Wednesday, November 29, 2006

Trading with Fibonacci

What's Fibonacci All About?

First, for the uninitiated, we'll start with a brief summary. Leonardo Pisano Fibonacci was a mathematician who traveled widely with his father, an Italian diplomat. His book, Liber abaci, was published in 1202 after his return to Italy, and introduced the numeric sequence that came to be known by his name.

Fibonacci includes a series of ratios that are found throughout all of nature. These ratios appear just about everywhere - in music, in Greek architecture, in the alignment of planets, in the way a tree sprouts its leaves, in the way a mollusk grows its shell. There are simply countless examples of this phenomenon.

What on earth does any of this have to do with trading? If you are a natural-born skeptic like me, you're probably not terribly impressed by anything you've heard so far, and rightly so. There is no logical reason to believe that any trading vehicle (stock, commodity, or currency) will suddenly stop and change direction of its own volition when the price or exchange rate retraces by a particular ratio.

So why does Fibonacci work in the Forex market? Because Fibonacci ratios are a deeply ingrained part of the Forex culture. Big banks, hedge funds, and individual traders alike all pay close attention to these ratios, and frequently place their orders at Fibonacci retracement levels.

If enough orders accumulate at a particular level, the combined power of these orders can actually change the direction of the exchange rate when that level is achieved. This is the essence of the self-fulfilling prophecy that we discussed in last week's newletter.

If my assumption is correct that Fibonacci works in the Forex market not because of magic but due to a self-fulfilling prophecy, then there are certain conclusions that we can extrapolate from this premise:

Fibonacci Is More Effective on Longer-Term Charts

If we truly believe that Fibonacci is a self-fulfilling prophecy, then we should live by the credo, "the more, the merrier." In other words, the more orders that are placed at a particular level, the more likely it becomes that the level will hold as support or resistance.

What can improve the chances that there will be a large quantity of orders at a particular Fib level? Visibility is the key. If the other players can't see the Fib level, they can't place their orders accordingly.

For example, if a Fibonacci level forms on a five-minute chart during the Asian trading session, any opportunity to place a trade based on this retracement is likely to come and go before European and American traders have wiped the sleep from their eyes. Since many of these traders will never observe this opportunity, there will be fewer orders placed at that level. This makes it less likely that the level will hold when the price reaches that area.

However, if the same scenario occurs on the daily chart, traders all around the world will have the time and the opportunity to place their orders accordingly. Since Forex is truly an international market, with traders located on every part of the globe, this aspect of Fibonacci trading takes on added significance.

Fibonacci Is More Effective on Commonly Used Retracement Levels

The most commonly used Fibonacci ratios are 38.2%, 50%, and 61.8%. However, 23.6%, 78.6% and 100% are also legitimate Fib levels. Some traders even use Fibonacci "extensions" that go beyond 100%, such as a 161.8% retracement. There are also Fibonacci Arcs, Fibonacci Fans, and Fibonacci Time Zones.

Which of these techniques will be the most effective? If we truly believe that a sizable quantity of orders (or a quantity of sizable orders) will make the difference, then we must give more weight to the levels that garner the most attention - the 38.2%, 50%, and 61.8% levels. In Fibonacci, as in many aspects of trading, sometimes it's better to keep things simple.

Click the Trading with Fibonacci header link above to learn more about trading with Fibonacci retracement and extension levels.

Good day and good trading.

The Trading Learning Curve

Have you ever noticed that awareness is the first step toward future growth? If you want to improve in any area, read on below to understand the four stages of awareness as they relate to good trading.

The learning curve in any endeavor involves four stages:

1) Unconscious incompetence (where the trader has no idea how much
he doesn't know about trading)

2) Conscious incompetence (where the traders realizes after initial losses
that he has a lot to learn)

3) Conscious competence (where the trader has developed and is now
doing well as long as he works his system and its rules)

4) Unconscious competence (where the trader has mastered the rules
and also knows when to break the rules as conditions change, in a
complete flow with the markets based on great experience)

One of the biggest problems beginning traders face is not having a defined method or system to tell them when to get in and out. This leads to ego-based decisions which ultimately make it harder for the trader to pull the trigger due to increased uncertainty and overthinking the position. The way you avoid thinking too much during the trade itself is to practice consistent execution of your system's trades. This takes you from the conscious incompetence stage where the trader has not learned how to execute, to the conscious competence stage where you know that if you just focus on consistent execution of your plan, you can expect to win more consistently over time. It also is less stressful on your emotional state, since a systematic trader takes his ego out of the game and focuses on execution.

Every trader who wishes to improve his bottom-line results must decide what area most needs attention right now. The trader must start by taking an honest self-assessment of strengths and weaknesses, prioritize the highest impact areas and then focus on changing one behavior at a time. Most ambitious traders (myself included) have at one time tried to tackle too many issues at once, only to not produce the desired change in any of those areas. Change takes time. Just as a golfer hitting a drive or a basketball player shooting free throws has developed a certain "muscle memory" for success by repeated practice, so too have you created a muscle memory for your mindset, both in trading and in all areas of your life. The hardest part of the process is changing that memory from one that hasn't worked to one that will produce consistent results. But once your mind starts to recognize and get comfortable with these new procedures, maintenance of the change will be much easier.

You must commit to one objective and focus on it. Give yourself a month to work on a given issue, focusing on it each day in your trading journal. Set up potential solutions and then try them out to see if they fit your personality. Create a method to measure your progress. Do you have trouble taking a loss at your pre-defined stop objective? Trade very small for a month, and just work on following your system and taking each loss. The financial impact will be small for a month, but the discipline you instill will last you for years if done properly. You can take this approach with any issue you face. Just remember to stay focused on one habit at a time until you are confident you have mastered it.

Click The Trading Learning Curve to learn more about becoming an aware investor speculator and trader.

Good day and good trading.

Tuesday, November 28, 2006

Fundamental Principles of Investing

Stock trading basics are a necessity for traders to become prosperous in the stock market. It is necessary, if you will, to establish some fundamental principles as you are beginning investing in the stock market. Here are some basic strategies to follow:

Stock Trading Basics

Develop a stock trading plan! It’s pretty difficult to make a cake without a recipe and the same definitely applies to stock trading basics. Even the most experienced traders can get themselves into trouble by not following their plan. When are you going to buy a stock? When are you going to sell it? What are you going to do to prevent losing a lot of money if your stock goes bad?

Once you’ve developed your stock trading system, stick with it.

Trade safe and often. Especially for beginner investing, this is an important stock trading basic. Although your daily profit might seem small, it accumulates over an entire year. It is always better to win small than to lose big!

Look for stocks with the highest growth possibilities, and don’t hold stocks when their growth possibilities are close to the average value. When this happens, a wise stock tip is to switch to a stock that is more profitable. This requires stock technical analysis, but the results are worth the effort. Remember to factor in your transaction costs such as bid-ask spread and brokerage fees.

Avoid risks as much as possible and only take calculated ones at that. The most important stock trading basic is to remember that you are in this to make a profit and the best way to do that is conservatively. Don’t put all of your capital into just one stock. Portfolio diversification will be the thing that keeps you alive in the market, especially as you learn the stock trading basics.
Risk Reward Ratios

It’s important to realize BEFORE your first trade that not all of your investments will be successful. This stock trading basic is exactly why you need a trading plan. If you don’t have a trading plan, it is difficult to make money investing in stock. If you’ve ignored the plan for selecting your stock, and you don’t have a stop loss strategy, you may not have any funds left when your purchase finally quits falling. By not taking too many risks, having a stock investing system, and being willing to take small profits, an investor is able to keep the risk reward ratios tipped in his favor.

Learning stock trading basics isn’t difficult. Fundamental and technical analysis are things that anyone who is interested is able to learn. But the stock trading basics don’t lie in the details as much as they lie in the approach of the investor concerning stock trading basics and risk reward ratios. Once an investor has developed a successful plan and follows it, the rewards will far outweigh the risks and he/she will truly become a successful trader.

Click the Fundamental Principles of Investing header link above for more information on being a successful investor speculator and trader.

Good day and good investing.

Monday, November 27, 2006

Peak Performance Trading Tips

Peak Performance Trading Tips

By Van K. Tharp, Ph.D.

These trading tips will help you get yourself in the best possible condition mentally to perform at a peak level. They are not necessarily new, but they are critically important.

So whether you’ve heard them before, or not, now is the time to employ them in your trading and in your life. Both will improve as a result.

Tip #51: What It Takes To Have Confidence

Dear Dr. Van Tharp: Overconfidence presents a trading conundrum. I find I can’t trade big or successfully without lots of confidence. But when I’m at my most confident, the point where I lose all anxiety, I tend to have my biggest losses. How can a trader retain a healthy level of anxiety while remaining confident enough to "stay big"?

Sincerely,

N.

Dear N,

First, you have to know yourself. And this isn’t a small step because most people are not willing to go inside and do some exploration because they are too afraid of what they might find. Instead, they just say, “I already know myself.” But what if you have unlimited potential and you just don’t know how to tap into it because you are not willing to explore how you are blocking yourself?

Once you know yourself you can set up objectives that you are comfortable with and then set up trading systems that really fits you. Jack Schwager remarked after two market wizard books that the key element of success of all of the traders he interviewed was that they had systems that fit them. And I believe that’s part of having the confidence to trade your system.

So let me ask you the following questions – all of which are necessary to have a system that fits you.

Have you written down your beliefs about the big picture and does your trading system fit the big picture?

Have you written down your beliefs about the market (what works and what doesn’t) and does your system fit that.

Have you written down your beliefs about each part of a trading system and does your system fit that.

Are your objectives clear and do you have a position sizing algorithm that’s designed to meet your objectives.

Typically if your trading system fits all of those criteria, then you’ll feel really confident trading it. If not, then there are more questions to ask yourself.

What are your criteria for feeling confident about a trading system?

Do you understand how your system will perform in the six kinds of markets (and I’ll address this on the next tip). And here I don’t mean just its average performance, but the statistical outliers (i.e. two standard deviations away from the mean). Are you happy with that? Also, if your system is performing well above average, do you realize that and understand that below average performance usually will follow.

Do you have a worse case contingency plan and do you know how to keep most of those potential disasters from wiping you out? This is an important part of confidence and if you are not there then you shouldn’t be trading.

Lastly, are you following the ten tasks of trading as discussed in my Peak Performance Course? These are designed to 1) keep you disciplined and, most importantly, 2) prevent mistakes or at least prevent you from repeating mistakes.

I’ve covered a lot in this tip, but your question encompasses a lot. Trading is really a business. Most businesses fail because of lack of planning and what I’m really suggesting as the answer to your question is that you:

Treat trading like a business and not a hobby. If you haven’t done these things, then you’ll typically be the most confident at the end of a winning streak and then have your biggest losses, just like you said. If you have done these things, then you’ll understand the big picture for you and your performance will be much more consistent and elevated.

I’ve seen major trading entities that did not cover many of these points with their traders. Most of them performed poorly or eventually failed. And I’ve coached some entities (as well as many individuals) to encompass these points and when they do, they tend to flourish.

Click the Peak Performance Trading Tips header link above learn more about Van Tharp's excellent trading training programs.

Good day and good trading.

Sunday, November 26, 2006

Dollar Falls To New Lows Against Euro And Pound

InterbankFX Forex Report

The U.S. currency dropped sharply on Friday. The fall was led by a slide against the euro, where the breaking of the key 1.30 mark prompted a decline across the board. The greenback set new lows against the euro and pound.

The dollar drifted lower against the euro during overnight trading in New York. The decline picked up momentum in the 3 o'clock hour, with the greenback breaking sharply lower. The slide continued until about 5:30 am Eastern Time, when the dollar reached a level of 1.3104 against the euro. This was the lowest level since April of 2005. Since the 5:30 am Eastern Time, the dollar has kept to a narrow trading range against the euro. At 1:40 pm Eastern Time, the euro was worth 1.3095 dollars.

The greenback held steady against the yen in early morning trading in New York, but a euro-led decline in the dollar dragged it lower in the 3 o'clock hour. The downward momentum continued until after 7:30 am Eastern Time. The greenback reached a mark of 115.58, its lowest level in about 3 months. There was a mild recovery during the middle of the day. By 1:40 pm Eastern Time, a dollar was worth 115.77 yen.

After unremarkable trading in the overnight period, the dollar also dropped against the pound during the 3 o'clock hour. At about 5:30 am Eastern Time, the greenback reached 1.9349 versus the pound - its lowest level in almost 2 years. Range-bound trading marked the rest of the morning and the middle of the day. By 1:40 pm Eastern Time, the pound was worth 1.9315 dollars.

The overall slide in the greenback impacted its trading against the loonie as well. The dollar fell against its Canadian counterpart during the early morning hours in New York. The greenback hit a level of 1.1305 - its lowest level against the Canadian dollar in about a week and a half. The dollar drifted off this mark during the rest of the morning. By 1:40 pm Eastern Time, a dollar was worth 1.1336 Canadian dollars.

Click the Dollar Falls To New Lows Against Euro And Pound header link above to see the latest forex pairs buy and sell signals.

Happy trading next week!

Friday, November 24, 2006

Euro Pound At Monthly Highs

Incredibly wild night of action in FX markets as both euro and pound verticalzed in thin holiday trade to take out multiple option barriers and triggered a torrent of stops. Once the EUR/USD crossed the psychologically important 1.3000 level it invited massive inflows of speculative capital as momentum players, option sellers and wrong footed dollar bulls all scrambled for euros sending the pair higher by 70 points in a matter of seconds. The pound also rallied hard taking out the 1.9300 barriers as it made 20 month highs.

Having now reached these august levels the question facing the market is - what’s next? Although, much like a snowball rolling down a mountain, these momentum rallies can take a life of their own , we suspect that after some sober post holiday analysis the markets may conclude that this move is a bit overdone. With EUR/USD now above the 1.3000 level it will become progressively more difficult for EZ exporters to sustain their growth which has been the underlying foundation for the region’s economic recovery. Already producers worries are evident in tonight’s French production outlook which slipped to 14 from 17 expected. Unless EZ consumers increase their spending - and up to now they have shown very little inclination to do so, even with the motivation of higher VAT taxes next year - EZ growth could slow markedly into Q1 of 2007 putting a halt to any further rate hikes from ECB.

Meanwhile in UK, the economic news was also not supportive of this monstrous move in the pound as UK GDP printed slightly weaker at 2.7% versus 2.8% expected. More troubling for pound bulls was the sharp slowdown in private consumption which rose only 0.4% versus 0.6% expected. Given the fact that BoE’s recent rate hike decision was made with a surprisingly dovish 7-2 vote, further rate increases from UK central bank may not be forthcoming.

In the near term however, none of these economic considerations may matter as sheer momentum could easily overwhelm the fundamentals. In a typical irony for FX markets, volatility skyrocketed as a time when almost no one expected it to – during a holiday leaden week when US and Japanese traders were away from their desks. Once they return on Monday this one way market may finally begin to pause.

Click the Euro Pound At Monthly Highs header link above for more information about the forex market.

Thursday, November 23, 2006

Happy Thanksgiving

On Thanksgiving you'll find me where there is mountains of turkey and pie, sweet yams and potatoes piled high to the sky. Football being watched, football being played and long Christmas wish lists being made. Grandmas sneaking tastes of cool whip to her favorite grandkids, and dishes to be done less work to the highest bids. And surely you'll find me with the ones I love most. Talking and yes, eating and making a toast. To this meal To this day To the years yet to come. To my family and friends and to all of the fun. And of course to you my very good friend, I hope your Thanksgiving Day is wonderful to the very end. Happy Thanksgiving!

Wednesday, November 22, 2006

Euro Dollar

Now that we're getting into the holiday season, the news – which matters little for the direction of the forex markets anyway – begins to matter less than ever.

Case in point – Tuesday morning's (Nov. 21) action in the euro/dollar, with no major economic news anywhere in sight. So it's hard to explain the sharp 50-pip rally in the EURUSD if you're a "fundamentals" kinda guy. Sure, you could say that the euro rallied "as traders speculated the [U.S.] economy may be slowing enough for the Federal Reserve to reduce interest rates" (Bloomberg). But come on – is this sort of speculation anything new?

A better definition for Tuesday's market action could be a “technically-driven” rally. And as the end of the year approaches, you should prepare for more of these "technical" moves. Forex trading volumes get thinner during the holiday season, making it easier for a few traders to push the market around.

In this environment, having the right technical analysis method becomes critical. Our Currency Specialty Service won’t help you every time, but it might do it often enough to make a difference. For example, here's an intraday forecast we sent out on Tuesday morning, just as the EURUSD rally was starting:

09:15 ET/14:15 GMT
[EURUSD] Last Price: 1.2799
This little thrust down from a triangle should bring the correction from 1.2852 to an end. I'm looking for a low in the 1.2777-97 range.

The actual low came at $1.2799, just two pips above the upper range of our target. Lucky guess, you say? Not really. See that red line on the chart with the numbers 0.618 on it? That's a Fibonacci-derived support level. That's how we knew to expect the 1.2777-97 range to provide good support – and it did.

Get Forecasts of the Forex Markets You Follow.

Our Currency Specialty Service is a professional-grade advisory tool previously reserved mostly for global forex pros. With it, you can build your own, flexible and affordable, currency package to suit your trading needs. Each package is a bargain and the more you choose, the less each one costs.

Click the Euro Dollar header link above to learn more.

Good day and good trading.

Tuesday, November 21, 2006

Political News & The Markets

Before President Bush had even finished congratulating the Democrats on their return to power, analysts were already speculating on the impact on business from this political news. Since both parties have their “pet projects”, a change in power should shift focus on industries such as: pharmaceuticals, financial services and energy. Changes in these industries can have an effect on their profitability; learning to evaluate the political news impact on these businesses is a crucial stock investing basic.

Pharmaceuticals

It is likely that political news will have a tremendous impact on the pharmaceutical business. A part of the Democratic agenda, because of the rising cost of medicine, has long been to use the clout and incredible buying power of the federal Medicare program to force lower prices for prescription drugs. If adopted by private health insurers, such a move would serve to actually cap drug prices. Such a move could affect the profitability of drug makers and successful traders would be wise to monitor changes in the mammoth industry.

Financial Services

The political news impact on the financial services business could also be quite noticeable. The key component in this area could be proposed changes in the Sarbanes-Oxley law, Capital Hill’s response to a plethora of corporate accounting scandals, requiring stricter financial controls and greater disclosure. Business has resisted such rules, alleging they are expensive, but Democrats, as a rule, have supported the idea of greater disclosure, especially in CEO pay, which could have a ripple effect on the bottom line corporations. As the wise investors follow these events, they will invest more time in stock technical analysis of the affected companies.

Another change in the financial services business that could feel the impact of the political news are Fannie Mae and Freddie Mac, the two congressionally chartered companies that possess approximately 40 percent of the $10 trillion home mortgage market. Republicans had sponsored controls on these companies that the Democrats oppose. It is likely that these efforts will be reversed once the Democrats are in power.

Energy

It is quite possible that the energy sector will be affected the most by the political news impact on business. One of the crowning achievements of the Bush administration was the Energy Policy Act of 2005, which included a number of perks from for the oil, gas and coal companies, including tax breaks that the Democrats opposed. Democrats have already proposed hearings on oil industry profits; some have favored a “windfall” profits tax. Such moves could have immediate effects on oil futures.

In essence, the political news impact on business can already be seen, with the frantic analysis and stock market advice. For the investor already monitoring the upcoming events relating to business and the upcoming political news impact, it is necessary to continue following a strong stock trading plan, including a stock market trading system such as Japanese Candlesticks. As seen in other examples, uncertainty can create nervous trading in the markets, but it can also create great opportunities for profit. Having a stock investing system that aids in predicting the trends and drawing successful conclusions on the direction of the market is sure to create successful trading as business feels the impact of political news

Click the Political News & The Markets header link above to learn and become a successful trader.

Good day and good trading.

Struggling Stocks

On Wall Street, the old saying that “no news is good news” does not seem to hold true with struggling stocks. During the first week of November, 2006, the stock market struggled amid subdued trading as traders waited for indicators on the overall health of the US economy. Although oil prices fell and Boeing Co. was a stock market mover with its huge military contract victory, there was very little to talk about as stocks struggled.

Although the stock market news of the Democratic victory in the mid-term elections did spur a sell-off, stocks struggled as experts and analysts attempted to predict the changes in store as the Republicans lost power. This shift in the balance of power touched off concern about industries from health care and pharmaceuticals to energy and defense. Experts said that while the news of falling oil prices was a positive, the markets seemed to be taking a rest in the absence of an announcement or event that could provide a boast. Finding a successful trade when the stocks are struggling is the mark of truly knowing how to invest in stocks.

With the general end of the “earning season” for most companies, investors are looking for signs in the economy that indicate a general slowdown in the rate of inflation. The possibility of additional interest rate hikes continues to loom over the stock market and dampen the enthusiasm of positive news in the market. In these times, investors spend more time looking for hot stock market picks when, as a whole, stocks are struggling.

In times such as these when stocks struggle, traders require a strong stock trading plan. First, an investor needs a successful stock trading system such as Japanese Candlesticks. This provides the trader the ability to successfully analyze the markets. After understanding the movements in the market, the investor can implement trades expecting to make money. When stocks struggle and the market lacks volatility, the trader can look for companies to buy straddle options or buy strangle options. Such moves provide limited risk but unlimited profit potential. Other strategies include: selling covered calls, and buying or selling puts. Since the market is somewhat bearish during a period such as this, the strategies involved tend to have lower risk reward ratios. Although the market is struggling to find profit, that doesn’t mean that the successful trader must struggle. The key is for the investor to shift his, or her, thinking to a more conservative approach and look for opportunities that while offering lower returns, also offer lower risk.

Stock investing systems offer the trader a valuable way to perform technical analysis on companies and their stock to find trading patterns and be able to identify investment opportunities. In spite of the fact that stocks may be struggling, following a trading plan helps the investor to find the companies that are moving and implement trades. A trader cannot simply develop a plan and follow it. This plan should be living and changing as the market evolves. Struggling stocks should only cause an investor to adapt the trading plan, not to quit making money.

Good day and good investing.

Monday, November 20, 2006

Oil: Off The Deep End

A friend of mine sent me at least a dozen emails this year proclaiming “Peak oil! Peak oil!” The media was full of the same opinion; the story was POPULAR. Why? The evidence was not overwhelming; oil supplies weren’t dwindling; there were no lines at the gas pump. It was only that oil prices were at a record high.

After oil prices plummeted in late July, the emails dwindled too, and so did the news stories. Interesting how our perceptions are colored by the opinions around us, isn’t it?

To look at this peak oil anxiety from a different point of view, here are some facts:

If the Earth were an apple, we have yet to drill even through the skin of it.

Two theories compete to explain the origins of petroleum. The popular one, of biologically originated “fossil fuel,” is an antique (1757) and has little to no research confirming it. In fact, a mathematical model incorporating quantum mechanics, statistics, and thermodynamics suggests that the formation of crude oil requires pressures not reached in the earth’s crust.

The other theory is Russian, 50 years old, and holds that oil is abiotic in origin, originates deep within the earth, and may exist in truly vast reservoirs in the mantle. This theory has much affirming research, yet low popularity.

A scientist showed that a mixture of calcium carbonate, water and iron oxide heated to 1,500 degrees C and crushed with the weight of 50,000 atmospheres will produce hydrocarbons – i.e., oil.

The perspective of the Russian theory was applied to explore and develop more than 80 oil and gas fields in the Caspian district. They produce oil from crystalline basement rock, where dinosaurs never roamed.

There is a recorded case of an oilfield in the Gulf of Mexico that, at the point of a near exhaustion, re-filled itself with oil of a different geological age.

In other words, running out of oil might be a less rational fear than running out of air to burn it with.

Now that peak oil stories generate a lot less interest than they did this summer, what is interesting is this chart of the Daily Sentiment Index for NYMEX Crude presented by EWI's Energy Specialty Service:

As you can see from this chart, peaks in sentiment reached a bullish extreme three times during the past year, mirroring almost exactly the peaks in oil prices (and hysterical "peak oil" headlines).

And now, the DSI again shows an extreme reading – but this time, on the bearish side: Only about 25 percent of oil traders are bullish on the commodity.

Does this mean there is a possible trading opportunity at hand in Crude?

Maybe, but if I were you, I would definitely want to look at the Elliott wave counts for December Crude in our Energy Specialty Service before pulling the trigger. Sentiment can be a powerful trading signal – but it's not everything.

As you can see, we at EWI use many other analytical tools besides Elliott wave to help us understand the big picture. There is one big advantage this perspective gives you – and that is independence of thought.

That's why, when my friend sends me more peak oil emails, and the headlines and commentators shout “Peak Oil” again, I'll know that we might be near another peak… in oil prices.

Click the Oil: Off The Deep End header link above to learn more about the low risk high reward trade setups Elliott Wave analysis provides.

Good day and good trading.

Saturday, November 18, 2006

Weekly Stock Market Outlook

Expiration week ended up being bullish, with the S&P 500 as well as the Dow both breaking above key resistance lines (the NASDAQ Composite didn't have horizontal resistance to speak of). The VIX and the VXN also both sank to even lower lows. The indices remain overbought, while the VIX and VXN are both at extreme lows typically associated with a top. But, for about the fifteenth week in a row, both of those bearish factors have been shrugged off as traders sent the market higher. The thing is, despite the pressures against it, the coming week (a shortened holiday week) is traditionally bullish as well. So, we won't be shocked to see more of the same upside.....we just wanted to set the theme in place as you read through our opinions on our charts.

NASDAQ Outlook

The NASDAQ actually lost ground on Friday, losing 3.2 points (-0.13%) to close at 2445.86. For the week, the NASDAQ Composite gained 56.14 points (2.35%)...the best performance of all three indices. Yet, we have to wonder if Friday's lagging was a red flag. The NASDAQ leads the market - both up and down. And truth be told, the composite did well to only close slightly lower....the range was lower, and the index spent most of the day much deeper in the red than that - a late day rally salvaged Friday. On the other hand, the NASDAQ remains within a bullish set of trend lines, so the trend is still to the upside, technically.

There's plenty of support between 2373 and 2412. It's comprised of the 10 and 20 day lines and/or straight line support (red, dashed). Unless the NASDAQ decisively breaks under that lowest part of that support zone, then we wouldn't worry too much about any short-term dip. On the other side of the chart, resistance (blue, dashed) is at 2494 and rising. So, there's plenty of room for more short-term upside before the composite necessarily hits a wall.

As for the VXN, it's still a thorn in our side. Stunningly, it broke under support at 16.20 last week to close at 15.33. We saw a slightly higher range for the VXN in Friday. A bearish hint? Not exactly - it still closed lower than Thursday. As far as the VXN is concerned, we'd say keep watching for a break past the resistance line at 17.45 before assuming the composite is really headed lower. By the point in time that would actually happen, the NASDAQ would have had plenty of time to sink back to and under its support lines.

Volume, although choppy, remains bullish.

NASDAQ Chart

Click For A Larger Chart

S&P 500 Outlook

The S&P 500's gain of 1.45 points (+0.1%) on Friday left at at 1401.20 for the week. On a weekly basis. the index closed 1.47% higher (+20.30 points) than the previous week's close. All in all, the SPX is still in the bullish zone it's been in since August. So despite the all the bearish bullets being fired still to this day, the market has thus far been bullet-proof. It's got to end sometime, but as we've said about a billion times in the last four months, now ain't the time.

The lower edge of the bullish zone - the support line - is currently at 1382 and rising. It's the blue dashed line below. The resistance line is at 1415 and rising as well...the broad red line you see below. As long as the SPX stays in that relatively mild upward slope, the bulls and the bears have found a happy medium, with neither team getting overly anxious (or nervous) along the way. That's why the trend has managed to persist as long as it has.

But, last week, the VIX finally broke under support at 10.30, and stayed down there, closing at 10.05 on Friday. The direction is bullish, but wow....how much lower can it go? At the same time, the SPX followed through on the cross above the 10 day moving average line. Although, we're stochastically overbought, the bulls may see a little short-term relief in that the upper edge of the bullish zone has not yet been hit. That may well be the room needed in the coming week for just a little Thanksgiving rally.

On other fronts.....

The S&P 500 is now 7.7% above the 200 day moving average line - a statistical rarity, and one of the reasons we think the index could get reeled in very soon. But, stick with the overall momentum until it's clear the sellers are actually going to get some traction.

S&P 500 Chart

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Dow Jones Industrial Average Outlook

The Dow Jones Industrial Average gained 37 points on Friday to end the week at 12,343. That 0.3% gain on Friday meant a 1.94% gain for the week....a 235 point improvement on the previous week's close. And, as we've seen for most of the year from the Dow, these blue chips continue to offer consistent gains with relatively little volatility.

Truthfully, if we weren't staring a low VIX/VXN in the face, we'd have to say this chart was extremely bullish - it has all the right qualities we would need to say things are likely to continue this way. Volume has been good into the rallies...and increasing along the way. And the momentum has clearly been to the upside. All in all, the Dow looks poised to keep moving higher at this measured pace.

Perhaps the VIX and the VXN are irrelevant at this point, at least as far as these blue chips are concerned. Clearly investors don't have a problem with being stochastically overbought, as we saw in October.

Dow Jones Industrial Average Chart

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Friday, November 17, 2006

Peak Performance Trading

Peak Performance Trading Tips

By Van K. Tharp, Ph.D.

These trading tips will help you get yourself in the best possible condition mentally to perform at a peak level. They are not necessarily new, but they are critically important.

So whether you’ve heard them before, or not, now is the time to employ them in your trading and in your life. Both will improve as a result.

Tip #50: What It takes To Be One of the Best Traders

What Are You Willing to do to Succeed?

Dear Dr. Van Tharp:

"What's a reasonable goal for me as a trader? Can I make a living trading? Can I make millions trading? Is that reasonable for a former professional?”

“I’m aged 46, and I’d like to move into full time trading. I’ve accumulated about $200,000 in cash. What is possible for me given my age and goal to become a full time trader?”

Sincerely, E.R.

Dear E.R.,

Your trading goal is up to you. You can certainly become a full time trader. That is probably possible within a year to 18 months. You can certainly take a million dollars out of the market and you could reach the stage where you take a million dollars out of the market each year. It depends upon what you are willing to do.

However, there are a number of questions that you will need to ask yourself because each scenario has a different answer.

How much do you love trading? How committed are you to being a full time trader making millions? Are you willing to work 12-16 hours a day, 6 days per week, for the next five years? Are you willing to work at least four to six of those hours a day on starting your own trading business? Are you willing to spend another hour or two a day developing probably the most valuable skill you could ever have, self-knowledge?

Are you willing to give up most of your free time -- at least until your trading business is off and running soundly? And are you willing to think about trading when your family is still enjoying the things that you used to do together?

Will you do whatever it takes to be the best -- including discipline and full responsibility for your results? You would need to start by spending at least the first six months really working on yourself, looking at all of your psychological patterns and developing ways to overcome any personal obstacles.

In addition, you will need another four to six months to develop a business plan that will be the basis of your trading business. Most people don't treat trading like a business. And most businesses fail because they don't plan.

Are you willing to learn a new way of thinking about the markets? This means thinking in terms of risk to reward, understanding that risk is what you lose when you lose in a trade and understanding that position sizing is the core of how you’ll work to meet your profit targets. Probably most of what you have learned about the markets needs to be turned upside down, examined, and then probably thrown out as garbage. Could you handle it?

Would you be able to develop at least three systems that fit the big picture? And are you willing to work on these systems enough so that they become great systems?

I mention all this because all of these things are required if you are really serious about being a top trader that earns a lot of money in this field. I have made the studying of top traders my vocation and have written books on all of these subjects for years.

It's all up to you. Are you willing to do the necessary work or is the goal too lofty?

My Peak Performance Home Study Course will get you started and guide you through a lot of the work that you will need to do. I recommend that you devote a full two hours each day to working on it until you’re completed.

Until next week’s tip, this is Van Tharp. Have a good weekend.

Click the Peak Performance Trading header link above to learn more about becoming a successful trader in the financial markets.

Have a good weekend.

Thursday, November 16, 2006

Elliott Wave Trading

Discovering How to Use the Elliott Wave Principle. Elliott Wave identifies low risk high reward trade setups. Along with proper position sizing and taking trades in low risk high reward trades, a trader will be successful in trading in the long term. Remember losses are a part of life. Just keep trading losses small and gainers big. This is what Elliott Wave trading is all about.

Fibonacci ratios are named for the famous 13th-century mathematician Leonardo Fibonacci of Pisa, the most important mathematician of the Middle Ages. Fibonacci popularized the current decimal and Hindu-Arabic numbering systems. He also discovered (actually rediscovered) the numeric sequence that bears his name, the Fibonacci sequence which begins with the number 1 and in which each subsequent number is the sum of the previous two: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89 and so on. The sequence in turn gives rise to several unique ratios, including .618, .382 and 1.618 — the Golden Ratio. These ratios exist throughout nature, in everything from population growth to the physical structure within the human brain, the DNA helix, many plants and even the cosmos itself.

Many investors today know that Fibonacci ratios are used for market forecasting. But few realize that Fibonacci analysis of the markets was pioneered by R.N. Elliott. The use of Fibonacci ratios requires a valid Elliott wave interpretation as a starting point. Unfortunately, many non-Elliott analysts try to find Fibonacci proportions between market moves that are not related to each other in any way. This has made the approach appear far less valuable than it is.

Elliott had two chief insights concerning Fibonacci relationships within waves. First, corrective waves tend to retrace prior impulse waves of the same degree in Fibonacci proportion. For example, wave (2) often retraces 38% of wave (1). Other frequent wave relationships are 50% and 62%. Second, impulse waves of the same degree within a larger impulse sequence tend to be related to one another in Fibonacci proportion, as shown in Figure 3 here:

Wave interpretation rules and Fibonacci relationships together are powerful tools for establishing investment strategies and reducing risk exposure. Investors use them to help decide where to get in, where to get out and at what point to give up on a strategy. Thus, the Wave Principle lets you identify the highest probability direction for the market, plus adopt an optimum position to take advantage of it all while protecting yourself against lower-probability outcomes.

Click the Elliott Wave Trading header link above to learn about trading low risk high reward trade setups.

Candlestick Charting

Candlestick Charting - Why is it Different?

Would you like to learn about a type of trading chart that is more effective than the charts you are probably using now? If so, keep reading. If you are brand new to the art/science of chart reading, don’t worry, we are going to discuss candlestick charting. This stuff is powerful, but it is really quite simple to learn and the results can be impressive!

Technical Analysis…a Brief Explanation

Stock technical analysis is simply the study of companies and their stock prices as reflected on price charts. Whether these charts employ candlestick charting or are simple bar charts, technical analysis assumes that current prices should represent all known information about the markets. Prices not only reflect facts, they also represent human emotion and the psychology and mood of the moment. Prices are, in the end, a function of supply and demand. However, on a moment to moment basis, human emotions…greed and fear, panic, hysteria, elation, etc. also dramatically affect prices. Markets may move based upon people’s expectations, not necessarily facts. A market "technician" attempts to disregard the emotional component of trading by making his decisions based upon chart formations, assuming that prices reflect both facts and emotion. Charts, even those using only the basics of Japanese Candlestick charting, help the successful investor to compile data into a useful format.

Bar Chart Basics

Both standard bar charting and basic candlestick charting are commonly used to convey price activity into an easily readable chart. Usually four elements make up a bar chart, the Open, High, Low, and Close for the trading session/time period. A price bar can represent any time frame, as shown with the horizontal element of the bar. The total vertical length/height of the bar represents the entire trading range for the desired period. The top of the bar represents the highest price of the period, and the bottom of the bar represents the lowest price of the period. The Open is represented by a small dash to the left of the bar, and the Close for the session is a small dash to the right of the bar. At this point, you might be asking yourself why you need to know candlestick chart analysis if you understand a bar chart. Having said that, let’s look at the stock investing basics of Japanese Candlesticks now.

Candlestick Charting Explained

The answer to the question above may not yet seem obvious, but the results are. Basically, candlestick charts are much more visually appealing and informative than a standard two-dimensional bar chart. As with a standard bar chart, candlestick chart patterns have the basics as well; OPEN, HIGH, LOW and CLOSING price for a given time period are included. The body of the candlestick is called the “Real Body” and it represents the range between the open and closing prices. A black, or filled-in, body represents that the commodity or stock closed lower than its open, or in a bullish condition. When the body is open or white, the commodity or stock closed higher than its open, indicating a typically bullish condition. A thin, vertical line that may be found above and/or below the real body is known as the “Upper” or “Lower” “Shadow”, and its presence represents the high or low price extremes for the trading period. Now that you have the basics of the candlestick charting, let’s compare them to bar charts.

Comparing Candlestick Charting and Bar Charts

Lacking the Shadows of a basic candlestick chart, a bar chart cannot reflect the difference between a price extreme and a high or low. For example, a stock that opened high, but traded low for the day would not be accurately depicted in a bar chart. In a basic Candlestick chart, however, the Upper Shadow would show the extreme of the opening price as well as the trading range for the day. In this example, the basic candlestick chart formation more accurately represents the trading of the day. In addition, since the stock closed lower than the open, the Real Body would be black; indicating that the day’s trading was bearish. A typical bar chart is simply unable to provide this level of information. And remember, these are just the basics of a candlestick chart!

In conclusion, even the most basic of candlestick charting methods provides its user with a valuable technical analysis tool. When used with a productive stock investing system, you can successfully analyze stocks and their trends before you invest. Why use a limited bar chart when you can have the power of candlestick charting? Your bottom line will know the difference!

Click the Candlestick Charting header link above to learn more.

Good day and good trading.

Wednesday, November 15, 2006

Van Tharp Trading Workshops

Kick Start Your Trading Career

With our launch of the 2007 workshop schedule, now is a good time to address the topic of "What courses should I attend if I really want to become a great trader/investor?"

We get many inquiries about the Van Tharp Institute from people just like you, who weigh the value and opportunity, versus the time, travel and expense that they have to incur to attend a trading workshop. Therefore, to make the choice easier for you (one way or the other), I thought it would be valuable to provide an outline of what our workshops are and how they fit together, so that you can make an informed decision as to whether attending a workshop is something that you would like to do. In addition I'm making you an exceptional offer at the end of this article.

Thankfully, our workshops have a great reputation both for their content and for the level of attendees that frequent our events. This incredibly high caliber of clientele just keep coming back. Time and time again, we see the familiar faces repeating or attending a new course both for the educational experience and the networking opportunities – so we must be doing something right!

Whether you are starting out on the trading journey or have been a trader for many years, there are fundamental strengths that will help you to be the best trader you can be and our goal is to give you the tools and materials to help you do just that.

Van K. Tharp has close to 25 years of experience coaching traders, and in conjunction with his world class instructors, they have put together a trading curriculum that is unrivalled in the industry.

I. Foundation Workshops – Tharp Fundamentals and the Backbone of Great Trading

Although these workshops are called Foundation Workshops, they are definitely not basic. We name them that simply because they provide the core material that everyone who wants to become a great trader should master. We regard them as the starting point for your trading education regardless of your background or trading experience. Also, these core workshops are just as valuable for the short term trader as they are for the long term trader because what you learn is not dependent on the market traded, nor the timeframe.

Blueprint for Trading Success
Peak Performance 101
How to Develop a Winning Trading System that Fits You
These courses will help you master yourself, understand what you need to do for profitable trading, learn to develop a blueprint for trading/investing success, and learn how to develop systems that fit who you are

II. Specific Strategies and Proven Techniques in Various Trading Styles

Once you have a solid foundation and understand a new way of thinking about trading and investing, then we offer many courses that will give you a technical background and help you fill in the details that you will probably want. Can you take these courses without the foundation material? Yes you can, but doing so is like learning how to write a specific computer program without even knowing the basics of computer programming or understanding the potential mistakes that you could make.

Proven Swing Trading Strategies
Professional E-Mini Futures Tactics
Highly Effective ETF and Mutual Fund Techniques (this is essentially our course for learning great stock market trading techniques).
Professional Day Trading Strategies
III. Pre-requisite Material

We have one course and one program that definitely require other pre-requisite courses, so we’ve put these at the last level.

Advanced Peak Performance 202 (Peak 101 is a pre-requisite).
The Super Trader Program. (Peak 101 and Dr. Tharp’s approval required).
This week we’ll take a look at our Foundation Workshops:

How Our Courses Work

1. The Blueprint for Trading Success Workshop is the ultimate course to provide you with exactly what you need to master trading success, whether you are a full-time professional who wants a solid foundation or someone who would like to make a lot of money trading/investing and eventually move into trading full time for yourself. Dr. Tharp will walk you step- by- step through a series of 52 pertinent questions designed to get you thinking strategically about your trading. He will touch on all of the specific areas that you need to address, in the order that you need to address them. You will walk away from this workshop with a business plan outline and an understanding of why you want to trade, how you want to trade, the specific steps that you need to take to create a winning trading plan that works in any market condition and what type of trading systems you want to incorporate into your plan. You’ll also learn some of the key things that you need to personally master in order to be successful. You will learn how expectancy, position sizing, R-multiples, objectives, the big picture and other Tharp concepts fit together. After this workshop, you will know where you need to delve next to increase your profits and success in the markets.

2. Peak Performance 101. We have identified two types of people that frequent the Van Tharp Institute – those that believe that trading is purely technical and a learned skill (those people tend to head for the Systems and Strategy workshops first and eventually join us at Peak 101), and those who already know that their thoughts and beliefs play a huge role in their individual trading results. The bottom line is that we can prove that trading is largely psychological and that you must master yourself if you want great trading results. Peak Performance 101 is Dr. Tharp’s core psychological workshop and his most famous course for over 15 years. This is the workshop for anyone wanting to know how great traders think, behave and act so that they get consistent and profitable results, without stress. In this workshop, not only will you learn what makes a great trader great, but you will also find out what is holding you back. Whether it’s overtrading, not pulling the trigger, over confidence or lack of confidence, or just making mistake after mistake – there are many ways that people sabotage their market experiences. Taught exclusively by Dr Tharp, this workshop is designed to break down any barriers that you may have, as well as teaching you specific tasks and strategies that will improve your trading results overnight.

3. Developing a Winning Trading System that Fits You. We meet many people every year who spend small fortunes buying other people’s trading systems, and following their recommendations and ideas – yet they still don’t win in the markets. Is it because we think that we can’t do it ourselves? Or is there a holy grail that a few have mastered and when they do they won’t share it? Well, Jack Schwager, after writing Market Wizards and The New Market Wizards concluded that the secret was to develop and trade a system that fits you. And that’s what we help you do in this course. Don’t be confused with thinking that “creating a system” is having the technical know-how to develop a cutting edge software program. That’s great if you have that skill, but that is not a proper trading system. Anyone can create one if they have the knowledge and commitment to do it. In this workshop, you will learn the key components of a trading system (there are more than most people realize), how and why they are needed, and how to use position sizing to help you fulfill your trading objectives.

Summary

As you can see, these are the three core workshops that form the basis of Dr. Van Tharp’s work. But it takes commitment and discipline. Once you know how you think and why, uncover what you really want to achieve with your trading and then develop a specific plan to make it happen. You can fit workable trading systems into that plan and you’ll be well on your way to success as a trader. From there, you can look at specific trading strategies that might fit with who you are and add them to your arsenal. For example, many such techniques are taught in the upcoming swing trading workshop. We’ll look at some of the Specific Strategy Courses next week.

Click the Van Tharp Trading Workshops header link above to learn more about the excellent live and home study trading programs.

Good day and good trading.

Diversification

The Benefits of Diversification

After talking to a lot of traders over the years, I found most traders need consistent knowledge and education to further develop the trading right habits.

One of the first issues that most traders must address is the lack of a written trading plan. It reminds me of that classic quote: "If you don't know where you're going, any road will get you there." Usually that unfocused road is a path to losses in the markets, as most traders go on a reactionary journey to chase stocks that are up on news or blow out of losers only after the pain gets too great.

In addition to needing a clear plan, most traders still have trouble following their plan due to the Emotions of Fear and Greed. Fear of loss is understandable, but what always amazes me is how many traders have trouble staying with their best trades due to the fear of losing their gains and giving back their profits. I've never had an issue with taking some money off the table as an idea wins, but it's these winning ideas where the bulk of my profits are made. So you have to be willing to let the rest of your winners run, as they can move much further than anyone ever thought possible.

This then leads into the strategy that you will be much better served taking smaller positions across a variety of ideas, rather than loading up on just a few ideas and then getting scared when the slightest market blip against you causes you to run prematurely for the exit. It's much better to have each position be small enough that you can breathe easier and follow your indicators and method, rather than violating your rules and not letting your approach produce the edge it was designed to capture.

So the real secret then is proper diversification across not only various ideas at small position sizes, but then further diversification across various strategies to profit from both trending and sideways markets.

Click the Diversification header link above to learn more about keeping your risk low and reward high.

Good day and good trading.

Tuesday, November 14, 2006

Trading Zone

'The Zone' is a place where every trader wants to be to perform at peak levels. The zone is a place where time is considered to slow down or almost stand still, where you feel acutely more aware of your surroundings, at one with your environment. This transcendent state is often called other things, such as a 'runner's high' for athletes feeling the endorphin surge released during physical exertion.

Mihaly Csikszentmihalyi named this experience (and the title of his book) 'Flow', and he noted that people who are doing what they love to do tend to have the best odds of getting into this flow. They become totally absorbed in the present moment, with no distractions (can you say this about your trading?). He also called flow a mindset that is 'intrinsically rewarding.' This suggests that we should trade not only for the money, but also because we enjoy it on a deeper, more personal level. Great traders, like those shown in Jack Schwager's Market Wizards series of books, show a love of the trading game itself in addition to the desire to make money.

So how do we get ourselves into this flow state? Csikszentmihalyi defines six important prerequisites to allow entrance into the zone:

1) Confidence - As a trader, you must have confidence in your trading method, and believe that you will succeed if you implement your trading plan. This allows you to place your entries and exits promptly and thoroughly.

2) Focus - A narrow focus on the task at hand is required to get into the zone. Fears about the outcome and regrets about past losses do not exist here.

3) Visualization - A trader pictures what success look like, and gets in the zone through visual processing of data. Verbal cues can take a trader out of the zone.

4) Pleasure - When you enjoy trading, it raises the odds that you will participate fully and maximize your efforts. This increases your chances at achieving mastery which further increases your enjoyment. Those who view trading as work will feel a struggle to find great trades, while those who love trading will feel in harmony with the markets and opportunities appear more easily.

5) Relaxation - Once you get to the zone, you may tense up as you feel in new territory. Fear tends to bring you out of the zone. Stay relaxed to let yourself stay in the zone.

6) Excitement - Some tension can help performance, but too much intensity will create undue stress and hurt performance.

The other element traders need to get into the zone is Preparation. Larry Bird hit key shots under pressure in basketball games because he had practiced so many times in the gym that his shots under pressure felt more automatic to him, which increased his confidence. Traders must spend the time necessary to make trading skills "automatic" and create winning trading habits. When you are totally focused, you cannot be thinking about technique or strategy. Preparation and practice allow you to develop the skills you need to stay in the zone.

Click the Trading Zone header link above to learn to be a better trader.

Good day and good trading.

Sunday, November 12, 2006

Futures Trading

A futures trader's mission is to be profitable by taking the preponderance of technical and/or fundamental evidence he or she has on a market, and then making a well-founded trading decision based on a trading plan of action. That is the best a trader can do. If the market does not respond in the way the trader thought it would, he or she will hopefully have a tight protective stop in place and losses will be minimal. Then, the trader moves on to the next preponderance of evidence on a market, and the process starts over.

I take pride in the fact that I portray futures trading in what I feel is a "realist" fashion. Nowhere on my website or in any of my feature stories on news wires do you see claims made by me that futures trading is an easy way to make money, or that my trading methods are "guaranteed" to make you profits. People in the futures industry that make those claims, use fancy wording or "smoke and mirrors" to skirt the real facts are less than genuine, I believe.

Those of us who have been in the business for many years know there is no "Holy Grail" for futures trading success. We know how brutal the markets can be to even the most savvy and deep-pocketed traders. The principals at the big hedge fund called Long-Term Capital Management certainly know what I'm talking about. (That's the big speculative trading firm-­which supposedly had trading geniuses at the helm--that went bust a couple years ago after the markets they were trading made a devastating turn against them. Some well-known investors got burned.)

Yet, there are individuals, me included, who are fascinated by the markets and trading, and find great satisfaction when we are able to "take some money off the table." We know there are dangers to futures trading, but sound and strict money-management principles can greatly reduce the dangers of losing all of one's trading assets.

One of the realities of futures trading is that there are trade-offs to just about every trading method or trading philosophy. (When we think about it, there are advantages and disadvantages to just about everything we do in life, so why should futures trading be any different.)

Here are the trade-offs for just a few futures trading methods. These trade-offs may be obvious to some, but I believe it's prudent for all traders to have a very clear picture and a keen understanding of what they are up against when they initiate a trade and take on "the market," which can quickly turn into a two-headed monster if it is not respected and understood.

Purchasing options on futures: This is a great way for individuals, especially beginners, to participate in futures market trading and limit their risk to the price paid for the option. Traders sleep well at night, knowing that if the market makes a violent turn against them, they won't get a margin call from their broker. The trade-off: For the traders that purchase options, the timing of the trade has to be even more precise than straight futures trading, as options expire well before the underlying futures contract and "time decay" continually erodes the option premium. Also, in volatile markets, options premiums increase significantly. Finally, if an option that is purchased is not "in the money," any favorable moves in the underlying futures contract price will likely not be matched on a one-to-one price basis by gains in the option's value.

Selling options on futures: There's an old market adage that says the vast majority of the profits made in options trading are made by the sellers and not the buyers. I don't disagree with this. The trade-off: There's another old adage that says options sellers will make good profits--until that one time a market turns unexpectedly and violently against them, and wipes out all the profits they had previously made writing (selling) options.

Trading volatile markets: There are indeed big profits that can be made trading volatile markets. The past couple years the energy futures markets have been one example. The trade-off: Volatile markets can turn against a trader "on a dime." Big profits can turn into big losses in very little time. I call a highly volatile market a "gunslinger's" market.

Using tight protective stops: I use protective stops with nearly every trade. It's a good way to go into a trade with a plan of action, should the market turn against you. For traders who don't have real-time price data or who can't monitor price action all session long, stops are an excellent risk-management tool. However, protective stops are not perfect. They are not effective in "fast" market trading in the pits that sees a price vacuum. Stops are virtually useless when a market makes a limit move. Floor traders will sometimes "gun" for resting stops, trigger them, and then the market seems to reverse course.

"System" trading: By "system trading," I mean traders that solely use computer-generated buy and sell signals, based on some parameters that are fed into a computer trading program. Some of these trading systems are advertised as being 90% profitable. The trade-off: What many system trading advertisers don't tell people is that with most computer-generated trading systems, a trader is in the market--either long or short--virtually all of the time. Draw-downs on the trading account can be, and many times are, very large. Also, some of the claims of high profit percentages are based on a trading system that is hypothetically back-tested over several years.

Good sunday and a good new trading week.

Friday, November 10, 2006

Efficiency Portfolio Testing

Understanding The Efficiency Portfolio Testing
By Van K. Tharp, Ph.D.

Next week we’ll be doing another update to the IITM efficiency portfolio, but before I do I’d like to explain what I’m doing and why I’m doing it. A few of our readers seem to think I’ve completely lost it with the portfolio testing. However, if you are one of them, then you might want to examine your own beliefs about the markets and what you believe it takes to develop a system, and most importantly why an educational process like this would press your buttons. For example, one reader writes:

“...the latest attempt with the efficient portfolio trading 'strategy' has bothered me for some time. Is this a joke? A test? An attempt at showing that if one discards all the advice and methodology that IITM offers one will fail?? Trading using a random non-proven strategy and modifying it as one goes along seems completely contrary to how I interpret what IITM recommends and teaches in general about system design and about trading processes and business plans…What does back testing tell you? You are not just grabbing stuff from thin air and pushing it into subscribers mailboxes, are you? Why would anybody want to see your "indicator" if you have no idea what it means? If you have not tested it at all? “

“Come on! I have had some hope that the stuff provided by IITM has been authentic and credible and the last year or so I have spent much time evaluating concepts and building my systems/methodology based much on ideas you have provided. This has been the way I have seen as offering the most potential so far. I have got some promising results but am not finished testing my system and business plan yet….what is mentioned above though makes me actually doubt that what you say has any relevance at all. I really hope that is not the case. There are too much non-tested irrelevant comments out there anyway. I would not like to put IITM on that list.“

So first of all, thanks for your email; it gives me a basis for this article.

Now let me mention a few keys to trading success.

First, you can only trade your beliefs about the market. You cannot trade the “markets” as such. Consequently, anything you do must go through your many filters. If the efficiency portfolio testing is pressing your buttons, it’s probably a good thing. You can learn something about yourself, so I’d suggest you take a look inside and see what is going on. What is annoying you about it and why?

We’ve develop a very extensive process for helping people do this and the testing of the efficiency portfolio is actually part of the process. I’m not giving any trading recommendations…I’m simply illustrating some very early testing processes that I recommend you go through. And there is probably no better scrutiny for testing an idea than doing it in front of thousands of readers. Those processes (and I’m shortening it for this article) include:

Deciding who you are and laying out your objectives. I did that in the early articles.

Describing your beliefs about the market is the next step. I’m a strong believer in trading great trends and I believe that such trends will continue. And by the way, I’ve done extensive testing with efficiency. I described a methodology very similar to this for over a year in Market Mastery during 2001-2002. My point in doing so was to show that you could trade positive efficiency stocks even during a bear market. As an illustration, look at Autozone and DeLux Checking during 2001. The testing was profitable until we reached the bottom of the bear market when there were no positive efficiency stocks. In addition, I’ve been trading efficient stocks for a long time with positive results and some of my best results have been shorting negative efficiency stocks. I’ve also taken one time period, selected a set of positive efficiency stocks and traded it in real time with a 25% trailing stop. In about six months I made about 19% with that portfolio. I was also trading negative efficiency stocks real time and doing well with them that the same time. Thus, I have extensive experience in real trading with this concept already and I’m convinced it works. What I’m not sure about is if being fully invested according to the efficiency of the market works.

The next step is to work out how you want to actually trade. Then trade it or paper trade it to see if it works for you. My purpose in doing the efficiency portfolio is to illustrate an example of this process. And I’m trying out some new things such as selecting the number of positive and negative stocks according to the efficiency of the market. I BELIEVE that this process that I’m following is much better than back testing because you are actually doing it and can see what happens rather than having the computer do things and spit out results that are always replete with errors that you do not know about. I’ve only changed the rules when it was clear that the testing was not meeting my objectives because it was generating far too many trades. If you want to keep the trades longer, widen the stop and that’s what I did. It’s still generating more trades than I really want, but I’m going to stick to these rules in the testing for a while. However, this process allows you to get a real feel for how your idea works in the markets and what could happen. And you can even gather preliminary R-multiples for it. This is the step that I’m illustrating in Tharp’s Thoughts on a monthly basis.

The next step, once you are satisfied with the result of the preliminary testing is to really trade the concept with small position sizing (perhaps for a year). This is where you collect real R-multiples.

And if you like the results, then you can trade the system with full position sizing.

Some people cannot trade anything unless it is somehow tested by a computer and the computer spits out positive results. However, this does not fit my personal beliefs system for all of the following reasons:

I don’t know of any good software for testing. NONE. All of them have errors built into them and you also have the possibility of data errors. Thus, 1) I would not trust the results of a computer back test and 2) I would not trust the results if the back test rejected the system not knowing if it was or wasn’t due to computer errors. It could cause me to totally reject a great method. However, I have back tested it to the extent that the software I’m using will allow (see comment five below) and it tests out very well.

I want to know the expectancy and the R-multiples generated by the system. However, I don’t know of any software that will give me that the way I want it.

The key to success and meeting your objectives is position sizing. Most of the testing software is designed to optimize indicators, and does not even consider position sizing which is the key factor in trading success.

What if the concept you are testing is very discretionary? Most good traders can come up with great ideas for trading, but they are very difficult to test because you have to figure out how to get the computer to think the same way you do. My efficiency concept is very discretionary and this is only way I know how to test it. I’m simply looking for a market that is going up in a nice straight line. The computer won’t give me that. However, it will give me a selection of 100+ stocks that I can look at and choose from. How can you test that with a computer? You cannot. The chart below illustrates one of the top efficiency stocks defined by my algorithm as of November 3rd. I would never trade anything that looks like that. So how could I test a portfolio that rejects those? Read my interview at the end of Trade Your Way to Financial Fre-edom to see what I say about software and back testing in general.

I currently use AIQ to screen for my stocks in the portfolio I’m testing. AIQ has a feature in which I can buy all the stocks with an efficiency greater than some value that we’ll call X and sell it after a fixed holding period. That concept actually tests out very well, vastly outperforming the S&P 500 during the same holding period. AIQ claims it's one of the better methods they’ve seen. But I would never trade most of the stocks that it is testing such as the one in the chart above. And the only way I know to reject those stocks is for me to do it by personally looking at each of them.

When you are testing the stock market over time, you’ll find that a) many stocks disappear over time and b) many new tickers also appear. In addition, stocks split and have dividends, all of which make the backtesting more complex or less accurate and often impossible to do.

I also want to say that people always equate the indicator or the setup with the system. And this is a total fallacy. I call it efficiency testing, but efficiency really refers to the straight line stocks that I like to trade. The concept I believe in is that what goes up will continue to go up. Furthermore, I believe (but with less certainty) that the smoother the line, the more it is likely to continue. I could use any trend following indicator to find stocks that have the “look” I want. I just happen to use efficiency.

I’d also like to mention that I do trade efficiency stocks in my personal portfolio. However, my criteria are much more rigid than the one I’m using in this portfolio. I might only find one or two that I really like each quarter.

However, efficiency does have the interesting quality by which I can measure the efficiency of the entire market and match my portfolio (percentage of long and shorts) to what the market is showing. In the portfolio testing (and again this is just to illustrate the testing process to all of you), I’m looking at the efficiency of the overall market…which might be 60% positive and 40% negative. Thus, I have to find the top six positive efficiency stocks and the bottom four negative efficiency stocks for the portfolio to be fully invested. Every week/month my portfolio could change depending on the efficiency of the market. How could one possibly back test that concept? I have no idea. However, I can look at it over time, like I’m doing in the newsletter and determine how useful it is.

My impression is that most people are finding the efficiency testing very useful. However, if it clashes with your beliefs, then examine why. And if you are still happy with your beliefs, then great…you can skip that article each month. However, if enough of you think it’s not useful, please let me know and I’ll stop doing it. Or, if you are getting value from the process, then we’ll keep going.

About Van Tharp: Trading coach, and author Dr. Van K. Tharp, is widely recognized for his best-selling book Trade Your Way to Financial Fre-edom and his outstanding Peak Performance Home Study program - a highly regarded classic that is suitable for all levels of traders and investors.

You can learn more about Van Tharp by clicking the Efficiency Portfolio Testing header link above.

Have a good weekend.

Stock Market Growth

It’s easy to identify the concept, simply look at the bottom line of the Dow Jones, S&P 500, or NASDAQ each day and see if their respective scores are higher than the day before. String together days, weeks, months or years and you can get a much broader picture. But for successful traders, stock market growth is much more important than just a number. This is because the number not only symbolizes the bottom line for the market, but in most cases, the bottom line for the investor as well.

After the Dow Jones stock market grew from 10,000 to 11,000 in the spring of 1999, it began a slump that caused it to tumble to 7,300 in the fall of 2002. This slump, fueled by falling corporate profits, affected the prosperity of many companies and threatened the portfolios of many investors. Now, with corporate profits steadily earning large profits, oil prices falling and a stable approach to interest rates by the Federal Reserve, the stock market news is very good and now is a great time for beginning investing in the stock market. Not only has the stock market grown to an all time high, but traders have stock trading plans and stock investing systems to guide them through this stock market growth. With a stable economy and surging corporate profits, some strategists believe that the stock market will continue to grow for some time.

The strength of this growth in the stock market has been corporate earnings. After tumbling to a low in 2002, the earnings of America’s corporations have been rising ever since. Coupled with somewhat of a lag in the market’s response to this profitability and an environment that is stable in both energy and interest rates, the potential for a continued climb is evident. Needless to say, with such growth in the stock market and with variables in place for continued successful trading, now is a great time to be investing in the stock market!

Whether speaking of an experienced trader or the beginner investing in the stock market, the parameters for making money during this period of stock market growth are the same. An investor needs to approach the market cautiously, using the best tools available. Technical analysis and a stock trading system are those tools! Stock technical analysis provides the investor with the information necessary to make sound judgments about the stability of a company and its stocks. A stock trading plan provides the trader with a consistent approach to investing. Such a plan is valuable, not only in good times, but in bad times as well, protecting the trader from the instability of emotional trading and an uncertain approach to difficulties in the market.

Using the resources available and being alert, a solid investor will be able to capitalize on this period of growth in the stock market. As the bottom line of the stock market continues to rise, it is only right that the bottom line of the investor goes up with it! Be wise, do the fundamental and technical analysis and make some money!

Good friday and good investing.

Thursday, November 09, 2006

USA Unemployment Rate

Hunches, Feelings and Emotions.

Arguably the most significant economic report to come out of the U.S. lately was that of a 5-year low in unemployment -- which is very good news for the U.S. economy.

The strong economy, of course, means that the Federal Reserve might raise interest rates at their December meeting. Which would be good news for the U.S. dollar.

On the other hand, despite the forex media’s claims that higher rates benefit the dollar, it's hard not to see that while the Fed has only pushed rates higher for most of this year, the USD has been losing almost the entire time.

Huh? Does this mean that higher interest rates have been hurting the dollar? Isn’t that the opposite of what “interest rate advantage” theory says should've happened?

It is. But if this little paradox baffles you, you’re obviously not a fundamental analyst. Because here’s their “explanation” – are you sitting down? The dollar has fallen this year, they say, “…on anticipation higher borrowing costs are slowing economic growth.” (Bloomberg)

OK, let me see if I got this straight. When the Fed raises rates and the dollar gains, it’s because of the growing “interest rate advantage.” And when the Fed raises rates and the dollar falls, it’s because “higher interest rates are slowing U.S. economic growth”?

Y-yup. That’s the double-edge sword of the conventional economic forecasting for you.

As a forex trader, this leaves you in an unfortunate position. Because if you trade the EURUSD, for example, and believe that the Fed’s decisions are important for this market, how do you know when another rate hike is “still good” for the USD, and when it’s already “too much”?

I wouldn't know, either.

Of course, all this talk about “interest rates this” and “interest rates that” is just speculation. Oddly, it’s this very speculation that moves the currency markets. Speculation is all about hunches, feelings and emotions – in short, about traders' mass psychology. After all, forex markets only move because forex traders move them.

That’s why, to succeed, you want to anticipate traders’ collective mood and thus their next move. And few other analysis methods help you do it better than Elliott wave. To see what difference it could make in your trading, read our latest forex forecasts right now.

Click the USA Unemployment Rate header link above to read the reports and learn more about human social nature and its repetitive patterns which have predictive value.

Good day and good trading.

Trading Journal

I trade not only to make money, which is the first goal, but also to learn about myself. Trading gives us lessons not only about what to do or not to do next time in a trade, but also Life Lessons about personality traits that could improve the rest of our lives too - IF we are willing to work on them. Like all habits we form, change takes time, and we must commit to improving one element of our trading personality at a time, with total focus. Journaling can help identify goals and issues, as well as track progress.

What does your Trading Journal look like - or do you not have one? It is critical to keep a Trading Journal. Yet statistics show that 97% of people do not have written goals, so why would a written journal be much different? In my journal I ask myself every day "Did I execute my trading plan properly?" If I did execute my plan correctly but I lost money, I give my trading that day a Plus. If I did not execute my plan, even if I made money, I give my trading a Minus. I also ask what caused me not to execute my plan. Was it lack of confidence in the system, fear, distractions, or something else? I then write out a positive solution regarding how I can fix this in the future. I also write down if I override any of my rules. I have generally found that my ego-based decisions to tinker with my system added little value, and often hurt more than it helps. The ego wants to feel like it is adding value on top of the system, to make the trader feel important. I believe that trading for ego satisfaction is probably even more damaging than trading for entertainment or excitement, as the ego risks getting damaged by the financial fallout that can occur.

In my Trading Journal, I also note any insights on the current market, patterns that are working or not working, and other issues I encountered. I also list in my records my thoughts, feelings, ideas for improvement, strategies that did or did not work, etc. Reviewing your entries and exits in a trading journal helps you identify your strengths and weaknesses.

In my Trading Journal I like to go back and look at my trades over the last month, to see how they subsequently performed. If I sold too soon, I want to find out why. Besides the daily observations, I commit to doing a post-trade analysis every month at the end of each month. I note what I did right and wrong, and seek to learn from mistakes to minimize future errors in similar circumstances, while also looking for winning patterns where I seek to repeat big successes. I call this a Success Profile. Be honest, and ask good questions: "What worked? What will I do differently next time?" Write about your thoughts, feelings and behaviors to see if you can spot patterns. Also keep notes on your trades you liked but didn't make. What held you back? Do you notice any patterns there that are causing you to miss opportunities? Look for patterns among your non-trades too to see what you are missing.

One of the daily notes I like to make is to ask myself, "How Do I Feel Today"? In three primary categories: Physical, Emotional and Spiritual. I grade myself from 1 to 10, with 10 being best, and I write a note to myself about why I feel positive or negative in each category. There is no science in this case, but more of a personal 'gut' sense of where my mind, heart and soul are at on a given morning. Not surprisingly, some of my best days have correlated with scores of 26 or better, while I find that any total score under 24 is not very conducive to sharp, focused trading. The key if you score yourself low in an area is to then ask "Why?" and "What can I do to feel better now?" In some cases, if I feel sluggish physically, I have been known to get out of my chair and do jumping jacks and push-ups. This may sound silly to traders used to sitting for long periods, but I prefer to boost my self-esteem by even marginal exercise if I need it to feel better about myself, in additional to any physical benefits. Both positive and negative emotions seem to translate into trading. I will journal to improve how I feel about an emotional issue, and if I feel spiritually malnourished, I will take time to pray and meditate. The bottom line is that whatever gets you feeling better about yourself will tend to make you a more confident and focused trader and investor.

Good day and good trading.

Wednesday, November 08, 2006

Exchange Traded Funds - ETF's

Exchange Traded Funds (ETFs) have been one of the hottest trends in the stock market for the last few years. They have many advantages that both traders and investors should consider.

ETFs are similar to mutual funds, in that you are getting the advantage of diversity by investing in a group of stocks all at one time. However, there are some major differences between these two types of funds. The most important difference is that ETFs trade just like stocks. You can use any broker to buy an exchange traded fund, such as QQQQ, just like you would buy MSFT, INTC or any other stock. This is a major advantage over mutual funds, which are much harder to get in and out of.

ETFs are also not actively managed. Mutual funds usually have a group of people who manage the holdings of the fund and try to provide the best possible returns. ETFs simply track a set group of stocks, usually based on an already established index. Either the major market indexes such as the NASDAQ 100 or other indexes as with the more focused funds like IYF from iShares, which tracks the Dow Jones Financial Sector Index.

Another major advantage to ETFs is that they usually provide a highly liquid asset to trade. According to Yahoo! Finance, which has a large section of their site devoted to information about ETFs, there are 33 funds that have an average daily volume (past three months) greater then 1,000,000 shares. The most heavily traded funds are QQQQ, SPY and IWM. These three funds track the NASDAQ 100, S&P 500 and Russell 2000 indexes, respectively.

The future of ETFs is in the tracking of assets other then stocks. Last year, streetTRACKS released a fund that just holds gold and allows investors to buy gold without the normal hassle of commodity trading. The StreetTRACKS Gold Shares ETF trades under the symbol GLD. Another new fund is Rydex's Euro ETF, the Euro Currency Trust (FXE), which is the first to track a currency. The two newest commodity ETFs are the U.S. Oil Fund ETF (USO) and the iShares Silver Trust (SLV). Still more commodity and currency funds are being planned for release in the future.

Good day and good trading.

Trading The News

Following stock market news can be a great source of information for the successful trader. Whether gleaning facts or anticipating emotional responses by other investors, it is possible to garner a great deal of information from stock market newsletters and from both the print and network media outlets.

For example, the stock market news was buzzing on October 27, 2006 when the US Commerce Department announced that the economy was at its slowest pace in over three years, spurring speculation that the comfortable landing many had desired might not be found. Investors forced up the price of stocks in October, speculating that the economy was entering a slow period. The theory was that a gradual leveling wouldn’t affect corporate profits or consumer spending. A gradual slowdown is desirable to protect the economy from the threat of inflation and to encourage the Federal Reserve to lower short-term interest rates. Technical analysis of the stock market news led investors to believe that the report on the GDP (the broadest measure of the economy) would show slowing growth, but the report confirmed the belief that the sluggish housing market might affect other areas of the economy. The 1.6 percent growth rate was below the expected 2.1 percent forecast, fueled mainly by the lethargic housing market.

While the stock market news seemed to affect the greed and fear of the investors, some experts viewed the downturn as an indication of profit-taking and consolidation. The news of the stock market adjustment was the perfect opportunity for some traders to take a deep breath after the recent run and review their portfolio diversification. While trading was down for both the Dow Jones and NASDAQ stock exchanges, their totals were still up, further indicating a temporary adjustment and not a major downturn.

Such movements are valuable when learning about the stock market. For a beginner investing in the stock market, it is important to differentiate between technical facts and emotional trading. While stock technical analysis changes only if information on a particular company or its stock changes, emotional trading can be affected by a stock market report on the news. Even a skilled trader can be moved by such sensational news, so it is imperative that a beginner be wary. It is possible for a trader, using a stock trading plan and a stock trading system, to avoid being lured into reacting only to news about the stock market.

A stock investing system is crucial because it prevents a trader from becoming emotionally invested in the stock market news. This system should include stop loss strategies and techniques which aid the trader in decision making when a stock is faltering. In addition, a stock trading system should implement technical analysis with candlesticks, keeping the investor focused on the factual side of trading and not on which member of the stock market is making news. Using a system such as Japanese Candlestick stock trading, even a beginning investor can be certain that he, or she, is prepared to act analytically even when the stock market news is bad.

Good day and good trading.

Tuesday, November 07, 2006

Systematic Investing

It sounds logical enough; an investor needs a good stock investing system. But then comes the obvious questions; what is a stock investing system and how do I establish a good one? First, a stock investing system is a system for evaluating stocks, identifying risk and profit objectives, and planning a long term investing strategy. Secondly, a good stock investing system will also include a stock trading system such as Japanese Candlesticks. While it is important to realize that even the best stock market investing strategy isn’t perfect, successful traders maintain that the discipline to follow their plan contributed to their success more than their trading philosophy. They know that the proof of a good plan is tested over time.

Adding to the success of a stock investing system are the stock market trading tools, specifically the tools used for stock technical analysis. When coupled with a system such as candlestick chart analysis, an investor can know that his or her trading plan contains the components necessary to establish a successful presence in the market. With all of this power available, an investor must still be able to recognize when they have made a mistake and recover successfully. A good stock investing system will include stop loss strategies so that an investor is prepared in the event that a particular investment goes bad. Preparing for exactly such a situation can be the difference between success in the market and complete failure.

Another valuable concept for the investor is portfolio diversification. A portfolio that has a broad variety of commodities, varying levels of risk, and diverse profit potential can be an excellent way to insulate an investment. This way, it is possible to speculate on a stock and use the rest of the portfolio as a hedge against a devastating loss. Such a practice is valuable in any stock market trading system.

How does the investor figure into a stock investing system? The investor is the centerpiece of every successful, or unsuccessful, trading plan! The market is a psychological adventure, with euphoria, boredom, joy, pain, greed and fear all attempting to alter the stock investing system of the investor. A wise trader is able to withstand the emotions of the market and stick to the stock trading plan. Avoiding investing in unknown markets and resisting the temptation to invest out of boredom are factors in avoiding potential problems.

While the market has many pitfalls, a good stock investing system can assist any investor who wishes to realize a profit trading in the market. When beginning investing in the stock market, it is immensely important to develop a plan to trade stocks, acquire the necessary stock market trading tools to create an edge, and learn from those who have gone through it all before. While the market is unpredictable, the principles and techniques needed to be successful are time tested and reliable. As with any event in life, a good stock investing system and the lessons learned by others will provide the best investment advice an investor can ever receive.

Click the Systematic Investing header link above to learn more about having a sound investing plan.

Good day and good investing.