TIMING THE TRADE
Timing a trade is a crucial factor in making money that many people do not take as seriously as they should. I have found that when I take the time to time my trades, I can turn many trades that would have been losers into winners, small winners into large winners, and not make a few trades that would have ended up as big losers. Yes, I have missed moves, but Ive learn to say, So what? and move on, as I believe that I have made or saved much more money in the long run with the ones that I got a better price on or ignored. The reason for my love of using multiple times frames to get into and out of trades is that they not only help me to get the big picture but more importantly they help me time my trades.
In my trade, though I knew I wanted to go short, it took three days after getting my initial alert that I went short at 12,712. Thats a long wait for many people, but it paid off. Even if I lose money on the trade, I at least got it at a better price, at least 100 points better. I didnt have to endure a 300-point move against me and a safe stop was closer.
Being that I was 1,500 points late getting into the down move, I had to find a safe way to get in. I did so by thinking of my entry as a day-trade. I choose to use my ever popular 30-minute-after-the-open breakout system. Ill go more into that in a short while. By doing so, I got short when the market broke below the range it established in the first 30 minutes of trading. If I was wrong, Id get out at the top of that range. Risking about 100 points, however, I actually gave it a bit more room in case it decided to close the gap (see Figure 11.3). I ended up timing this trade as I would a day-trade, and I would get out as a day trade if I was wrong. However, if I was correct, I was in for the long haul. Because I was able to time the trade as I did, I was able make a low-risk high-potential trade.
LOOK FOR PATTERNS WITHIN THE LONG -TERM TRADE
When looking to establish an entry, I like to first look for the long-term direction of the market and then I try to find a shorter term tradable pattern within that longer time frame. This could be in either the same time frame you are looking at or a shorter time frame. The reason for doing this is as I mentioned above to time a trade and reduce risk. I just showed how I used a 30-minute breakout system on a 5-minute chart to time an entry into a longer term trade. I needed to get into the market and I need a way to do so with as little risk as possible. This was just a pattern I was looking at in order to time my trade better. I could have chosen another pattern as well. I could maybe have gotten in after the break of Trend Line A on the open, with a stop at the high of the move the day before. But there was more risk involved if I did that as the stop would have been about 200 points away.
Here are a couple more examples of finding patterns within patterns.
The grains have been on a tear the last year and a half. They have reached all-time highs, due in part to strong demand from China, alternate use of them in making ethanol gas, and a very weak dollar. Look at the weekly soybeans chart, Figure 11.4, and you can see the steep upward move. If you had missed the move and wanted to get in much later what can you do? The only way to trade this, assuming you are going to go with the trend, is to wait for a pullback and then find a smaller pattern within that big uptrend to get in with. You may think its too late to get into the trade, but the thing keeps going higher and higher as people are still driving it up. One thing I took away from reading Reminiscences of a Stock Operator by Edwin Lef `evre is just because a market is too high doesnt mean it
cannot go higher.
At the first set of ovals there is a pattern I like to trade. Its very simple. I look for a retracement in the uptrend and then wait for the stochastics indicator to cross over the oversold line. I know Im wrong if either the stochastics goes back into the oversold area or the market takes out the lows it made when the stochastics bottomed out. I can also look at the pattern in the second set of ovals. Where the market tried to go lower and couldnt, as soon as the stochastics cross back up, I would go long. Now the trade Im looking at has not happened yet. Im waiting for it and what Im waiting for is for this current dip to repeat one of these two patterns; when it does I will get in. It takes me all of one minute a day to see if the market is close to fulfilling one of these scenarios. I had been looking at a continuous chart of soybeans for the big picture, but I would use the current most active month to actually time and make a trade.
The next step is to take it down to a smaller level, to either time a better entry or to day-trade. Im going to use the active front month for this part of my analysis. Ill use the 60-minute (Figure 11.6) and the 5-minute (Figure 11.7) charts to see these patterns clearly. The 60-minute chart is just to show the strength of the uptrend and to spot areas of retracement. The points A and B correspond to the patterns and entry points in the 5-minute chart.
For the first pattern you would need to be watching carefully to get in as it happened at the end of the day. The market gapped lower, traded down toward the moving average on the 60-minute chart, then rallied to close the gap and tried to sell off again. The second sell-off wasnt as strong as the first and had formed and broken Trend Line A, indicating the sell-off had failed. As soon as that trend line gets broken, you have a buying opportunity. You can also confirm this with the crossover of the stochastics. Now this happens in the last five minutes of trading so it would be more of an overnight trade than a day-trade. As you can see, the next day the market exploded. This is a great example of how using two different time frames you can see different patterns that will signal a terrific trading opportunity. Your stop could be the days low and your target would depend on your holding time. But using the longer time frames you can easily find good targets to shoot for.
In the second example, the bull market is still the same, but the pattern I see is a little different. We still have the market selling off and forming Trend Line B, but this time I see a double bottom and a divergence between the lows of that double bottom and that of the stochastics, indicating the last move down was not as strong as it looked. As soon as that trend line gets broken, you have another entry level with a small stop loss just under the double bottom.
These types of trades are the best you can make in a strongly trending market. Just look for any sell-off and then find a pattern that you can use to get into the market that has a low risk area. By finding these low risk entries in the direction of the major trend, you are giving yourself a better chance of making money.
KNOWING THE RISK
This leads me to the point that the entry is only as good as the risk. Entering into a trade and leaving yourself at risk for too much is not a good trading decision. Win or lose, if you are exposing yourself for more than you can handle you will probably end up getting hurt in long run. You must know the risk you are going to take before you get in. As you are thinking through a trade, think risk first and then profit, and only then should you concentrate on getting in if the risk/reward ratio is worth it. All your planning and making of scenarios is what will help you establish the risk. Money management is what all good traders have in common and money management cannot occur if you are unaware of the risks. This may sound obvious to you but in my days as a broker I noticed many an amateur trader not give risk its due consideration. The bottom line is that knowing your risk will help in evaluating a trade more than anything else I can think of.
DECIDING HOW MUCH TO TRADE
Not only do you have to know your risk and where you are getting in but you have to know how many contracts you will be trading. Not every trade and not every market is the same. There are times when you can be more aggressive and other times when you may want to trade lighter than normal. Ill go over this more in the money management chapter later in the book. For now, Ill say that position size cannot be done properly if you do not know the risk and the potential of the trade working. If a trade has a great setup and a small risk I may consider putting on more than my typical size trade. The key is getting out if Im wrong. Its also at this stage where you need to decide if you will be adding to the trade and by how much at any set levels or patterns. Dont just add to a trade because you are making money. If you are going to add to a trade it should be as well thought-out as your initial trade was, as in reality its a whole new trade.
The last thing I can think of is that the entry of the trade is like giving birth. The planning of the baby came way before he entered the world. Okay, not every baby is planned and some are the result of a lot of alcohol, but lets ignore those. Pregnancy is a nightmare or at least living with a pregnant woman can be. And labor is no joy, especially if your wife is doing it naturally and squeezing your hand till your fingers turn blue. Before the baby is born youre thinking, Oh my, $140,000 for college, but on the other hand you say, At least now there is someone to take care of me when Im old and pooping my own pants; its a good risk/reward ratio. But after the baby is born, now that is when the hard work actually begins. All the monitoring and worrying whether hell get into the right preschool and having to come up with scenarios if he doesnt. Well thats just like putting on a trade. Just because the trade is on, doesnt mean you can relax. You need to monitor that trade just like you would your firstborn, constantly checking it and asking, What will I do if his fever gets to be 104?, or We are going out for 4 hours, is 25 diapers enough?, or is 2 gallons of sun block enough for his face? and so on. Its not till the baby goes off to college when you can relax, just like the only time you should relax when you have a trade on is when you exit it.