During a live session a few Monday’s ago, we drew out the following map of the 240 minute $USDAUD [the Australian Dollar against the U.S. Dollar]:

We began by noting and marking the ‘Sunday Gap Rip’. When markets first began trading literally 24 hours a day, from Sunday afternoon until Friday afternoon, gaps became less and less common occurrences. But the recent high volatility in the markets have begun spinning more and  more gaps into the picture – and the traders not experienced enough to remember how to deal with them have to do their homework to understand the implications of gaps and how to deal with them.

One of the ways I have found to help traders think about open gaps is the ‘Gap Rip’. Imagine printing out a chart and ripping it down the middle, separating price into two discontinuous sections: You have two charts of the same commodity or currency but they are no longer connected. When a market Gaps open and the Gap remains open, this is exactly what has happened: the Price action was so violent it disconnected the current action from the prior price action.

The first Open Gap lower on the chart occurred on a Sunday opening and it not only disconnected the current action from the prior price action, it broke below prior minor Swing Lows to the left. At that point, we added a red Major down sloping Median Line and its Parallels to give us the Probable Path of Price. We then noted that after heading lower, price climbed back to retest the Open Gap area but failed to climb higher to test the red down sloping Upper Parallel.

When price broke back below the Gap Zone with a Wide Range Bar, we added a green down sloping inside Median Line and its Parallels that seemed to be doing a much better job interacting with price action. Three bars later marked the end of trading on Friday. When trading resumed on Sunday afternoon, price Gapped open lower once again, and the Gap remained open, literally ripping the price action from the prior week away from the unfolding price action of the upcoming week. These are signs of a violent move lower-the sellers have a lot to sell and they are pressing to sell before price slips further away from them!

The last three bars deal with the price action on Monday, when we were hosting our live mid-day Mentoring session. If you look above at the first open gap, I marked the timing of the horizontal consolidation with a dotted magenta line – and then transferred it down to the current opening bar from Sunday night. This dotted bar serves to remind me that price consolidated for that amount of time above, at the prior Open Gap, before beginning its violent move lower. I put it in place now because one of the Newtonian Laws we use over and over, as stated in the Emerald Tablet, ‘As above, so below’, generally comes into play in these situations [For every action, there is an equal and opposite reaction]. I will watch closely as price unfolds and I literally expect a violent reaction as price reaches the end of the magenta dotted timing bar.

As I pointed my feelings about this timing bar and its relationship to the ‘Gap Rip’ to the members attending the live session, I also circled the confluence formed by the red down sloping Median Line and the green down sloping Outer Parallel –and remarked that the area of confluence [or Energy Point] coincided with the end of the timing bar, and the Energy Point would hit around Friday. I told everyone it should be interesting to watch how price played out between now [that Monday] and Friday. If it formed a mature structure with some horizontal consolidation, I would expect there might be a great opportunity to short this market Friday if price had not significantly violated the Open Gap area. I finished marking out the chart and saved it in my charting program, so we could revisit it later in the week to see how price had unfolded. We also put this chart on alert as a part of everyone’s homework for the week.

As it turned out, we did revisit this chart on Friday, though it was on everyone’s homework alert. But let’s see what one student did with the simple map I drew on Monday as Friday approached:

Though we did not revisit the potential trade set up on Friday, at least one of our students did her homework: As Friday approached, she entered her limit sell order at 1.0370 in the Australian Dollar with a 41 pip initial stop loss order. She noted on her chart that price had consolidated in a horizontal fashion all week and there was selling pressure at the Open Gap area all week long. She placed her stop loss order above that selling pressure at the same time she placed her limit sell order and waited patiently as Thursday turned into Friday – she was letting price catch up with the price action. And when Friday came around, she was rewarded with a fill in her limit sell order. She noted on her chart that she was planning on holding the position over the weekend. She also marked several potential Profit Objectives with purple horizontal lines, just below 1.02, around 1.01 and the last at 0.9925. Any of these objectives if reached would give her a solid risk reward ratio – at minimum, well over four to one using a 41 pip stop.

Let’s see how the trade looked after the weekend:

Price Gapped open lower again on Sunday night by 50 pips. On Monday morning, she took a partial profit on one half of the position at 1.0180, booking 190 pips. As price climbed back out of the hole early Tuesday, she entered an order to sell back out the half she had taken profits on at 1.0302, with an initial stop loss of 1.0333 [a stop loss of 31 pips] and was filled on her limit sell order quickly. It is important to note that she is treating this second entry as a separate order, with its own stop loss. Though it is not apparent on this chart, she moved to a break even stop loss order on the open half of her first trade. She is now playing with the market’s money, and even if she is stopped out of both of the current open positions, she will make money on this idea and the two positions combined. She framed her trade and as price unfolded, she adapted it to the market conditions, taking profits on one half and then reinstating the full position at a better price. She is continuing to use the Open Gap to show here where the selling pressure remains – that is the key to the original trade as well as the secondary entry at 1.0302.

Let’s take a look at how the trade progressed on Tuesday and Wednesday:

Take a close look at this last chart and read her comments as the trades unfold. She started with a carefully framed trade, looking to reach a potential four to one risk reward ratio. Bu taking partial profits and then re-entering at the Open Gap resistance area, she was able to successfully adjust her plan as price unfolded after price opened on Sunday afternoon.

Here are the profit objectives she planned and achieved:

1. 1.0180, on one half of the position, netting her 190 pips, reached on 9/19/2011 at 10 am.
2. 1.0150, on one half of the position, netting her 220 pips, reached on 9/21/2011 at 2:30 pm.
3. 1.0088, on the one half she re-entered, netting her 214 pips, reached on 9/21/2011 at 2:30 pm.

Her total risk on this position was 113 pips total and her total profit for this position was 624 pips. This gave her a total achieved risk reward ratio of better than five to one, better than her originally planned risk reward ratio of four to one.

As she did her post analysis of this trade on her last chart, note that she chided herself what she considered a mistake: She believed price would test the prior low [‘look to the Left and be Right’] and her original order was to take profits on her entire position at 1.0090 but the anxiety of holding the position made her change her plan and take half off at 1.0150 – but all in all, this trade was a planned well and executed well. She had very logical entry points and did a wonderful job collapsing her risk, moving her initial stop loss entry to break even as soon as price moved well below her entry level and then finding logical areas to leave her limit buy orders to lock in profits.

We stress the importance of planning your trade before entering your trade and then trading the plan you have made. If you wish to trade like a professional trader, you have to learn to think, manage and execute like a professional trader. Our upcoming seminar, Building a Professional Trade Plan, will focus on this extremely important topic, taking you step by step through all the essentials a solid trade plan needs if you wish to be consistently profitable. 

Let’s use this trade to highlight one last important thought about trading: Some have tried to paint Market Geometry, our web site, as giving ‘endless education’ but giving no live analysis or signals. First, we are proud to offer ‘endless education’; there is no better compliment in my mind. Second, the results of our students speak for the results of our efforts to teach traders to be consistently profitable using what they have learned from us to find and enter their own trades in any market, on any time frame. We teach live, we use live charts, we point out potential trade areas in advance, as diagrammed in the trade above – we just don’t hold ourselves out as a ‘chat room’ that is there to call out mindless trades. Let’s compare the results of this single trade with an entire month’s results from a ‘chat room’ style web site.

Before I begin this rate of return analysis, let me state up front I am not taking these results from one of what I consider to be a ‘shady’ website, one that misrepresents their results. I am using their results because they are stated relatively clearly, their numbers seem to be accurate and the results they show on their web site look quite impressive. Here are their results for the same month our student made her Australian Dollar trade: 

According to their risk disclaimer, subscribers must have a minimum of $200,000 in their account and this amount will be fully margined; at minimum, they trade two full size Gold futures contracts and two Silver futures contracts at all times. Here are there results for the month:

On $200,000 worth of margined positions, they made a gross profit of $73,060 – This looks like a very handsome profit, indeed! In their disclaimer at the bottom of the page, in smaller print, they note they are currently in a drawdown of $42,300 from that profit and are apparently still holding the open position. According to my calculations, that leaves them with a net profit of $30,760 for the month, based on $200,000 of margin. But let’s assume they finished the month with their entire $73,060 intact.

Now let’s see how our student’s single trade, lasting about three trading days, holds up to their month of trading. To compare ‘apples with apples’, we will normalize the leverage used by adjusting the amount of contracts she used when entering her planning and executing her trades to match their leverage:

To make the math easier, we’ll convert her trades from cash Forex to CME Australian Dollar futures contracts. Each Australian Dollar future requires she put up a minimum margin of $2,363. If she used the maximum $200,000 as margin, she would be able to trade $200,000/$2363 = 84 contracts. Since she made 660 ticks, she would have netted a profit of over $554,000 on her $200,000 account in three trading days [a simple rate of return of over 750 percent]. Now stop for a moment and look at these numbers, please. Are they possible? Yes. Are they repeatable over time? No.

If you used maximum leverage on your account, as many ‘chat sites’ and ‘trade touting’ sites show in their flashy numbers, when you hit a losing streak, you will quickly lose all the money in your account and more.

Let’s assume a more conservative stance: The web site we referred to stated they traded at minimum two Gold contracts and two Silver contracts. Because of a recent margin hike by the CME Group in August, it would take $72,700 in margin to trade two Gold futures contracts and two Silver futures contracts. If our trader had used $72,700 in margin, she would have been able to trade 30 Australian Dollar futures contracts and she would have netted $198,000 in profits before brokerage, compared with their stated net maximum profits for the month of $73,060.

But are those numbers realistic and sustainable: Of course not! Our trader would have made over 270 percent on her over-leveraged account but any run of losers would quickly wipe her account out. These numbers are unrealistic and not sustainable.

We teach traders to be consistently profitable. We want them to learn their craft and then be around for years to come, as their accounts grow at a sustainable pace. Let’s look at a ‘sustainable’ rate of return. If our trader had $200,000 cash in her account and traded 8 contracts, using a total maximum margin of $18,904, she would have used less than ten percent of her account on a margined basis and she would have netted over $52,000 on her three day trade. She would have realized a 26 percent simple rate of return. These numbers are more realistic – and had she taken a loss, she would not have lost her trading account; had she been stopped out at her initial Stop Loss order, she would have lost $3,280 – roughly 1.6 percent of her account.

But let’s look at her trade using an even more conservative approach: What if she used no leverage in her trading, simply trading $200,000 unleveraged in the cash Forex markets? If she sold $200,000 worth of Australian Dollars at 1.066 and bought them back at 1.000, she would have made a net profit of $13,200. On a single trade that lasted three days, she would have netted a simple 6.6 percent rate of return. Is this realistic? This is absolutely a realistic rate of return, though I would caution everyone, including her, that the best traders in the world lose at least 1/3 of the time, so solid money management is extremely important, even when you are trading using low or no leverage. Top money managers average 15 to 35 percent rate of returns, not 200 or 300 percent.

The key to becoming a consistently profitable trader is to begin with a solid trade plan, based on quality money management principles. Only take trades with good risk reward ratios [I suggest three to one or better as a starting place for most traders] and set a maximum stop loss you are willing to take on any trade and never take a trade requiring a larger stop loss. Last, once you plan your trade, keep that trade plan in front of you and follow it religiously. ‘Plan your trade and trade your trade’.

If you are interested in learning more about what we teach, how we teach professional traders to be better traders and non-professional traders how to be become consistently profitable, come visit us at Market Geometry. And if you want to learn how professional traders plan their trades, we’re hosting a seminar October 22^nd via the internet. You can see all the details by clicking here.

•    The importance of trading with a plan
•    The Philosophy behind a successful Trading Plan
•    The what, how and why of Trading Plans
•    How to turn your thoughts, step by step, into a Trading Plan
•    What Professional Traders Include in their Trading Plans
•    Risk Management
•    The Beginning of a Trade Plan: Beginning to use Excel for your Plan
•    Building simple but powerful metrics that are a must in your Trading Plan
•    Record keeping of those metrics

Each attendee will get access to copies of the Trade Plan examples we build during the session. Additional examples may also be available for download after the session.

Approximately six to eight weeks after the seminar, each attendee will get a DVD of the seminar. Shipping and handling anywhere in the world for attendees is free.

The price for the ‘Building a Professional Trade Plan seminar’ is $749.00, including a full length DVD, copies of the Trade Plan examples and shipping and handling anywhere in the world.

You can sign up and pay for the first in this important series of seminars here

If you are unable to attend the live seminar, sign up and we’ll send a copy of the DVD and give you access to copies of the Trade Plan examples we build during the session. Additional examples may also be available for download after the session.

Remember, this is the first in a series of seminars that will teach you to think and act like professional traders act and think when planning and executing their trades. We will do our best to help you become more consistently profitable – but you must put in the time and effort.

My first impression? We should have ten- and eleven-year-olds manage our retirement money! The three groups averaged a 12.4% non-annualized increase in the value of their trading account over that short period of time, using no leverage and only being able to be long stocks. They set their maximum risk to no more than 20% of their account on open positions, though they never approached this level of risk. One of the main tenets in my own trading, and one of the things I insist upon when I mentor other professionals is that stops are always in place the moment a position is put on, as well as logical profit targets. I taught this to the students and they practiced it religiously.

What made these students take to trading so quickly and seemingly easily? My slogan is “Master Your Tools, Master Yourself.” I believe mastering yourself and your emotions about positions and money (greed and fear, the “need” to make money) is the most difficult part of trading. I try to build simple tools to help take these emotions out of most traders’ minds, but at this young age, though the students are truly enthusiastic, they are generally not burdened by these emotions. They have no house payments and all the other burdens so many adults have when they first begin to learn to trade. These young adults also have a “clean slate.” They have not been bombarded with the unrealistic and even fraudulent claims so many vendors use when trying to sell their trading books, courses, or software. To these students, this is just another skill, like long division or expository writing, which they have to master, though I dare say the students I helped seemed a bit more
enthusiastic about learning to trade than learning long division!

My son really enjoyed the experience. Those of you who follow my writings here at MarketGeometry.com, MedianLine.com and the presentations I give at The Traders Expos may know that Sean has been helping me update my hand-drawn charts for several years, and has spotted several incredible opportunities that I managed for him (his sharp eyes and charting abilities led to a nice short crude oil position just above $146 a barrel and a nice long position at $35 a barrel). It's safe to say that his college fund is ready to go!

As soon as school was out this year, I got an unexpected request from him: He asked me when I started to learn about trading. Regular readers here or people who follow my writings on my Web pages know that I was extremely lucky to have an older brother who loved to speculate in the commodity markets. His interest in trading and a family friend who owned a large scrap yard in Chicago and traded to hedge his cash metals holdings led to me learning about charting and trading at Sean's age. Once I repeated the story to Sean, he immediately asked me if he could trade an account like I did when I was his age. To be honest, I felt I owed him the same opportunity that my brother gave me, so I offered him this opportunity:

• He will trade a simulated account for a minimum of six months, though depending on the results and his ability to master essential skills, the trial may go longer.
• He may pass; he may fail. As I tell all my students, the profession of “trader” is not stamped on your birth certificate. The key, in my opinion, is whether he can master himself.
• If he passes the simulated account successfully, I will fund a small trading account with a $2,000 maximum stop out on the entire account, which is exactly how my brother started me out in commodities.

He's in the middle of his first simulated trade, and he came rushing into my office during one of my live mid-day mentoring sessions to tell me he got filled on his entry, so several hundred people are now watching the results of his trade live as he moves the stop orders closer. He is nicely profitable in this first trade and about to enter his first stop profit order today after the market closes.

But besides successful simulated trading, he has to learn and master what I consider to be important tools that will give him an edge in the marketplace. For example, over the weekend, we were updating weekly commodity futures charts and cash forex charts. Of course, I never saw the question coming: “Dad, can I trade futures and forex in my simulated account?” I thought about limiting him to stocks, but I teach everyone that the repeatable patterns you should be looking for and researching come in all markets and in all time frames. Since he is in middle school, I wouldn't let him focus on short-term trading, but I decided not to limit him to just stocks.

That opened a whole new set of tools and techniques for him to learn, but I like teaching and I have all the tools pre-built for my own trading. If he was going to trade stocks, futures, and forex, one of the first things I needed him to learn was the concept of equivalent risk. Even if he only traded stocks, this is a very important concept that very few traders understand or utilize. So let's dig into this topic using some simplified examples I put together for people who have only a basic understanding of spreadsheets. (Like most people, I use Microsoft Excel.)

Many retail traders trade in blocks, meaning that they always buy 100, or 1,000, or 10,000 shares of whatever they are trading. If it goes up, they make money, and if it goes down, they lose money. But is always trading the same amount of shares exposing their account to the same risk each time they take a trade? Maybe a simple image will make the flaw easy to spot:

This trader always buys or sells 10,000 shares of whatever he is interested in, regardless of price or the volatility of the stock. This trader is trading the same number of shares each time he trades, but he is not exposing his capital to equivalent risk.

The first thing that jumps out at most people when I say the trader is not exposing his account to equivalent risk is the difference in price between the two stocks. Ten thousand shares of Apple (AAPL) was worth about $2.5 million US dollars when this was written. Ten thousand shares of Archer Daniels Midland (ADM) was worth about $260,000 US dollars. The trader would obviously have much more capital invested in 10,000 shares of AAPL compared to 10,000 shares of ADM. But that's easily fixed, right? What if the trader simply did the math so he invested in an equal face value of each stock? Let's take a look:

Let's do the math. One thousand shares of Apple was worth about $250,000, and 9,600 shares of ADM was worth about $249,600. Now that the trader is initially investing a similar amount of money in each stock, is he exposing his account to equivalent risk?

There are many ways to measure volatility; none are perfect and some are extremely complicated. For this exercise, I used a very rough measurement of the Average True Range (ATR), which is an average of the daily high minus the daily low, adjusted for market gaps. This measurement is available on all charting packages, and although it is a very basic measurement, it's a starting point (I do not use the ATR in my own position sizing and money management calculations, but as I said, none of these measurements are perfect and this exercise is meant as a starting point.)

It's easy to compare the volatility of these two stocks: Simply take the average true range and divide it by the price of the stock. By this measurement, Apple has an ATR volatility measurement of 0.0344 and ADM has an ATR volatility measurement of 0.0230. If you've seen charts of these two stocks, it shouldn't surprise you that Apple is a more volatile stock. But adjusting just the amount of cash you invest in each stock so that you have invested an equal amount of cash doesn't reflect the differences in the volatility of the two stocks. And if we add instruments like exchange traded funds (ETFs) and futures and cash forex to the things we might trade, the volatility becomes extremely important, though most retail traders don't understand they are not accounting for the different volatility of the instruments they trade, nor do they change their position sizes according to the volatility. Let's look at a series of simple Excel spreadsheet examples that will show you how to get started measuring the volatility of the instruments you are trading and how to compare them—and then enter into positions that expose your account to similar, if not equivalent risk.

Let's start out with an Excel spreadsheet and a handful of popular instruments: Apple Computer [a stock],  GLD [The ETF for Gold], SPY [basically a closed-end mutual fund that allows you to buy and sell the stocks that make up the S&P 500 Index in one simple trade--it preceded the ETFs of today but functions about the same way], the CME E Mini 500 S&P Futures [the most popular stock index future traded in the United States, it basically mirrors the cash S&P 500 Index] and the Comex Gold Futures [the most popular futures contract based on the price of cash Gold listed on a United States Exchange].

Let's take this diverse list of instruments and examine different ways we might try to get to the point where we are exposing our account to similar if not equivalent risk when we take a position in any of these instruments. Let me re-state the idea: When we take a trade in Apple computer, we want to expose our capital to the same amount of risk when we take a position in Gold futures several days later.

Some of you may still be wondering why we want to try to expose our account to similar risks each time we take a trade: If you have a wonderful day or week trading Apple Computer and then have a losing trade in Gold Futures, if you are using equivalent risk and a good risk/reward ratio [the importance of which I have written about many, many times], you should still have a very nice profit when you net the outcomes of the two trades.

We've already discussed this and the obvious conclusion is that the price of the instrument does not necessarily relate to its value, especially when comparing it to other instruments. Let's keep building our spreadsheet.

Now we add our first measure of the volatility of each of the instruments we are going to compare. There are many ways to measure volatility and many ways to use these different measurements. For example, a very short-term trader may not be interested in knowing that there are occasionally 'out of character' spikes in price in the instrument he or she trades every five or ten years on weekly bars because they are focused on five minute bars [These events are called 'Black Swan' events and although most people believe these events occur about once every 100 years, the measurements simply predict  that in the case of normally distributed data, roughly 1 in 22 observations will differ by twice the standard deviation or more from the mean, and 1 in 370 will deviate by three times the standard deviation. They are of much greater interest to portfolio managers or traders that hold positions over long periods of time. I use a longer term approach to calculating my measurement of risk and volatility, so I do take into consideration these 'third deviation' moves.].

But for this exercise, using a 20 period average true range is a good start for our volatility measurement of each vehicle. Begin with this measurement and you can always choose to replace it after you work with it for some time and learn about other methods and their strengths and weaknesses.

To do any calculations, we'll need to know both the current price of the instruments but also, the value of one dollar in a stock [of course, one dollar in the United States is worth one Dollar] or one point when trading futures [one point refers to a move from 1075.00 to 1076.00 in the E Mini S&P futures; it refers to the move from 1250.00 to 1251.00 in the Gold Futures]. These values are assigned by the exchanges.

I NEVER trade without entering an initial stop loss order into the market at the same time I enter my entry order; I want my capital protected at all times. I have a maximum size stop loss I use based on my research of the a combination of the volatility of the instrument, as well as how far each instrument can trade past market structure roughly 80 percent of the time and still return to the major trend. Some people feel this is a redundant measure of volatility, but it is a number that relates to my own willingness to risk a certain maximum amount of capital for each instrument, based on its trading characteristics--do not confuse this with the average true range, for instance. I add the size and value of my maximum stop loss for each instrument I trade so I can compare what I am risking.

Now let's start building the calculations that will allow us to compare risk! I'll begin by assuming we are trading 10,000 shares of stock each time we make a trade or 10,000 futures contract. Let's see how that works out numerically.

Just glancing quickly at the row marked 'Dollar Risk on Position' should be an eye opener for those of you that always trade the same number of shares each time you trade different stocks or trade the same number of futures each time you trade different futures. For example, if you trade 10,000 shares of Apple, using the ATR method, you are risking $86,000 if you bought the high and sold the low of the day as projected by the ATR [this assumes you are not using stop loss orders to limit your risk or that your stop loss order is larger than the ATR projected move for the day]; if you traded 10,000 shares of the ETF GLD, you would be risking $20.000. These risks are not equivalent and it gets even more striking if we compare the risk associated with taking a position of 10,000 shares of Apple stock and 10,000 E Mini S&P futures: You'd be risking $86,000 on the Apple position and $9,000,000 on the E Mini S&P futures position - that's an incredible difference in risk!

I'm not suggesting the majority of traders or even a few traders are out there trading 10,000 shares of Apple stock and making the assumption that they are taking the same risk when trading 10,000 E Mini S&P futures. But I am suggesting that the majority of traders have not done an exercise like this and really don't have any idea how the risk on each instrument they trade compares. And it is something each trader needs to know if they trade multiple instruments.

So let's build a new set of calculations and see if we can come with something that approaches 'Equal Risk' for each instrument we trade, each time we take a position.

By taking the ATR of an instrument and multiplying it by its Dollar value or One Point Value and the maximum stop loss I am willing to use for that particular instrument, we can easily generate a standard measurement of risk for each instrument; we can then use that standard risk measurement to compare the 'riskiness' of one instrument as it compares to others.

Are there other ways to measure the risk of an instrument? Yes. This is meant as a beginning example and is actually quite useful, as simplistic as it is, but feel free to explore and use other measures of risk or volatility.

Now let's build a table around this standard risk measurement and see if we can work our way to actual equivalent risks across these instruments.

By using the standard risk measurement, we are now able to use a simple formulae to come up with similar or 'equivalent risks' when taking positions in any of these instruments. This table assumes that the standard position used to determine the position size in any of the other instruments is based on 10,000 shares of Apple, but you could easily change the number of shares or even change the standard from apple computer to any instrument [for example, I use U.S. 30 Day Treasury Bills as my 'standard unit' and compare the riskiness of all other instruments to 30 Day T-Bills].

Note I purposely shared the Excel formulas when making calculations; and as I have said several times, this worksheet is meant as a starting point for each of you. To get a real feel for the relatively volatility of the instruments you trade, I urge you to re-create this spreadsheet, with the instruments you actually trade - or you can simply use the instruments I have used and practice your excel skills. But if you have the ability to get the current 20 day ATR for each instrument, when you create your own copy, use the current ATR and don't forget to use your own maximum stop loss sizes!

I hope you find this exercise interesting. Many of you may have never thought of looking at your position sizes using this type of tool - give it a try! Some of you may have better tools for comparing the volatility of instruments - If so, please feel free to drop me an email and share your thoughts, questions and criticisms.

I wish you all good trading.


Let us begin this journey with a look towards physics.

Sir Isaac Newton is thought of as a physicist, a mathematician, and the founder of calculus. But he was also the 'Master of the Mint' later in his life and literally saved England's financial system by switching from the silver standard to the gold standard. Even less well known, Newton was a Master Alchemist, so heavily involved in alchemy that he eventually died from having massive amounts of mercury in his body from his many alchemical experiments.

But Sir Isaac Newton's contributions to science should not be diminished; he developed the first practical reflecting telescope and his Three Laws of Motion dominated the scientific world until the early 20th century. His Third Law of Motion 'For every action there is an equal and opposite reaction', is particularly useful when applied to the trading markets. The Third Law of Motion may have had its founding in Newton's first and true love, alchemy, for he was truly one of the most important alchemists in his lifetime. His favorite alchemical manuscript was the Emerald tablet.

Hermes Thrice Greatest or Thoth, was reported to have lived around 1900 BC. The Emerald tablet is attributed to Hermes and Sir Isaac Newton's translation is perhaps the most popular alchemical work still studied today. Its essence is simple: 'As above, so below'.

Let's take a look at the chart. It can all start with one line:

We are looking at a chart of the Euro FX futures on the Chicago Mercantile Exchange.  The 60 minute bars on this chart appear in early March of 2010.  I begin with a major low pivot on the left of the chart and draw a blue up sloping simple trendline that touches many smaller pivots. I call this simple trend line with many touches a multi-pivot line. Let's look at another chart and I'll show you the pivots I chose to draw this line.

When working with charts and hand drawing lines in particular, it's important that you remember and mark where you trained or curve fit the particular line you are going to work with. Here you can see that I used many pivots and the up sloping blue simple trend line does a good job catching the highs and lows of price as it moves forward. Remember every bar within the blue box was used to train or draw the simple blue trendline.

What can I do with this simple blue trendline? Another name for this simple trendline that goes through so many pivots is a Center Line.

I look to the left and see a Major Swing Low. Starting at the Major Swing Low to the left,  I copy the Center Line and project it forward. The original simple trend line is called the Center Line and  the second line is called the Action Line. It carries the same slope or frequency as the Center Line. Note that the Center Line captures the frequency of Price and the pivot of the Action Line always precedes or comes before the Pivot that begins the Center Line.

Now I think back on the Emerald tablet: 'As above, so below'.

I have generated a Center Line that catches the frequency or probable path of Price and I copied the Center Line to a prior Major Pivot to generate an Action Line.

'As above, So below'.

Now I ponder: 'For every action, there is an equal and opposite reaction'.

I measured the distance from the Center Line to the Action Line and using the same distance, I create a line that has the same slope or frequency of the Center Line and add it below the Center Line. This is called the Reaction Line.

It can all start with one line. One thing passes into another.

Price has been in an uptrend but now consolidates, leaving three simple drives to the top. The three pivots, when connected, have a negative slope. But eventually, price begins its move higher again.

Using the pivot on the far left, I connect the three drives to the top and this gives me a red down sloping simple trendline. You can see that once price broke through this trendline to the upside, it switched back and retested this simple trendline from the upside and then began its climb higher; when it retraced, it tested the simple red trendline from above, and the trendline acted as support.

It can all start with one line.

This is a down sloping Center Line. You can see the pivots and switchbacks marked with green circles that I used in defining this Center Line. I was taught Action and Reaction Lines and the theory behind them from Dr. Alan Andrews. In the mid-1920s, Dr. Andrews studied the work of Roger Babson who was a devout student of Sir Isaac Newton's Laws of Motion. Babson was particularly focused on Newton's Third Law of Motion, 'for every action there is an equal and opposite reaction'.

Though Babson had his own methods of technical analysis, Andrews and a group of graduate students at MIT literally tore Babson's work apart, piece by piece, and then developed the Action Reaction method. It all starts with one line. The one line is the Center Line, which projects the probable path of Price.

'As above, so below'.

Once I find the Center Line, I simply transfer the slope, or frequency, down to the prior Major Swing Low to the left. The second line drawn always begins with a pivot before the pivot that anchors the Center Line and is called the Action Line. The distance between the Center Line and the Action Line when combined with the frequency of the Center Line is used to project a Reaction Line.

Once again, I simply measure the distance between the Center Line and the Action Line and then using the frequency or slope of the Center Line, I draw a line equidistant from the Center Line but this time above it.

You should take note that I have blue up sloping lines and red down sloping lines on the same chart. Because these lines have opposite slopes, they are lines of opposing force.

Let's take a closer look at these lines of opposing force.

I have been a professional trader for nearly 40 years now. When I begin trading, the personal computer not been invented, so software charting packages were not available. In the early 1970s, there were a handful of companies that published comprehensive chart books that came out every Friday afternoon. Most professional traders either subscribed to the services and had them delivered by mail on Saturday or picked them up at a bookstore late Friday afternoon.

Some traders kept their own charts by hand; I was taught to hand chart at a very early age by one of my older brothers that traded commodities. I continue to hand chart to this day. It's one of the routines that I use in my preparation each day.

More than 20 years ago, I began to notice that some of my more effective charts had both up sloping and down sloping lines and both sets of lines had important roles in defining the probable path of price. I did extensive research on these lines of opposing force and they quickly became one of my tools of choice. I named them Diamonds® because of the space formed when lines of opposing force are overlaid on the same chart. Though I have been using them successfully for more than 20 years, this is one of the first presentations of my proprietary work with Diamonds®; in fact, this is also one of my first public presentations of Action Reaction Lines and the theory behind them.

When using Diamonds®, you can project support and resistance from two different sets of lines, lines of opposing force, well into the future. These two sets of lines were defined in early March and by simply measuring the distance from the Center Line to the Action Line and projecting it forward above and below the Center Line numerous times, Diamonds® were formed that project far into the future.

If you look carefully at the top of the chart, you'll see that I marked a pivot that touches the up sloping blue Center Line with a circle. This will help us keep track of where price and time is as we move on to the next chart.

Now orient yourself by finding the place mark on the top left corner of the chart; This place mark coincides With the place mark on the prior chart.

You can see that price sold off hard and looking closely at the large swing down, you should be able to tell that price found support and resistance T both Lines of Opposing Force and their projections. In essence, using Diamonds® adds a fourth dimension to traditional three-dimensional charting. Diamonds® will give you a very accurate probable path of Price if your Center Lines reflect frequencies of price; once you've set up your Diamonds®, look for repeatable entry setups that you know have likely profitable outcomes.

Action Reaction Lines and Diamonds® require the use of strict money management. When you add the second layer of Action Reaction Lines, you will find many more interactions of Price with tested lines. At times, you will be buying against down sloping lines and selling against up sloping lines--something I rarely do when using Median Lines. It is imperative that you master these tools before using them with real money in your trading account--and more important, you must use surgeon-like money management skills to limit your risk. I was taught many of my money management skills by Bruce Kovner, while I was a money manager and mentor at Commodities Corporation--and I urge those that would try to master these tools to work hard on their self discipline and money management skills.

Once the long wave lower is finished, Price corrects and begins to move higher but then it heads lower again; note that it does not make a lower low. Price then begins a vertical move higher and gaps significantly higher one weekend when the markets are closed. Price tries to trade lower but is unable to fill the gap. Once it fails to fill the gap and turns higher, I start to pay particular attention, because an open gap is an unusual event on a long-term chart. Price generally comes back to fill gaps.

The last Major Swing High tested the red down sloping Reaction Line and then traded lower. Price is now testing the intersection or confluence of a red down sloping Reaction Line and a blue up sloping Reaction Line. I call these areas where Lines of Opposing Force meet Energy Points, and find that when price interacts with these Energy Points, either a change in trend occurs or an acceleration of the ongoing trend occurs.

Price stopped at the Energy Point and then turned lower; note that Price failed to break above the prior Major Swing High. Just as the unfilled gap caught my attention, the inability of price to climb above the prior Major Swing High alerts me that there are probably significantly large limit sell entry orders, meaning large traders are looking to enter short positions in this market and have left their orders at or near the last Major Swing High.

As a place marker, note that I've drawn an ellipse. Let's zoom in on this area and take a closer look.

I have zoomed in on this chart to make easier to analyze the significant areas as well as show what entry set up pattern I have spotted. I have also marked in my limit sell entry order as well as my initial stop loss order; both will be entered on my electronic platform at the same time. Never trade without 'hard' stops; stops protect your capital from ruin.

Once again, looking at the chart, price retested the red down sloping Reaction Line. The Reaction Line acted as solid resistance and note that price was unable to break above the prior Swing High. Large traders are aware that markets tend to fill gaps and are looking for a relatively high probability area to enter new short positions. On the test and retest of the red Reaction Line, I note that both tests were made with large range bars that closed with good separation below the Reaction Line; this is another clue that there may be a good amount of sell orders above the market.

Four bars after the retest of the red Reaction Line, I put my orders in the market. I'm risking 40 ticks and even if price only makes it to the retest the top of the open gap, I should make 125 to 140 ticks of profit, giving me a potential risk reward of better than 3 to 1.

Now that the orders are in the market, let's see what price does.

Four or five bars later, price rallies and retests the red down sloping Reaction Line; my limit sell order is filled, so I'm short this market. I immediately check to make sure that my initial stop loss order is in the market and being worked on the exchange server.

Let's see how this trade plays out.

You can see that once I was short this market, my initial stop loss order was never threatened; in fact, price never re-tested the red down sloping Reaction Line again.

Now it's a matter of style and money management: I marked five areas with circles that were potential profit targets. You could have taken profits as early as the area where price filled the gap, or you could have taken profits when price tested either the first or second up sloping blue Reaction Line. Or you could have chosen to take profits at either of the two energy points where down sloping and up sloping Reaction Lines [Opposing Lines of Force] met.

I also marked the new swing highs that were left as price continued to ratchet lower. If you are position trading, you can simply work lower and lower stop profit orders as price leaves new swing highs at lower and lower levels until you eventually get stopped out. If you followed this method strictly. you'd probably still be short the Euro FX futures, with a stop profit order above the prior Swing High. This is called boxing in profits and is generally how I position trade, although I usually do have a logical profit target in mind - some significant level - in this case around the area of confluence or Energy Point just below 126 in the Euro FX futures [There are some Major Lows in the 1.25 to 1.27 area from March and April of 2009].

Whether you are a Physicist, an Alchemist, a Greek or Egyptian God or just simply a trader, it can all start with one simple line.

Maybe it is. But consider this: Wouldn't it be great if you knew where all the police cars and cameras were that were monitoring speeding, so you could drive down the road at your own pace and then slow down when you got near the speed traps? Does that sound crazy too? Have you heard about radar detectors, laser radar detectors, and even GPS real-time systems that mark out the current speed detection traps near you? Some people have all of this and more on their smart phones already!

Wouldn't it be great if you knew when the person you were playing poker against was bluffing, or holding a poor hand but trying to bet up the price of staying in the game, just hoping you'll fold? Did you know that most people who play poker have personality traits that make them do something physical when they are nervous, holding that bad hand, trying to drive the price of the pot higher? Some talented poker players can easily spot the “tics” or “tells” of their opponents after playing a few hands against them.

What if you could see the tics or tells of a trending market as it is stretched ever higher, while there are fewer and fewer new buyers? This market will eventually turn—wouldn't it be great if you could spot a sign that the market was running low on directional energy and likely to turn soon? I'm not talking about squiggly computer-generated lines that lag price by ten or 20 bars! By definition, they may confirm changes in behavior, but they won't give you changes in behavior in advance. I'm talking about real signs the market offers, to those who look for the signs, that will give you a tell that the current trending market may be running out of directional energy.

Does it sound crazy? Does it sound like one of those “Get Rich” ads you read in the trading magazines that (hopefully) make you chuckle?

Let's see if I can make a believer out of you!

Here's a chart of the CBOT 30-year bond futures. You can clearly see price was in a nice downtrend and then began to consolidate. After some time, price climbs out of the consolidation, making a series of higher lows and higher highs. And then price shoots higher, breaking above major swing highs to the left in one bar—a clear sign that there has been a change in behavior.

Wouldn't you like to have been able to read the signs that this change in behavior was coming?

Price gave you the signs you needed. It left tells that its downtrend was ending and a likely change in behavior was on the way. Looking at the chart now, can you identify those signs? Can you see the tells the market left? Let's go on and see what the market offers us. We're looking at market structure and signs that there may be changes in behavior coming.

Price continues higher, breaking above the up-sloping Median Line before pulling back, but note that it does not test or break the lower parallel, nor does it break below the prior major swing low. Then price heads back higher in a stair-step fashion. You'll note I added a pink line that has the same slope as the Median Line and connected it to the first major swing high, and this line catches the current high to the tick.

Median Lines and their parallels mathematically project the path of least resistance for price—and this means it is the most probable path of price, since all things in motion seek the path of least resistance.

You can see that price is currently making higher highs, but if you measure its progress against the sloped lines, its path of least resistance, it is just re-testing its prior high. I'll bet I've just totally confused many of you! When I show these charts in live seminars or live Webcasts, I tell people to turn their head to the right and look at how far price has moved upward against the sloped lines. But I believe most people don't turn their heads, and truthfully, most people listen to me talk about price making progress against the sloped lines, but really don't understand what I am talking about.

So let me quote an old saying: “A picture is worth a thousand words!” Here goes!

By rotating the chart so your eyes align the sloped Median Line with the natural horizontal plane, you can now see that as measured against the probable path of price, the Median Line and its parallels, price is not making new highs, but instead re-testing its prior highs. There are no signs that this market is turning yet, no tells that this market may soon exhibit a change in behavior. But when you looked at the prior chart, price was clearly making new higher highs.

When you look at the same chart aligned with the path of least resistance, price is merely re-testing prior highs. Don't worry if you still don't understand what I mean. I believe humans are visual in nature, and I have plenty of pictures!

Let's see where price goes now. Looking at this chart, you can see that price made a series of higher highs and then pulled back before making a new, higher high. Price never tested or broke the lower parallel line and it really never broke below any major swing lows. Price worked its way higher to new highs. And “worked' is the key word!

How much energy is price expending to make each of these new highs?

Like the gas tank in a car, price only carries a certain amount of potential, or directional, energy, and when that is used up, it must either pause and refill its tank or else a change in direction (behavior) occurs.

As I said, the key word here is “work:” How efficient is price using its stored directional energy?

When price becomes less and less efficient, it runs out of directional energy that much quicker. Suppose you are driving your car at 55 miles per hour, burning the gas in your tank at 35 miles per gallon, and then decide to pass a series of cars. You push down harder on the gas pedal and your engine revs up and your car speeds up to 80 miles per hour as you scoot past the cars to the right of you while your engine is now burning gas at 8 miles to the gallon! Your car's efficiency has just declined dramatically, and even though you are now further along the highway and ahead of the cars that were ahead of you, if you continue burning gas at this less-efficient rate, you will run out of the gas in your car's tank much more quickly and have travelled a much shorter distance than if you had continued to use the gas in your car's tank at 35 miles per gallon.

We are visual in nature, so let's see what that looks like on the same chart we just looked at.

Price continues to make higher highs—in fact, it made a new high—but it is becoming less and less efficient. When I turn the chart so the path of least resistance, or the Median Line, is aligned with the horizontal plane, your eye should tell you that price is not making new highs. In fact, using this efficiency chart, price is actually now making lower highs! As price becomes less and less efficient, it is more and more likely to either pause to restore its expended potential or directional energy or else a change in behavior will occur. If I hadn't turned these images, most of you would not have seen the “tell” that price is giving you. It's there for you to read, as clear a sign that when a particular poker player rubs their chin when they up their bet, they are bluffing!

Price will show you where it is likely to go if you slow down and look for the signs.

By now, if you hadn't been looking at the tilted charts, it's obvious price has undergone a change in behavior. But if you were relying on a squiggly, computer-generated line to show you signs of the coming change in behavior, it wouldn't have caught it. And most of you who just look at standard charts wouldn't have gotten excited about getting short until price broke below a major swing low or the lower parallel Line…but price was long gone by then! Once again, let's begin by looking at the below efficiency chart. By looking at the “tells” that price leaves behind, you can be ready before the change in behavior occurs. You would be surprised how much this simple visual trick can improve your trading!

In the MarketGeometry.com mid-day mini mentoring sessions, I had been telling members to turn their head to the right for months as I talked about price “losing efficiency” just before a change in behavior occurs. And though I swore to myself I was going to keep this visual trick to myself until my new advanced seminar debuted in late-April, several weeks ago, in a moment of weakness, I just popped up a tilted chart, a chart clearly showing price losing its efficiency, and the chat session stopped dead in its tracks! All the members had heard me, over and over, talking about it. But when I showed a tilted chart, the light went on. I also saw a distinct change in the profitability of some of the traders I mentor. One of them is now on a nice winning streak and she attributes the improvement in her trading to beginning to pay detailed attention to the efficiency of price. Her new mantra is, “Trade less, pay attention more, make more.” It was clear that I had been seeing price losing its efficiency and using it as a visual clue for years. I had been talking about it and trying to explain it to the traders I teach for years, but it took a simple visual tool to clearly explain the idea. Once members and the traders I taught saw the tilted efficiency charts, the idea was clear.

After I debuted the tilted efficiency chart, whenever I begin analyzing a chart bar by bar in the mid-day mini mentoring sessions, once price begins to lose its efficiency, people catch it and call it out before I can even mention it. It's a very powerful concept that can help you catch many major turns. Now that I showed how powerful a tell the lack of efficiency can be, did you go back to the first chart I showed you and look carefully for the signs price left right in front of you that it was either going to consolidate and re-store its energy or exhibit a change in behavior?

Ok, I'll scroll back in price and time and see if we can spot some of the signs price left for us.

Price went through several phases in this downtrend. It headed lower quickly, reaching its most efficient point as it tested the lower pink reaction line. But when it was unable to hold below the reaction line, it quickly climbed higher and tested the upper parallel, or the action line. Once again, price failed to break out of the action/reaction line set. Price gapped lower and then spent a great deal of time restoring its energy, trading in a consolidation pattern, or energy coil. It stayed in this trading range so long that it drifted out of the action/reaction line set to the right, but note that price was unable to make it above a line with the same slope, equal in distance and projected forward in space and time. Price headed lower again, but once again, it began to lose efficiency.

Did you see any of these signs? Did you tilt your head?

And now you can see we are right where we started this charting exercise. Price lost efficiency, trading in a consolidation phase, and then a change in behavior occurred when price was able to trade well above pivot B, a major swing high. Tilt your head, tilt your screen, but by all means, pay attention to the signs, or “tells,” that price is giving you! There is so much information contained in simple price charts if you just take the time to look for them.

It's a pleasure and an honor to be back writing!

I wish you all good trading,

Tim

1. Not planning your trade before you enter it
2. Trading and not using 'hard' stops
3. Using too much leverage
4. Using stops that are too large [similar to number 3, above]
5. Being too anxious to find trades: Over Trading
6. Trading with Risk Reward Ratios too small for your winning percentage
7. Not sticking with your plan after the trade begins: Don't take profits because you are nervous. NEVER move your stop to a 'worse' level!

Traders are people and they tend to share the same human strengths and weaknesses. I like to say technical analysis is 80 percent science and 20 percent art [though that 20 percent is quite large!] and in this case, I'd say that keeping your thoughts and emotions under control when you trade is much more than half the battle. I like to plan my trades before I enter them and write the plans on paper with a pen [writing the plans on excel spread sheets on my computer do not evoke the same feelings in me]; this allows me to have the plan in front of me and I can 'follow along' or 'paint by the numbers' as the trade unfolds. If I get anxious or if I walk out of the trading room and come back in and need to refresh my mind, the plan is there in front me: I simply look at the plan, find my place, and go back to executing the original plan. Plans, if you stick with them, take many of the emotions out of your trading.

Last year, I had the good fortune to host a daily pre-market morning session, sponsored by the CME Group; I recently moved from Chicago to Arizona, so this year, the daily pre-market morning sessions became the Market Geometry Mid-Day Mini-Mentoring Sessions. Our goal at MarketGeometry, and one we try to foster in each mid-day session, is to help each trader become more consistently profitable. For over an hour each day, we work hard on reading market structure, trying to identify the current frequency [or trend and speed of trend in any given market]. We always stress the importance of solid money management and good Risk Reward ratios. As each session unfolds, we never know where we are headed and where we are likely to end; the goal is to foster good trading practices and help members become more consistent in their trading.

One of the techniques we have been talking about recently has really struck a chord with some of our members and it has helped their trading immensely. I call it 'Rolling It Forward' and it's a technique that can help take the pressure of 'making money' out of your trading. If you are new to trading or you are not a consistently profitable trader, you constantly feel pressure to have a winning trade. This constant pressure clouds your judgment and often makes you take trades you would not have taken if this pressure weren't there; or this pressure causes you to change your trading plan, exiting trades early because you 'must' have a winner!

Though I hadn't started talking about 'Rolling It Forward' to the mid-day session members until a few months ago, the idea came about when I mentored about 350 Chicago Mercantile Exchange Members that were trying to learn to trade 'off floor', out of the pits, in 2005. Even though I had been a CME Member in the 1990's, I was surprised just how impulsively most of these professionals traded once they were 'off floor'. If the bars on the chart on their screens started to turn up, they'd often get long at the current price, with no thought about the where they would get out if the trade were profitable, no thought about where they'd get out if the trade turned against them. They bought or sold however many contracts they felt like trading at the time: sometimes 10, sometimes, 25, sometimes 5--there was no rhyme or reason. This meant they might make a wonderful trade using 5 contracts and follow it up with a losing trade using 25 contracts and then lose all they had just made and more! In short, most of them came off the floor and did whatever felt right--and it just wasn't working. And so they came to my CME Seminars, looking for guidance.

The idea of 'Rolling It Forward' is simple: If you use relatively constant position sizes and have a positive winning percentage, it's pretty easy to find yourself halfway through the month with enough profits in your account to nearly guarantee a winning month, assuming you keep trading the same style the rest of the month. But if you trade 'Helter Skelter', varying your position sizes and moving your stop loss orders when your emotions overcome your better judgment, you'll soon be looking for work as something other than a trader! There are many tips and tricks I developed to help off floor traders during that period, but this is one I had completely forgotten about until someone in one of the on-line Mid-Day Sessions asked me about position sizing [increasing the size of your positions as you accumulate more profits in your account].

I initially answered that the first and foremost goal was to become consistently profitable, and we still had too many people attending that weren't consistently profitable. I explained that 'consistently profitable' meant that if you looked at the new profits and losses of the past five or six months, one or two months should stick out--and those should be the losing months, not the winning months. Having profitable months had to be the 'norm' before you could even begin to think about increasing the size of your positions. And so I re-dedicated all we do at Market Geometry to making its members more consistently profitable. And that reminded me of the 'Rolling It Forward' exercise I had used with the CME Members and just how powerful a concept it can be. Let me walk you through it.

First, I went back and chose the results from a CME Professional member that was just beginning mentoring. These are the first five actual consecutive trades he brought to his first session for me to look at, in summary form [presenting them in a chart by chart form would not aid this discussion].

[Download an Excel version of this spreadsheet]

Looking at his composite spreadsheet, you can see his trade parameters as he planned them, the results and my comments.

He started out alright. My only advice to him was that in general, five S&P points was a little large for an initial stop because if he wanted to reach a 3:1 Risk Reward target, he'd have to take his profits fifteen S&P points past his entry--and fifteen points was at or around the entire day's average recent range, so he would have to catch most or all of the range on a normal day if he constantly used five point stops. I also noted that his original plan had included a 1:1 Risk Reward; in general, a trader would need to have a winning percentage of over 75 percent to trade with 1:1 risk reward ratios, after you factor in slippage and commissions.

I suggested he use slightly smaller initial stops and look for trades with Risk Rewards that were at 2:1 or higher. I personally do not take trades with initial stop losses larger than three S&P points and I never take a trade with a Risk Reward below 2:1--I am much more comfortable in the 3,4 or 5:1 area when intraday trading. I don't find these trades that difficult to find once you get used to looking for them and if I have to wait to find a trade that fits my acceptable profile, that doesn't bother me at all. I want to be
consistently profitable and it costs me nothing to wait for an acceptable trade.

He had a good plan for his next trade: He used a smaller initial stop loss and the Risk Reward was greater than 2:1. The trade started out as a nice winner and looked like it was going to run straight to his profit target--it was already five S&P points in his favor! But when it began to turn back lower, he let his emotions get the better of him: He had that feeling that the market was going to continue to head lower and hit his stop loss. He didn't want to take a losing trade! This was the pressure of 'making money' talking to him and he threw his plan out of the window. Rather than risk having this trade become a loser, he panicked and took the two S&P Points still left in the trade [If you are curious, he would not have been stopped out and price would have reached his original profit target if he had stuck with his plan]. Once the trade was closed, he realized he had two winning trades for his first two trades. He was riding an emotional high: This 'off floor' trading wasn't hard!

The next day, he saw his third trade opportunity right after the S&P open, when the market gapped open lower. Most floor traders 'know' the market loves to fill open gaps, so that gave him his trade idea. He already had two winning trades and was feeling good about his trading, so he decided he would go back to using 'looser' stops for this trade. The market had just opened and the economic numbers that had come out before the opening
[ and caused the market to gap open lower ] had left this market volatile, with fairly wide range bars. He didn't want to get stopped out and then have the market turn around and fill the gap!

This trade had nothing going for it: The initial stop was too large, the risk reward was poor, he was taking an entry right after the open that was fighting against the trend. And he made matters worse: When price got near his initial stop loss level, he looked at the screen and the size of the 'buy' orders shown by his platform. Then he watched price hesitate and turn just a bit higher. He was certain the buyers at this level would keep price from going lower, but price was so close to his stop, he cancelled his existing stop and moved it five S&P points lower. Remember, he just had two winning trades in a row and was running on an emotional high. He was certain price would never break through this level and hit his new stop loss order.

But price did break through the lows and quickly stopped him out for a rather large loss. On this single trade, a trade he was certain was a sure winner, he had lost all he had made on the prior two trades and quite a bit more. If you 'eye up' the first three trades, you should be able to see the usefulness of 'same size' maximum stop losses per contract, as well as what damage you can do to your account if you move your initial stop loss order to a worse level.

I haven't yet mentioned leverage. Though many brokers will let you trade three or four E Mini S&P contracts per $10,000 Dollars, by doing so, you are exposing your account to extremely large percentage swings on each and every trade. Overtrading [trading too frequently] and using too much leverage will drain an account faster than anything else--and people that lose all the money in their accounts are generally guilty of both of these.

I understand not everyone has $100,000 for their trading accounts or $50,000 or even $25,000. Many of you scraped about $10,000 together [or a touch less] to begin trading. Think of this money as your Trading University funding. You need to practice, practice, practice--without losing all your capital. Using simulated trading is fine, up to a point, but eventually, you will have to trade using real money, because only then will you experience all the positive and negative emotions that you have to master before you can become a consistently successful trader.

If you are trading a $10,000 account [or something close to that], if you choose to trade E Mini S&P futures, learn trading only one contract. That one contract will give you all the spills and chills and thrills you can handle, and then some. The goal is to survive the learning period, with as much of your capital intact as possible. No matter what instrument you decide to trade, use leverage carefully, use consistent sized smaller stops and don't take a trade just to take a trade: Have a trading plan and use it.

He continued to use a large initial stop [seven S&P points] for his fourth trade, because he saw what he thought was a great set up right after lunch: Price was trading in a range and when it broke out, he'd catch the move! This was going to be a sure 16 point winner and it would get him all the money he had lost on the last trade and a little more! He had two winners in a row; that last large loser was because of the opening gap, but it was afternoon now and he was sure he'd get his money back by the close.

Price broke out to the upside and he went long [just as he had in the morning]. He was sure now that they'd fill the gap left on the open--Price broke above the top of the range and he put his initial stop loss well below the bottom of the range.

Price went a little higher after he went long but then it broke back into the trading range; a few bars later, it headed towards the low of the trading range. Soon, he was looking at where his stop was placed and where price was trading and he realized he had only put his stop loss order one S&P point below the low of the range! He decided that was too close to the prior lows and they might 'wash and rinse' him and then take price back higher, but he wasn't going to let that happen! He moved his stop loss order to a worse level to give the trade more room. Now he was risking 10 S&P points to make 16 S&P points: The size of his stop was huge and his risk reward ratio was only 1.6:1.

They did wash and rinse those traders that had tried to go long at the bottom of the range; he breathed a sigh of relief when he wasn't stopped out and price climbed back into the range. But the relief didn't last long. Two bars later, price headed lower again and this time, ran into quite a few stop loss orders; the selling continued and he was quickly stopped out for his second losing trade.

Please take the time to notice that the size of his two losing trades are much larger than the size of his two winning trades. When you look at your trading statistics [and I hope you all keep trading statistics and review them regularly], this is a sign you are on the road to ruin.

When he eyed up what would be his fifth trade, he decided he had been risking too much on each trade. He decided to go back to the five S&P point stop he had used for his first trade; three S&P points seemed too small and he didn't want to lose seven more S&P points, so he settled on five S&P points. He had used five points on his largest winning trade--that one worked pretty good.

Price started to sell off on the opening and after watching it head lower for awhile, he decided the sell off was probably going to continue. He found a place on his chart where price had run into resistance yesterday afternoon and when price got to that area, he got short three S&P contracts.

Price congested underneath this area for five or six bars; to him, it felt like there was a giant order to sell just above the market! Other traders also had this feeling that there was a giant seller just above the market--and more and more short S&P positions were created right below this resistance area.

Price suddenly began to spike higher. He looked at his charts again and realized he had placed his stop loss order right at the bottom of that trading range from yesterday, so he moved it higher, now risking eight S&P points on the trade--but he was confident the bottom of the range from yesterday would stop the rise. And it did stop the rise for a few bars.

Then price began to creep higher, slowly edging into the trading range. As soon as he began to feel his stop loss order was in danger of being executed, his first thought was: I can't take another large losing trade! The last two losses had really cut into his trading account. He was certain price was just about to turn around and head lower--so he couldn't allow them to stop him out of his short position now! He moved his stop loss order higher [for the second time!] by four more S&P points.

The end of this trade came swift this time: Roughly two minutes after he cancelled his stop loss order and moved it higher by four points, price spiked much higher, taking him out of his position with a twelve point S&P loss.

In three trading days, he managed to have two winners and three losers. That's not a fatal win/loss ratio; in fact, if he had an actual risk reward ratio above 3:1, he would have net made money. But in his five trades, he had made seven S&P points and lost 35 S&P points! You don't even have to do the math to know that that risk reward ratio was fatal.

In three trading days, he managed to take a $10,000 trading account and lose $4,200 of it. And the sad truth was he wasn't really trading a $10,000 account; I proportionally down sized everything [his account and the positions sizes, profits and losses] to a $10,000 account so most of you would better relate to the sizes of the wins and losses. He was actually trading with a multi-million Dollar account [so imagine how much money he actually lost].

'Where did I go wrong?', he asked me when we met at the end of the week. I started to list the mistakes--and he had made most of the mistakes I have on my 'Don't ever do this' list:

1. Don't use too much leverage. Once you become a consistently profitable trader, there are simple ways to slowly increase your position size without emptying your account.
2. Keep your stops relatively small. Stops are often your best friends. By using consistently sized maximum stops, you'll be around much longer to learn your trading skills.
3. NEVER trade without stops and NEVER move your stops to a 'worse' level. Once the trade begins, you have emotions tugging at you and you often make poor judgments; in my opinion, your first thoughts about a trade are usually the best because they came before this emotional tug of war.
4. A solid actual risk reward ratio pays for many sins. If your actual risk reward ratio is 3 or better, you can have three or four losses in a row and if you are using consistently sized smaller stops, you can still have a good month.
5. When you take a trade, don't think about 'getting the money back'. Take trades because they make sense. The market has no memory, so trying to take revenge on the market is a waste of emotional energy--and these 'revenge trades' seldom work.
6. If you find you have had several bad losses in a row, try taking a few days off to let your head clear and then evaluate what you were doing that led to the large losses. Make certain you learn something from your mistakes!
7. Set 'circuit breaker' levels in your trading account--perhaps at every ten percent. If you lose ten percent of your account, take some time off, then re-evaluate your trading plan. If you are trading multiple contracts, you must lower your number of contracts at one of these 'circuit breaker' levels. If you manage to make back the ten percent, you can always slowly increase your number of contracts.
8. Set rules for yourself and never violate them. If you violate a rule, impose a stiff penalty on yourself: a week off of trading? When you violate rules, it is a clear sign you are out of control.

What should a solid five trades look like? Here is a set of five consecutive trades I took in the 30 year Bond Futures. You can see the chart that spawned the last trade in last week's Moneyshow article: ' How to Develop Your GPS for Chart Reading'.

The first thing you should note is that I am using much less leverage than the trader in the first example. And I am using smaller consistent stops for each trade. I don't HAVE to use all five ticks, but I like to hide my stop order behind market structure and that generally takes all five points.

Now look at my planned or initial risk reward ratios: 6:1, 8:1, 4:1, 3:1 and 8:1. By looking for trades that realistically have initial risk reward ratios of better than 2:1, I am able to withstand two or three [and maybe four losses in a row] without doing much damage to my account. How do I know if the initial risk reward ratio is realistic? Here are the actual outcomes: 3:1, loss, loss, 3:1, 9:1. There is nothing I can do about the losses, but if my winning trades had actual risk reward ratios of 0.5, 1.2, 1.6 when I had been looking for 3:1 or 4:1 or 8:1, it would be time for me to re-evaluate how I was choosing my initial profit targets.

By using consistently sized smaller stops, the two consecutive losing trades didn't take my account into negative territory. And here's the key: In the first trade, I 'Rolled Forward' three stop losses. That means that when I took a profit of fifteen ticks in the bonds on that first trade, I had fifteen ticks in my account as padding against a string of losing trades. Since I was consistently using 5 tick stops, I could have lost five ticks on the next trade and only been back to break even--I still would not be feeling the pressure of 'needing to make money' to recover from large losses.

As I said last week, a picture is worth a thousand words. Let me show you what 'Rolling Forward Stops' look like.

This spreadsheet says it all. You can see how many ticks I have added to my account after each winning trade and how many I lost from my account after each losing trade. The center column shows you how many losses I have 'Rolled Forward'. And finally, the last column shows you how many losses I have left in my account before I begin to draw down actual capital from my starting levels.

By using consistently sized smaller stops, even if I had started out with two losing trades, with a solid risk reward ratio of 2:1 or better, my third trade would have easily covered the losses from the first two losing trades. Don't dig big holes! Trust me, they are MUCH harder to fill up! Trade with consistent sized stops, use smaller leverage, only take trades that make sense and just keep Rolling Forward those stops.

The goal is to become a consistently profitable trader. And that means three or four winning months in a row--and the losing months should be barely negative, because you are controlling those losses!
Here's the secret to having a winning month: At the end of week three, if you have 13 losses rolled forward, it is extremely likely you will have a nice winning month. There is no pressure left for the rest of the month, so you can relax and trade free! And once that winning month closes, you have positive momentum to start the next month out with. Keep the same stops, the same risk reward ratios and the same realistic profit targets and do it again. Before you know it, you'll be on your third or fourth winning month. You'll be a consistently winning trader!

Just keep Rolling Them Forward!

I wish you good trading.

Timothy Morge
www.marketgeometry.com
www.medianline.com

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 tmorge@sbcglobal.net , 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.

Plan Your Trade, Trade Your Plan!

One of the most interesting and fulfilling experiences I have had in my 30 year career as a professional trader, moneymanager and educator has been my work with the hundreds of professional traders at the Chicago Mercantile Exchange and Chicago Board of Trade trying to make the transition from being floor traders to 'off-floor' or 'screen traders.' For the past 2? years, I've been teaching half-day Market Map Seminars and then acting as mentor to many of these professionals. Some of them have 25 years trading experience and some of them are fairly inexperienced and want to start their career 'off floor'. But all of them want to be consistent winning traders.

Most beginning traders think that they have to find the 'magic' entry method to be a successful trader. When they struggle, they begin hunting for the newest, hottest indicator-the one touted in the advertisements that take that new supercomputer to run, because it's built with 'cutting edge' technology.

Becoming a successful trader depends on a trader finding a tool that helps you spot repeatable patterns. Becoming a successful trader depends on taking the time to master the tool you have chosen to make your own. And most important, becoming a successful trader means you must master yourself. That means you have to look deep within yourself and identify your strengths and weakness. And then put in the work to overcome your weaknesses and play to your strengths. Becoming a successful trader is hard work, but the payoff is well worth the effort.

All traders experience difficulty with self-discipline. A trader can have the best entry tool available and if they can't follow their own rules, they'll likely fail. Successful and profitable trading takes a solid repeatable entry set up, moneymanagement, good risk reward ratios and most of all, these things must be planned in advance and then the plan mustbe executed as the market is moving in real-time.

Inexperienced traders have trouble with discipline because they don't understand just how important it is. The professional traders I work with that are trying to 'relearn' their craft by becoming 'off floor' traders have problems withself discipline because on the floor, they are used to making trading decisions instinctively. But when they sit down infront of the screen to trade, they find it's a different experience and they fall into the same traps that generally trip up inexperienced traders. How can you improve your discipline as a trader?

When I work with traders at the Chicago exchanges, I make them fill out a potential trade entry sheet before they take a trade. The sheet is designed to make each trader think about why they are entering a trade, where in relation to theday's range they are entering a trade, how much are they initially risking on that trade and how much do they expect to make on that trade if it hits their profit target. This forces them to go through basic money management and risk rewardanalysis. If the entry order gets hit, they then have to keep track of how they manage their orders. Again, this reinforces their money management skills. And last, once the trade is closed out, they have to rate the trade and give a brief description of how they feel they executed that particular trade. Here's what one of the potential trade sheets look's like:

How do I get these professional traders into the habit of filling out trade sheets? All traders are the same: They want to talk about trading and they want to talk to their mentor about their trades. Because I have several hundred traders at the two exchanges vying to get in to see me and talk about their trading or ask questions during my 'open office' hours, I have one rule for admittance: A trader must bring in a completed trade sheet and a chart of the trade or I won't talk to them about the trade or their trading. Sound severe? Trading is hard work and only the traders that are willing to put inthe work will survive. I drive this point home day in and day out with this simple technique. Successful traders learn earlyon to have a plan and then to trade their plan. And the easiest way for me to teach them to 'have a plan' is to make them fill out potential trade sheets and keep images of their charts.

I cannot tell how strongly I recommend you try this in your own trading. This is very much like keeping a trading journal-another great tool that helps instill discipline-but by design, it makes you go through the potential trade, step by step.And by design, it makes you check your entry method, your money management, your risk reward, your order management and finally, it makes you review just how you did on each of these steps for any given trade.

If you'd like a copy of the Market Maps Trade Sheet, just drop me an email with the words 'trade sheet' in the subject or body of the email, or you can email me and simply ask for one. Here's the email address you should use:

tmorge@sbcglobal.net

I'll gladly send you out two versions, a Microsoft's Excel spreadsheet and a Microsoft's Word document. You can use whichever is easier for you!

But more important, plan your trade and trade your plan!