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October 21, 2009 - Issue #446

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Article

The Importance of Your Trading Road Map by D.R. Barton, Jr.

Trader Education

Systems Home Study Course 

Trading Tip

Recovering from the Financial Flu by Paul Kluskowski

Mail Bag

Photos and Comments from our October Workshops

Feature

The Importance of Your Trading Road Map

 by 

D.R. Barton, Jr.

 

"Would you tell me, please, which way I ought to go from here?"
"That depends a good deal on where you want to get to," said the Cat.
"I don’t much care where--" said Alice.
"Then it doesn’t matter which way you go," said the Cat.
"--so long as I get SOMEWHERE," Alice added as an explanation.
"Oh, you’re sure to do that," said the Cat, "if you only walk long enough."

(Alice's Adventures in Wonderland, Chapter 6)
--Lewis Carroll

Last week, I attended a very interesting “round table” type of event where folks gathered to discuss issues they were having and how to solve them.  In this case, the discussion was on broader business issues, but I was struck by how much it related to trading.

The first three people were all at very different places in their journeys. I suspect the probabilities were extremely high that just about anybody listening in could make an excellent predication about where each person would end up.

The first lady was full of passion about helping student athletes prepare for life after competitive sports.  However, she lacked any plan for turning that idea into a useful program that student athletes would want and then monetizing that program.  I would guess that if she finds the right resources and develops a solid plan to get to her destination, she’ll do well.  If not, she’ll most likely flounder (though passionately).

The second person up at the round table was a bit of a mystery.  Obviously, he was an intelligent guy, full of life experience.  He had so many areas of interest and so many skills that he had no idea what he wanted to do, let alone how to go about doing it.  We could have very well substituted his name for Alice’s in the quote above.  Until he gets a destination in mind, there’s no way he can put a plan together to get there!

The last person at the meeting had a vision for helping lots of folks.  He had a plan — a road map — that would direct his actions and navigate the bumpy spots in the road.  He still needed some resources and some infrastructure but this person had intention, a destination and a plan.  If I had to back one horse, this guy was the one.

The lack of a destination and, equally as important, a map to get you there keeps many travelers from getting where they need to be.  And so it is the same with traders and investors.  The lack of a plan or a road map leads to days, months or even years of frustration.

A Destination and a Map of the Territory

Lewis Carroll was so insightful with his books on Alice.  This exchange between Alice and the Cheshire Cat has been drilled into our collective mind so deeply that it has spawned its own saying: “If you don’t know where you’re going, any road will take you there.” Lewis Carroll (Charles Dodgson) actually never wrote that phrase; it appears to be another of those sayings that grew out of the “collective wisdom” of people through the years remembering the sage advice Alice received from the smiling cat.

In Van’s groundbreaking book Trade Your Way…, he does a great job of showing us the value of objectives.  (That section with fellow Market Wizard Tom Basso is so good that it’s worth a re-read if you haven’t looked at it lately.  Pages 50 -59 in the second edition).

Arguably, after we have our objectives, the rest of trading is about creating the plan—the road map—and then executing the plan.

As with most areas of trading, weaknesses in the trading plan are magnified for intraday traders.  This is because the opportunities for mistakes are multiplied in the intraday time frame and the leverage available makes mistakes more pronounced.

That’s why a daily road map is so important for intraday traders.  And every day trader I’ve worked with uses some form of a very unique road map to get them headed in the right direction every day.

Our Intraday Road Map – The Key Number Ladder

The unique road map used by all top day traders I’ve worked with is a “key number ladder.”  This is the tool that tells them what price levels require action, and when to sit quietly and wait.

The markets change.  Today’s markets have very different characteristics than the markets of just a few months ago.  And a year ago, during the market meltdown, the markets were very different, as well.

The map that professionals use to navigate on a daily basis the ever changing markets is the key number ladder.

One of these top traders is my great friend and business partner Christopher Castroviejo.  I’ve included a little about him at the end of this article so you can get to know him better.  One snippet:  He has 37 years of Wall Street experience and among other things, ran a hedge fund desk that achieved 34% compounded returns for eight years.  Pretty darn impressive.

Christopher helped me bring the “key number ladder” concept to a sharp focus even though I had studied the idea with many folks before.  The utility of the key number ladder never made great complete to me—until Christopher showed me his personal notes compiled over many years.

In short, key number ladders tell us the points that require action during the trading day.  These are the few price levels where the market is most likely to have a major launch, or a significant pullback.

To understand how we use the Key Number Ladder, here’s an example we gave in a webinar last week for our E-Mini course graduates.  The night before the webinar, we identified an area of the number ladder that would be an action area for us on the following trading day.  Here’s an excerpt from that Key Number Ladder:

We had three numbers that were grouped within less than three quarters of point of each other, giving us a key level to act.   If the market gapped up and traded down to this area, it would have been a place to buy.  As it happened, price gapped below this level and traded up to +/- one tick of the key number zone three times during the day.  Here’s what that looked like on the chart.

As you can see, this really was a KEY zone that day!  The trading signals aren’t always that clear-cut, but most days, the Key Number Ladder gives us the road map we need to make clear trading decisions and isolate the few low-risk, high-probability entry points for the day.

In your trading, identifying these key areas will ease stress and can help get you in when the market is ready to move.  To get you started, look at areas like floor trader pivots, recent daily highs and lows and key moving averages.  You’ll be amazed at how the market has a memory for key points from the recent, and not so recent, past!

Great trading,

D. R.

P.S.  As promised, here is a little more about my co-instructor, Christopher Castroviejo.

As I mentioned earlier, Christopher has spent 37 years in and around the markets. His resume and track record on Wall Street became something of legend: stints with Smith Barney and J.P. Morgan, a partnership at Bear Stearns, financial consultant for The Vatican Bank. Christopher was hot and getting hotter. Highlights include turning $10,000 into $178,000 in four weeks, 8 straight years of 43% compounded profits as a top hedge fund manager, a sleek Manhattan brownstone and a spacious summer getaway in the tony Hamptons.  Christopher even struck up a friendship with his money making idol, billionaire George Soros (to be honest, the people Christopher has worked with in the field is a veritable “who’s who” of Wall Street elite).

Along with multi-million dollar wins, there were a few huge losses; in just six short weeks, $10,000 became a cool million, and quickly nothing but air. And, in one monumental transaction gone wrong, Christopher lost $15 million dollars in just a few months…$1.5 million of it his own money. But, unlike the Vegas poker player who can’t leave the table, Christopher learns from the missteps as well as the wins. “You have to reinvent your performance all the time. I used to see the business as just about orchestrating wins, but the rational way of thinking about it is really about controlling your losses.” 

Anyone who has read Jack Schwager’s Market Wizards series (the first of which featured a chapter on Van) knows that many of those top drawer players became the traders they are by learning lessons in their own personal “trials by fire.”  Christopher has certainly been through his own version!

Today, Christopher is active intraday and swing trader and he continues to manage money for a select list of Wall Street insiders.  He teaches a few courses a year with me; we hope you can join us.

About D.R. Barton, Jr.:  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 guest on both Report on Business TV, and WTOP News Radio in Washington, D.C., and has been a guest on Bloomberg Radio. His articles have appeared on SmartMoney.com and Financial Advisor magazine. You may contact D.R. at  "drbarton" at "iitm.com".

Disclaimer 

 

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Trading Tip

Recovering from the Financial Flu

by 

Paul Kluskowski

With back to school days behind us, the once dormant topic of swine flu is moving back to the forefront as cold and flu season presses ever closer. We all know what to do to minimize our chances of catching the flu in the first place: vitamins, hand-washing, vaccines, etc. These measures may be effective in which case we congratulate ourselves. Or, in spite of our best efforts, the stress of daily life leaves us vulnerable and we find ourselves bed-ridden with a nasty set of symptoms. When this unfortunate outcome befalls us, there is little that can be done to cure it. Instead, we must simply relieve the symptoms as best we can, wait it out, and rest generously. Any attempts to hasten the process inevitably lead to relapse and the recovery phase must begin anew. In essence, only patience and acceptance will prevail. Much is the situation with the current economic and financial conditions. 

After decades of expansion and inflation, and in spite of government’s best efforts, the US economy has caught a form of financial flu: deflation. Like the human version, deflation cannot be cured. It represents a period of economic contraction, debt-clearing and balance sheet re-building. It must simply run its course. And this is the point that the Fed seems to overlook. While its actions are well-intended, the attempt to cure that which must be endured may well bring the patient more harm than good.

Without a doubt, the Fed’s medicine of choice has been easy money: low short-term rates, quantitative easing, bailouts and rebates. In the face of a seized credit market and plunging demand, certain amounts of stimulus are appropriate. Like vitamins for the weary, the stimulus has been thus far effective in preventing an all-out collapse of the financial and economic structure of our country. One need not look far to find these encouraging signs that everyone is heralding as the end of the recession:

• Recovering commodity prices
• Stabilizing home prices
• Increasing home sales
• Slowing job losses

To be sure, the situation is stabilizing. Rivaling the relative size of other grand recoveries such as the New Deal or the Marshall Plan, it would seem that America has ducked another Great Depression. At the same time, the “medicine of choice” is what brought this financial flu of deflation in the first place. Much like trying to cure a hangover with a Bloody Mary, the Fed’s easy money policy has yet to produce one of the truest indicators of recovery: new jobs. The challenge embedded in the Fed’s current strategy is to create an environment in which overall supply and demand remain roughly at parity to each other. Too much demand brings inflation as more and more dollars chase goods and services. Too much supply brings the inevitable deflation as prices must fall to edge out competitors and maintain cash flow. Clearly the Fed favors the former. Unfortunately, during these stimulative periods, it is difficult to ascertain real demand (raw materials being converted to products sold at a profit) from false demand (raw materials being stockpiled while product inventories are cleared satisfying any future demand).

Real demand is a precursor to prosperity, when the flow of capital is such that people and businesses feel confident about the future. Present spending begets future spending. Entrepreneurs start new businesses and companies open up new jobs to meet ever-increasing demands. Consumption of raw materials and production of final products rise in step with each other. This was very much the case during the 1980s and early 1990s.

False demand, however, does not generally bring prosperity. A good example is the recent uptick in new auto sales. Fueled nearly exclusively by low interest rates and cash-for-clunker rebates, this summer saw many autos leave the new car lots. Yet, this clearing of the inventory has not resulted in a large-scale increase in production line activity. The reported job gains number in the single thousands compared to the long-term auto job losses in the hundreds of thousands. The stimulus caused a spark, but hardly lit a fire. Dealers moved some old inventory, but car companies are not increasing their production. In essence, there’s no sustainable demand to meet the production capacity.

So how does one differentiate real demand from false? I look to two indicators. First and already acknowledged, is job growth. We can readily understand that companies do not hire unneeded workers. The act of hiring new, additional workers is a real indicator not only of legitimate demand, but of confidence in the future as well.

The other is a commodity that cannot tell a lie. While copper is often called the commodity with a PhD in economics due to its ability to predict recoveries, it too can be misled by false demand. Foreign governments holding large reserves of US Dollars have reportedly been stockpiling certain commodities as an alternative to cash (e.g., copper, oil, and iron). Since these commodities can be readily stored, stockpiling efforts can create the impression of real demand. There is, however, at least one economically important commodity for which supply and demand are always perfectly matched. It cannot be readily stored in large quantities and, as such, cannot be fooled or misleading. That consumable is none other than electricity. 

Through an amazing 24/7 dance, electric supply is carefully matched to actual demand. Let the balance shift ever so slightly, and the consequences are readily apparent. Too much demand leads to brownouts/blackouts. Too much supply causes harmful circulating currents that result in overheating of generating and distribution stations. Electricity always knows the truth. For the second year in a row, electric demand has declined in the US. This has not happened since 1949. While some of the decline is attributed to conservation and seasonal factors, much of it points to losses in industrial consumption. Likewise, residential usage has receded along with a growing number of customers whose accounts are in arrears. Until both job growth and electric demand recover, it remains likely that we have not fully recovered from the financial flu that is deflation.

As we migrate into fall, many will be watching the market’s behavior. The Fed’s easy money has clearly gotten the patient out of its sickbed. Now, it remains to be seen if the economy can continue to heal itself as the Fed begins to back away from its massive stimulus. While we may have seen the bottom, we are probably quite some distance from the end. Until real, sustainable demand begins to take hold, we must continue to endure that which cannot be cured. 

About the Author: Paul Kluskowski is an independent investment manager currently living in Minnesota. He is a long-time student of the stock market and Van Tharp. Paul was the founding president of Van's Local Chapter in Washington, DC and has participated in the Super Trader program. He can be reached at [email protected]

Disclaimer 

Mail Bag

This week we'd like to share photos from the workshop and our client dinner last week. 

Trading Game Results from the Blueprint Workshop. 
Margarita came in second highest in the game.

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