People who want to profit from the market often ask experienced traders how they come up with their trading strategies. Newcomers are often overwhelmed by the amount of available data and are a bit mystified about how to navigate through it. But, even more often, they want to know how to develop a strategy that works consistently, and they expect to find ?secrets? that brings them a stable profit. As I tell them, however, there is no crystal ball, no magical insight to be had on the market. Instead, I like to share with them three proven rules and habits that allow me to test my strategies and determine which to continue using.
My three rules are actually quite simple:
1.Learn to identify the direction of the market and follow it; that means that you buy when the market is going up and sell when the market is going down.
2.Always know when to exit a trade; specifically, remember to always place a stop loss and a profit target after entering a trade.
3.If you are using a trend-following strategy, find a trending market.
For the first rule, there are, of course, many ways to identify the direction of the market. You can use chart pattern recognition like Trend Lines, Head-and-Shoulder Formations, Flags, Pennants and so on. Other chart pattern techniques include candlestick formations like Hammers, Dojis, Dark Cloud Covers (quite an interesting name), Morning and Evening Stars and others. You can also use indicators like Moving Averages, Parabolics, MACD, Bollinger Bands and many others.
All these tools are designed to help you to identify the direction of the market, but none of them is ?best.? They all serve slightly different purposes, and individual traders need to research them to know which is right for their own style and goals. However, once you feel confident that you've found a tool which gives you the direction of the market, you should simply follow it. Jesse Livermore said something more than 100 years ago which still applies today: ?Successful traders always follow the line of least resistance. Follow the trend. The trend is your friend.?
The second rule is also straightforward: as soon as you are in a trade, place a stop loss order and a profit target. Make sure that your profit target is larger than your stop loss, because then you will make money even if you just achieve a 50% winning percentage. You should even be able to do better. Setting these markers and sticking to them is key to ensuring that you don't let your emotions get in the way of your preparation. Know when to accept a reasonable profit and when to cut your losses. Otherwise, you're simply gambling and depending on luck, not a system that you can evaluate and depend on.
Third and finally, watch multiple markets and look for one that is trending. Not every market will always be profitable. Besides, it is trends, not markets, that make money for traders. For example, if the e-minis are not moving, check the currencies, or the grains, or oil, or gold. These days we have more electronic markets and tools than ever, and you shouldn't have a problem finding a trending market.
Following those three rules should allow you test, clarify, and revise almost any strategy you come across or develop on your own. The most important thing to remember about all three rules is that they help you determine whether a strategy is consistently profitable. As long as you are making more than you are losing, you have a successful strategy, and following these three rules will help you stay focused on that outcome.
There's nothing magic about finding a successful strategy. Many people like to make it sound more complicated than it actually is, and some newcomers have trouble accepting that it can be so simple, but it is. The key to trading success is to keep it simple.
Many of the more common commodity trading strategies actually serve two purposes. The turn of a profit is but one. A hedge is the other purpose. Hedging is a method of minimizing risks by attempting to purchase some form of insurance. As well as minimizing risks, it also usually caps potential profits. One of the strategies to accomplish this is known as the spread.
The majority of the commodities trades do not involve trading the commodity directly, but more in buying or selling a futures contract. "Going long" and "going short" are two of the most basic strategies
To go long means to purchase a futures contract while anticipating that the price will rise before the contract expires. Futures contracts are very similar to stocks or options because vary rarely do the traders or specialists have any actual contact or participation with trading the commodity itself.
Conversely, to go short means to sell the contract while anticipating that the price will drop before the contract expires. Many novices are often perplexed by this strategy. The have trouble wrapping their mind around the concept that the contract is sold by the trader before they even own it.
While the notion may be confusing, the practice is quite simple. While the technicalities remain unseen by the traders, the inner workings are rather simple. The contract is borrowed and the one is bought to make of the shortfall later.
An illustration of this concept is as follows: Trader X sells a futures contract in May for September wheat for $6.00 per bushel. The contract will be written for a minimum amount, which is typically around 5,000 bushels. The price falls in August to $5.40 per bushel. This will yield a profit of 60 cents on each bushel, which equals $3,000, excluding commission. The profits and losses for these ventures are settled daily for trading accounts and the broker balances the books by buying a contract of the same type on the trader's behalf with the trader's money.
Effective trading strategies are a combination or different types and lengths of contracts. Throwing in some form of spread is one of the simplest. There are a number of varieties that can be executed, but a simpler approach is sometimes the best move.
An example of this more simple approach is illustrated in this hypothetical situation. In May, the price for a July wheat contract is $5.90 per bushel and for a September contract the price is $6.00 per bushel. By predicting the spread between these two and by anticipating changes before July to greater than 10 cents - and to be correct in that prediction could yield a profit by selling the July and purchasing the September. By shorting July and going long in September, you do profit.
This profit is incurred by watching carefully the behavior of the contracts and acting accordingly. In June, the July contract may have risen to $6.00 per bushel and the September to $6.25 per bushel. By liquidating both positions, in other words, settling both contracts, this results in a 10 cent loss on the July contract, but a gain of 25 cents on the September contract. This means a 15 cent profit per bushel. A small commission will be incurred on the turn around, but it is minute. On a contract that covers 5,000 bushels, this means a net gain of $750.
While a larger gain would have resulted had July not been shorted, but all trading carries risks and it is impossible to predict the future, especially in the stock market, with any degree of certainly. Hence, the term, speculation is used to refer to these activities.
There is an element of rationale for betting against yourself by shorting and by going long at once allows the trader to hedge their best on whichever direction they expect the market to take. Utilization of this spread strategy as well as with many other variations does succeed in capping the potential for profit. However, it does work to minimize downside losses as well.
Both Rockwelltrading@gmail.com & Amar Mahallati are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.
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