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The Basics

Is there such thing has hybrid trading?

decisionPhilosophical question: If you trade partly in a mechanical fashion and partly in a discretionary fashion, are you really trading mechanically at all and not just discretionary?

I ask that question after re-reading an old article on the subject of hybrid trading, which is described as combining mechanical and discretionary approaches. The piece takes the view that mixing the two approaches can serve to counter the issues which each of them have individually.

In terms of the mechanical approach, the advantage is suggested to be that such systems provide very clear signals and thereby reduce the opportunity for psychological issues cropping up to derail our performance. On the negative side, however, sometimes mechanical signals can completely conflict with the market view we’ve developed. Whether that’s a bad thing is open to interpretation, though. 😉

The reported advantage of discretionary trading is that it allows us to trade in a way which may better account for current market situations. The short-coming, though, is that such an approach can be subject to psychological problems, as well as a simple lack of market understanding.

The article goes on to basically describe hybrid trading as being an approach in which the trader decides which signals provided by a mechanical system they will take and which they will ignore. Doesn’t this basically sound like a bad implementation of a mechanical system?

Personally, to my mind if there is any kind of discretionary element to the trading process, particularly with respect to entry and exit, then I consider it a discretionary approach overall. This does not mean there can’t be mechanical aspects, however. There certainly can.

In fact, many discretionary traders are mechanical in the way they approach things like position sizing and risk management. Setting trade account exposure at 1% is an example of this.

Stock traders often use filters to narrow down the number of companies to look at for consideration. That’s another example of a mechanical process in what can be a very discretionary overall approach.

So does having a mechanical element to your otherwise discretionary trader make you a hybrid trader? Or does it just make you more efficient?

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Reader Questions Answered

How can I stop abandoning my trades?

Here’s a question that I’m sure is on the minds of alot of new traders.

My concerns have to do with my actions. I have a well laid out game plan with very specific rules for entry, management and exits. Yet i abandon them in mid trade. This is my short coming. Either deep down i do not believe in my game plan and/or I can’t handle losses which is part of trading. Any insights on this matter would be greatly appreciated.

Naturally, I can’t make a really good judgement on a specific case without a lot more detail and knowing the trader. That said, however, I can perhaps provide a little guidance in diagnosing the problem.

Losses and trust definitely go hand-in-hand. The thing I would ask is what the pattern is regarding when trading plans get overridden. Is it about taking profits too quickly? Is it about jumping out of a trade at the first sign of it moving into the red – meaning not allowing it time to turn around?

If the fear of taking losses is driving one out of positions too quickly, then generally the best plan is to cut way back on position size. Trade as small as you possibly can. Make the potential losses your system would suffer be psychologically meaningless. By cutting the pain factor you should be able to focus just on execution much more effectively. As you gain the confidence to not mess around mid-trade, you can start increasing your trade size, gradually.

If it’s second-guessing your system that’s the problem then I would inquire how much testing you’ve done with it. Generally, the more testing you do, the more comfortable you’ll become with the system.

There’s also the possibility of over-analysis. Basically, that means reanalyzing the market once you’ve entered your trade – and changing your mind. This can be a major problem for traders who are always looking at the market. One way to avoid that is to walk away and only re-evaluate things based on certain criteria – time lapse, price level hit, etc.

These are just some immediate thought as to potential problem points.

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Reader Questions Answered

Including Slippage and Other Expenses in Your Trade Figuring

Here’s a type of technical question relating to determing your trade position size that I came across on one of the forums I visit regularly.

When figuring Position Sizing per trade does it really matter enough to add maybe 5 pips “for slippage” onto the total pips there are between the entry and initial stop loss when figuring the Position Sizing as opposed to not adding any for slippage.

When determining the risk you’re taking on a new trade (and you absolutely should do that first, before you deside how big a position you take) you should include every element of potential loss or cost. That means not only the points or pips or ticks you are risking on the trade, but also the commission, interest (carry or margin) that you could end up having to pay, and any slippage that is to be expected.

To answer specifically about adding some amount for slippage, that depends on the market you trade. Very active electronic markets tend to have little to no slippage on order execution. Ones that are thinner will have larger slippage. Experience will tell you how much is normally. It doesn’t hurt, though, to factor in something above average. Better to be more conservative.

When you’re doing system testing you want to be as conservative as possible. Much better to assume higher costs and larger slippage and be pleasantly surprised to achieve better than expected profits. Just don’t go overboard because you might end up ruling out a perfectly good system.

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Reader Questions Answered

Is the Turtle Trading System a Good One?

I addressed a question on LinkedIn the other day that I thought would be something of interest to folks here as well. The asker inquired:

I am trying to learn more about the ‘Turtle Trading system’ outlined in Micheal Covel’s book. Has anyone have experience with it? Is it easy to learn and follow?

The book to which this gentleman refers is The Complete TurtleTrader. It’s one which I did a review of a while back (Book Review: The Complete TurtleTrader). Actually, I think the Turtle system is presented in a better fashion in Way of the Turtle, the one written by Curtis Faith (Book Review: Way of the Turtle). Covel’s book is a good history, but Faith’s is a more indepth view of the Turtle way of trading.

To answer the basic question, though, while the Turtle system is easy to learn and follow, it is not one most traders can use. It requires a lot of capital to employ properly. In response to that, Gerry (the questioner) asked:

Are there better trading systems out there? Also, does your book go into the steps of setting up a trading system for a small investor?

My response to that is better, of course, is a relative judgement. What is great for me might be awful for you. What may work well for large portfolios, may work poorly for small ones, and vice versa. If you don’t have the capital to trade the Turtle system as designed, then yes, there are better ones for you out there.

As for my book (The Essentials of Trading), it does indeed talk about trading systems. There are three chapters talking about developing, testing, and comparing them.

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Deep Posts Trading Tips

Making Money While Being Wrong Most of the Time

Last week was pretty poor by the standards of the year so far. Among the trading strategies I outlined for the readers of the service I write for during the day I advised ten specific trades – about two per day. I only made money on three of them – a 30% win rate (I’m normally closer to 60%).

You know what, though? It was still a profitable week – up 9 points ($450 on the mini S&P futures trading a single contract).

I bring this up to make a point. Traders, especially new ones, have a tendency to think that you can’t be profitable with a low win rate. That’s not true, as my example demonstrates. In this instance my winners were twice as big as my losers. Taking good trades and maintaining disciplined risk control are to be credited for my finishing the week in the black instead of the red.

The other thing too is not getting caught up on the whole right/wrong thing. Profitable trading is not about being right. It’s about making good trades. Sometimes those trades aren’t going to workout, and sometimes that happens in bunches. If you keep taking good trades, though, things will work out in the long run.

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The Basics

What is Scalping?

If you spend much time in trading circles you will almost certainly come across the term scalping. So what exactly is that? According to the Trade2Win Traderpedia, scalping is:

The term used for a day trade method where trades are opened and close within a very short time scale, perhaps anything from a second or two to a few minutes.

Basically, scalping means dipping in and out of the market quickly, going after very small gains, but very frequently. This type of trading methodology requires a very intense focus on the price action in order to identify the little price patterns which indicate scalping opportunities. This is an entirely technical approach where the trader focuses 100% on price (and possibly volume).

Scalpers have the advantage of high win rates, though obviously each win is for only a small amount. Because they are in and out so rapidly, their exposure and risk is generally very limited. A scalper is unlikely to ever take a large loss (though they can take many small ones). Also, scalpers generally have very rapid learning curves because of the amount of time they spend watching the markets intently. One scalping trader can make as many trades in a day as other traders make in weeks or months.

If all this sounds intriguing to you, hang on before you jump in with two feet. First, as noted, scalping requires very intense and direct focus. Because of the speed of entry and exit, it also requires very high end technology and data. That makes it more costly in terms of resources and infrastructure than longer-term timeframes.

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The Basics

Tight Stops Make Me Nervous

Any time I see someone comment on a blog or in a forum, or hear someone say, that they use tight stops and/or recommend doing so I get nervous. Of course “tight” is a relative and nebulous term, but the implication to me is very close to their trade entry price. That’s what puts me on edge.

You might be wondering why. It’s for a good reason, I assure you. 🙂

Unfortunately, many traders (especially new ones) equate tight stops to low risk. That would seem to make sense, right? If my stop is close to my entry point I stand to lose less money if the market goes against me. That sounds like a good thing.

Here’s the rub. The closer you put your stop to where the current market price is, the more likely that stop is to get hit. Put it too close and you are almost guaranteed to get stopped out due to normal market volatility.

Your risk is a combination of the expectancy of the trade and how large it is. When you move your stop closer to the market you lower the expectancy of your trade. If you do it repeatedly, you basically assure yourself of not seeing the type of performance you expect to see from your trading system/method.

Of course it’s all a trade-off. You need to identify the stop level which is at the point where normal volatility during your proposed holding period isn’t likely to trigger your stop, but not so far away that you lose unnecessary points on a position that’s clearly going against you. That’s why it’s important that you keep that term “volatility” in mind. It’s the key to all this. Fixed stops will almost never be the best solution because volatility changes over time. As such the placement of your stops relative to where you enter a trade will necessarily vary.

So when you hear someone talk about tight stops or see them talked about on a forum be aware of all this. In some cases the speaker/writer won’t really be putting their stops too close – they just use the term. In other cases they do. Try to find out which one is true.