Update - It's Been a While

I haven't made any updates or posts for the entire month of June and for this I apologize to readers, it's a bit unprofessional on my behalf. Rest assured however, it's not because I blew out my account, but rather, it's because this is somewhat harder than I anticipated.

As of my last update on June 1st, I had been trading for the entire month of May and by the end I felt very mentally fatigued. It's a bit hard to put into words, but overall I just felt a bit stressed and my mind was cloudy and lethargic. I could feel the changes without a doubt. I no longer had that ambition and anticipation of opening up charts every morning at 7 am and being immersed in stocks and finance as I did when starting. In actuality, I felt a bit of an aversion and general apprehension to trading in general and did not look forward to continuing to do it. I think the best word to describe is that it felt a bit like nausea. I've read what happens to others when they don't stop ahead of time - they go on benders, throw precaution to the wind and ramp up the risk, and blow out. That isn't going to be me.

Rather than risk taking decisions with clouded judgement and give back what I earned, I decided to take a break and focus on other things. Don't get me wrong, while I still have a huge passion for this, I needed an outlet to pour my energy into other than this. In the mean time, I've been putting more emphasis on getting back in to shape, seeing friends, learning to cook, reading, teaching  my self a programming language (PHP) and overall doing things to keep busy. I also got a full time job in the mean time starting in July that kind of fell into my lap and I could not pass it up. 

Someone could ask, why stop when on a good run? I believe the answer to be that if I can successfully do this once, I will be able to replicate the results in the future as well - assuming everything that has occurred was not based on luck alone. I do not believe it was based on luck alone, and I put as much proof as possible along the way to reflect this. 

This was also the goal I made at the beginning of this experiment - to see if I could do this. The results say that I do have an ability to make positive expectancy on my returns that isn't based on luck alone, but perhaps I don't have the necessary mental faculties or solutions to deal with the stress. I know that word (stress) is thrown around these days a bit too much, but it best describes the situation.

This, I think was the best case scenario, better than I could have hoped for or foreseen - get a chance to run my experiment and also get valuable work experience before school starts up again, and for that I am beyond grateful for. I got trading experience, learned a lot about myself along the way, earned some nice spending money and also get a chance to work and earn work experience as well.

A warm thank you goes out to everyone that has followed me or read any of my entries. You have helped keep me accountable and ensured I did not take dumb risks as you were in the back of my mind when it came to taking decisions.

(Below is my final account amount as of June 27, I started with $13,997 on May 1st).

Live long and prosper,
PontusTrade

Stats II - Reviewing the Paper Trade Strategy

For the past several weeks I've been testing a new trading strategy alongside my live trades. The goal has been to optimize the amount of risk per dollar earned using the least amount of capital possible. One requirement is the management of losing trades. This means exiting losing trades quickly in order to ensure not too much of the profits are chewed up in bad trades. There are two ways I cut out losers. The first is stop loss based, which requires exiting the trade when it appears that the probability of it going back in your favour is less than the probability it will continue losing. Follow along by grabbing the excel file from here 

The probability is derived from the likelihood of price moving in a certain direction based on experience or screen time of seeing similar price patterns and technical analysis (patterns, volume, indicators etc.). The other method is time based, wherein if the trade fluctuates between profit and loss for a few minutes or so but is not going in any direction, then I cut the trade. I prefer waiting to re-enter when price moves in my direction than having capital tied up in a position that's not moving anywhere yet.

Reviewing the Results

I started on May 11 and traded 14 days out of 22 possible days in May and skipped two market sessions. There were 108 winning trades, 29 losing, and 2 scratch trades (return of $0). The average losing trade lost $15.96 (median of $11) while the average winner returned $21.83 (median of $16). Anything where the average winner is greater than the average loser is good to see and in this case, about $5 more profit is earned than is lost per trade. Furthermore, the median profits and losses are both more than half as much as the average, which implies the winning and losing trades tend to gravitate to the average. The win rate is 79.14% but it might be biased since there are only 139 trials - as such I expect it to go lower in the future.

The average amount of capital risked per winner is $4,551.76 and per loser $4,071.41. This means that on an average, I tend to risk about 10% more capital on winning positions than I do on losing positions. This is an important observation because risk is almost entirely decided upon before entering the position or in other words I cannot know beforehand the correct amount to risk until after the trade is completed. One explanation is that there is an inherent bias in my method that tends to risk more on winners before they happen however the other explanation is randomness. What I mean by randomness is since there are only 29 losing trades but 108 winning trades, this discrepancy could be explained by a lack of samples. Either the method has an advantage in allocating more risk on winning positions before they happen (without hindsight) or this occurs due to randomness and should fall over time as more losing trades occur. None the less, I am more inclined to conclude that the method is good enough that randomness does not explain the results.

Next is the total gains, less the total losses and commissions which come to a net profit of $1526.30 or an average daily profit of $109.02 for the 14 days. The projected daily profit multiplied by 22 days comes out for a monthly return of $2,398.47 or an hourly wage equivalent of $13.63 assuming a typical office hours of 7 and half hours. For the amount of effort and uncertainty, it appears as though the return is too little to be worth the trouble. However, if the model is shown to be successful for the current level of risk, then theoretically one can increase the risk while maintaining as best as possible the present returns of the model. That $13.63 becomes $27.26 when doubling the risk and now it becomes very worthwhile. If we assume that the statistical returns suffer a 10% degradation when risk is doubled, then it is still worth it.

A reasonable question is why not just quadruple risk right now. The answer is in two parts. First, the transition from the current risk parameters to the next phase (doubling the current risk) must be as smooth as possible for the trader and as a result, the transition cannot be instantaneous. A problem arises in the psychological mindset of the trader because of the effect that money has. Doubling of risk now means that instead of losing an average of $15.96 per losing trade, the average loser will now increase to $31.92. It may not seem significant, however can we reasonably assume that the trader can still perform with the same results while experiencing larger draw downs? What if the trader doubles risk (capital or amount of shares) and now has a doubling in draw downs but only experiences one and a half times the present return? The model degrades as the losing trades now absorb more of the profits than previously.

Consider if I were given a million dollars to take risk with and perform the same results. I'm more than certain that the same results could not be replicated because I am not accommodated or psychologically prepared to deal with draw downs of tens of thousands of dollars which at my current risk level may only represent $15, an amount I am comfortable with losing. What I am advocating is that if the model works with the current risk employed then it should be possible to slowly increase risk while maintaining the same statistical advantage. It may take a year to get to a point where risk can be doubled and have the same results, and maybe another year or two to triple the current risk and have the same level of returns. A tripling represents $40.89 equivalent wage per hour. Easier said than done, but it is none the less a reasonable expectation. The biggest problem is that while risk may increase exponentially, profits per amount risked may only increase linearly.

Correlations and Standard Deviation

Below are lines of best fit for the amount of capital used (risk) per winning trades and losing trades. For winning trades, the majority of returns are distributed towards the lower range. In fact, 85 out of 108 winning trades have a return between $0 to $30 and 92 of the 108 or 85.2% of winning trades used $6000 in capital or less. The correlation between capital used and return for winners is 0.167 meaning that the amount of capital used and the return per capital has no correlation at all. Using more capital or taking on more risk does not seem to suggest greater returns.

One explanation could be that as more risk is taken, confidence in holding the position erodes and as a result I tend to exit prematurely. The key to success is emotional control and discipline which can only occur when the amount risked does not breach a comfort level. Taking on more risk than one is comfortable with can affect logical decision making processes and cause mismanagement of trades. Whether or not that is enough to explain these observations is difficult to ascertain as I would need to track the average amount of time a trade is held. Overall, what this shows is that I need to push my advantage and focus on the strengths. That is  lots of smaller returns but with a high probability of occurring and not risking more than $6000 of my capital at any one time. One final observation. Take a look at the outliers for returns less than $40 (above the grey box) which seem to suggest "scared money" where the returns do not justify the amount of risk undertaken.

The correlation for losing trades comes up to 0.51 which is good enough to suggest that more risk means higher losses. From the previous graph we concluded that more risk does not guarantee higher returns while from this graph we conclude that more risk leads to larger losing trades. These two observations alone spell it out very clearly - more risk does not guarantee greater returns and leads to suboptimal returns for the amount of risk taken. More risk is not justified because we are not compensated for the extra risk we take, at least according to this model of course.

Standard Deviation

The standard deviation for winning trades is $18.9 while the average profit per trade was $21.83. For losers, the standard deviation is $19.05 while the average loss per losing trade is $15.96 and so for winners the standard deviation is less than the mean while for losers the opposite is true. Standard deviation measures the dispersion of the profits and losses from their respective means. In this instance, the profits per winners tends to be dispersed below the mean while profits per losers are dispersed above the mean. This is not something we want to see and should find a way to improve it so that the std dev of profits per winner is greater than its mean. An explanation for why this occurs could be that lack of samples and outliers skewing the data. For example, I removed the largest single loss of $82 and the average loss fell to $13.60 from $15.96 (17.35% change) but standard deviation fell to $14.64 from $19.05 or a 30.12% change.

Too Good to Be True? Maybe... Maybe Not

Sometimes, things that are too good to be true usually are because they omit certain key facts that otherwise would not paint such a rosy picture. With everything presented thus far, such as a win rate close to 80% and five times the dollar return for every dollar lost, it seems too good to be true for me as well.

There is of course the possibility I'm making it all up, cherry picked the winners and threw out the losers. This would be a big experiment in self delusion and if I did this, rest assured, I'll blow out my account soon enough so for now let's assume this isn't the case. However, I think there are some convincing reasons as to why we can trust the results. Also keep in mind I posted all the trade results.

Reason 1 - No Shorting

My practice account does not allow shorting (betting that price will drop) and as a result I could only buy stocks and hope to sell them at a higher price. This is important because this mini experiment began on May 1st and in the entire month of May there were only 6 days where the S&P 500 closed higher than the open.

Reason 2 - Return of $588.97 Trading Facebook

I traded 3950 shares of Facebook, lost $161 and made $747.97 for a net return of $588.  The reason I traded so much Facebook is because of the liquidity (large amount of volume). The graph below shows Facebook stock, and as we can see, price has been falling ever since the May 18 open. The only way I made money was by (for lack of a better word) betting against the prevailing downwards trend. Moreover, IPOs aren't shortable until after some time has passed. So I made profits on a stock that was falling by buying it. What this means is that I was able to pinpoint with a high degree of accuracy places throughout the day where price would reverse against the prevailing trend. I believe that this could not have occurred through randomness alone.

Conclusion

The method seems to work. The only reason it will fail is due to the psychological differences when trading with money you don't care about losing as compared to money you do care about losing. As a result, when I put this into live trading very soon, I will know that any deviations from the model is due to my error in mindset and not the system or technique itself. Doing all this, if for nothing else, has provided me with a key insight of where I will need to focus my energy if I am losing - not the system, but the mindset.

June 1st - Live Trades

Profits of $1271.62

End of Day Update

Kinda difficult day and a bit stressful. Overall came out ahead, but made a few mistakes along the way that cost profits. Hedging worked but I didn't sell the hedging component when it was $200 in profit and ended up selling it at a loss instead. It's easier to say this from hindsight.

Mid Day Update - Hedging

Hedging my $1200 in profits with equal amount of cash in TNA... market is directionless in lunch and it ussually tends to be moved easily due to low volume. Fearing a market move up over lunch and into mid day, I got in TNA as a hedge in close to equal amount of cash. The hedge is about 97% effective which is good enough for me. I am anticipating a sell off into close and I want to be positioned for it without having to endure draw downs and profit swings of $300 dollars at a time. Like this, profit will stay at $1200 for the rest of the day. If the market sells off into close like I anticipate it will, then the hedge is dumped and I ride the sell off into close.

Morning Update

Live trading today, this is the morning start carrying the position from two days ago with 415 added shares yesterday.

May 30 - Live Trades

Cleared Profit of $136.01

Open Position Profit of $366.00

Live trading today with two positions! The first batch is 300 shares at $20.50 and then I added 400 more at $20.42. I sold the second batch of 400 shares at $20.76 and captured $136.01 in profit. Now I have 300 left riding from $20.5 which are protected to the downside by the profits and as a result I can afford to hold them for another day or two in case the market will continue its down move.

Second Batch of 400 Sold (Closed Position)

First Batch of 300 Left to Ride (Open Position)

Downside Targets ES Minis (S&P 500 Futures)

I'm anticipating a high probability market bounce around 1307 +/- a few. However, should that fail there should be a sizeable flush to 1300 and 1295. In any case, that spot is good for a decent reversal.

Downside Targets TF (Russell 2000 Futures)

On the other hand, I'm short the Russell which seems like it has a bit more room to give back before a potential bounce. So far, we've given back exactly 50% of the gains from the May 20th lows. What I would want to see is an overnight move to 755.

Trading Beliefs & System - Part I

This is going to be the first of several posts on my trading beliefs and methods. I could start off by showing some charts and saying "buy here, sell there" but that's not really useful. Out of the thousands of systems and indicators that exist, all of them take a back seat to money management and risk control. Any method can be shown to make money given the right market conditions. Trying to have dozens of trading systems or indicators prepared for every market condition is about as effective as trying to learn every language.

Give people a system with a 60% probability of winning and you will still have handfuls of people losing. No further removed are people who win the lottery or retire wealthy from professional sports only to hit financial hardships later on. So if it's not the system or method, then it must be something else. The most important aspect then, in my opinion, is one's mindset and how they manage risk. Below are a few beliefs and ideas I incorporate from experience and from the material I've read over time that makes sense to me.

1. Anyone can make money, but not everyone ends up keep it

There's the rub! The fact that absolutely no skill, intelligence, or anything else other than money is required to make money. Similarly, that's also the allure which draws in so many willing participants. In fact, I believe that the reason why people end up losing so much money is because their first few trades makes them money. It's really sick if you think about it. Consider the following scenario I just made up. The year is 1999, the stock market's booming and rap is still good. Meet Jim. He works in HR and just last week he made several thousand in the stock market. Jim isn't the sharpest guy around and unfortunately for him most office jokes are made at his expense. Dave works in accounting, he just graduated from a good school, and the only other person who thinks more highly of him other than himself is his own mother. Now, Dave overhead the cooler talk about Jim's financial success so now his brain's working overtime thinking "If Jim can do it, and Jim ain't a bright guy, than I sure as hell can too".

Dave doesn't really have any idea what he's doing but he just made his first trade and made some money. Of course, he will take it as a credit of his abilities. Dave is now hooked and there's no way out, especially not after he just made more in half an hour than he will the entire week. He will now arbitrarily increase his risk by using more capital in the hopes to make even bigger returns. By the third trade he starts losing right off the bat but refuses to sell at a loss nor does he realize that he will still have profits from earlier if he exits now. Instead, depending on how much pain his ego can take, he will have given it all back to the market and possibly more. He's a bit shocked, but no doubt still has his resolve intact and believes he can make it all back in no time and so makes another trade. A winner again, he has his composure back and reassures himself that this isn't so hard after all. That unlucky sod will now be hit with a string of four hefty losses in a row - the market that is his mistress will punish him for his transgressions. His world now lays shattered and he will spend all his waking minutes wondering what went wrong.

The quest for the Holy Grail is afoot and Dave starts reading every piece of financial news he can get his hands on and is on the prowl for stock tips. He starts watching financial TV shows and reveres every word he hears from analysts and news anchors, conveniently forgetting that if they were any good they'd be out making money not behind a desk. Dave has fallen prey to something called the "free lunch fallacy" (which I just made up) where he believes the market owes him something just for existing. Since he's the particularly egotistical type, he will blame the market, corrupt wall street players out to get him, the government, his nagging wife, the broker, his co-workers and not necessarily in that order either. He will lay blame on everyone except himself.

Sure, Dave may beat himself up over losing money but don't be fooled as he is only wallowing in self pity and isn't willing to examine himself and look to improve. Instead, Dave will help subsidize someone else's car payments all because he's too proud to admit defeat. Our old friend Jim may not be smart, but he's doing something right. Jim sees a stock going up, so he's going to buy it too and follow the crowd. He knows he's not smart enough to fight a force bigger than himself, Jim is a simple but humble guy. Dave on the other hand thinks it's too expensive and a dumb idea so he will opt to buy a stock that's been falling for weeks instead, thinking it's gotta bounce just because he bought it.

Had Dave started off losing 5 or 10 times in a row, I'm almost certain he would have walked away and swore off playing the markets as a sucker's game for fools and cheats. Unfortunately, Dave wanted the easy money and the good life and he got it, just not how he thought he would. Moral of the story - don't try to outsmart the markets or project your ego and biases about what you think should happen.

2. An object in motion tends to stay in motion

Price moves in the direction of whoever has the most money backing up their beliefs of where the price should go in the future. Whether it is one person, a hedge fund, or the majority of market participants is not relevant. If price is moving higher, it will continue to do so until the buyers are exhausted or until someone with a bigger pocket sells against the prevailing trend.

Respect and follow whoever swings the biggest account or stay out of the way. Don't try to be a hero by going against the prevailing trend because hero's are remembered for their glory and there's nothing glorious about trading - it's also bad for the account.

3. It's not immoral to win

Nobody puts their money on the line if they didn't think they could make more back. Freewill involves consequences and part of that includes losing. Sure there are cop outs like traders add liquidity, or short sellers are pushing prices down to help out price discovery and so on. While those statements are true, it doesn't change the reality. At the end of the day, someone's lost money and someone's made money. I'm here to learn and if possible create a methodology that has the potential to generate a stream of income. I'm under no illusion that I will likely not succeed or that I'm doing it for purely altruistic purposes.

4. Trading is not the same as gambling.

Gambling is defined as "staking or risking money, or anything of value, on the outcome of something involving chance". Strictly adhering to the definition, then one could very well argue trading is gambling. However, consider it from a different angle: isn't living also a gamble? Commuting, for example, involves risking one's life (arguably the most valuable asset one can posses) in exchange for monetary compensation and accepting a small probability of dying that exists. That in itself is a gamble too but it is not really seen that way because the odds are so small that we tend to dismiss it. In fact there is risk in doing anything, even in doing nothing because at one point or another DNA replication errors will occur and produce cancerous cells. Thankfully, the cell will terminate itself before it can replicate its its faulty DNA (see apoptosis). The conclusion is this - life is risk - those small probabilities eventually catch up with you and like Benjamin said, the only things certain in life are death and taxes.

Attempting to avoid or dismiss the existence of risk will not make it any less real. Instead, embrace the risk of life and realize that although it is impossible to remove it, we can mitigate it. Driving attentively, following speed limits, exercising and so on will mitigate risk of dying. Where people can go wrong in trading comes from an irrational fear or misunderstanding of risk coupled with a deep seated mental desire to avoid risk at all costs and yet be correct at all times. This translates into chasing after that winning system that doesn't exist or blindly taking the advice of others. On the other extreme, you have people with absolutely no respect for risk and take on huge position sizes without adequate preparation and end up blowing their accounts up. Sometimes they win but how many fail for every winner? Refusing to embrace risk combined with a brazen ego to never admit fault is an easy way to lose. The reason why many end up in a loop of relying on systems, analysts, hot stock tips, newsletters, or financial news is simple - by doing so, it takes away the responsibility and accountability of being wrong. When a trade goes sour, most people will initially refuse to accept the loss when it is still manageable and instead exit when the loss is too big to emotionally handle.

Going back to the topic of gambling. Most people immediately associate gambling with the casino and reckless high rollers losing their kid's college fund. From there, they apply the attributes of a casino onto the stock market or treat the market like a casino. However, three differences outlined below show why this is not the case.

• In a casino, the odds will never be in your favour unless you own it,
• Secondly your bet is completely gone when you lose. As we approach a near infinite amount of games, the house will always win. 
• Therefore the only way gamblers can win is by a streak of wins and/or proper money management but never through odds alone (unless it's Poker against other people).

In the market, you generate the odds and in turn are ultimately responsible for the freedom that this entails. This means that unlike a gambler, a trader can come out ahead both from winning streaks, proper money management and favourable odds as well. On top of that, you are able to recuperate your initial investment with minimal loss when wrong if you act quickly. This means taking trades with good probability (i.e., going with the trend), risking manageable amounts of money at any one time so that no one trade will make or break you, and exiting losing positions quickly.

I didn't intend this post to get so large, so it's commendable if you've reached this far and I hope something of value was imparted. If you disagree with #4, feel free to say why in the comments below!

May 16

Profit of $79.27

Only made one trade today. Price went as low as 20.32 intra-day so the price entry could have been a bit better.

Statistics Part 1 - Probability of a Streak of Wins

I paper traded today and had one losing position and a scratch trade on GMCR after 4 minutes with no direction. There have been three days of good paper trading profits, from Friday through to today. This a step in the right direction because to me it means that I could not have done this due to chance alone, or at least it is unlikely. If the above is true, then the only other explanation is that my method seems to put the odds in my favour enough to turn a profit. I don't use anything other than price and price action, volume, and Bollinger bands to make my entries, so this is a very pure setup without any indicators to clutter the charts. The reason I bring this up is that indicators tend to work in one market condition but not in others, while price, volume, and standard deviation of mean price work in every condition.

Overall, that makes 3 days of profitable paper trading and 5 days of profitable live trading in a row without a draw down. Let's do some light statistics to get a different perspective. Assume that just like a coin flip, there is a 50/50 chance of a trade being profitable because price can go up just as likely as it can go down after entry. The size of the gain or loss is irrelevant. Also assume that each trade is selected during market hours in such a way that it is completely random. Further assume that each trading day is the cumulative of all trades for now and the amount of trades per day is not important.

Guessing 8 coin flips or having 8 profitable days in a row has a 0.39% chance of occurring while guessing 5 coin flips in a row (counting only live trading days) has a higher chance at 3.125%. Although 3.125% is quite high, it is still low enough to suggest that perhaps luck alone is not sufficient enough to explain the results thus far. 

Okay, but what if we want to know the probability of getting a streak of 5 profitable trading days in a sample of 100 days? This changes things up a bit and gives a different perspective all together. The calculations come up to 79.56%. This means that if I were to trade for 100 days, I have a 79% chance of having at least one streak of 5 profitable days. Not so impressive now is it. For all I know, this winning streak is about to end. I've tabulated the results for more streaks of trades below. Of course, my trading is not completely random (or at least shouldn't be) as I try to pick only the ones I think have a greater chance of turning out positively and it might skew the results. Then again, my decisions can appear just as random to any other trader. As can be seen, having 10 profitable trading days in a row out of a total of 100 trading days means you are really good - the probability of that happening is just 4.76%. Accomplishing that means you have a quantifiable edge. Of course, 9, 8, and 7 are all good too and desirable.

These results should only be taken at face value and I am well aware that the risk of ruin is present. This does not imply that I can now use more leverage or trade more aggressively. Furthermore, market conditions (choppy markets) can always abruptly change so that whatever edge I have will be diminished. If this were to happen, then something called random reinforcement may occur. Random reinforcement occurs either when an inexperienced trader has a streak of wins and attributes it to intuition and skill or when an experienced trader endures a streak of losses even though the trading methods have statistically worked in the past. The experienced trader will commit random reinforcement error when they attempt to adopt a new trading method instead of realizing that randomness can create both a streak of winners or losers regardless of trading experience. Misattributing the streak of losers to the system no longer working is how one commits this error since any new system they adopt has a lower probability of succeeding regardless, simply for the fact that the trader is unaccustomed to it. This is also partly why I rely mainly on price and volume, so that in the event that a random streak of losers occurs, I will know for a fact that the problem is not the trading system but my focus or mental state, since volume and price are as old as the market and can't be wrong.

And finally, the sample size is too small to make anything other than a preliminary conclusion - a more accurate measure would be to tabulate the total trades instead of profitable vs. unprofitable days. I'm going to do this in the future. For now, see the paper trading profits for today below and let's do one more quick analysis. Today I had a streak of two winners in the morning, then a loss which was followed by a 7 win streak in a row. There were a total of 10 trades all together, so that means that the probability of enduring a 7 win streak in 10 total trades is about 3.84%. Not bad.

May 14th

Profits of $235.35

Today was an unusual day. While waiting for my new brokerage account, I saw a good trade opportunity. I sold half for $107 and held the remainder into the close since the market looked weak, Apple was making new lows and I had a feeling that the markets would give way and push lower. I wanted to hold 371 shares overnight for a possible gap up since the markets today sold off into close and also made new lows after close. I think the odds of the previous market lows being taken out are at least 60% but regardless I'd rather stay in cash. There were three trades in total so commissions come up to $21, whereas with the other broker it would have cost $14 only and would have given me the ability to scale out 100 shares at a time instead of half at a time. Good day overall.

One thing to notice is that my average profit per cumulative trading days is about $141 dollars net. That's still $3 less than my previous job per day. Also keep in mind that I am also exposed to potential loss which will reduce my gains per day even more and I'm giving up potential resume padding. By the looks of it, working would be better... for now that is. If you count the effects of capital gains tax, then I should come out ahead from trading by a little bit. Just food for thought.

Live Account

Paper Trading Account

I also traded on my paper account and cleared about $84.49 net by lunch and logged off afterwards. I made some bad entries buying SanDisk but I closed it quickly once I realized it wasn't as good as I thought. Cutting your losing positions quickly is a great way to preserve profits.

Week 2 in Review

Last week proved really hard to trade in due to the direction less moves taking place. The S&P traded in a range of about 30 points all week, one day up and then the next down with reversals throughout the day. This made it a hard playground for anyone going long or short. Without a clear defined trend, this puts the odds against me considerably and I think I would have had a good chance of stomaching some losses. Knowing my limitations, I stayed out of the market and paper traded. I've posted a screenshot below to show that my balance hasn't changed since May 8.

In the meantime I've found a new broker to trade with. They charge 0.01 per share with a minimum of $0.99 per trade, so in other words one dollar per 100 shares in and a dollar to exit the position. That's two cents lost immediately on entry plus the spread (difference between the bid and ask at any one time) which I don't pay more than 2 or 3 cents for. So in total, I lose about $3 round trip if I exit as soon as I enter.

So why is this a worthwhile venture? Well for one, I can risk less capital at any one time with 100 shares worth of capital. With my current broker, it costs $14 round trip plus a 2 cent spread requires a 16 cent profit just to break even. It's unlikely anyone can win like this in the long run unless they are already extremely experienced (which I am not yet) and even if they were, their opportunity cost in time wasted would ensure they would search for something else to do. 

Now, one might ask "okay sure, you risk less, but don't you also win less?". That's a very valid point and I agree with it completely, but I'm going to offer a different perspective. When one enters a trade, most times it does not reverse against them as soon as they enter. It rarely happens unless you manage to buy right at a peak or sell short when the stock has bottomed. If you manage to buy at the peak or short at the bottom more than 60% of the time, you'll be a millionaire soon since you can just do the opposite and make money. Since there aren't many successful traders that make millions like this we can assume this is not the case. What is the case however, is that most trades at one point or another do end up being profitable but are none the less closed in a loss. 

Say you buy 700 shares during an up trend (average commission of 0.01 per share) and find yourself up 5 or 7 cents ($35 or $49) in the next minute. Price falls a bit and you're down 9 cents ($63). In the next few minutes it's back up to 8 cents profit ($56). Now, you won't exit because:

1. You still think the market will go in the direction you want (which is a bad mindset but that's another story) and you believe that since price was down earlier but has come back up, it must keep going up. 
2. You've already paid $14 in commission, so you might as well stick with it and see how the trade goes since if you sell at break even you lose that money

Now what will happen is that price will fall below your entry by 24 cents. You still believe in the trade, so you continue holding it. It goes up again and your only down 4 cents, but if you exit now with a 4 cent loss you lose that 14 cent commission also. So instead, you wait. It's been 15 to 25 minutes now and your trade has gone nowhere. You've had at least 3 chances to get out for a scratch trade (break even) or for a small gain,  but this time around the price manages to fall and it falls hard,  maybe down 50 cents ($350) in a minute. Eventually, you cannot psychological endure the loss any more and quit on a reactionary emotion. What happened? Well that initial trade that went in your favour initially was turned into an unnecessary loss almost triple the highest return you had at any one point due to trader error and the desire not to waste that $14 on the trade. 

Wherein lies the problem is that the longer you hold a position where the price stays range bounded or doesn't immediately go in your direction after entry, the more your risk of loss increases. This is because you can only win when price goes up but can lose in two ways (break even losing commission or selling at a loss). Since price isn't going the direction you believed it to and now 15 minutes have passed, then you are most likely wrong. This is because not enough traders believe the same thing as you do in order to create a an imbalance on the demand or supply side and get price moving. You are a sitting duck, the trade is no longer under your control and you are now gambling on an outcome. A recipe for disaster and heartache.

Let's re-identify the problems. Firstly, the trade was too large to begin with and the trader was not psychologically primed to deal with that huge of a swing. Secondly, since the position was so big and the commission is hefty, the trader subconsciously has a connection to his trade where he feels he has to stick with it since he's already put so much at stake. Plus, he also thinks that if he's right and waits just a little while longer, he can score big and make several hundred in profit - this is pure greed and acts like beer goggles.

With only 100 shares at stake, the trader would have lost $50 at most if they sold on the drop. Instead, if they hadn't exited earlier (the most correct decision) they can still wait for a retracement in the next few minutes and sell maybe at only a $24 dollar loss. The previous trader that went in big with 700 shares won't be able to do that since he panicked when he saw a $350 loss, where as the 100 share trader can stomach a $50 loss (since $50 represents a smaller emotional value to him) and wait for a price reversion to the mean. He'll still lose, but maybe not as much. Of course, the best decision was to have exited before hand and captured that small $9 profit earlier when price was fluctuating. Now, he still loses but not as much, but also incurs opportunity cost.

While it's true that trading just 100 shares at a time won't bring in the big money, it still has the potential to bring in a decent amount of money, maybe a hundred or so. For me, since I still consider myself a beginner, this is fine for me. I'm not looking to strike it out of the park, but what I am looking for is to learn and if possible subsidize the cost of my entire education with the market's money. In other words, if I can learn (emotional control, analysing bad trades, recognizing set-ups until it becomes second nature, reading volume flows etc.) while still making some money on the side or at least breaking even, it's still worth it to me.

The end goal, I believe, of anyone looking to succeed shouldn't be to make money, but instead to do the right thing when it is required. If one can make the right trades and react when faced with new information, the rest will come on its own. My goal is to become proficient enough with 100 shares at a time, then when I've shown that I can handle and return profit with an positive expected value, then I'll double it to 200 shares at a time as necessary. Over time, the change should be seamless enough that it won't feel like a huge plunge. That's what I think anyway, and it makes sense to me.  

I paper traded on Friday using 100 and 200 shares on average, holding no more than that at any one time. Data was delayed by 20 minutes, but I did not cheat (that's going to have to be taken on trust). Fills are also pretty accurate. I had sell orders on the ask that were not filled unless there was volume coming through. I made a total of 68 trades for the day, about 5230 shares traded, and with a profit at the end of the day of $420. Total commission cost was (5230*2)*0.01 = $104. With the current commission scheme, that would have cost 7 times 68 or $476. See image below.

For the next week until my new account is opened up, I'm going to be paper trading daily and posting my results. My hope is to get 3 days out of 5 in profit.

May 8th

Return - $17.99

Not a very eventful day as I mostly sat on my hands. I'm waiting for the bearish wave to end and today's market behaviour looked somewhat bullish considering we closed almost break even after being down more than a percent earlier in the day. Only one trade was made today and the only notable thing about it was that I sold within 2 cents from the high of the day. Otherwise, it was par for the course.

Charts

Check out the chart of TZA below. Today's reversal with the long upper wick is quite bearish on its own merit. Further compounding the problem, we have a declining resistance line. The first two blue circles created the trend line, the third confirmed that it is reliable and the fourth (today's) represents that the trend line is being respected. Overall, we have three bearish technical clues (1) trend line resistance , (2) the bearish candles, and (3) the two days in a row of price rejection on the trendline. The price also tagged the upper Bollinger band on the daily before reversing.

The next path is down meaning that indices will reverse to the upside. After having digested the less than stellar news from Europe from the weekend, there are fewer obstacles blocking the upside. One thing may be a surprise bond yield increase overnight or more political statements from talking heads. I place the probability that TZA will move to 18.50 by week's end at least 60%. I'll follow up on this at the end of the week.

Also, here's an example of a successful triangle pattern like the one above, but on today's minute chart. Once it broke to the downside of the triangle, at 20.05 at 2 pm it fell until price stabilized at 19.60s. The pattern told me to either enter into the inverse of this ETF or to otherwise stay out until the pattern shows its hand. Thus, we can trust the pattern from the previous chart above to be reliable.

Russell 2000

Next is the Russell 2000 with a Raff channel with lines drawn at +/- 1 and +/- 0.5. It's very clean in the way it follows patterns and easy to chart and that's what I like about it. There's very huge support in the highlighted box in the left chart, dating back from the start of 2011 where I count 17 months worth of pattern. Pretty significant stuff. It gave out last summer, turned resistance in late October but now it seems to be support once again

I've outlined where I think we could retrace to on the chart to the right. This can take as little as 4 days or by the end of the week since it's happened three times now. However, it is also realistic to anticipate 2 weeks of congestion, similar to the price pattern from April 10 to 27. Of course, this can all blow up if something happens in Europe again and we break the lower part of the support channel I drew. One scenario I see is that we retrace the losses, and then push back lower again due to European turmoil. See the summary below. 

Observations / Summary:

1. February 1 to 3 (3 trading days)
2. March 6 to March 13 (6 trading days)
3. April 23 to April 27 (5 trading days) 
4. Else, if you count the congestion from April 10 to April 27  (14 trading days)

• Note how Russell has been making lower lows and highs after each major move showing its weakness

May 7 - Close, but no cigar

Day's Return - $22.76

Time Spent - 9:30 am - 12:56 pm (3:26 hours)

Today was a scratch day. The total return after commissions comes out to $7 an hour ($79.76 profit net $57 in coms). With that said, I'm pleased with today's performance. Although the return was minimal, I did not lose my head in a very choppy market. My entries were good but the trade management was sloppy. My biggest regret of the day was that I had the bird in the hand but let it fly away. The bird in particular was Tempur Pedic (TPX) which having traded at $80 in April is now at $48. No doubt, some big players must have been waking up on the wrong side of the bed to cause this 45% decline.

I entered short 280 shares at $48.31, endured an unrealized loss of about $100 for a few minutes and closed out the position at $48.15 in profit. Price then fell lower to $45.44 by 12:45 which would have been a "hypothetical" $758. Realistically, perhaps half of that could have been realized. After that, I closed my computer and went outside, as my mind was in obvious disarray and rather than risking revenge trading or entering dumb trades I got up and left. One point for discipline.

Sloppy trade management turned a potential large winner into only a $40 dollar win. Looking back, it's important to take note that even if the analysis (anticipating lower prices) and trade entry are good, but trade management is poor, one will still fall short. All three components must be in good form in order to succeed. Nonetheless, I'm happy because the analysis was spot on, meaning in the future I need to focus on the trade management aspect.

Return

Account Statement

Commissions are a big impediment. I made 4 round trip trades for a total cost of $57 yielding $79.76 in return. Had I been with another broker, such as Interactive Brokers,  commissions would have cost $0.005 (half a cent) per share or $15.4 in total (profits of $64 instead). Repeating today's activity for 10 days means that $420 dollars will go to the bank and not my pocket. This isn't intended to be an excuse or scapegoat since all 4 trades were profitable.

It is a cost of doing business, but in the sense of commuting with a hummer or with a fuel efficient car. You still get there on time but it costs you more with the hummer and you derive no additional utility. This is just an observation I'm keeping in mind for possibly switching in the near future.

Closing the First Trade

I've decided to liquidate the trade based on a few reasons. The first is that I could have sold it on Wednesday and instead opted to hold through Thursday. The price only increased another 30 cents above Wednesday's high, so considering the risk of holding overnight it was a suboptimal risk to reward ratio. On top of that, I don't want to hold over the weekend either.

Secondly, tomorrow (Friday May 4th) is the US non-farm payrolls and unemployment rate release at 8:30 am. These are usually strong enough on their own to change the market direction in an instant. I figured these two scenarios that could happen and how I would respond:

(a) The job report is currently forecasted at 145,000 and the market expects 165,000. In in other words, it is already priced in by the market and the forecasters gave out a small number so that when they release anything above 145,000 but less than 165,000 it will still be used to rally the markets and attract new money, even though in retrospect it wasn't anything spectacular.

(b) Job report numbers, are in my opinion, the most easily manipulated and misleading government statistic available since they always seem to be really good when the market is on a down trend and neutral otherwise. Could be just a coincidence, but money talks and it says to me not to gamble on these reports. If they turn out to be good, I'm going to jump on TNA (the opposite of TZA) with half the capital and scalp it out and be done by noon.

(c) If they are indeed bad, we'll sell off hard into close and with the weekend coming up, it will add more fuel to the fire since people will be more hesitant to hold over the weekend when the entire week has been weak. Then I'll just reload my previous position but with half as many shares.

Trade Debriefing

Fortune has been smiling upon me this week. I got a good entry going all in (which I don't normally do) and price rose quickly. Not to get ahead of myself since one could argue I just lucked out and did no better than guessing the flip on a coin, but to put the returns in a bit more perspective:

• At my summer job last year, I worked 8 hours a day (40 in a week) for $18 an hour for a total of $675 a week
• Dividing this weeks' returns by the same amount of hours comes up to $27.65 an hour. That's a middle manager pay or a top of his class, fresh out of university, petroleum engineering grad (harhar)
• Now consider that I bought on Tuesday and sold on Thursday, so I only worked two days or 19.5 total trading hours. During this time, I slept in on Tuesday, played Xbox during slow trading sessions (since there is no activity) and cracked a few eggs for lunch. The only downside was the lack of air conditioning and office gossip.
• One thing that hasn't changed is taxes - they'll take my income tax bracket times half the total profits. In this case, the government takes about $165 give or take (preferably more take than give). That's all fine and dandy, since I'm no more than a middle man, hustling money from one group of crooks and giving it to an even bigger one. 

Now, why am I saying all this? Well because I believe that it should be theoretically possible to repeat this scenario multiple times. The same way people can lose thousands of dollars and their deplete their retirement funds on the stock market, there must be a way to do just the opposite. For now, only time will tell if I am correct in believing this, but with due diligence and tilting the odds in my favour as much as possible, it should be doable. I'll recap to this post 3 months from now to see how far we've come.

First Trade - What Now?

Yesterday I posted about how I had an opportunity to sell for a thousand profit but opted not to. My reasoning was that I anticipated additional downside in the next few trading days. In today's premarket around 8:30 am, price fell to 17.84 and is now at 18.93. Overall, I'm up $1200 or just shy of 8.6% in one trade. The ideal move would have been to sell yesterday and buy back again today in the morning - so that is one strike against holding. However, there is no guarantee I could have timed it perfectly. With that said, this my rationale for why additional downside can occur.

Looking at the Russell 2000, we can observe that price has made a lower high in the few weeks and is generally weak. The highlighted black box below is important because it shows us that price has been following it very closely. We can see that back in Q2 of last year, price behaved very well to the box, bouncing as support off the low end. In the present, price is also behaving to this 8 month old pattern. Price now is bouncing off the upper red line. Note, that this is highly improbable to be due to coincidence alone - somehow, the entire behaviour of the market as a whole has created this orderly pattern. Our job is to exploit it. What I am targeting is a continued move down back to the top red line of the box. The best case would be to break below the entire box, but that is unlikely and too far to forecast at the moment.

The chart below is the daily chart for the last few weeks. Looking in the last few days we can observe something very important. Price had fallen, touched the upper red line of our black box, bounced, retested it and moved higher to candle stick A (in the right chart).

Candlestick A - Investors bought up shares on good news, then sellers came in and pushed the price even lower than the previous day after making new highs. Very bad news if your looking to go long

Candlestick B - Price fell further in the day on Wednesday, but managed to claw its way back up. This means either that buyers came in at the lower prices or sellers eased their selling pressure. Price closed up for the day.

Candlestick C - Today, Thursday, price opened up at or a bit higher than the high of the previous day. Sellers took control or lack of buyers removing the floor resulted in price falling even further. What this signifies to us is that the buyers who came in yesterday have lost their money, they have either exited or are holding out for a move back up. Furthermore, new buyers will be wary of entering just yet, that is assuming there are still enough new buyers to continue the move up.

Overall, what we can conclude from this is that there is a more than 50% chance that price will move down to test that support level. At that spot, TZA will be at about 20.35 which represents an additional $1400 dollars in profit for my position. Anything over 50% is a trade worth taking, but I'm still not convinced.

What If I'm Wrong?

One should always have a plan prepared as to how they are going to react when they are wrong. The biggest problem is positive job numbers tomorrow and good unemployment rate that will send shorts scurrying to cover and side line longs to buy the dip. That would be disastrous to my trade and would most likely lead me to liquidate. However, the allure of the money now and the possibility that the job numbers are fudged tomorrow are leading me to sell more likely than not by the end of today. By the end of today, I will either reduce the position by half or more, or liquidate it entirely.

Edit - Liquidated the entire position and waiting until after unemployment reports tomorrow for further action.

1st Trade

The first trade to christen this foray is taken on May 1st of 2012. Note that the post is being made on May 2nd because May 1st was spent getting the blog up and running.

Reasoning - After some good economic reports at 10 am, the market had gone into rally mode. Entry into the trade was based on two main reasons. First, I believed the market movement up to be over zealous and weak since the previous day was a sizeable down day.

Secondly, anything in the low 17s to high 16s seemed like a entry point with favourable odds. This is because the low on TZA was $16.60 on March 27th and the high was 20.7 and 20.5 on April 10th and 23rd respectively. In other words, based on the last month of trading there was more potential for a move up than a move lower from my point of entry. With that said, one should be careful to not discount the effects of decay on price movements since this is a leveraged product (click here for a more detailed explanation).

Overall, the entry was 18 cents off the daily low, which was pretty good given the circumstances and sizeable price drop from market open.

Discussion and Rationale - There was an opportunity to sell at 18.60 to 18.70 on the morning of May 2nd for a return of $1000 or 7% on the account. A good question to ask is, wouldn't a rational decision have been to cash out at that moment? The answer is complex and open to debate (yes). My thought process was that the entry price was good on its own merit. I am anticipating a continued move down on the Russel 2000 (and all indices) into next week and as a result would prefer to have exposure in the event it does happen. With the entry price being good there is a decent cushion of profits to cover in case I am wrong. I will exit at $200 profit no matter what (not withstanding a large overnight move against me). However, when in doubt, the correct decision is to reduce your position size or take profits off the table up to the point where you no longer have emotional residue hindering your decision making process, i.e., your comfort zone. 

Also, note the cup and handle formation setting up on the 5 minute chart above. The handle is in the process of being completed, and the move that comes next is a breakout to the upside with a lot of momentum. See here for more detail on the cup and handle.