Profitability – Moving Beyond Basics
“If you want to trade like the best, you need to think like the best.”
Trading is a zero sum game. There is always a winner and there is always a loser. All traders, both successful and unsuccessful, have the same goal: to consistently harvest profits from the market. In order to do this, traders need to overcome numerous obstacles, learn countless lessons, and if they want to become “super traders,” discover the ultimate trading secret. What is the “Ultimate Trading Secret”? The answer is quite simple: trading wizardly does not exist. If you really want to be successful as a trader, you must have the following basics:
- Establish a quality trading plan. Your plan should be very detailed, including daily, weekly, monthly, and annual profit objectives. Make sure to include detailed areas for execution criteria and risk management strategies, as these are areas critical to your success. Establish short, medium, and long-term trading strategies. Successful traders know how to react to any market developments.
- Find a top quality trading platform. Speed and execution are essential. Ideally, your broker will have a variety of platforms you can evaluate. Remember, even the best platform can’t make a bad trading strategy work. If you’re losing money, analyze your approach before blaming the platform.
- Work with a good trading strategist, not just a broker. This model is followed by all successful institutions and hedge funds. The structure is direct. Researchers and strategists find opportunities and develop strategies to exploit them; the trading division then executes the strategy. This system works for several large, well-known organizations. If you want to duplicate their results, you need to follow their structure.
- Give up on quick fixes. You need to be 100% prepared to roll up your sleeves and learn the markets from the ground up in order to succeed day after day, trade after trade. Software can be a great tool, but it should never be the only tool in your toolbox. Fear and greed have no place in trading - it’s funny how expensive those “low commission/zero commission” brokers can be.
Moving Beyond Basics
To help position traders protect their accounts and become more profitable, CFTI focuses on highly refined futures and options combination strategies. One of the first things you need to do if you are serious about long-term profitability is learn how to properly incorporate options into your trading strategy. Simply put - if you are not employing proper option strategies, you are literally throwing away thousands of dollars in profits each year.
There are three basic truths about options:
- Exclusively buying options all the time is a guaranteed way to lose money.
- Selling options as a stand-alone strategy, while statistically sound, will likely invert your account after a string of ten winning trades. When you sell naked options, the profits you make will eventually be given back (with interest) on trades where, for one or two days, your guard is down.
- When used in combination with futures or spot currencies, options can be the most powerful tool you can incorporate into your trading. Properly used, you can enhance returns, minimize risk, turn losing trades into winning trades, and even lock in profits at the start of a trade.
Locked-in Profits Combining Options & Futures
This strategy is designed to take advantage of the inefficiencies inherent to some markets. The following example uses crude oil, but these opportunities can be found in several different futures markets, as well as the Spot FX market. A strategy like this requires specific market conditions before it can be executed. The trade below was issued by CFTI in early November 2005. By simply taking the time to learn how to apply real-world option strategies, traders would have been able to take advantage of a trade where the profit was locked in upon entry.
- From the CFTI Strategy Page, November 1, 2005 the following trade was issued:
Buy November crude oil @ $65.50 per barrel
Sell (write) November crude oil 65.50 call @ $2750
Buy November crude oil 65.50 put @ $2400
Days to expiry: 20
Net cost: Credit of $350*
Margin required: $2500
On November 20, 2005, the expiration date, crude oil closed at $61.03. The November 1 position expired with a net profit of $350.
*This represents a 14% gain in 20 calendar days. All profits were fully locked in upon successful execution.
The easiest way to understand this strategy is to picture the trade being executed at no cost. If that were the case, at expiry the intrinsic value of the put would offset the decline in the long position, and the call would expire worthless. The net result would be zero, no loss, no gain. The above trade was actually executed with a net credit of $350, which was yours to keep, regardless of the direction in which the market moved.
This trade would have been impossible to structure without the proper use of options. Options are meant to enhance profits and hedge against loss. If you understand how options work, you’ll see that this position hadno risk, once it was executed properly. This type of trading should be on every trader’s radar and executed as often as possible. Opportunities like this are not uncommon, but you need to know how to properly structure the trade. These opportunities tend to occur in volatile markets and in the spot FX market more frequently than in calm markets. Floor brokers and institutions keep a close watch for these types of trades.
Under the right conditions, options can be combined with futures or spot currencies for short-term plays and day trading, while keeping the door open for larger profits.
Short-term strategies – Enter the Retracement Matrix
CFTI ’s mission is to educate, not sugarcoat the truth. Successful day trading is the goal of over 70% of the trading population. It also has the highest casualty rate among all styles of trading. If 100 “well trained” people start trading on January 1, by March 1, only 40 will still have any trading capital. By June 1, that number will dwindle to about 15, and by December 31 only 3-7 people would be left still trading. The rest would have lost too much money and been forced out of the market. This statistic would have held true regardless of books read, software purchased, or training courses taken. The remaining, successful traders would have developed a structured, adaptable, forward-looking trading methodology. In all likelihood, none of them would have set the bar for the top earner in the group on any given day or week; instead, they would have focused on consistent profits. “Consistent profits” – two key words, which placed together, represent the art of successful trading.
Day trading losses can generally be boiled down to the following reasons:
Over-trading is a major account killer. CFTI recommends clients limit themselves to a maximum of 2 trades per day.
Not taking profits is a sure way to erode your confidence over the long term. Nothing makes you second-guess yourself more than watching a $400 profit slip away and become a $600 loss. The cure for this is having a profit objective and properly combining them with trailing stops.
Poorly placed stops are also guilty of draining accounts. Placing stops for short-term trading is challenging. To help its clients, CFTI has devised a predictive algorithm to calculate stops, short entries, long entries, and exits.
Following too many markets is another common mistake made when day trading. CFTI suggests tracking two or three markets and learning them as intimately as possible. Simply being familiar with a market increases your chances of success significantly.
Laziness and an overall lack of knowledge are other reasons day traders lose. Too many traders place their hopes, and money, on rear facing technical indicators, subjective chart patterns and gut feel. Long-term success can only come from an effective, consistent approach taking into consideration the fact that people, not computers, make trading decisions. Learn the markets, follow an effective approach to trading, and structure your trading as successful traders do.
The Answer — Retracement Matrix Trading
Before explaining “Retracement Matrix Trading,” I like to tell people about my first currency trade in 1996.
I have always been a diligent researcher, and having had some success with trading crude oil and natural gas, I decided to move my focus to currency futures. I chose to trade the Deutschemark, opened an account with $10,000, and bought a very expensive piece of software. I also studied charts, and learned everything I could about the German economy. After two weeks of analysis and research, I entered the market at 0.5646 at 8:47 a.m. At 8:57a.m., ten minutes later, I was down $8,000, and I finally leaped out of the market crystallizing my loss, completely destroying my confidence as a trader. I was shattered. For years I had been playing seasonal patterns in the energy markets and made money. Now, in one trade over two months profits were gone. I added more money and lost it. Eventually I threw in the towel. I was finished with funding someone else’s account. I decided to learn from a friend who was a successful trader in New York. What I learned from him changed my views on the market. I started to view trading in a different light. He taught me how fund managers, institutional traders, and floor brokers view and trade the market. I learned the great, open secret to trading – if I wanted to have the same success as a top fund manager, I needed to view and trade the market like a top fund manager. I needed a solid, dynamic, forward-looking system. I needed to focus on consistent returns.
Doing some quick calculations tells us that there are about 235 trading days in the year, including a 2-week break and 10 holidays. Assuming you trade on only 210 days, and you are able to average $85 per day in net profit on a $5000 account, (about 1.7% daily), at the end of that 42 week period, your account would have grown to $22,850 with a net profit of $17,850. By focusing on consistency, you would have a net return of 357% for the year.
The Retracement Matrix is an excellent tool used by CFTI clients to simplify the trading process and contribute to more consistently profitable trades. This method has been developed by CFTI to generate entries, stop losses, and daily profit objectives. By using a predictive algorithm, the Retracement Matrix generates key pivot, support, and resistance points.
The chart below shows how the Retracement Matrix is used to generate entries, profit targets, and stop losses. (The Retracement Matrix is inside the red and green boxes.)
Retracement Matrix Trading February 22, 2006 – Target $180 per contract
Click image to enlarge.
One of the benefits of Retracement Matrix Trading is the minimal time commitment involved. Most trades last between 15 and 45 minutes in the morning. These trades can be executed with accounts as small as $5000 and have a high probability of success. Notice that each “Scalp Target” on the chart above represents a profit objective of about $200. One important note about the performance of Retracement Matrix Trading – from January 4, 2005 to February 17, 2006, over 70% of the day trade signals resulted in profitable trades.
If trading were easy, wealthy traders would be commonplace. As a serious trader with an eye on measurable success, you must be prepared to invest the time, money, and effort to successfully navigate the markets. While it may be fun, re-inventing the wheel will not boost your account. The groundwork has been laid. All you need to do is follow in the footsteps of successful traders and use the tools available.