Saturday, February 8, 2014

I have found the Holy Grail of Trading!

Now that I got your attention and probably lost any credibility I might have had with you I have not found the holy grail of trading.  The past month or so has been filled with several epiphanies and I think I found MY holy grail.  Which in short is just a trading system which I believe is complete enough to consistently make money using.  I will break down my trading system in steps and the tools I use to essentially document the trading system for myself and for all to see and criticize.  Below is the overview of the breakdown.

Wyckoff's Three Laws:  I've studied Richard Wyckoff's work and it is absolutely brilliant but the most important concepts that I believe every trader should have ingrained into their minds each and every time they analyze the markets are his three laws:
  • The Law of Supply and Demand 
  • The Law of Effort versus Result
  • The Law of Cause and Effect
This is the cornerstone of my trading and all the tools I use evolve around these three rules.  I ask myself these questions each time I analyze the markets.
  1. Are we trending or are we in a trading range?
  2. If we are trending then is the effort (volume) supporting the result (price move)?
  3. If we are in a trading range what are the upper and lower price boundaries?
  4. What was the amount of volume and time spent in the trading range and does it support a sustained price increase/decrease to make money from?
Support and Resistance:  This is probably the most important aspect to any trading system.  Being able to accurately define support and resistance areas alone could result in at least a 50% chance of being right on any trade.  More importantly, it is at these support and resistance areas that the battle of demand and supply is fought determining if there will be a continuation of the trend or a reversal.  I have not found any other tool better than Point and Figure chart to accurately determine support and resistance and hence it is my tool of choice and has been since the beginning.

Volume:  The second most important aspect to any trading system.  Does volume precedes price?  I think so and I think anyone that relies on price only will have a more difficult time making money consistently in the market then one who uses both price and volume.  I am of the mind that you want to follow the big money and not fade them to really catch those big trends.  How would you determine if the big money is buying or selling without analyzing volume?  Volume analyzes the effort of each price move.  I use two tools to look at volume and that is simple volume bars and volume by price both of which help me determine the volume support at specific price levels and strength/decline of any trend.

Price Bar Analysis:  Candlesticks vs bars? Another of the trading community's  great debates.  Honestly, they both are telling you the same thing however, candlesticks are more visual.  In the end though so long as you can determine the journey of price for that time period represented by the price bar and if it was bearish or bullish then feel free to pick your poison of candlesticks or bars. Just a note that I will follow up with in a separate post, up bars are not always bullish and down bars are not always bearish.

In the posts to follow this one I will provide examples of my recent trading highlighting all the points I've mentioned above into my analysis.  You will notice that I don't use any traditional technical indicators which signal when to buy or when to sell.  The reason is they do not fit into my understanding of how the markets work.  A MACD or Stochastic does not tell me anything about supply and demand.  Below are my steps to trading and the time frame makes no difference. The analysis is exactly the same.  Just don't expect a 50 cent trading range on a 5 min chart to lead to a $10 breakout move.

Entry Analysis:

1.  Define support and resistance areas using point and figure charts
2.  Determine if we are in a current trend or trading range in the timeframe being analyzed.
3.  Determine any price and volume congestion using volume by price.
4. If we are in a trading range determine the next possible price pause area above and below the trading range. This will determine you risk reward on any breakout.
5. Wait for the breakout of the trading range and ideally a test of the breakout range to enter your trade.
6. If we are trending again determine the next possible price pause to determine you risk reward should you enter the trade.

Exit Analysis:

1.  I usually place my stop loss just below the top of the trading range on an breakout higher.  I've found that if the price comes back into the trading range then it usually isn't a good sign.  The same goes for a breakout lower from the trading range I will place the stop slightly higher than the bottom of the range.  The loss is usually very small and I've found myself when trading lower time frames that i will get stopped out 2 or 3 times before the trend kicks in and my profits completely overshadow any small losses I've taken.

2. If the price has moved in favor of my position then having the predefined levels of support and resistance and volume congestion zones handy really help.  Usually when price hits a support or resistance level it will usually go into another temporary trading range (remember this is where the battle of demand and supply happens) so you can either exist your position at whatever profit you have at the time or wait to see how the trading range resolves.

Price can sometimes simply pullback or bounce higher when it hits support or resistance respectively without going into a trading range.  I've found that when that happens its just a temporary pause in the move and the trend will continue in the original direction.  The reason being is that the pullback serves as an opportunity for the big money to pick up some cheaper shares from weak hands and then continue to rally the market.

You will notice that this is all really prep work before you even begin the trading day.  The rest of trading day is really just waiting and watching to enter based on your price and volume analysis.

So there you have it my trading plan.  In the following days I'll be posting with examples of my recent trading to highlight both the success and mistakes I've made.

Thanks for reading.

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