under-leverage than over-leverage. I like to trade about I E-mini S&P for every $15K [about 5 to 7:1 leverage -Ed. ]. I also use what I call equivalent risk, meaning that I keep a spreadsheet matrix with current ATR-based (average true range) volatility for the instruments I trade. If I trade 15 bonds, according to that matrix, it is equal to X number of S&Ps or X number of currency contracts. I adjust the size of the trades so that the risk for any one position equals a maximum of 2 percent of capital.

"If I can't get trade location that's ideal, I generally pass on the trade."

Do you have other trading rules?

I always try to take trades with good trade location. If I can't get a trade location that's ideal, I generally pass on the trade. If I do take a trade with trade location that is acceptable, but not as ideal as I originally planned, I trade with less leverage. I never take trades where I can't define both the stop area that is acceptable and at least one area that is a good logical profit objective. Never chase price. There will always be another trade setup. When I am not in rhythm with the market, I don't trade. Forcing trades is one of the worst sins. Time invested in trades is expensive. If a trade is becoming stale and not progressing as I thought it would when I put the position on, it's best to go flat. Being flat can be a much more creative state of mind, and stale trades just tie up your capital and your mind.

Finally, If I don't feel good, I don't trade. And I mean emotionally good, physically good-any distractions mean that I am not at my very best. And to trade these markets day in and day out, I have to be ready, with good tools and a good mind.

"...it's very difficult to go from trading money for the house to being the house-that is, to trading your own cash."

How important are psychology issues, mental attitude, etc.?

Mental attitude is extremely important. If I feel defeated, I am defeated. Attention to detail and being well-prepared springs to mind as other things affected by your mental state. I might add that it's very difficult to go from trading money for the house to being the house that is, to trading your own cash. I used to tell traders that worked for me that if they were busy worrying about making the mortgage payments, they'd never trade successfully. I saw it nearly every year as young traders approached bonus time and they and their wives started mentally planning how they'd spend their soon-to-come bonus-and the pressure would mount on them not to lose money. That killed many young traders at banks, and even more on the floor of the exchanges.

How have you integrated Trend Dynamics into your trading plan?

In two important ways, first the way Trend Dynamics teaches one to correlate multiple -timeframes. Before Trend Dynamics, I did not understand the synergy and interaction of timeframes. In addition, Trend Dynamics has helped me to identify the kind of price action in the larger timeframes that indicates reversals in trend which affects my larger contextual view of the markets.