The Holy Grail of Trading and How to Find It. Part 1

One of the reasons that most traders fail is their unending search for the so-called Holy Grail of trading, which they never actually find.

Let me say at the outset that your Holy Grail is right in front of you.

This series of posts is to present how I found my Holy Grail and how it is evolving.

Firstly, let's decide what this Holy Grail is. For me, the Holy Grail is "what I do" to be consistently profitable in my trading. I hesitate to call it a methodology or system because it's a lot more than that.

There are only three things that a market can do: Go up, go down or go sideways. That's it! Lets clarify this a bit and say: Trend up, trend down, chop sideways. As soon as I make this clarification, I have to qualify my descriptions by attaching a time frame or periodicity to the clarification.

In subsequent posts, I'll explore the way I would suggest that this elusive "grail" quest take place. Let me start by saying that there are many, many methodologies that can lead to consistent profitability. What is hard is the putting in the steps to make that methodology consistently profitable.

The answer is CONSISTENCY. I think it was Henry Ford, the auto magnate, that devised the production line so that less skilled workers could effectively carry out skilled work. Adapting the production line methodology to trading is a way of making consistent profitability a reality.

To be continued....

Holy Grail

As I progress with my book  I find it's really slow going- much harder than I thought since I want to do a really proper job. Meanwhile I thought I'd share some key ideas here on the blog that will end up in the book.

One of these key ideas is the search for the Holy Grail. There will shortly be a series of posts comprising a number of parts entitled: The Holy Grail and How to Find It. If you've signed up to twitter you'll be notified as this multi part series of posts hit the blog.

Trading is all about Probabilities

Trading is all about probabilities.

We have pictures that have a high probability of disclosing momentum and order flow in certain directions. But these are only probabilities because it only needs a very strong hand to do the opposite of what the then order flow is showing.

But this is the best we can do. If our pictures are correctly described and we have backtested them up the wahzoo then we will have the statistics of the probabilities.

Calculation of probabilities is done in many endeavours including weather forecasting and electioneering. This is a link to a very intereesting article from the Sydney morning Herald on probabilities being used to forecast the recent U.S. presidential elections.

http://www.smh.com.au/technology/technology-news/he-called-it-and-now-silvers-a-popculture-star-20121112-2978j.html

Discretionary Trading

There are some great conversations in the comments to the previous post. The last question was:

El, per your stat, how many contracts, say on euro futures do you trade per $30,000?

As an example, 1 contract per $10,000, i e 3 contracts per $30,000?

Can you expand a bit on what you beleive is a "proper" account per so many contracts?

 The answer depends on many things including: Are you CP? What your win rate is. What your average trade size is (the average of all wins and losses). Your risk per trade and so on. In other words, how many contracts can you trade without wiping out your account. Making this assessment is crucial if you want to trade aggressively or even passively. Once you have this number then it should be reduced to half, to a quarter or even less depending on your degree of aggression.

All of this depends on having comprehensive back testing stats with a large enough sample size to be relevant. The back testing is not only to validate you as CP but also to provide the information for proper position sizing.

Expected Earnings

Last week there was a question in the comments to a post. The question was:

What do you consider to be a reasonable yearly percentage return on account from day trading alone (ie excluding income from your options trading etc) after commissions etc?

 I have written about this in the past, particularly in the early days of the blog in 2010 so go back and read those comments too if this topic is of interest.

Firstly, let me say that discretionary trading is not a return on an investment. Discretionary trading is not investing. It's a business like any other. So believing that "I have $30,000 of capital and I want to earn 30% a month" is not the way to look at discretionary trading. If you were using an algo to trade fully automatically then things are more passive and the way you looked at trading would be a bit different to discretionary trading.

But the question, in a slightly different form, needs to be answered. If someone wants to become a discretionary trader then he needs to create a business plan, a trading plan, and that means looking at return not on capital put the return from exertion and risk.

Now, we need to define what we do:

• what we trade
• how many hours and how many days a month are we doing it
• what is the risk per trade - VERY important subject I'll post about separately
• what the criteria for entering and exiting trades are. 

We can then back test our trading plan. From the results of this testing we can work out approximately how many trades we will make a month and what profitability might be achieved. We can tweak our plan until we see the numbers that we want. But at this stage it's still only a guesstimate.

The next stage is to paper trade the plan so that it can be validated in real time. paper trading is not the same as live trading due to the vagaries of fills and the psychological impact on a trader but if you can't get the results you want by paper trading then it's highly unlikely that you'll achieve them live so this step is important unless you want to risk money on the unknown.

Whatever your methodology, you can only earn what the market gives you. Market activity varies as does volatility. You cannot predict either in the short term so the more paper trading stats you have, the more accurate your calculations of future stats will be - large sample size.

How much can be earned is different for every trader and his trading plan.

Let me draw attention to the CFTC disclaimers relating to past performance not being a guarantee of future profitability and the unreliability of hypothetical trades.

Now let's look at the specifics. You have done your back testing and/or back testing and paper trading and you see that:

1. I have $30,000 in my trading account
2. I trade 4 hours a day
3. I risk $1,000 per trade
4. I trade 4 times a day and 19 days a month
5. I trade about 76 times a month (#4 = 19 times 4)
6. My win rate is 73%
7. My average win is $573 after commissions
8. My average loss is $842 after commissions
9. My projected profitability over the long term is therefore:

           Winning trades per month = 76 x 0.73 = 55.46
           Amount won a month        = 55.46 x $573 = $31,778.58
           Losing trades per month    = 76 x 0.27 = 20.52
           Amount lost per month      = 20.52 x $842 = $17,277.84

       Nett amount earnable per month (projected) = $31,778.58 - $17,277.84
                                   = $14,500.74

 Let me point out that if the same trader worked for 6 hours instead of 4 hours at the same level of profitability then with the same $30,000 he would earn $21,751.11.

These numbers assume that there is a tested trading plan and that the trader will stick to the trading plan. No trader I know, including me, sticks 100% to a trading plan.

So now cut these projections into half.

As you can see, you are not getting a return on your capital but have a business that is capitalised so that with the trader's exertion and expertise, profits are made. The capital does not earn the money. The trader does.

Less Regular Posting

I started writing a book a few months ago and it's taking more time than I ever imagined, so after today my posts will no longer be daily ones. The working title of the book is:

Making Money With Market Profile™  
: An Actionable Guide To Using The Profile Every Day

Instead of short daily posts, I'll talk about specific trades in a bit more depth when I post and I'll also address specific subjects I think are important or answer questions from you that I think worth a post. The first of these new posts will be an answer to a comment/question last week-

What do you consider to be a reasonable yearly percentage return on account from daytrading alone (i.e. excluding income from your options trading etc) after commissions etc?

We tweet whenever there is a new post so use the button to join me on Twitter. You can also use a number of apps to convert the tweets into emails. But I guess you all know that.

The blog turned 3 years old last week and I have posted on virtually every trading day since. If you read the blog from the beginning, you can see all the pieces that go into becoming CP. There are over a thousand pictures and videos showing most of what I do. Many have used these resources to get to CP. Good work guys!

The Video training is still available. At the moment, I take a couple of traders at a time to mentor and I will continue to do that.  I still will respond to all my emails and all my former students will always be able to reach me for whatever they need.

Anyway, it's biz as usual, but we'll just talk about it a little less often.

Quiet Europe

The market in Europe was very quiet in the morning today. Volumes are shrinking. It feels like a tennis ball at the top of it's bounce.

The game since I woke up today was to short around VAL and cover when order flow stalled. Not too hard but I only traded from the short side, a few ticks at a time. There's a nice gap below in the RTH chart and I'm hoping the price gets in there.

Continuation

The Feds pumping of money into the system is continuing to push stock markets higher. Yesterday was a fairly squat day but this morning, London time, the advance continued.

The DAX found support at the POC and then just dug in and continued higher. The story was clear to see. Context is king.

The Story So Far Today

The pic below is the 24 hour Profile of the ES. Its about 9.30am London time. The Profile is very revealing and has a number of trades that can be done just off it. Using the bar charts for timing lessens the heat that I have to take. Note how well the POCs and VAL/VAH work.

1. Triple top of the first distribution of 10/17 down to the VPOC
2. BUY off the VAL of 10/16 14:30

There's still about 5 hours before ES RTH and I'm sure there will be some more trades even before then. After RTH begins, I use both the 24 hour Profile and the RTH one.

Sticking to a View

...until it's been proven wrong is an important part of trading. Sometimes a position needs a little more time than usual. yesterday was one of those times.

This is a followup to yesterday's post. The first pic shows that FavFib line being reached and bounced off before RTH began. The second pic shows how that same FavFib line can be faded during RTH, the first time it gets touched.

Yesterday was the 3 year anniversary of the start of the blog. Thanks Rino for your good wishes. It seems a lifetime ago. The markets are still in this state of transition. Volumes, volatility, HFT have all changed and are still changing. Discretionary traders are complaining because they are getting lost in the noise. The key is to have a rigid methodology but to be able to vary the details to fit the context. For me, identifying the trend and then trading the pullbacks is that rigid methodology. The other details are just me using my discretion.

When you look back in the blog to October 2010 and read forward, that basic theme stays intact. I've tried to show lots of ideas about how to deal with the context - using your discretion. Most traders try to mechanize their trading. That's OK if you are satisfied with the results from mechanized trading. I am in many cases and that's why I have FloBots. But when I want the highest win rate and profitability - green most days - I trade as a discretionary trader.

Car Wash?

No, Cow Wash!

  

We had the annual country show here in our area in France. There were cows, horses, sheep and other animals being displayed and judged, and lots of stalls with stuff and food for sale. Fun morning.

My prep for today's ES includes looking at support and resistance. Note how the FavFib resistance corresponds to Profile resistance at VAL of the last distribution on Friday.

Time for Coffee

When price opens in the middle of value in a quiet market, there's plenty of time for a coffee. My Nespresso is deliberately two floors below me so that I have a walk to get an espresso. It's a trip I make about 8 times a day.

Today's Profile tells me to look for a SELL at VAH and as BUY at VAL and to drink coffee until one of those events happen. That doesn't mean I just put orders out there. It means that I qualify the picture when price gets there and see whether it meets my trading plan's requirements.

Jiro Dreams of Sushi

As you know, Kiki is a great Nipponophile (person who loves things Japanese). I can't even count how many bento boxes she has. Well anyway, she came across a movie that I watched a couple of nights ago: Jiro Dreams of Sushi. It's a docu-movie about an 80+ year old man in Tokyo who has a Michelin starred restaurant. It seats only 10 people who sit on bar stools and book a month in advance. His restaurant is acknowledged to make the best sushi in all Japan.

Jiro teaches his sons and apprentices to make sushi. It takes about 10 years to get to learn basic competence.  His sons are in their 50's and still learning. Jiro's philosophy is to do the same thing over and over again in order to achieve perfection. Does all this sound familiar?

ES broke an important FavFib yesterday (Wednesday). I took the pics this morning and price of the ES is bouncing up to the bottom of the FavFib which is now resistance. This will play an important part in my decisions until we are far enough away from it. The MP charts show the RTH and the 24 Hour Profiles in separate charts. Interesting?

BTW, Twitter link should be working now. Thanks Rino.

A Pic is Worth 1,000 Words

Today's post is the pic below. I'm posting it to show how the markets honoured the MP support and resistance areas. When price hits these areas, I look at my bar chart to see whether I should BUY, SELL or DO NOTHING.

And Again!

If a trader doesn't know how to use Market Profile then he is at a distinct disadvantage. Entries are earlier, trades are surer and can be entered on maximum size knowing that the probabilities are strongly in favour of the trade.

Today, again, price was accepted inside value and there were all the signs that the VAL would not hold. Yes, I scaled out at VAL, small, but in the belief that the next stop was the dotted red line below. The VAH of the overlapping distribution.

Again!

The Profile did it's thing again. The VAL of Friday's last distribution held the market and bar chart confirmed. Then down the zipper and on down.

Trade Setting Up??

Today's pics are a series of the DAX. Price opened right on the VAH of yesterday and dipped into the VA. Is it a BUY or is it a SELL? Too early to tell in pic 1.

Now let's see what happened next.

The market chose to accept value within the VA. Short at about 7332. The market is quiet ahead of the Jobs number so I will take profits on half at the POC and may be earlier if order flow dictates.

 

Took profit on half at 7325 as the market stalled at the POC area and covered the balance at 7333 as the TPOs went 3 wide straddling the VAH, making the trade into a 50/50 probability or maybe 60/40 to the upside. I made a net profit of 6 points on a half size trade, less commish.

This Chart Talks To Me

Again, the Profile tells the whole story and the bar chart confirms and gives the timing.

Here, the DAX opened above value, traded up just through the VA of the 10/02 split along the interposed zipper, making a double top. The bar chart showed the overbought but it was the last peak of the big CCI that corresponded with the resistance on the Profile. So we had a buy although on a 50% size on the open and a 100% sale as the market hit resistance.

The next short was as price went into VA of 10/03 and it flew down to VAL. In fact, the bar chart gave the sell at just above the VAH but the confirmation of the Profile was the entry into the VA.

I'm flat now and will either buy the VAL or sell a confirmed break. The market is waiting for the Spanish bond auction results as I'm writing and the market may react on the result.

Context is King

The DAX opened within the previous distributions VA and then accepted value below the VAL. This was a short. But then look what happened. As I tell my mentoring students, context is king. What happens and what doesn't happen is key here.

The price made 3 stabs down into the zipper of the 10/02 08:00 distribution. It should have reached the bottom of the zipper and with a little follow through traveled down the zipper of the 10/01 distribution. But it rejected the lows 3 times. There's that number 3 again. The other key bit of information was that price had been accepted in the VA above so when price went back in, BUY, BUY, BUY.

Deja Vue

I love how patterns just keep on repeating themselves. I tell my students that they have an advantage if they are visual people because they will remember the patterns better. I wasn't visual when I started, but over the years have become very focused on the patterns.

Today's open was a repeat of yesterday's so I didn't even need to have a good memory. Price opened at the VAL of my split distribution, tested the VA and rejected it giving me my first trade, a short.

The market then did what it did yesterday and went back to the VAL of yesterday. Resistance works well the first time. It has to prove itself the next time. This time it didn't and value was accepted within the VA and I went long. I didn't even have a chance to scale out at the POC as price went up so fast so I scaled out just below the VAH and then exited the balance after price came back down into the VA.

Following the Flow

The DAX opened and rallied to the VAL of Friday's last distribution. My 2 minute bar chart showed that this was also the time for a short. I took the short at about 7233.5. Price then entered the VA and was accepted (2 rows of TPOs). I scratched the trade at the cost of commissions and went long as it re-entered the VA at about 7238.5. I exited half at VPOC around 7254.0 and looked to trade the balance up near the VAH at around 7264.0. The market co-operated and I exited the trade. I couldn't find a re-entry and watched the market go higher. But that's OK as I had stuck with my trading plan.

Markets may be even quieter this week as the various Asian countries have their Golden Week.

What's Better Than A Banana Split?

Yesterday's Market profile chart of the ES shows how clearly it's possible to spot order flow as value changes. The key is splitting the Profile into distributions. Apart from the "obvious" support and resistance, the Profile is talking to me and showing me what "they" are doing. Yesterday, whatever news was thrown at the market, "they" just kept on buying.

Traders tend not to use all the info there is the Profile. People somehow focus on the mechanics rather than what the Profile is showing in terms of underlying market activity.

Market Profile Rocks!

If there was anything that was invented for day traders that makes a real difference, it was Market profile. Thanks again, Pete. It just tells me exactly where I am in the market. Learning how to use it is really worthwhile, even though there is little educational material in the public domain that is worth much.

Today's DAX chart shows today, so far. The pic was taken just after noon, London time.  It's magic. The low was held by yesterday's POC. The high was held by the VAH of the first distribution of 09/26. It's invisible until you do the split. Worth learning?

Trend Day Down

Yesterday was a trend day down in the stock indexes (indices?). What that means for me is that if the market retraces some of that move before the open of the next session, I look for a place to put a trade on.

In today's case it was the ES. I was up at about 4.30am London time and had to wait until after 7.30am before my trade appeared.

Price had been trading above the 33EMA on the 2 minute chart. I used 2 minutes as the volume is thin in the Asian session of ES. The Picture tells it all.

Hitting the Target

I awoke at my usual early time and went through my usual morning routine looking at the web to catch up on news and then looking at the overnight charts. I try and get a feel for the day to come. Bullish? Bearish? Sideways?

Once I've done that, I create a vision of the possibilities for the day's range. At the moment I'm trading four markets: DAX, Euro FX, Light Crude and ES. I mark up my charts.

Today's DAX chart shows the simplicity and effectiveness of this process. Price opened just above the VAH. I envisioned at least a test of yesterday's VAL and a possibility of lower if the VA of 09/20 was penetrated and accepted. My bar chart provides the confirmation and timing.

Context

This Light Crude Market Profile chart is a good example of what I have been talking about in recent posts about context. While it's possible to trade CP without this context, using it allows me to have a higher win rate and trade larger size more confidently when I do my business at places that the context verifies.