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Lessons from the Pros - Futures

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Is it Time for a Checkup?

Tue, Jun 30 2009, 11:10 GMT
by Don Dawson

Online Trading Academy

As many of you have noticed, the stock index Futures have had a drastic cut in volatility since their all-time high volatility in October. At that time, the ES (E-mini S&P) had an ATR (Average True Range) of approximately 90 handles (full points). That is about $4,500 per contract from the day's low to the day's high. Today, the ATR is about 20 handles or $1,000 per contract from the low of the day to the high of the day, almost an 80% haircut.

With this decreased volatility comes questions and possibly self doubt about our trading strategies. Is it time for a trading plan checkup? We have all heard that once we develop our trading plan that we should stick to it regardless of what happens, right? There is sort of a catch twenty-two here, and the answer is a definite "yes, but."

Some of the reasons a large percentage of traders lose is,

1. They don't have a trading plan or they don't follow the one they do have

2. The other extreme is the trader who has to tinker with or tweak his trading plan too often

3. The trader who never updates his plan for whatever reason

The first reason probably fits the largest percentage of traders. A majority of traders just don't take the time to write a plan. Then you have the ones who do write one and they just don't have the conviction or discipline to follow it.

The second reason is driven mostly by emotions. We have a losing trade and think we see what "caused" it so we want to change our trading plan around based on that trade. Remember, trading is a probability business and one trade should not break or make a trader.
If over a large sample of trades you start to see this "pattern" then perhaps yes, it is time to make some changes, but not only after one or two trades. Confidence comes from doing something over and over. If you keep making changes too frequently, you will never build this confidence needed to execute your trading plan.

The third reason can run you out of business over time if you do not change your plan. Just like any successful business, and trading is a business, you have to be on top of your game to know when to make changes to your business plan. These changes do not have to be major overhauls either. For example, adjusting our timeframes we are trading in to fit our risk/reward model, changing our entry and exit strategies such as taking profits at targets instead of using trailing stops when the market has small ranges, or adjusting our maximum daily dollar loss to be more in line with the different volatility you are experiencing in the market. This is where keeping a daily trading journal and then reviewing it on a regular basis helps. The journal is where you will find these subtle changes that need to be made to your trading plan.

The third reason can run you out of business over time if you do not change your plan. Just like any successful business, and trading is a business, you have to be on top of your game to know when to make changes to your business plan. These changes do not have to be major overhauls either. For example, adjusting our timeframes we are trading in to fit our risk/reward model, changing our entry and exit strategies such as taking profits at targets instead of using trailing stops when the market has small ranges, or adjusting our maximum daily dollar loss to be more in line with the different volatility you are experiencing in the market. This is where keeping a daily trading journal and then reviewing it on a regular basis helps. The journal is where you will find these subtle changes that need to be made to your trading plan.

If the answer is "yes, but", then how will you know when to update your trading plan? What I have found to work for me is to put in my trading plan the schedule for when I am going to review and possibly update my trading plan. Using a calendar to tell me when to check my trading plan keeps me from tinkering with the strategy. For example, I am comfortable with doing quarterly reviews. Notice I said reviews and not updates. There may not be any need for an update, but I always want to review my plan. As our trading careers progress, we learn new things. As we learn, we need to adapt our trading plans to this new wisdom we have obtained. Keep in mind that the worst time to make changes to your plan is while you are in a trade or experiencing an equity drawdown. Your emotions will be running high at this time and you will probably not make a rational decision about your trading plan. Remember, when you make changes to your trading plan this is for the long haul and not the next couple of trades.

Below we will discuss how to handle some of the daily fluctuations you can expect in the markets as you trade. These types of days or series of days are the ones that you have to guard against making impulsive/emotional trading plan changes.

As I have written before, when your trading is going well you are probably bored to death. Each day you just come in and follow your plan, execute your orders and limit your emotional input during the day. This is almost like being in the zone while you trade. It takes a lot of work to get there, but once you do, your trading will go to a new level. While you are in this zone and trading, you will experience a couple of these types of days without a doubt. Being prepared to handle these days will help you accept the outcome easier.

Uneventful days or decreasing volatility (much like the environment we are in now)

• This is where having realistic expectations is so important. Having the same expectations of profit as you did last October in this slow environment would cause you to hold on to trades for too long. Your actual account equity can stay stagnant for a long period of time when the markets go into this quiet mode. Many people think of trading as where everyday, the market is swinging wildly and you are on the phone screaming "buy – sell –buy" hundreds of times per day, but this is not the case. There will be times you will look back on your charts and see the market rally or decline, hear of stories that should have moved the markets or have watched signals pass simply because of the low volatility. It is during these times that you can easily wander away from your trading plan and try to trade differently. This results from frustration mostly of just sitting and doing nothing. If there were ever a time to exercise patience this would be it. Remember when we were talking about confidence in our plan? At this point, we will need plenty of patience, as well, to allow our plan to work.

• When a trader gets a huge windfall profit, one would think it can only be good. Making fast easy money can cause problems in your trading down the road. This is where Mr. Ego usually steps in and starts screaming in your head, "See how easy this is? We should be able to do this on every trade." Or worse yet, you start calculating into the future your "new" income level if you can do this a couple of times per week. These inflated expectations lead you to stray from your trading plan in the future by trying to keep that same emotional high alive by trading in any means you "think" it will take to make that profit again. The ideal thought process is to not get overly excited about a winning trade nor should we worry about a losing trade. Unfortunately, we are all humans and when it comes to these feelings, it is sometimes very difficult to contain our emotions. If we can just keep in mind that trading is a probabilities business and have the discipline to follow our plan and be prepared for any outcome, we can survive these over-exuberance type days. It is a good idea to have a strategy to handle these days somewhere in your plan. Just as a catastrophic loss can have long-term negative effects on your trading, so can letting a windfall profit turn into a loser.

• Let's first differentiate between the inevitable losing trading day and the bad trading day. The first one is going to happen no matter who you are. The sooner you come to accept that losing days are part of this business, the better off you will be. Now the bad trading day; this is the one where you get hurt so bad that you do not know if you can come back to trade either financially, mentally or both. To help keep from having these bad days, we need to have something in our plan that helps us when we are having a losing day that will stop it from turning into a bad day. This is where good money management and again, discipline will help. The most important element in my trading plan is my daily circuit breaker of how much money I will lose before I stop trading for the day. I cannot tell you how many times this has saved me from revenge trading later in the day. My plan is to physically leave the office when this circuit breaker is hit. I am done trading for the day. My experience has been that if you continue trading after a large loss with the idea that you will make it back, you will lose even more money and very rarely make any back. Another bad thing to do is to double-down on a losing trade trying to make it back with a smaller price move in your favor, another recipe for disaster. Let's face it - we cannot be on top of our game every trading day. So when the markets take your money, they are politely telling you this is not your day. The market is the master and we should always listen to the master. Use that circuit breaker my friends! Let's live financially and mentally to come back and trade again when things are more conducive to us making money in the markets.

If anybody is looking for the answer to what success is, I leave you with this quote:

"Themeasure of success is not whether you have a tough problem to dealwith, but whether it's the same problem you had last year."

Follow your plan

Published on  Tue, Jun 30 2009, 12:22 GMT