Back when John Belushi and Dan Aykroyd were regulars on Saturday Night Live (SNL), a younger and wilder Steve Martin frequently joined that outrageous cast during guest-appearances. A relatively new face in comedy, Steve Martin fitted in perfectly. I remember some absolutely hilarious SNL moments from those days.
One particular skit that Steve Martin did stands out in my mind. It was called, ?How to be a millionaire and not pay taxes.? Standing all alone on stage wearing his trademark white suit and black tie, Steve Martin looked into the camera and carried on like a cheesy investment guru trying to rustle up clients with a ploy that went something like this:
?Yes, you too can be a millionaire and not pay taxes. How, you ask? First, get a million dollars. Then, when the IRS asks why you didn?t pay taxes, simply say, ?I forgot?.?
My retelling of the skit does not do it any justice but I think we can draw a correlation between the source of comedy from that skit and the way many people approach trading.
It?s safe to say that virtually all traders have the ambition, desire and drive to make money trading, even a million dollars. But like Steve Martin?s comedy sketch, the most crucial element is missing: HOW to make a million dollars trading?
No, I?m not going to promise that ?You, too, could make a million dollars trading and not pay taxes?. But I am going to share with you some very basic elements of trading that will help skew the chances for success in your favor.
At its very core, the art/science of trading can be broken down into three key components:
- A set of High Probability Indicators that generate High Probability Trades
- Consistent execution of your trades
- Successful management of those trades
High Probability Indicators (HPI?s)
HPIs are simply a set of indicators or chart formations (or a combination of the two) that, when they manifest in a predetermined way, allow you to predict, with a greater of accuracy than not, the direction of the market over some period of time or that the market will meet a particular price objective. A High Probability Indicator generates a High Probability Trade.
Most successful traders I know keep it simple and have two or three High Probability Indicators. I use three specific chart formations and have given each of them a name. For example, when I see a "tight range extension higher" (TRE-H) manifest itself on a daily bar chart, I can predict, with greater accuracy than not, that the market will take out that day?s low before it takes out that day?s high over the next several trading sessions. I build my High Probability Trade around that indicator and that set of assumptions. I determine my entry point, my stop-loss exit point, my profit exit point for one half of the position and then my profit exit point for the remainder of the position. It is with the remaining half of my profitable position where I employ less mechanical strategies and become more intuitive, relying on my 20 years of trading experience to maximize the profit potential of the trade.
Consistently execute your trades
If you have a set of two or three back-tested High Probability Indicators that have proven to predict price direction with a greater than 65% (70% + would be better) degree of accuracy, then the only thing left to do is execute those trades and manage them successfully. But this is where the system breaks down. This is where the emotional/mental side of trading derails a perfectly good trading system. Maybe a string of losses keeps you from pulling the lever when the next HPI manifests itself and you know the rest of the story. The trade moves in your direction then you either watch it achieve your price objective and then stew in remorse and anger because you missed out on the trade or, you chase it and get in too late skewing the risk/reward ratios against you. The position gets stopped out and the loss is exaggerated because you got in too late.
Successfully manage your trades
Perhaps you?ve got a winner on your hands where you are short multiple contracts. You think the position has ?home run? written all over it, but you can?t perfectly explain why. Your rules dictate that you get out of your position at a particular price point. Part of you wants to cover the full position to lock in a nice profit. The other part of you wants to let it all ride. Being obedient to your rules, you cover your full position at the prescribed level and sure enough, within two days, the market breaks hard. The market never rallied high enough to the point that your original buy stop would have been filled. You experience the frustration of ?I shoulda-woulda-coulda stayed short?.
So how can a trader who already has the first component of the trading equation (a set of proven High Probability Indicators) go about putting behind them the emotion that derails their ability to execute their trades? How can a trader successfully tap into their intuitive side to allow themself to maximize a position?s profits while also being prevented from jeopardizing their account?
One way is to SIMPLIFY the process.
When we follow a standardized process for trade execution, we help negate the impact that emotions can have on that process. And when we create a set of rules within which is a subset of rules that allow for less mechanical, more intuitive management of our trades, we can potentially realize additional profits from those intangible insights into market direction without over-exposing our account to risk. Here is how it works:
S ? Scan your charts for HPIs. Create a ?Watch List? to help manage your inventory of trading opportunities.
I ? Identify a high probability set up.
M ? Map out the trade?s entry point, stop-loss exit point, and profit exit point.
P ? Pull the trigger. By systematizing the process as we are talking about here, the anxiety associated with executing a trade is greatly reduced. Instead of focusing on whatever issues keep you from pulling the trigger, your focus is on following a procedure, a set of instructions. Mapping out and understanding exactly what our risk is also reduces the anxiety of entering a trade.
L ? Let the market do its thing. It?s not very often that you won?t have to take some heat on a trade. It?s a great feeling when a trade goes in your favor immediately and stays that way. But that?s the exception and not the rule. As a good friend of mine would say, ?Let it breathe!?
I ? Isolate your feelings, emotions, and inclinations to tinker with the trade. The best way to do this is let go of the mouse and pick up a pen. Journal your thoughts to explore and understand why you are wrestling with the urge to adjust your pre-established parameters for the trade.
F ? Focus on your rules for managing the trade both mechanically and intuitively. I have established strict rules for when I will allow myself to manage a trade intuitively. First, one-half of my position must meet my first profit target and be filled. If I feel the position has continued potential beyond that point, I allow myself to be risk no more than the profit banked from the first half of the trade. This is very important: when allowing myself to trade less mechanically, my risk never exceeds break-even on the entire trade.
Let me give you a recent example:
- Based upon a HPT that my HPIs generated, I sold 4 Canadian Dollar futures at 9530.
- I placed an order to buy 2 CAZ9 at 9455 OCO 9601 stop.
- I placed a separate order to buy 2 CAZ9 at 9601 stop.
- I was filled on my order to buy 2 at 9455 for a $1,500 gain.
- I left the stop in place on the remaining 2 contracts. I felt strongly that there was further downside potential, but could not point to any one of my three High Probability Indicators to support my feeling. My rules gave me permission to be flexible at this point since I had locked in some gains. I could risk up to break-even on the trade.
- After covering one half of my position, the market made it as high as 9569, which never really threatened my 9601 buy stop, and then fell sharply.
- I converted my buy stop at 9601 to a trailing stop and was filled at 9420 on the remaining 2 contracts for a profit of $2,200, which was 35 points better than my first exit point. By giving myself permission to be flexible and intuitive within a structured set of rules, I was able to pull an extra $700 dollars out of the trade.
Y ? You. That?s right. You. No matter how mechanical we try to make it, each trade carries with it some level of stress. So take some time for you. Walk away from your trading station after you?ve exited your trade, even if it?s only for a minute. Take a few deep breaths and allow the last trade to get put behind you and begin to prepare for the next.
Anyone who promises that you will make a million dollars trading should be taken with as much seriousness as Steve Martin doing stand-up comedy. But as we break the trading process down to its three core components of (1) a set of high probability trades, (2) the consistent execution of those trades and (3) successfully managing your trades, we can better see how to improve our profit potential. By adhering to a system for trade implementation, like SIMPLIFY, you can reduce trading anxiety while at the same time allow for flexibility in managing your trades, thereby allowing you the opportunity to developing and profit from your intuitive side.
Oh, and don?t forget to pay your taxes.
Bill Provenzano can be contacted at Upside Breakout