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#883 March 27, 2018

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Feature: Observations about Trading Systems: Designing My Trading System: Part 5:by G
Workshops: April Packed With Special Events: Oneness with Van Tharp, New Futures, and Adaptive, Advanced Swing Systems, offered only once each year.
Tips: Being Out of the Markets — Headline Risks and the Market’s Anxieties, by D. R. Barton, Jr.
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In both our Adaptive Swing and our new Futures workshops your instructor will go that extra mile to make sure that you fully understand the content you will learn.

After Adaptive Swing, Ken provides three follow up coaching sessions to answer your latest questions.

In addition, Ken will host three coaching calls following the workshops, approximately one per month and if you can’t make a session, you can watch the recording when it’s convenient for you. These sessions are more than just Q&A as traders also share what’s working great for them and collaborate on ideas to make the systems even more robust.

After Futures Trading, Gabriel has agreed to offer a 2-hour online group call approximately 6 weeks after the workshop to offer a quick market assessment, see where everybody stands, answer questions, and offer support as needed. He will also offer ongoing email support for 3 months after the workshop to encourage and assist those traders with additional questions about trading the futures markets.

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Feature Article

Designing My Trading System:

Part 5: Observations about Trading Systems

by G

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Editor’s Note: G (who requested anonymity) is a client with an engineering background

who has been working on developing trading systems for the last several years. He

details his observations and insights from that process in this five-part series of articles.

SYSTEM OBJECTIVES

It is hard to overstate the importance of clear objectives in guiding the development of a successful trading system. Your objectives narrow the choices of possible trading systems that fit your personality, your experiences, and your vision for your future. Minor objectives may change over time with exposure to new concepts and more trading experience but your major objectives will drive your future choices, and accordingly, they deserve ample thought.

Your trading methodology has to make sense for you even if it’s the opposite of what makes sense for other people. Choices made in developing your approach to trading should suit you personally to minimize internal conflict. Only then will you have the confidence to remain true to its development and its execution during tough times. The long-term advantage of developing your own system from scratch (rather than trading someone else’s system) assures you of high compatibility with your beliefs, personality, edges, and objectives. That compatibility becomes one of your sustainable edges. As Curtis Faith of Turtle fame noted: “It’s not about the system, it’s about the trader’s ability to execute the system.”

PROBABILITIES

I have used probabilities extensively in my system development process and I use probabilities daily in my trading execution. Probability theory can solve problems no other approach can solve. So why can only the rare adult in the US figure out the correct answers to simple probability problems?

Probabilities are difficult for the human mind to grasp; the math is just too tough for most people. Probabilities math is abstract and builds upon other higher math disciplines that need to be understood first. Further, the language around probabilities is overly scientific which requires training before most people are comfortable with it. Perhaps worst of all, correctly computed probabilities are often shockingly counter-intuitive. Non-mathematicians who have learned to depend on their instincts tend to quickly dismiss computed probabilities because they seem or feel wrong.

How can you use probabilities to your advantage when designing your own trading system? Here are two simplifications that work for me every day.

First, using compiled ‘frequencies of occurrence’ is much easier to comprehend than probabilities, e.g., 70% of all reversals stay in a sideways Bollinger Band. Characterization of price behaviors can be reduced to frequencies of occurrence that are most meaningful to you.

Second, graphical overlays on price that indicate current odds or small changes in odds obviate the need for calculations or guesses. There are ample choices for overlays to represent odds that are based upon your characterization work of price behaviors.

I discovered two different edges from using frequencies of occurrence and graphic overlays on my charts.

Most traders can’t detect small changes in odds and assume small movements are noise until there is a large and conspicuous change to which more traders react. I designed graphics that tell me when odds have moved from a 50% win-rate to 55% which represents a small improvement in the positive expectancy. Such small price movements usually look just like noise and the volumes on those bars confirm that most traders typically ignore such movements. I often enter with a tiny probe position to take advantage of this market inefficiency.

When pricing conditions appear that accompany higher odds of success, it is mathematically advantageous to increase position size substantially. Detailed characterizations of such favorable conditions and their trade outcomes demand a lot of time, however, the benefits of such tedious characterizations make the time well spent. I have measured the results of my most favorable condition, based upon ~1,800 positions taken. When those conditions occurred, I measured an 81% win-rate with an expectancy of 0.8R using a 3xATR trailing stop. When those conditions present themselves now, I enter at double my normal position size and I am 100% confident in both my odds of success and my likely gains — without computing anything! My well-developed graphics tell all.

FINAL THOUGHTS — EDGES, LEARNING, AND GRATITUDE

My most important edge these days is not the edge I started with. Early on in my system design process, I believed that improving signal-to-noise ratios for better entries was my best path to a sustainable edge. Since then, my system has evolved to succeeding mostly from combining conditional probabilities with variable position sizing based on a Market’s Money strategy. Position sizing isn’t just important to my trading … it has become the center of my trading universe!

Similarly, the advantages of scaling-in and scaling-out (SI & SO) are lost on the majority of traders. Most traders’ innate desire to be right completely sacrifices SI & SO without a second thought. A trader who uses a constant position size for all trades gives up an important edge. Using SI & SO, you can restrict full position size to those instances in which your confidence is the greatest. Scaling-in is certainly an unnatural act for most traders but for some trading vehicles, SI & SO can increase the Reward-to-Risk ratios and Profit Factors consistently and safely.

While most people think learning is a gradual linear process (likely based upon their steady progressions during school years), my learnings about system development, trading and myself have been a non-linear and unpredictable evolution. Based on adult learning research, that seems to be the general case. Graphically, the process resembles a side-view of a wooden stair case in which every board has a different depth, height, and worst of all — unique angle. You might be able to imagine seeing such a staircase in the following graph.

Based on a chart by Dr. Hossein Arsham

Traders who don’t know about the unpredictability of these kinds of “steps” may lack the mental stamina to stick with the learning process long enough to reach the second, third and fourth spikes of awareness, capabilities, and insights. Most give up too early. Instead, the later advancements are where the real payoffs occur for those who stick with the process.

After five years of sporadic flashes of insight and awareness, of endless system testing, modifications, and tweaks, and of replacing my limiting beliefs with more useful beliefs, I am just now becoming confident in fully using the trading system I built. All along the way, I kept tailoring my trading system to fit my objectives, preferences, and beliefs. I would imagine that most traders would view my trading system as a high-risk, counter-intuitive and unnatural approach to trading. But for me, my system is low-risk, obvious, and trading it has become natural with practice.

Finally, I am very grateful to Van, Ken, and RJ for sharing their time, experience, insights, and for always being there for me when I needed them.

— G

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About Teaching You Everything He Knows

See video below.

In this 2 minute video, students discuss the benefits of taking Dr. Ken Long's upcoming Advanced Adaptive Swing Trading workshop this April.

Trading Tip

Being Out of the Markets — Headline Risks and the Market’s Anxieties

by D. R. Barton, Jr.

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"I call investing the greatest business in the world ... because you never have to swing. You stand at the plate, the pitcher throws you General Motors at 47! U.S. Steel at 39! and nobody calls a strike on you. There's no penalty except opportunity lost. All day you wait for the pitch you like; then when the fielders are asleep, you step up and hit it."

— Warren Buffett

Last Friday morning started out with me pulling out my hair (figuratively, of course). I woke from a restless sleep and spent three hours on market and individual analysis above and beyond my normal daily scans and reviews. At the end of all that and no matter what I looked at, I came to the same conclusion:

There was nothing to do.

And then a great feeling of calm came over me - because I get to share this important message that we individual traders need to hear from time-to-time.

One of our great edges in the market is that we don't HAVE TO trade. We don't HAVE TO be invested. Many institutions have a mandate to be fully invested or nearly so all the time. As individual traders, however, we have the extra freedom to be out of the market — which they don't have. And it's an important one. Let me explain...

Some of Van’s earliest work comes in to play here of course. Van developed his "ten tasks of successful traders" about three decades ago. For those of you not familiar with this subject - Van found that what made traders successful was not a particular system or strategy or timeframe or instrument. Rather, their success came from the process they followed, their top tasks set them apart (that’s my paraphrase of Van’s early research!).

These ten tasks have stood the test of time. Van’s continued research into understanding successful traders led him to expand the list of tasks to twelve. One of the new tasks was "being out of the market." It's that important.

Waiting for the right opportunity is also such a cornerstone for Warren Buffett (see quote below) that one version of his thoughts on the subject has become an internet meme:

So let me share a succinct summary of the market right now that led me to my current "do nothing" posture. In approximate order of importance:

Market volatility (especially big individual down days) inflates options premiums to the point that calls or puts are very overpriced. In turn, this squashes reward-to-risk ratios to the point that making a directionally correct market call mutes the opportunity for returns while it also expands downside risk. More seasoned options traders can use vertical option spreads that allow them to minimize the impact of this increased volatility premium but the asymmetric moves of the buy and sell and leg still pose added risk.

Single stock volatility also affects stop placement – and when you have to move stops further away from the entry price to accommodate price moves, your profit targets have to grow or traders risk making trades with poor R-multiple potential (a measure of reward-to-risk also pioneered by Van).

Headline risk is the potential for news items to move a stock or the market as a whole by an extreme amount — like yesterday Tuesday, March 27. There are three areas where we have heightened headline risk today:

The Trump v. China Trade War: Will this become known as Trump's Folly or is the President using a shrewd negotiating ploy? Either way, this is the one biggest issue that could derail the Trump Growth Narrative

Facebook / Social Media: This situation is probably going to get worse before it gets better. I still believe there will be little if any long-term damage to FB from this issue but even if this is the case, the ride could be a rocky one for FB and social media stocks in the intermediate term

Trump White House Staff Unrest: The revolving staff door combined with the ongoing Russian investigation seem to be getting closer to a tipping point. News on these fronts can move markets...

Intraday jitters: One-way volatility is one thing, but the fear which traders sense is palpable in the markets right now. In the most recent four-day stretch (Thursday through Tuesday) the S&P futures have ranged during regular trading sessions - 56, 72, 61 and 82 points. Contrast these figures with a four day stretch from October 12, 2017 when the daily point ranges were 7, 5, 7, 5, and 4.75! The current 5-day Average True range is almost 11 times higher than that low-volatility stretch from last fall.

So What?

The so-what factor today impacts different kinds of traders differently -

Long-term traders – make sure your “get out” stop loss values are in place.
Swing traders – if you strategies don’t adapt well to volatility gyrations, this may be your Warren Buffett moment to “do nothing” for the time being …
Intraday traders – Enjoy! Trying to find good day trading opportunities over the past couples of years has been tough so make hay while the sun shines.

Your thoughts and comments are always welcome — please send them to drbarton “at” vantharp.com

Great Trading,

D. R.

About the Author: A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena. He is a regularly featured analyst on Fox Business Networks’ Varney & Co. TV show (catch him Tuesdays at 9:30 a.m. EST), on Bloomberg Radio Taking Stock and MarketWatch's Money Life Show. He is also a regular guest analyst on CNBC World, CNBC's Closing Bell, Fox Business Network’s Cavuto Coast to Coast and Making Money with Charles Payne and the China Global Television Network. His articles have appeared on SmartMoney.com, MarketWatch.com and Financial Advisor magazine. You may contact D.R. at "drbarton" at "vantharp.com."

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