The E-mini Trading Professor

Archive for the ‘Stock Market’ Category

It was another week of unusual market moves and prolonged periods of price stagnation. As I have been saying for quite some time, the recovery from our current recession will be typified by a “mixed bag” of economic reports. Of course, this week was no exception, though the market chose to react to various reports in unusual fashion.

Friday was probably the most baffling day this week. Most economists expected the economy to add 8000 new jobs, but ADP reported that the economy actually shed 95,000 jobs. As you can see, the experts missed this particular prediction by nearly 100,000 jobs. You would expect the market to react negatively to this sort of news because employment has become a very hot topic of late, but the market chose to march merrily along its way and posted a healthy gain for the day. There are several technical factors that contributed to this gain, but it was by and large a confusing reaction to very bad news.

This sort of market action was the norm for the week, though we did experience some prolonged periods of market stagnation. Of course, this doesn’t surprise me. Since the futures market is based upon broad stock market indices, the market needs smaller investors to reenter the market and purchase stocks. I would be hard-pressed to come up with a rationale for anyone to initiate a long position in the current economic climate. To say the least, the potential for sizable gains in the market are less than compelling; on the other hand, it would not be difficult to envision a sharp correction from current index prices.

It is my opinion that the majority of market participants are traders, not investors. While traders provide an essential function in the market, the market requires smaller investors investing on a fundamental basis. Yet, the fundamentals for our current market condition are shaky and there are many pressing questions about our economy. The dollar has been weak; volume on the ES e-mini contract has been, at times, light and erratic.

To compound the current economic woes, a cottage industry in disseminating bad economic news has kicked into high gear. This is not an unusual phenomenon during recessionary periods. Quite simply, bad news sells. Of special note are the gold bugs, who come out of the woodwork during every recession and tout the benefits of owning hard assets like gold. I feel that some exposure to gold is essential for most individual investor’s portfolios; but dumping your life savings into gold is not a wise idea. There can be no disputing, though, that gold has enjoyed a very profitable run in recent years, and has outperformed the stock market of late by a considerable margin. But my point is a simple one: buying massive amounts of gold is simply not the answer to our current economic recession.

We were able to trade very effectively this week though, as numerous opportunities for high probability setups were the norm. Generally speaking, we earned between $200 and $400 most days this week. Friday was the exception, though; as the market was particularly flat and we managed only a small gain of $100. Fortunately, we had no losing days this particular week.

The E-Mini Trading Professor System trading room enjoyed a wide variety of visitors and the conversation was brisk and interesting. Lots of new faces, and more new long-term customers joined than usual. As a trader, I feel like traditional investors are currently looking for alternatives for making money in ways that are untraditional, especially participants who have typically invested solely in the stock market.

Looking ahead, next week would appear to be a reasonably volatile week as there are a plethora of importance and pertinent fed and fed agency announcements that the market will have to digest. All in all, it should make for an interesting and profitable week of trading.

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This list is for traders but also applies to investors.

1. Recognize mental blocks. If you believe that the financial markets are rigged, stay away. Bias is blinding. If your ego requires constant feeding and vindication, do not trade. If being right is more important than making money, steer clear of the stock market. If you must be dogmatic, direct your energy into following these rules.

2. There is no needle in the haystack. There’s no reliable way of picking a single winner from the thousands of stocks listed on the exchanges.

3. Resist betting it all on the longshot because the outcome is based purely on luck. Dr. Ziemba explains the mathematics of horse racing. The point is that the bettor is better off with horses that finish the race “in the money”. They don’t have to come in first.

4. Diversify. Spread your bets around. It’s the only way to be on board the winner.

5. Trade small. Bet only a small fraction of your equity on each position. You must take risk to get reward, but ruin is certain if you take insane risk. It’s defined in Fortune’s Formula. Think Adventures in Conditional Probability.

6. Press the winners. You must compound a winning streak.

7. Never throw in good money after bad. Never double down. Ever.

8. Do not rationalize. Down is NOT up. Red is NOT the new black. If the account equity is shrinking, your bets are in the wrong direction.

9. Establish a stop loss. Place it in the appropriate location (except just above the swing high or under the swing low where everyone else put theirs), a place where you can be statistically confident that the move in the present direction is over. Don’t use a tight stop for lack of equity. The market doesn’t care about how much is in your account, so trade a smaller position size and put the stop in the proper place.

10. Use the stop loss. Just do it. Immediately. No excuses. Having a “mental” stop loss is the same as lying. There’s no point, because the longer you let it slide, the deeper the doo-doo.

*Observe Rule Nine. Always. Don’t go to the bathroom without it.

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Many traders have their own theory on how to place stops on their e-mini market orders, or whatever kind of order they place. Frankly, I insist that e-mini day traders place their stops in a manner that gives them adequate protection. My stop ranges are anywhere from 12 to 20 ticks, depending upon the nature of the market that day.

But I want to address those who day trade without stops and indicate what a terrible risk they are taking because a sudden spike could signal the end of your e-mini day trading career. Stops are an important and essential part of any e-mini trading strategy to keep from encountering catastrophic losses.

I also move my stops when a trade is in progross….let’s assume that I have made a good trade and am in the money and I have initially positioned my stop at 12 ticks…once I am 1.5 points into the money, I manually move my stop up to 4 ticks…once I have reached two points, my stops are at my market entry points, and if I let the trade run I continue moving my stops upward to protect my gain. Remember this…..NEVER LET A WINNING TRADE BECOME A LOSING TRADE…and stops are a great way to do this.

You may choose to use a trailing stop strategy, where once you reach a certain point in profit the stop moves automatically according to a preset you put in before the trade gooes in. I prefer moving my stops manually, which may be the remnant of the “old school” way of doing things, but I feel much more comfortable placing my stops this way.

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It is fitting that chaos theory got its start in the humble, but frustrating, field of meteorology. Why does it seem impossible for all our hot-shot meteorologists, armed as they are with ever more efficient computers and ever greater masses of data, to predict the weather?

Two decades ago, Edward Lorenz, a meteorologist at MIT stumbled onto chaos theory by making the discovery that ever so tiny changes in climate could bring about enormous and volatile changes in weather. Calling it the Butterfly Effect, he pointed out that if a butterfly flapped its wings in Brazil, it could well produce a tornado in Texas.

Since then, the discovery that small, unpredictable causes could have dramatic and turbulent effects has been expanded into other, seemingly unconnected, realms of science.

The conclusion, for the weather and for many other aspects of the world, is that the weather, in principle, cannot be predicted successfully, no matter how much data is accumulated for our computers. This is not really “chaos” since the Butterfly Effect does have its own causal patterns, albeit very complex. (Many of these causal patterns follow what is known as “Feigenbaum’s Number.”)

But even if these patterns become known, who in the world can predict the arrival of a flapping butterfly?

The e-mini stock markets are said to be nonlinear, dynamic systems. Chaos theory is the mathematics of studying such nonlinear, dynamic systems. Does this mean that chaoticians can predict when e-mini stocks will rise and fall? Not quite; however, chaoticians have determined that the market prices are highly random, but with a trend. The stock market is accepted as a self-similar system in the sense that the individual parts are related to the whole. Another self-similar system in the area of mathematics are fractals. Could the e-mini stock market be associated with a fractal? Why not? In the market price action, if one looks at the market monthly, weekly, daily, and intra day bar charts, the structure has a similar appearance. However, just like a fractal, the stock market has sensitive dependence on initial conditions. This factor is what makes dynamic market systems so difficult to predict. Because we cannot accurately describe the current situation with the detail necessary, we cannot accurately predict the state of the system at a future time. Stock market success can be predicted by chaoticians.

Manus J. Donahue III
An Introduction to Chaos Theory and Fractal Geometry

The upshot of chaos theory is not that the real world is chaotic or in principle unpredictable or undetermined, but that in practice much of it is unpredictable. And in particular that mathematical tools such as the calculus, which assumes smooth surfaces and infinitesimally small steps, is deeply flawed in dealing with much of the real world. (Thus, Benoit Mandelbroit’s “fractals” indicate that smooth curves are inappropriate and misleading for modeling coastlines or geographic surfaces.)

Chaos theory is even more challenging when applied to human events such as the workings of the stock market. Here the chaos theorists have directly challenged orthodox neoclassical theory of the stock market, which assumes that the expectations of the market are “rational,” that is, are omniscient about the future. If all stock or commodity market prices perfectly discount and incorporate perfect knowledge of the future, then the patterns of stock market prices must be purely accidental, meaningless, and random (“random walk”), since all the underlying basic knowledge is already known and incorporated into the price.

The absurdity of believing that the market is omniscient about the future, or that it has perfect knowledge of all “probability distributions” of the future, is matched by the equal folly of assuming that all happenings on the real stock market are “random,” that is, that no one stock price is related to any other price, past or future. And yet a crucial fact of human history is that all historical events are interconnected, that cause and effect patterns permeate human events, that very little is homogeneous, and that nothing is random.

With their enormous prestige, the chaos theorists have done important work in denouncing these assumptions, and in rebuking any attempt to abstract statistically from the actual concrete events of the real world. Thus, the chaos theorists are opposed to the common statistical technique of “smoothing out” the data by taking twelve-month moving averages of monthly data-whether of prices, production, or employment. In attempting to eliminate jagged “random elements” and separate them out from alleged underlying patterns, orthodox statisticians have been unwittingly getting rid of the very real-world data that need to be examined.

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There is a tendency to believe, even among investment professionals, that once the e-mini market starts to go up the “good times” have arrived and the market is going to go up forever. Conversely, the is also a tendency to believe, even among investment professionals, that once the market starts to go down, or correct, “the sky is falling” and the market will continue fall ad infinity. Like members of a devoted political parties the “up” crowd, or “bulls” feel comfortable when the market is going up and they are in control. I think it is also important to note that since or economy is almost universally expanding because our population is increasing, which in turn causes of GDP to increase.

But our markets tend to over expand, and the over expansion is followed by corresponding contraction…and this contraction is when the “sky is falling crowd.” the “bears” have their day in the sun. Many investors tend to be either bulls or bears, and strongly identify with the market either going up or the market going down.

Of course, an e-mini day trader doesn’t affiliate himself with any “political investing party.” Bulls, bears….these are wonderful basketball and football teams but are of little consequence for a trader. We are happy to go long or short at the appropriate times without conscience or investing preference. Like most traders chaotic investment philosophy goes to where the money is…long or short and where the money is.

I started out as a stock and bond man….but concentrate entirely on index futures contracts now. Of course, my trainers and the media in general portrayed the futures and options markets as “voo-doo” markets and not to be taken seriously. No, I was trained to believe that the only investing occurred on the NYSE and NASDAQ. (and the NASDAQ was barely respectable back then) I did trade some TED Spreads (Treasury-Eurodollar) but nothing like the scalping style I employ now.

The reason for my conversion is much the same as the reasons other traders….we have nano-second access to any market through home computers, and as home computers have proliferated so has the number of firms that cater to home traders or small office traders. While I hate to admit it, my investing career has taken me all the way back to Quotron.

My early investing career was very much influenced by the writings of Benjamin Graham, and Graham and Dodds writings were very much the gold standard by which other authors were judged. Value investing, as was Grahams preference, along with detailed study of balance sheets and cash flow statements were the rage, along with neighborhood investment clubs. The world has certainly changed.

The newspaper have for years written enumerable article about stocks busts, market crashes and the economic calamities that face stock investors.  It makes good news, and adds to the negative image of investing in equities and the market in general.

But those calamities are problems that face long term investors.  You know, the buy and hold guys.   For years, the general line of thinking was to buy a stock and hold onto for years and reap the rewards in your retirement years.  Of course, the dynamic nature of the stock has, to a certain extent, changed that line of thinking.

Of course, there are still the hordes of mutual fund holders who have invested untold billions in these investment vehicles.  I have a low opinion of mutual funds, as an investor cannot exit a fund until the end of the day.  Additionally, very few fund managers even come close to matching the indexes they are supposed to be imitating.  Why pay exorbitant fees for substandard performance?  I will never understand it, but there are trillions of dollars still invested in these investment vehicles.

However, recent changes in investment structuring from the Chicago Mercantile Exchange has made investment for primary income a very attainable goal.  Several product lines are aimed directly at the consumer market and priced well within the average budget.   The are called e-mini’s and are investments that are traded during the day, and seldom held overnight.  No worrying about the stock market here, you are in complete control of your investment future.

I don’t want to give you the impression that day trading is like an ATM machine that simply spits out money all day, but with proper training and practice a day trader can easily earn $500 a day or more and not hold any positions over night.  Of course, most individuals have never given serious consideration to investing in the markets, which many consider relegated to Wall Street experts.  But nothing could be farther from the truth.

There are many courses, some home study, that are reasonably priced that will give you more than the pre-requisite knowledge you need to be an effective day trader.  Thousands of people, from housewives to businessman, have turned to day trading and greatly increased their income and improved their lifestyle.

The secret is training.  It is very important that a day trader spends time learning the slightly illogical movements of the market.  Again, with proper knowledge this illogical movement becomes second nature to understand.

The benefits to e-mini day trading for a living are many fold:

1.  More time with your family and children.
2.  No more boss, your self-discipline is the key to success.
3.  Time for leisure activities and enjoying the fine things in life.
4.  You control your income.  You have the skill to make money, and nobody can take that away from you, fire you, or change your job.  More than anything, once you learn to trade, you can become completely in control of your lifestyle.

So, I propose that you consider exploring the benefits of e-mini day trading and see if it suits you.  It’s not for everyone, but it’s wonderful for a lot more people, especially if they have the knowledge of what is possible in trading right from your home.  You are your own boss, and master of you own lifestyle.  No more corporate mentality to deal with.

One common characteristic of ineffective e-mini day traders is the execution of too many trades throughout the course of a ES e-mini trading session.  There are many causes for this phenomena, but if you are making 15 trades a day you are probably guilty of this offense.  In my world, there are not 15 excellent trade set ups on the average e-mini trading day.

Over trading during a trading session will eat away at your profits or enhance your losses.  On the other hand, your futures broker will love you because his commission account will soar, but I don’t think your futures account will withstand the commission shock.

As I see the market begin to form a good set-up, I start an argument with myself.  I usually look for reasons not to take the trade.  Is the set up really a good one?  Do some of the oscillators or price action appear to be pointing to avoiding the trade?  Am I trading on intellect and not emotion?  These are all questions I ask myself as I prepare to enter a trade.

I think the cause for over trading has its roots in emotion, specifically greed.  After all, every trade has a binary outcome and the possibility to make money, and making money is the reason most of us trade the ES emini contract.  You make money on high probability trades, though, not trades with shaky set up probabilities.  I like to fish, for example, and the only way to catch a fish is to have your line in the water.  You won’t catch that nice fat walleye if your line is in the boat.  I think this analogy is a good one for trading, too.   Many people feel the like they need to maintain active positions in the market in order to catch the next “big move.”

One clarification here:  I am a scalper, which is a technique for carving out 2-3 potential points per trade during the normal market action I observe.   Which is to say I look to make 4-6 trades a day to achieve my profit target.  My average trade lasts 5 to 10 minutes and then I take my profit, or cut my loss.  Now there are times when the market gets into a nice trend and I may sit in a trade for quite some time, but that is not the rule, rather it is the exception. (a very pleasing exception, at that)

My point is a simple one, don’t over trade.  Usually you are “chasing the market” when you trade to often.  You have to tell yourself that there are times when you will miss a potential trade and err on the side of safety.  This is especially true of countertrend trades, which are the bane of my existence.  Countertrend trades must be scrutinized with the greatest of care because they can account for many losses. The market might well head into opposite the direction for a bar or two, only to resume the direction of the trend.  Years of heartache and cursing have hardened me against countertrend trades and I scrutinize them very closely.  You should too, the trend is your friend, and poorly thought out countertrend trading will make you old before your time.

One last note: Highly volatile markets will appear to produce many nice setups that can’t be trusted. You will be tempted to take many trades.  When trading the ES emini contract, you should note the Average True Range, and if it is swinging in the 8 point range and looks like a seismograph in a 6.5 earthquake, you are likely to get blown out of most of your trades  by simple market noise, at those times a profitable trade is more a function of luck than skill.  Volatile markets, with the long bars and long flags which are typical of this phenomena, are good days to to err on the side of caution, as trading may be risky proposition.  You will see many nice setups, then suddenly the market may change course: it’s like surfing in 30 foot waves, your chance to get crushed are very high.  Wait for calmer waters and trade in a market where your skill level can earn you safer returns.  Best of luck trading.

Low cost of entry. Great earning potential. No selling. Work from your home… in your PJ’s if you want. Sound like a great job? There is little argument that day trading can be one of the best jobs on he planet. But you have to learn to trade and up until ten years ago the only real traders were parked behind massive computers at investment banks or worked directly on the floor of the exchanges.

But that has all changed, and now day trading the ES Emini is within the reach of anyone with a computer. In the last 10 years, the exchanges have started developing products called “emini” contracts that are inexpensive and efficient for the small day trader to trade. With some training, it is possible to earn an impressive living trading from your home. This has created a veritable stampede of individual day traders into the markets, with mixed results.

Mixed results? I’ve been a trader in a professional capacity for a good portion of my life and have traded at both the retail and institutional level. The markets take some specific training to master, and common sense is not a quality I would use to describe market price action. At times, the market seems to move in ways that defy logic. That is why you need specific training to learn to stay away from bad trades.

There are many times that simply looking at the market and the price action occurring would lead you to a conclusion a certain outcome is inevitable. However, there are momentum oscillators and rate-of-change indicators that would show you that the move you are observing is simply “market noise” and not a good trading opportunity at all. You learn to look for specific set-ups that consistently produce profitable results. This skill is developed through training and experience. Still, many novice traders open a futures trading account and start trading without the proper education and the results are disastrous. It doesn’t have to be that way. You can be a very successful trader.

Learning to trade takes a steady hand and the ability to control your emotions. That, in itself, is no small feat, but emotions (specifically greed) are one of the toughest obstacles every trader must master. We are trained to look for specific set-ups, and taking trades that do not match the criterion we are looking for spell a losing trade. It also takes a good bit of time to acclimate yourself to the constant movement in the market as traders buy and sell.

The ES Emini contract trades well over a million contracts a day. That is a lot of traders buying and selling. Not all market price movement is indicative of a suitable entry to profit-you learn to discipline yourself to spot those specific instances when the market is primed to move in one direction and take a trade in that direction.

What has become very interesting is the wide range of individuals who now day trade for a living. I know housewives, lawyers, a doctor… a wide range of people have found this vocation resonates with their sense of work. And it has it’s advantages, too.

Day trading allow you to get your life back from the 9-5 grind of a regular job. I get to spend more time with my family and children, along with having time for some of the leisure pursuits I have always dreamed of doing. Trading is for everyone, but most people can be taught to trade with profitable results, and you only improve as you gain more and more experience. It doesn’t take a college degree or PHD in physics to trade, just a willingness to learn and follow specific directions. And really, is that so hard