Debt / GDP, Unemployment Rates, S&P Credit Ratings

To help put things in perspective we have complied the following table which compares three important and highly topical economic statistics as at Oct 2011.

Traditional forms of technical analysis have been practiced for decades with limited success. Most of the technical analysis methods taught to the public currently have not changed much for many years.

The entry points on patterns and trendline breaks are fairly easy to predict and the stop loss calculations most traders use are limited to a few methods.

However, the nature of the market has changed and the speed with which price moves has made the implementation of a conventional trading strategy much more problematic than it used to be.

Algorithmic trading has delivered an eightfold increase in the number of share transactions on the Australian stock exchange in just five years – but sharply reduced the size of each deal as disclosed recently by the ASX.

Trading statistics published by the ASX show that close to 1500 transactions a minute are being processed, compared with barely 200 in 2005. The weekly range of motion or average true range of a stock like Rio Tinto has increased on average 4-5 times compared with its ATR in 2005.

However those averages disguise peaks of activity, most often observed at market openings and closes. In 2006, the number of changes in the order books (buy and sell orders) peaked at about 2000 per second, while in the last year they hit 12,000 per second. For comparison, the current system has the capacity to handle up to 20,000 orders per second. If it continues to increase at the current rate, it will reach capacity by the end of this year unless computing power increases at a greater rate and the ASX stays ahead of the game.

The ASX would like the trading market to believe that the steep climb in the number of transactions reflects algorithmic traders breaking up a buy or sell order into hundreds of smaller deals that can be executed simultaneously, so that the market price is not changed significantly by their activity.

However, as this article will show, the other use of algorithmic trading programs is to create rapid movement of price to ensure that traders using traditional (known) trading methods are either trapped into bad trades or have their stops hit before the price rises.

In short, algorithmic traders manipulate the price in order to disadvantage traders who are unaware of the danger to their trading balance.

In conventional trading methodology, traders are taught to enter and exit a trade in a finite number of ways. Trading methodologies are widely taught and freely available in print and from trading educators. Entry criteria normally include breakouts from flags, pennants and triangles, falling resistance line breaks and rising support breaks.

Exit criteria, including placement of stop points are also widely known. These include but are not limited to penetration of a rising support line or falling resistance line, the first major low preceding the entry point, and an average true range trailing stop. It is also widely known that most traders trade emotionally. After a trade has run past their entry level, many traders will put their stops at the entry levels to make the trade become “risk free”.

Given the limited number of trading methodologies that are commonly used, if you were in the position of a competitive algorithmic trader and you had the ability and capacity to move price on an instrument, you would move it to counter the commonly used methods, too.

If you were a football coach and you had the opposition’s playbook, you’d use it, wouldn’t you?

In today’s high frequency marketplace price can move very rapidly. This is often done to the detriment of traders using traditional methods as the following charts show:

Above is the chart of Watpac (WTP.ASX). I would like to draw your attention to the price action on the 17th and 18th of January. In two days, the price moved from $1.90 to $1.95 down to a bottom price of $151.5. That is a 28.7% movement in the price of a top 300 company.

Did the fundamentals of the business change 28.7% in 2 days? Did the market segment interested in Watpac jump schizophrenically from euphoria to despair about its future value in 2 days? How would the valuers who determine the price to earnings ratio explain this? What possible explanation could there be for the rapid upward movement and rapid downward movement followed by settling at long term average, other than price manipulation?

The price action on the 17th was designed to trap traders into poor long positions. The price action on the 18th was designed to trigger any stops long traders may have had. This price movement on the 18th was designed to take out all stops set below the long term trend line, any of the previous three major lows and any traders who had entered in the previous several months who panicked about being down by 20%.

And it worked as shown by the volume traded on the 18th.

Another common pattern of price action that indicates that high frequency traders are manipulating price is the rapid price movement of an instrument prior to an upwards run. Find above a chart of STW Communications Group (SGN.ASX). I would like to draw your attention to the price action on 7 May in the centre of the chart. This price opened at 84 cents and plunged rapidly down to 76 cents before closing at 88 cents. The range of motion doubled the daily average true range.
Since many traders set their stops at major lows, the major lows on the 22nd of April, 24th of March, and 19th of March would all have been triggered by this rapid price movement. Often these rapid price movements occur at lunch time when traders are away from their desks and are unable to prevent their stops from being triggered.

This type of price action is frequently used as the trigger before an increase in the price. Its purpose is to shake out stops and pick up cheap volume prior to the price being marked higher.

As can be seen from the above two examples, price can move very rapidly in the current market and is instigated often by high frequency traders. These are only two examples of the hundreds that can be found on the ASX.

While this represents a grave threat to the uninformed investor, to the informed investor it represents an incredible opportunity. If the market manipulators change the price of an instrument in repeatable ways, then this can be used to the advantage of informed and educated traders. Currently, market manipulators do manipulate the price in a recognisable manner. Therefore, if a trader works in harmony with them, the trader can enjoy the benefits of the manipulations, instead of having their stops hit just before the price is marked up.

Michael Brook
http://www.tradingstate.com.au

When most people start trading, they never consider whether they are well prepared and have the necessary skills and attributes to be successful.  This is likely to be one of the last things on their mind.  Somewhere along the path of trading however, most people come to a realisation that trading is probably not as easy as they first thought.

With this humbling realisation comes a search and investigation in to what makes a successful trader.  They seek out what they need to do and learn about, in order to make all of this money they initially dreamed of.   They attend courses, converse with other traders further along the path of trading than them and make a committed effort to learning this new craft.

Whilst all of the tools may be gathered together including the new piece of charting software, data provider, new broker account opened, magazine subscription started, successful trading still has it foundations deep within the individual themselves.  It is probably only when people start trading for real with their own real money, that they begin to feel the emotional strains and pressures and then realise that they themselves may be a bigger part of the overall equation than initially thought.

OK, so we have reached this point in our trading lives.  We have become very interested in trading, saved some money for our trading capital, gathered some tools together at our disposal, started to trade and then lost some money.  Now we start working on ourselves; preparing ourselves to make all of this work so we can achieve our ultimate aim in trading – to make money!  Isn’t that why most people start trading in the first place?

Now we widen our search – we need to now work out what we need to do differently in order to start making money.  Rightly so, people then seek out the most important character attributes of successful traders.  Great idea!   What will they find however?  What are the most important character attributes of successful traders?

In my trading time, I have heard numerous responses to this question.  Not just one or two, but more than 10.  It certainly seems daunting to new traders when they are exposed to all of these different responses.

What are some of the responses I have heard?

Perseverance or stick-to-it-tive-ness was a common theme.  As Calvin Coolidge, the 30th President of the United States said in one of my favourite quotes, “The slogan ‘Press On’ has solved and always will solve the problems of the human race.”  Other similar terms include perseverance, commitment and determination.  For traders, this provides us the ability to continue on in the toughest of times even when everything appears all too much.  It is the edge that allows us to climb the walls that are obstacles when everyone else around us, turns away from the wall and does something else.

Another important attribute is humility.  All traders enter trades that lose money – you can’t simply get every trade right.  You will find the very best traders are very humble and they are the best losers.  Successful traders never move stops and accept losing as part and parcel of trading.  They are also not afraid to learn from others and admit they don’t know everything.

One attribute I don’t hear a lot about is patience.  You are not provided with great trading opportunities every day and the best traders are patient enough to wait long enough for high probability trades to come their way.  Financial markets are here to stay – they underpin the corporate arena in every country around the world, so they are not going anywhere.  Trading success is not going to happen overnight.  For most people, this is a life long endeavour so does it really matter if it takes you a few years to start trading profitably?

Another attribute is responsibility.  Successful traders make their own trading decisions based on their own analysis and trading plan but more importantly don’t blame anyone or anything else when it doesn’t work out and they lose money in a trade.  In a world nowadays where there is a clear trend of people looking for someone else to blame for their own actions, this is probably becoming less obvious.  The key is to be an adult and take responsibility for your own actions – you are solely responsible for your own success.

Successful traders are also conservative and very defensive.  Even though their primary motivation is to make money (as it is for all of us), they adopt a very defensive mindset and focus not so much on making money, but moreso on protecting the money they have.  This means they set and stick to stops and risk very little of their account on any individual trade.

With anything in life, confidence is important – trading is no exception.  Confidence in your self and the trading plan you develop.  One thing that will help with your confidence is your own knowledge and understanding of the markets, the products you are trading and various tools you use in your decision making.  Most importantly however, competence yields confidence. If you are not competent at something, it is highly unlikely that you will be confident doing it.

There are many other attributes that could also be listed here to include emotional control and stability, organizational skills and honesty.  There is no doubt that all of these are correct and valuable to possess, however I think there is none more important than the big D – Discipline.

Discipline is the level of self-control you have.  Trading all boils down to decision making and often the decisions that need to be made are difficult.  Let’s consider the options we have.  For any individual decision, there are often two options available to us.  The first option is the decision that will make us feel most comfortable and the one that we really want to take.  The second option is the one that follows our trading plan.  Most often these will be two very different outcomes.

There is one thing that assists us to take the second option and not the first – discipline.  I believe a key separator between successful traders and the rest, is they will act first upon their trading plan and not what they feel like doing.  Most traders make the decision that makes them feel the most comfortable whether this is letting a loss continue or to cut a profit short in order to realise some money.

When they feel super-confident about a trade, successful traders don’t allow greed to consume them and commit more money into the trade.  They trade according to their trading plan – they adhere to the money management rules in their trading plan.

“Discipline is the bridge between goals and accomplishments.”

Jim Rohn – motivational speaker

Here is what happens … we have our mind set on long term successful trading however other things influence our actions/trading decisions like emotions, our short term needs and our present mood.  These tend to overpower any long term goals we have, so we will often pursue short term pleasures and by doing so, avoid short term discomfort, at the expense of our longer term goals and rewards.  It’s human nature.

I was contacted recently by a colleague in Malaysia who had just watched a workshop DVD by psychiatrist Dr Ari Kiev on discipline and trading plans.  He asked the audience the question “What is the most important quality to be a successful trader?”

As there were many professionals in the audience, some said discipline, other a plan, some risk management.  Dr Kiev answered, “Yes, they are important but the most important thing is to tell the truth.  With integrity and truth in the way you approach the market and follow it, and run your trading business, you will be successful.”

My colleague continued and asked me what I thought about Dr Kiev’s comments.  Well, I can understand where Kiev is coming from with telling the truth, however I still believe that discipline is the most important.  Can you have honesty/integrity without personal discipline?  I would argue no.  If you lack discipline, then you probably won’t have what it takes to be truthful all the time.  Take that another step further, can you have any of the attributes listed here without discipline?  For example, can you be patient without a certain level of self-control?

Personally, I will be the first to admit that my time in the military starting way back at the Royal Military College, Duntroon has provided me some great skills and attributes to trade well – none more important than discipline.  Discipline has helped me greatly with my trading as well as other areas in my life.  It is discipline that makes me feel comfortable with deciding on what has to be done in accordance with my trading plan, as opposed to what I really want to do.

Whenever I talk about risk management in my workshops, I will always show a quote from Dr Van Tharp which says:

“Most successful market professionals achieve success by controlling risk.   Controlling risk goes against our natural tendencies.   Risk control requires tremendous internal control.”

For me, his ‘tremendous internal control’ equates to discipline.  Therein lies the key, doesn’t it?  If you want to achieve trading success, you need to manage your risk.  However, the problem is that to manage your risk goes against all the things we naturally want to do as people.  Often, we don’t want to cut losses and we do want to commit a lot of money to a trade that we feel super-confident about. In other words, to manage your money well, you need to be disciplined – this is how your mindset and money management are linked together.

By having your mind tuned into the trader’s mindset, you will be disciplined and committed to making all the right decisions.  Be disciplined and make it happen – it is a key to profitable trading.

Stuart McPhee

www.tradingasxshares.com