A polygraph machine drawing lines on graph paper.

Trading Intro

Our approach to trading - and what we believe is the best way to approach trading - is as a business. Just as building a successful business demands a disciplined, steady approach, so too does building a successful trading program.

Looking for excitement, 'rolling the dice' & trying to 'win the lottery' are NOT healthy approaches to trading and will usually end in financial ruin (even if there is some fun and excitement along the way).

Instead, a trader should take a steady and selective approach to trading.

This means:

  • Taking one's time when choosing and/or waiting on a trade (but acting with decisiveness & conviction once a decision has been made).
  • Trying to build an account one successful trade at a time and..
  • Being selective in the choice of trades.

A successful business usually grows one new product at a time. And no business tries to offer every product and take advantage of every deal and cater to everypotential customer's needs or desires.

Instead, the most successful businesses recognize their own strengths (and weaknesses) and stay focused on their target market.

A business that specializes in the construction of massive sports stadiums should not worry if the local custom-home builder is having a better quarter than they are. Construction demand is cyclical, sports stadiums are a specialty item and the payoff for one stadium contract can supersede many quarters - or years - of home building. And, the more homes in an area, the better the chances for a new stadium.

They need to remain focused on their strengths and do their best to ignore conflicting or contradicting influences... and the lure of fast-money somewhere else (the proverbial 'greener grass'). They may experience slow or ‘down' periods, but this is all part of a developing business... and a developing trading program.

In the same way, if you are most comfortable with trading the markets on a 1-4 week or 2-3 month basis, who cares if Joe X is scalping 12 ticks out of Bonds 3-4 times per week from his office overlooking the CBT trading floor. (And what you don't know is that he might be losing 30 ticks on the days that don't work out for him.) One profitable position trade can make up for missing 30--40 scalping opportunities... and involves a lot less stress and energy.

There will be days when you see a 20 tick rally followed by a 25 tick decline and then a 15 tick rebound in Bonds... and you swear to yourself that you saw it coming and could have grabbed at least 10 ticks out of each of these swings.

If that is not your trading style - and you have no intention of making it your style - then it DOES NOT MATTER 'what could have been'!!!

If you allow yourself to be distracted or seduced by that 'greener grass', you will always find yourself a day late and many dollars short, perpetually chasing the latest 'hot' market. (This principle applies to all aspects of life.) Remember:

Performance is Best Judged at the Finish Line!

Another important principle - that goes against common logic - is that the most successful trading programs often produce a higher number of losing trades versus winning trades. It is the size of each trade (large winners and small losers) - and the combined return - that matters.

Perhaps the best parallel to illustrate this is the one sometimes used when discussing trading: Baseball.

First and foremost, all the players in the Baseball Hall of Fame generated 'outs' (losses) 6-7 times out of every 10 at bats. A career .300 hitter only 'succeeded' (winning trades) on 3 out of every 10 plate appearances.

It is what he was able to accomplish with those 3 hits that makes all the difference in the world.

And, another key difference is that these hitters were able to squeeze out that extra 1 hit out of every 20 at bats. That is all that separates a mediocre, run-of-the-mill .250 hitter from a hall-of-fame bound .300 hitter... 1 extra hit out of every 20 at bats.

It is also what separates a successful and profitable trader from a break-even trader.

So, even though a trading system may take more losers than winners, it is critical to make sure you take advantage of every possible trade AND to get the most out of every winner. This is why I cringe when I hear someone carelessly throw around the highly deceptive adage:

"No one ever went broke taking a winner."

[See Axioms of Trading in Eric Hadik's Tech Tip Reference Library for a detailed explanation on why this adage is so dangerous.]

But, there is still one more important 'baseball' parallel to trading...

It has to do with those 3 times (out of every 10) that these players did get on base. In most cases, good hitters do not swing at the first pitch. They watch several pitches while getting a feel for that particular pitcher's style of pitching and also the objective that the pitcher and catcher have for that particular 'at bat'. Ultimately, this batter will probably swing at less than ½ of the pitches, often as little as 1-2 out of every 6-8 pitches.

When the player does decide to swing at a pitch, he tries to do it decisively and with conviction. (There are those times when he 'checks' his swing or takes a very 'defensive' swing when the initial 'look' of the pitch has fooled him. This, too, has its parallel in trading but is the exception and not the rule.)

Each market is similar in that reversals and signals (potential trades) are like pitches.

They are influenced by cycles ('when' the signals are being generated), just as pitches are often governed by 'when' the pitch is being delivered. Is this pitched being delivered:

  • With 2 outs or no outs
  • Before a dangerous home-run hitter or at the bottom of the batting order
  • During a period when the game is tied or when one team is 10 runs ahead of the other
  • When the pitcher is fresh - in the 2nd or 3rd inning - or when his speed and accuracy are beginning to falter in the 7th or 8th innings?

The same is true with potential trades ('pitches'). Are they developing:

  • As a new trend is just developing or after a long trend is showing signs of exhaustion?
  • In the beginning of a new cycle or at the culmination of an existing one?
  • With or against the underlying weekly or monthly trend? (In many cases, new daily trade signals are generated before the underlying weekly trend has completely reversed. This ushers in a couple different rules for confirmation.)

This helps determine some initial expectations, as well as perceived risk and potential reward. Although, just as in baseball, don't get so 'married' to one expectation that you fail to recognize when things have changed. Once a signal is taken and a trade is entered (swinging at a pitch), additional expectations can be built.

And, if the ball is in play when the hitter reaches first base - or a trade is still intact once the first objective is reached - other decisions need to be made (Try for second base or hold up on first? Tighten up trailing stops or take profits?).

I could take this analogy farther but I hope I have conveyed my point (and, believe it or not, I am not particularly obsessed with baseball so I don't want to lose you in this illustration)...

Successful Trading is a Steady & Selective Process that Requires
PatienceDecisiveness and Persistence.

If you are able to grasp and internalize this concept, you will be in a much better position to benefit from what we offer to our readers.

A sheet of paper lists several business transactions.

A Trading Perspective

The key to successful trading lies not in specific indicators, but rather in when, how, and where they are used. Indicators are nothing more than tools... and no single tool will accomplish every task you encounter.

You have probably encountered many approaches to trading and a plethora of indicators. Most innovations are nothing more than a twist on an old indicator. Many old indicators are also nothing new -- just a different way to describe a ubiquitous principle. This is why a master like W.D. Gann frequently quoted Solomon from almost 3,000 years prior: "There is nothing new under the sun."

True discovery usually lies in re-discovery. Many revolutionary discoveries are made by simply ‘tweek’-ing an old invention, or approaching a problem from a different angle. There is still a great deal to be learned from some of the oldest and best-known technical price patterns... like the key-reversal.

Key Point - The basic key reversal pattern.

Some readers may be convinced that a key-reversal is an over-rated and unreliable price pattern. In its original state, and by itself, this may be true. More likely, however, is that traders expect too much from this signal, have no means of filtering it, and do not understand when its application is complete.

This is what is explained in the following 3 examples of my Tech Tips. This is just one of nearly two dozen examples of how useless indicators have received a breath of new life into them or how over 25 years of trading and research spurred the development of new tools. But back to the example of key reversals…

key-reversal is any price tick which contains a new high (above the previous tick’s high) and lower close... or a new low and higher close (see illustration) [NOTE: For the purpose of the remaining discussion, a down-ward daily reversal from a prevailing uptrend -- a new daily high and lower close -- will be assumed in all examples. The principles discussed apply to all reversals, and all time frames, whether up or down.]

key-reversal is not intended to signal a major turning point. It only indicates that short-term momentum has changed. If it is not quickly confirmed, a key reversal becomes powerless! A key-reversal does reveal some important considerations. The fact that the prevailing trend initially followed through from the previous period (causing the new high or low), but then was able to reverse and close in the opposite direction -- says something significant about the prevailing sentiment.

The question is how long will this new sentiment dominate? This question begins to address the biggest problem that most traders have with indicators... overrating their effectiveness and applicability. The secret to consistent profits lies in knowing when to use (or when not to use) an indicator -- and for how long

Based on 25+ years of experience and observation, it has become obvious that most reversal patterns are only applicable for the next 1-3 periods.

If the pattern in question is a daily key reversal, it should have an impact for the ensuing 1-3 days... and no more. If the pattern is a weekly key reversal, it is applicable for the following 1-3 weeks... and no more.

This does not mean that the new trend (spurred by the key reversal) will terminate after three periods. Nor does it mean that a key reversal can not occur at a major top or bottom. What it does mean is that a secondary indicator must confirm by the end of that period -- in order to prolong the current move. If this occurs, then the new signal will spur an additional 1-3 periods of movement, or more.

Trading any given trend is like a road trip which begins in familiar territory with frequent stops and starts. As the trip (trend) progresses, the goal is to get to the freeway (main trend) and experience some ‘clear-sailing’. Ultimately, the freeway/main trend is exited and the stops and starts begin again until the final destiny (major top or bottom) is reached.

In the same way that a driver does not assume that every turn in city traffic is going to lead to clear sailing, a trader should not assume that every reversal is the final high or low. Only two (out of literally dozens, or even hundreds) can be THE top and THE bottom.

What does this mean? It should demonstrate how and where reversal patterns fit into an overall trading strategy... and into an overall trend. They are not indicators of the overall trend, whether or not it is a new or existing trend. They are indicative of very small trends within a larger period of consolidation. Eventually, one of these will place you on the on-ramp to a break-away move... but only one!

So, do not trade a key reversal (in any of the following forms) as if it is the main trend... and do not drive on city streets as if they are the freeway. Harsh monetary penalties are reserved for both of these infractions. With that groundwork laid, it is time to discuss the three most effective types of key reversals. They are:

  1. Double-Key Reversal
  2. Turn-Key Reversal
  3. 2-Close Reversal