Adaptive Moving Average A moving average that is either quick, or slow, to signal a market entry depending on the efficiency of the move in the market.
Algorithm A rule or set of rules for computing, that is, a procedure for calculating a mathematical function.
Anti-martingale Strategy A position-sizing strategy in which position size is increased when one wins and decreased when one loses.
Arbitrage The taking advantage of discrepancies in price or loopholes in the system to make consistent low-risk money. This strategy usually involves the simultaneous purchase and sale of related items.
Asset Allocation The procedure by which many professional traders decide how to allocate their capital. Due to the lotto bias, many people think of this as a decision about which asset class (such as energy stocks or gold) to select. However, its real power comes when people use it to tell them “how much” to invest in each asset class. Thus, it is really another word for “position sizing.”
Average Directional Movement (ADX) An indicator that measures how much a market is trending. Both bullish and bearish trends are shown by positive movement.
Average True Range (ATR) The average over the last X days of the true range, which is the largest of the following: (1) today’s high minus today’s low; (2) today’s high minus yesterday’s close; or (3) today’s low minus yesterday’s close.
Backtesting The process of testing a trading strategy on prior time periods, usually with just one instrument at a time. Instead of applying a strategy to a future time period, which could take years, a trader can do a simulation of his or her trading strategy on relevant past data in order to gauge its effectiveness. Most technical analysis strategies are tested with this approach.
Band Trading A style of trading in which the instrument being traded is thought to move in a range of price. Thus when the price gets too high (that is, overbought), you can assume that it will go down. And when the price gets too low (that is, oversold), you can assume that it will probably move up.
Bearish Of the opinion that the market will be going down in the future.
Best-case Example A situation that represents the best of possible outcomes. Many books show you illustrations of their key points about the market (or indicator) that appear to perfectly predict the market. However, most examples of these points are not nearly as good as the one that is selected, which is known as a “best-case example.”
Bias The tendency to move in a particular direction. This could be a market bias, but most of the biases discussed in this book are psychological biases.
Bid-ask Spread The spread market makers offer to potential investors who want to open a position with them. Typically, this spread is how the market makers make their profit. If you want to sell, you’ll get the lower price (that is, the market maker’s bid price), and if you want to buy, you’ll get the higher price (that is, the market maker’s ask price).
Blue-chip Companies Top-rated companies.
Breakout A move up from a consolidation or band of sideways movement.
Bullish Of the opinion that the market will be going up in the future.
Call An option that gives you the right to buy the underlying instrument at a particular price until the expiration date. It is a right to buy, but not an obligation.
Candlestick A type of bar chart, developed by the Japanese, in which the price range between the open and the close is either a white rectangle (if the close is higher) or a black rectangle (if the close is lower). This type of chart has the advantage of making the price movement more obvious visually.
Capitalization The amount of money in the underlying stock of a company.
Channel Breakout See "Breakout" definition.
Chaos Theory A theory that physical systems generally move from stability to chaos. This theory has recently been used to explain explosive moves in the markets and the nonrandomness of the markets.
Climax Reversal A sharp price decline following a sharp price increase. When a position is moving up, it will often move up dramatically at the end of the move; this is called a climax move. It’s usually followed by a drop in price, which is called a climax reversal.
Commissions Fees that you pay a broker to trade in the market.
Commodities Physical products that are traded at a futures exchange. Examples of such products are grains, foods, meats, and metals.
Congestive Range See consolidation.
Consolidation A pause in the market during which prices move in a limited range and do not seem to trend.
Contract A single unit of a commodity or future. For example, a single unit or contract of corn is 5,000 bushels. A single unit of gold is 100 ounces.
Core Equity One of the three ways of measuring your equity. In this particular case, you subtract the allocation of each position and
assume that it is gone until the position is closed. What remains, upon which to base your position sizing for other positions, is your core equity.
Credit Spread An options trading strategy by which an investor buys one instrument and sells another related instrument and receives money for the transaction. This is called a credit spread because the investor received money to make the transaction.
Dampening Factor A term developed by Ryan Jones for describing how to lower your position sizing after losses. It refers to a number whereby you move delta down at a faster rate than you moved it up. (See delta).
Debit Spread An options trading strategy by which an investor buys one instrument and sells another related instrument and pays money to make the transaction. This is called a debit spread because it costs the investor money to make the transaction.
Degree of Freedom A statistical term used to describe the quantity that equals the number of independent observations less the number of parameters to be estimated. More degrees of freedom generally help in describing past price movement and hurt in predicting future price movement.
Delta In fixed ratio position sizing, delta refers to the factor by which you determine how you add bigger positions. In fixed ratio position sizing one increases a position size by one unit as a function of some fixed ratio of the account, which Ryan Jones calls delta.
Delta Down Delta can be used to both increase and decrease position sizing with fixed ratio position sizing. Refers to decreasing the position sizing based upon a fixed ratio of the account called delta.
Delta Phenomenon A theory developed and trademarked by Jimmy Sloman and marketed by Welles Wilder that purports to predict the movement of the markets by what happens in our solar system.
Delta Up Delta can be used to both increase and decrease position sizing with fixed ratio position sizing. Refers to increasing the position sizing based upon a fixed ratio of the account called delta.
Dev-Stop A stop-loss criterion developed and copyrighted by Cynthia Kase that depends on the standard deviation of price movement.
Directional Movement An indicator attributed to J. Welles Wilder using the largest part of today’s range that is outside of yesterday’s range.
Disaster Stop A stop-loss order to determine your worst-case loss in a position. See stop-loss order.
Discretionary Trading Trading that depends on the instincts of the trader as opposed to a systematic approach. The best discretionary traders are those who develop a systematic approach and then use discretion in their exits and position sizing to improve their performance.
Divergence A term used to describe two or more indicators failing to show confirming signals.
Diversification Investing in independent markets to reduce the overall risk.
Down-Quiet One of the six types of markets in which the price is going down, and the market shows little day-to-day movement.
Down-Volatile One of the six types of markets in which the price is going down, but the market shows a lot of up and down movement, as opposed to a down-quiet market.
Drawdown A decrease in the value of your account because of losing trades or because of “paper losses” that may occur simply because of a decline in value of open positions.
EA mathematical abbreviation for the exponent of 10 used to help shorten the expression of large or small numbers. Examples: 5.3E3 = 5,300, 4.8E-3=.0048
Elliott Wave A theory developed by R. N. Elliott that holds that the market moves in a series of five up waves followed by a series of three correction down waves.
Entry That part of your system that signals how or when you should enter the market.
Equal Units Model A position-sizing model in which you purchase an equal dollar amount of each position.
Equities Stocks secured by ownership in the company.
Equity The value of your account.
Equity Crossover A form of position sizing in which the position sizing changes based upon your equity moving above or below some average.
Equity Curve The value of your account over time, illustrated in a graph.
Equity Model The method you use to determine your equity in anti-martingale position sizing. Three such methods are presented in this book: total equity, core equity, and reduced total equity.
Exit That part of your trading system that tells you how or when to exit the market.
Expectancy How much you can expect to make on the average over many trades. Expectancy is best stated in terms of how much you can make per dollar you risk. Expectancy is the mean R of an R-multiple distribution generated by a trading system.
Expectunity A term used to express expectancy multiplied by opportunity. For example, a trading system that has an expectancy of 0.6R and produces 100 trades per year will have an expectunity of 60R.
False Positive Something that gives a prediction that then fails to happen.
Fibonacci Retracements The most common levels used in retracement analysis, which are 61.8 percent, 38 percent, and 50 percent. When a move starts to reverse the three price levels are calculated (and drawn using horizontal lines) using a movement’s low to high. These retracement levels are then interpreted as likely levels where countermoves will stop. Fibonacci ratios were also known to Greek and Egyptian mathematicians. The ratio was known as the Golden Mean and was applied in music and architecture.
Filter An indicator that selects only data that meets specific criteria. Too many filters tend to lead to overoptimization.
Fixed Ratio Position Sizing A method in which position sizing is altered to some ratio of your account, called delta, rather than some percentage of your account.
Financial Freedom A financial state that occurs, according to Van Tharp, when your passive income (income that comes from your money working for you) is greater than your expenses. For example, if your monthly expenses total $4,000 and your money working for you brings in $4,300 per month, then you are financially free.
Floor Trader A person who trades on the floor of a commodities exchange. Locals tend to trade their own account, while pit brokers tend to trade for a brokerage company or a large firm.
Forex The foreign exchange. A huge market in foreign currencies made by large banks worldwide. Today there are also much smaller
companies that allow you to trade forex, but they take the side of the bid-ask spread opposite from you.
Fundamental Analysis Analysis of the market to determine its supply-and-demand characteristics. In equities markets, fundamental analysis determines the value, the earnings, the management, and the relative data of a particular stock.
Futures A contract obligating its holder to buy a specified asset at a particular time and price. When commodity exchanges added stock index contracts and currency contracts, the term futures was developed to be more inclusive of these assets.
Gambler’s Fallacy The belief that a loss is due to occur after a string of winners and/or that a gain is due to occur after a string of losers.
Gann Concepts Various concepts for predicting market movements. These concepts were developed by the famous stock market forecaster W. G. Gann. One of the concepts is a Gann square, which is a mathematical system to find support and resistance based on the extreme high or low price for a given period. The attainment of a particular price level in the square, according to Gann, tells you the next probable price peak.
Gap An area on a price chart in which there are no trades. Normally this occurs after the close of the market on one day and the open of the market on the next day. Lots of things can cause this, such as an earnings report coming out after the stock market has closed for the day.
Gap Climax A climax move that begins with a gap at the opening.
Generalized Ratio Position Sizing In this method you simply adjust the speed at which position sizing increases with FRPS.
Group Heat Each group, be it a sector of stocks or a grouping of commodities, will tend to move together. Thus, it is important to control the total open risk in any one group, known as the group heat.
Gunslinger Someone who makes high-risk trades or investments.
Histogram A graphical representation of a distribution of data.
Hit Rate The percentage of winners you have in your trading or investing. Also known as the reliability of your system.
Holy Grail System A mythical trading system that perfectly follows the market and is always right, producing large gains and zero drawdowns. No such system exists, but the real meaning of the Holy Grail is right on track: it suggests that the secret is inside you.
Indicator A summary of data presented in a supposedly meaningful way to help traders and investors make decisions.
Initial Risk The difference between your stop level and your entry price when you open a position in the market. It is usually referred to as R in this book.
Inside Day A day in which the total range of prices falls between the range of prices of the prior day.
Intermarket Analysis The use of the price moves of one market to predict what will happen to another market. For example, the price of the dollar might change depending on what happens with Treasury bonds, British pounds, gold, and oil.
Investing A buy-and-hold strategy that most people follow. If you are in and out frequently or you are willing to go both long and short, then you are trading.
Judgmental Heuristics Shortcuts that the human mind uses to make decisions. These shortcuts make decision making quite quick and comprehensive, but they lead to biases in decision making that often cause people to lose money.
Largest Expected Equity Drop (LEED) Used by Gallacher to describe a person’s risk limits. It refers to the largest drop in equity that a trader or investor can tolerate.
Leverage Describes the relationship between the amount of money one needs to put up to own something and its underlying value. High leverage, which occurs when a small deposit controls a large investment, increases the potential size of profits and losses.
Limit Move A change in price that reaches the limit set by the exchange in which the contract is traded. Trading usually is halted when a limit move is reached.
Limit Order An order to your broker in which you specify a limit as to how much you want to buy or sell a position for. If your broker cannot get this price or better, the order is not executed.
Liquidity The ease and availability of trading in an underlying stock or futures contract. When the volume of trading is high, there is usually a lot of liquidity.
Long Owning a tradable item in anticipation of a future price increase. Also, see short.
Low-risk Idea An idea that has a positive expectancy and is traded at a risk level that allows for the worst possible situation in the short term so that one can realize the long-term expectancy.
MACD See moving average convergence divergence.
Margin The percentage of the total price of something that an exchange requires you to have in order to open and hold a position in the market. It is usually set by the exchange that controls the trading of that particular market.
Marked to Market A term used to describe the fact that open positions are credited or debited funds based on the closing price of that open position during the day. If you have an open position, it’s considered to be worth whatever the closing price is at the end of the day.
Market Maker A broker, bank, firm, or individual trader that makes a two-way price to either buy or sell a security, currency, or futures contract.
Market Order An order to buy or sell at the current market price. Market orders are usually executed quickly, but not necessarily at the best possible price.
Market SQN A measure of a market’s movement through an application of the System Quality Number calculation. To calculate, the daily changes from close to close measured in percentage terms are averaged and the standard deviation is calculated. Plugged into the SQN formula, those values and the number of days (N) provide the market SQN score.
Market Type A categorization of market conditions that helps describe various price behaviors. Combining trend measurements of up, down, and sideways with volatility measurements of quiet or volatile yields six market types. Trading system performance varies by market type allowing traders to develop optimally performing trading systems for each type or to vary position sizing strategies by type.
Market’s Money A form of position sizing in which your core equity is sized at a conservative level while profits (market’s money) are sized at a more aggressive level. In other words, market’s money refers to your profits in the market.
Martingale Strategy A position-sizing strategy in which the position size increases after you lose money. The classic martingale strategy is where you double your bet size after each loss.
Maximum Adverse Excursion (MAE) The maximum loss attributable to price movement against the position during the life of a particular trade.
Maximum/Minimum Ending Equity When you simulate a position sizing strategy, two of the data points that you probably will keep track of are the minimum and maximum amounts of money that you have in your account at the end of each run of the simulation. When the simulation is complete, the maximum and minimum from all of the simulations is known as the maximum and minimum ending equity, respectively.
Maximum Mean Return When you do a number of simulations, you want to know the mean (average) return of each simulation. The largest of these is known as the maximum mean return.
Maximum Median Return When you do a number of simulations, you want to know the median (half are above and half are below) return of each simulation. The largest of these is known as the maximum median return.
Mean The average or the sum of all of the numbers divided by the total number of numbers.
Mechanical Trading A form of trading in which all actions are determined by a computer with no additional human decision making.
Median The middle point of a sequence of numbers arranged in sequence. In other words, half the numbers are above the median and half the numbers are below it.
Mental Rehearsal The psychological process of preplanning an event or strategy in one’s mind before actually doing it.
Mental Scenario Trading A trading concept in which the trader uses his or her macro assessment of what is going on in the markets to develop trading ideas.
Modeling The process of determining how some form of peak performance (such as top trading) is accomplished and then the passing on of that training to others.
Momentum An indicator that represents the change in price now from some fixed time period in the past. Momentum is one of the few leading indicators. Momentum as a market indicator is quite different from momentum as a term in physics to express the quantity that equals mass times velocity.
Money Management A term that has been frequently used to describe position sizing but that has so many other connotations that people fail to understand its full meaning or importance. For example, the term also refers to (1) managing other people’s money, (2) controlling risk, (3) managing one’s personal finances, and (4) achieving maximum gain.
Monte Carlo Simulation A simulation that determines the probability of trading results based on multiple trials.
Moving Average A method of representing a number of price bars (that is, showing the high, low, open, and close in a specific period of time) by a single average of all the price bars. When a new bar occurs, that new bar is added, the last bar is removed, and a new average is then calculated.
Moving Average Convergence Divergence (MACD) A technical indicator developed by Gerald Appel that follows the difference between a series of moving averages. The indicator has two lines, the MACD line and a signal line. A buy signal is generated when the MACD line rises above the signal line. A sell is generated when the MACD line falls below the signal. Because the MACD is generated from moving averages, it has a unique ability to capture wide-swinging moves in markets. Divergence, trendlines, and support can also be applied to the MACD to generate additional signals.
Multiple-tier Position Sizing Changing the value of your position sizing variable multiple times when some performance criterion is met.
Negative Expectancy System A system in which you will never make money over the long term. For example, all casino games are designed to be negative expectancy games. Negative expectancy systems also include some highly reliable systems (that is, those with a high hit rate) that tend to have occasional large losses.
Neuro-Linguistic Programming (NLP) A form of psychological training developed by systems analyst Richard Bandler and linguist John Grinder. It forms the foundation for the science of modeling excellence in human behavior. However, what is usually taught in NLP seminars are the techniques that are developed from the modeling process. For example, we have modeled top trading, system development, position sizing, and wealth building at the Van Tharp Institute. What we teach in our workshops is the process of doing those things, not the modeling process itself.
Objectives What you wish to accomplish as a trader with your account or your system. Objectives can be stated in terms of the desired goal, the worst-case drawdown to be avoided, or some combination of the two. There are many ways of thinking about objectives, probably as many ways as there are traders. The purpose of position sizing is to help you meet your objectives.
Ongoing Risk A term referring to the monitoring and management (through position sizing strategies) of open risk in a position or portfolio.
Open Position Value The price of an open position multiplied by the current number of units that you own.
Open Risk The difference between the current price and the value of the stop for all positions that you have open in the market. It’s another word for portfolio heat.
Open Volatility The amount of risk exposure for an open position or all open positions based on volatility.
Opportunity See trade opportunity.
Optimal F A method for determining position sizing developed by Ralph Vince that depends upon the worst-case loss you have experienced to date. The method uses iteration to determine position sizing.
Optimal Position Size The best position sizing method to achieve your objectives.
Optimal Target Risk Percentage The optimal portfolio heat divided by the number of trades you’re a likely to have on.
Optimal Retire The position sizing percentage that gives you the largest probability of reaching your stated goal.
Optimize To find those parameters and indicators that best predict price changes in historical data. A highly optimized system usually does a poor job of predicting future prices.
Option The right to buy or sell an underlying asset at a fixed price up to some specified date in the future. The right to buy is a call option, and the right to sell is a put option.
Options Spread A trading strategy by which one opens two options positions at the same time and profits from the difference in the price of the two positions. See debit spread and credit spread.
Oscillator An indicator that detrends (normalizes) price. Most oscillators tend to go from 0 to 100. Analysts typically assume that when the indicator is near zero, the price is oversold and that when the price is near 100, it is overbought. However, in a trending market, prices can be overbought or oversold for a long time.
Parabolic An indicator that has a U-shaped function, based on the function y = ax2+ bx + c. Because it rises at an increasing rate over time, it is sometimes used as a trailing stop that tends to keep one from giving back much profit. In addition, a market is said to be parabolic when it starts rising almost vertically as many high-tech stocks did in 1999, sometimes doubling each month.
Paradigm Shift A change from one way of thinking to another. It's a revolution, a transformation, a sort of metamorphosis. It does not just happen, but rather it is driven by agents of change.
Passive Income Income that occurs because your money is working for you.
Peak-to-Trough Drawdown A term that is used to describe one’s maximum drawdown from the highest equity peak to the lowest equity trough prior to reaching a new equity high.
Percent Margin Model A position sizing strategy that is based upon the margin set by the exchange in order to determine your position sizing.
Percent Risk Model A position-sizing model in which position sizing is determined by limiting the risk on the position to a certain percentage of your equity.
Percent Volatility Model A position-sizing model in which position sizing is determined by limiting the amount of volatility (which is usually defined by the average true range) in a position to a certain percentage of your equity.
Portfolio Heat The total open risk in your portfolio at any given time. This generally should not exceed 20%.
Position Sizing Strategy The most important of the six key elements of successful trading. This term, invented in the first edition of this book, refers to the part of your system that really determines whether or not you’ll meet your objectives. This element determines how large a position you will have throughout the course of a trade. In most cases, algorithms that work for determining position size are based on one’s current equity.
Positive Expectancy A system (or game) that will make money over the long term if played at a risk level that is sufficiently low. It also means that the mean R-value of a distribution of R multiples is a positive number.
Postdictive Error An error that is made when you take into account future data that you should not know. For example, if you buy on the open each day, if the closing price is up, you will have the potential for a great system, but only because you are making a postdictive error.
Prediction A guess about the future. Most people want to make money through guessing future outcomes, that is, prediction. Analysts are employed to predict prices. However, great traders make money by “cutting losses short and letting profits run,” which has nothing to do with prediction.
Price/Earnings (P/E) Ratio The ratio of the price of a stock to its earnings. For example, if a $20 stock earns $1 per share each year, it has a price/earnings ratio of 20. The average P/E of the S&P 500 over the last 100 years has been about 17.
Price Shock A sudden and very large price movement.
Price-to-Sales Ratio The ratio of the price of a stock to its sale. For example, if a stock sells for $20 and has $1 per share in total sales, then it has a price-to-sales ratio of 20.
Proprietary Methodology A methodology that a trader keeps to himself because (1) he doesn’t want to share its secrets or (2) he doesn’t want to answer questions about what he does.
Psychological Loss A loss as a result of your natural biases and psychology (usually larger than 1R).
Put Option An option that gives someone the right to sell the underlying instrument at a predetermined price up to a specific expiration date. It is the right to sell but not the obligation.
R Multiple A term used to express trading results in terms of the initial risk. All profits and losses can be expressed as a multiple of the initial risk (R) taken. For example, a 10R multiple is a profit that is 10 times the initial risk. Thus, if your initial risk is $10, then a $100 profit would be a 10R-multiple profit. When you do this, any system can then be described by the R-multiple distribution that it generates. That distribution will have a mean (expectancy) and standard deviation that will characterize it.
R-Multiple Distribution The set of trade results expressed in R-multiple terms generated by a trading system. The expectancy (mean) for the distribution describes the average expected result of the trading system while the standard deviation will describe the variability of the results around the expectancy.
Rvalue A term used to express the initial risk taken in a given position, as defined by one’s initial stop loss.
Random An event determined by chance. In mathematics, a number that cannot be predicted.
Random Entry System A trading system that enters positions randomly.
Reduced Total Equity One of the three equity models. In this case, you subtract out any allocation that you make for new positions, but when you raise your stops, you add back any amount that would be saved by raising your stops. The resulting number is your reduced total equity, which is then used to determine position sizing.
Relative Strength Index (RSI) A futures market indicator described by J. Welles Wilder, Jr., that is used to ascertain overbought and oversold conditions. It is based on the close-to-close price change.
Reliability How accurate something is or how often it wins. Thus, “60 percent reliability” means that something wins 60 percent of the time.
Resistance An area on a chart up to which a stock can trade but cannot seem to exceed for a certain period of time.
Retire Determines the trading goal (i.e., the retire amount).
Retire-Less-Ruin The probability of reaching our goal less the probability of having our worse case drawdown.
Retracement A price movement in the opposite direction of the previous trend. A retracement is usually a price correction.
Reward-to-Risk Ratio The average return on an account (on a yearly basis) divided by the maximum peak-to-trough drawdown. Any reward-to-risk ratio over 3 that is determined by this method is excellent. It also might refer to the size of the average winning trade divided by the size of the average losing trade.
Risk The difference in price between the entry point in a position and the worst-case loss that one is willing to take in that position. For example, if you buy a stock at $20 and decide to get out if it drops to $18, then your risk is $2 per share. Note that this definition is much different than the typical academic definition of risk as the variability of the market in which you are investing.
Rollovers Moving a futures contract into the next most liquid trading month when the contract expires.
Round Trip/ Turn A term that refers to the process of both getting into and exiting a futures contract. Futures commissions are usually based on a round turn as opposed to being based on charges for both getting in and getting out.
Ruin The amount of drawdown in your account at which you would stop trading.
Scaling-In A form of position sizing in which you keep adding to the position size based upon certain pre-determined criteria until you reach some maximum level.
Scaling-Out A form of position sizing in which you reduce your size when the open risk or open volatility exceeds a pre-determined level. The purpose is to maintain a constant risk, or volatility, in your account.
Scalping A term that refers to the actions, usually of floor traders, who buy and sell quickly to get the bid and ask prices or to make a quick profit. The bid price is what they will buy it for (and what you’ll get as a seller), and the ask price is what they’ll sell it for (and what you’ll get as a buyer).
Seasonal Trading Trading based on consistent, predictable changes in price during the year due to production cycles or demand cycles.
Secular (bull or bear) Market A term that refers to long-term tendencies in the market to increase valuations (bull) or decrease valuations (bear). Secular tendencies can last for several decades, but they say nothing about what the market will do in the next few months or even the next year.
Setup A term that refers to a part of your trading system in which certain criteria must be present before you look for an entry into the market. People used to describe trading systems by their setups. For example, CANSLIM is an acronym for the setup criteria of William O’Neil.
Sharpe Ratio A ratio developed by Nobel Laureate William F. Sharpe to measure risk-adjusted performance. It is calculated by subtracting
the risk-free rate from the rate of return for a portfolio and dividing the result by the standard deviation of the portfolio returns.
Short Not actually owning an item that you are selling. If you were using this strategy, you would sell an item in order to be able to buy it later at a lower price. When you sell an item before you have actually bought it, you are said to be shorting the market.
Sideways Market A market that moves neither up nor down.
Sideways-Quiet One of the six types of markets in which the price moves very little over time and the market also shows little day-to-day movement.
Sideways-Volatile One of the six types of markets in which the price moves very little over time, but the market shows a lot of day-to-day movement.
Signal to Noise Ratio A measure of signal strength compared with the background noise used commonly in engineering and science. One method of calculation involves dividing the mean by the standard deviation for a set of measurements.
Slippage The difference in price between what you expect to pay when you enter the market and what you actually pay. For example, if you attempted to buy at 15 and you end up buying at 15.5, then you have a half point of slippage.
Specialist A floor trader assigned to fill orders in a specific stock when the order has no offsetting order from off the floor.
Speculating Investing in markets that are considered to be very volatile and thus quite “risky” in the academic sense of the word.
Spreading The process of trading two related markets to exploit a new relationship. Thus, you might trade Japanese yen in terms of British pounds. In doing so, you are trading the relationship between the two currencies.
Stalking A term that refers to the process of getting ready to get into a position. This is one of the Ten Tasks of Trading from Dr. Tharp’s model.
Standard deviation The positive square root of the expected value of the square of the difference between some random variable and its mean. A measure of variability that has been expressed in a normalized form.
Statistical Significance A set of results has a cause and therefore is not random. The term is often related to sample size because larger sample sizes tend to better represent the population and minimize sample errors. Generally speaking, a sample needs more than thirty results before it can be considered having any statistical significance.
Step up/Step Down Function A mathematical function that has a fixed way to move up or move down in value.
Stochastic An overbought-oversold indicator, popularized by George Lane, that is based on the observation that prices close near the high of the day in an uptrend and near the low of the day in a downtrend.
Stop (Stop Loss, Stop Order) An order you put with your broker that turns into a market order if the price hits the stop point. It’s typically called a stop (or stop-loss order) because most traders use it to make sure they sell an open position before it gets away from them. It typically will stop a loss from getting too big. However, since it turns into a market order when the stop price is hit, you are not guaranteed that you’ll get that price. It might be much worse. Most electronic brokerage systems will allow you to put a stop order into their computer. The computer then sends it out as a market order when that price is hit. Thus, it does not go into the market where everyone might see it and look for it.
Support The price level that historically a stock has had difficulty falling below. It is the area on the chart at which buyers seem to come into the market.
Swing Trading A term that refers to short-term trading designed to capture quick moves in the market.
System A set of rules for trading. A complete system will typically have (1) some setup conditions, (2) an entry signal, (3) a worst-case disaster stop loss to preserve capital, (4) a profit-taking exit, and (5) a position-sizing algorithm. However, many commercially available systems do not meet all of these criteria. A trading system might also be described by the R-multiple distribution it generates.
System Quality Number (SQN) A method used in this book to determine the quality of a system. It is based upon the statistical t-score. The System Quality Number is also used as a basis for determining how to position size to meet your objectives.
System Quality Number 100 Score (SQN 100) The SQN score normalized to 100 trades. For systems with few trades, assuming 100 trades in calculating the SQN score can provide a sense (potentially false) of a system’s quality after many trades. For systems with hundreds of trade, normalizing the SQN score to 100 trades emphasizes the signal to noise ratio. A high number of trades can mask a weak signal to noise ratio and provide an impractical figure for developing an effective position sizing strategy.
T-Score The value derived from the statistical t-test which has several uses including testing whether a sample is significantly different than random results.
Tick A minimum fluctuation in the price of a tradable item.
Timing Technique A trading technique that attempts to assist people in entering the market just before an up move or in selling just before a down move.
Total Equity One of the three equity models that determines the value of your account by your cash and the total value of your open positions in the market.
Trade Distribution A term that refers to the manner in which winning and losing trades are achieved over time. It will show the winning streaks and the losing streaks.
Trade Opportunity One of the six keys to profitable trading. It refers to how often a system will open a position in the market.
Trading Opening a position in the market, either long or short, with the expectation of either closing it out at a substantial profit or cutting losses short if the trade does not work out.
Trading Cost The cost of trading, which typically includes brokerage commissions and slippage, plus the market maker’s cost.
Trailing Stop A stop-loss order that moves with the prevailing trend of the market. This is typically used as a way of exiting profitable trades. The stop is only moved when the market goes in your favor. It is never moved in the opposite direction.
Trading System A set of rules for trading a particular method or strategy. A complete trading system will typically have (1) some setup conditions, (2) an entry signal, (3) a worst-case disaster stop loss to preserve capital, (4) a profit-taking exit, and (5) a position sizing algorithm. A trading system might also be described by the R-multiple distribution it generates.
Trend Following The systematic process of capturing extreme moves in the market with the idea of staying in the market as long as the market continues its move.
Trending Day A day that generally continues in one direction, either up or down, from the open to the close.
Trendline A line connecting the tops (or bottoms) of rising or falling markets. This line is believed to reflect the market trend. Market technicians tend to believe that when the price “breaks” the trendline, then the trend is probably over. However, it often means that they simply have to draw a new trendline.
Turtle Soup A trademarked entry technique that is based on the assumption that markets typically reverse after 20-day channel breakouts.
Two-Tier Position Sizing Position sizing that starts at some level and then moves to another level when some predetermined criteria are met.
Units Per Fixed Amount of Money Model A position-sizing model in which you typically buy one unit of everything per so much money in your account. For example, you might buy one unit (that is, 100 shares or one contract) per $25,000.
Up-Quiet One of the six kinds of markets in which the price is moving up, but the day-to-day activity of the market is not active.
Up-Volatile One of the six kinds of markets in which the price is moving up, and the day-to-day activity of the market is fairly active.
Validity A term that indicates how “real” something is. Does it measure what it is supposed to measure? How accurate is it?
Valuation An exercise in giving some value on the price of a stock or commodity based on some model for determining value. See value trading.
Value Trading A term that refers to a concept in which positions are opened in the market because they have good value. There are numerous ways to measure value. However, a good way of thinking about it is that if the assets of a company are worth $20 per share and you can buy the company for $15 per share, then you are getting a good value. Different value traders will have different ways to define value.
Variability The possible range of outcomes for a given event.
Volatility A term that refers to the range of prices in a given time period. A high-volatility market has a large range in daily prices, whereas a low-volatility market has a small range of daily prices. This is one of the most useful concepts in trading.
Volatility Breakout An entry technique that calls for entering the market when it moves a specific amount from the open, based on the previous daily ranges of the market. For example, a “1.5 ATR volatility breakout” would call for entering the market when it moved (up or down) more than 1.5 times the average true range of the last X days from today’s open.
Win Rate The percentage of closed trades in which you make money.
Worst-Case Scenario A situation that represents the least desirable of possible outcomes. Typically, you need to plan for the possibility that this might happen through the proper use of position sizing. This will usually guarantee that you will survive as a trader.