April 3, 2013

Identifying, constructing and executing an asymmetrical trade On Twitter today I promised to share the chart of a pending trade I currently wake up thinking about each morning (about 3:00 AM). So, here goes. First, some background on my trading philosophy is in order. There are trades and then there are trades. In my mind, not all trades are created equal. In fact, I maintain a matrix of the signals I will take. The matrix lists just some of the following information: Pattern weekly Pattern - daily Length of patterns A launching or ignition pattern with the larger pattern Trend daily (using a moving average as a proxy) Trend weekly Any other technical factors

From this information I ballpark the risk I will take on a trade. I have capital segregated for futures and forex trading. I will risk between of 1% and 1.2% of capital on a trade, although under extremely rare circumstances I might risk up to 2% of my trading capital. About 5 to 15 times per year I get the highest category trade set up. These are set ups generally characterized by: 1. A 12+ weekly daily chart pattern with a horizontal boundary line 2. A breakout confirmed by the daily moving average 3. Confirmation by other technical factors COT data, spread behavior, against conventional wisdom Once I identify such a candidate market my mind becomes focused on how I can construct a trade that will produce a return of 5% to 10% or more on my entire trading capital. I never calculate risk or reward against margin used for the trade itself, the value of the underlying commodity contract, % of price change or the like. Risk and payout are always measured against total trading capital. In other words, per $1M of trading capital I am willing to risk $10,000 on a high quality trade, hoping for a gain of $50k to $100k. As a general rule, on a 1% risk trade I will assume a position of one futures contract (or 100,000 primary in forex) per $100,000 of capital, or 10 contracts per $1M. But depending on how the trade develops I may only be able to put on 5 or contracts per $1M. I try to stay alert and anticipate how I might establish a position of 15 contracts for the same 1% risk. This is where timing becomes so important. I see a 10% gainer coming in the Australian Dollar futures (or the AUDUSD spot forex). Here is the set up. On a weekly chart the Aussie is forming a massive and clearly defined 2-year symmetrical triangle on the weekly chart. Please know that I dont care if this is a continuation or reversal pattern I just want to be in on the trade. The solid boundary lines define the orthodox highs and lows of the pattern. The dashed lines define the weekly closing prices. I draw both types of lines in on major patterns. Factor LLC 2 North Cascade Avenue Suite 720 Colorado Springs, CO 80903 Email: Factorco@gmail.com

Of extreme interest to me is the 8-month rectangle that is forming in the late stages of the the triangle. I far prefer horizontal bounary lines (rectangles) in contrast to diagonal boundary lines (triangles). My experience is to wait for a breakout. Earlier in my carrer I would always try to get pre-positioned. This led to being whiplashed within a pattern, only to be gun shy when the final and decisive breakout took place. The daily chart more clearly shows the rectangle. This is the pattern I will key off of. But I am in no immediate hurry.

Factor LLC 2 North Cascade Avenue Suite 720 Colorado Springs, CO 80903 Email: Factorco@gmail.com

For me the challenge is tactical implementation. At the present time my plan is to buy 5 contracts per $1M at 1.0571 stop and another 5 contracts if on any day the market is trading at or above 1.0571 at about 3 PM MST. This is what I consider to be the closing price. I will risk about 106 points per contact although how the market breaks out will fine tune this determination. The best scanario for me would be if the market can rally to the upper boundary line of the rectangle, stall, and then pause for a week or so. This will allow me to fine tune the trade in hopes of taking a 15 lot position per $1M. No market every unfolds as I imagine it will. A trader needs to review a set up every day. The rectangle has a target of about 1.1060. I would take profits on half my position at this level. The triangle has a target of about 1.22xx. I would hold out for this level on the other half. I am not a believer in trailing stops unless the charts show me a good reason to become defensive. Within an uptrend my bias is to sell strength and buy weakness. So, why would I want to sell weakness by using some automatic trailing stop. A word to novice traders is in order. I believe large profits are attained by holding a position, not by active trading. You need to be willing to ride a market all the way back to the starting gate in order to realize a large profit. It is emotionally tough to give profits back on popcorn trades. But this is the cost of realizing a 1000 to 1500 basis point profit on an indivudual trade. Anyway, this is my opinion for what it is worth. If I can gain a position of 15 contracts per $1M, I stand to gain as much as $140,000 for a $10,000 risk. This is what I call an asymmetrical trade. I dont use indicators. I dont care about Elliott Waves. I cannot even spell fibonachi. I love moving average, depending upon how they are used (a subject for another year). I trade patterns and price. Patterns and price. Patterns and price.

P.S. I had gone into relative blog hiding for a number of months. My schedule has allowed me to become active for a week or so. I will soon be going into deep slumber. Sorry. ( : -( )

Factor LLC 2 North Cascade Avenue Suite 720 Colorado Springs, CO 80903 Email: Factorco@gmail.com