Investment and Trading Philosophy
Before making the decision to use or subscribe to any of our services, please read our investment and trading philosophy in detail and in particular, how it relates our analytical methods and strategies.
THE INVESTOR
An investor takes a large risk in exchange for a large potential return on risk capital that is not needed for immediate income or living expenses.
- A long-term investor is typically interested in individual stocks, someone who accumulates and maintains positions over a long period of time, from months to years. In this time horizon, individuals are pursuing the possibility of significant long-term capital appreciation with a clear understanding that this represents significant risk in terms of exposure to the market's gyrations.
- A proactive investor is typically interested in holding positions for a period of weeks to a few months, someone who is often interested in switching between mutual funds, or NASDAQ/AMEX exchange traded funds [ETFs] and AMEX Holding Company Depositary Receipts [HOLDRs] based on major stock or sector indices.
In pursuit of the stated goals, our approach is to monitor stock sectors and their performance relative to the major stock market indices using weekly and monthly charts while forming big picture scenarios based on economic outlook and psychology.
- The long-term investor is interested in stock sectors that show signs of emerging from long periods of underperformance. Once these sectors have been identified using the monthly price chart, component stocks within each sector are analyzed. The ones with the best overall technical picture are selected as investment candidates. As the time horizon is a long one, accumulation over a period of several months on an ever-increasing dollar cost averaging basis is appropriate. So long as the price is moving in the right direction, the investor adjusts the trailing stop loss order for each position each month. Once underperformance relative to the appropriate major market index is detected, the investors avoids new commitments and becomes more aggressive in protecting profits.
- The proactive investor employs a similar approach as the long-term investor, but uses a smaller time frame to execute the strategy, namely the weekly price chart.
THE TRADER
A trader is more risk-averse than the long-term investor. All trading activity in his or her well-capitalized trading account is treated in the context of an operating business; therefore, capital preservation is paramount. Professional risk and money management methods are implemented without fail. A conscious decision is made to time the entries and exits in a precise manner, generally using technical trading methods. The time horizon for a trader can range from a period of weeks down to a period of minutes, and we differentiate them based on their time horizon.
- A swing trader is typically interested in holding positions for a period of a few days to a week. A "swing" is a technical trading term, generally defined as a price move up or down that is uninterrupted by retracements. Exposure in this time frame can generally be managed by assuming a position with in-the-money call or put options instead of buying and selling the underlying stock or index.
- An intraday trader is typically interested in scalping during regular daytime market hours and does not assume any risk or exposure on an overnight basis. The intraday trader generally chooses highly leveraged instruments such as futures, and employs extremely disciplined risk and money management policies. Many intraday traders have a specific daily or weekly profit goal and do not take risks beyond those goals.
In pursuit of the stated goals, our approach is to monitor daily and intraday charts, while factoring in the immediate effects of news events, earnings releases, economic data, and other short-term events that cause periodic turbulence and volatility.
- A swing trader is interested in participating in stocks and commodities that are the focus of attention of other traders. Typically these are instruments that have large trading and transaction volume, making it possible to enter and exit with relative ease. For example, "name brand" stocks listed on NASDAQ and the NYSE that trade more than 2,500,000 shares per day with a minimum of 5,000 trades are of interest. Well-defined trade setups are identified prior to any transaction in order to determine the potential risk and reward, using the daily chart.
- An intraday trader is interested in scalping highly leveraged instruments to compensate for the small amount of time alloted to each trade setup. Online order entry and electronic exchange order matching/execution are prerequisites for high speed transactions. Given the criteria, only high-volume stocks, E-mini stock index futures such as the E-mini S&P 500 [ES], the E-mini NASDAQ 100 [NQ], the Mini-sized Dow Futures [YM], and financial futures such as the Electronic 10 Year U.S. Treasury Notes Futures [ZN] are the instruments of choice for intraday trading on small time frames typically under 60-minutes.
INTRADAY TRADING BUSINESS PLAN
We approach intraday trading as a business. Making money requires know-how. It also takes money to make money. While investing and swing trading can be done on a shoestring with risk-capital, active intraday trading for income involves taking calculated risks trading highly leveraged instruments with a reasonable sum of money in a disciplined manner. There is no way around this. The emphasis is on protecting the downside, because once the capital in the account is gone, the business is over.
Here is an example of how we calculate things. At this time, the overnight margin on one contract of the E-mini S&P 500 futures [ES] is US$3,563 with intraday margin at US$1,781. These are the exchange minimum requirements. It's irrelevant to us, because we do not want to over-lever our account. According to most risk and money management models, the most a trader should plan to lose on any given trade is 2 percent of the capital in their account. Since each point on the ES is US$50, losing about 2 points is the minimum we can expect on trades set up off a 5-minute chart should our initial stop-loss on most trades be hit. Therefore, a $100 loss, if we were to keep our daily loss contained to 2 percent of the account, means that regardless of the exchange requirements, we must have $5,000 of capital per contract. For each market that we participate in, we calculate these figures. Right now, there is often sufficient liquidity to trade ten ES contracts at once, and therefore, to maintain adequate margin according to risk and money management purposes, the trader needs $50,000 in capital. Remember, just like in business, there are ups and downs, and the trader must count on losses as part of ongoing business activities. If the trader does not know what he is doing, he must expect to lose even more while climbing up the learning curve, and this is why we suggest paper trading to test ideas and market models, rather than using real money until such time a model performs consistently.
What about the rewards? No doubt you have been to countless websites that make big promises, so we'll do some more math to show you what is realistic. For the purpose of illustration, let's take our $50,000 account to trade ES and work out some numbers. If we plan to lose two points per day, the least we plan to make is also two points per day. Two points is a reasonable expectation of profit on a trade set up off a 5-minute chart. Suppose we make money on three days and lose money on two; we net out a single winning day per week, and we're ahead $100 per contact. I know this seems like a small amount, but please bear with me. Let's look at the numbers. $100 per week multiplied by 50 weeks (two weeks' holiday) is $5,000 per year. That's a ONE HUNDRED PERCENT return on capital per year (before commissions and datafeed costs) using our conservative leverage. That's 140 percent return on the overnight margin, and 280 percent return on intraday margin! For us, ten contracts using our conservative margin means a $50,000 per year profit on $50,000 of capital - just by trading ES alone. I don't know about you, but not many investors or traders can match these numbers, yet most traders would look at this as "small change". That's because the truth is that most would-be traders are not adequately capitalized, and need to force enormous amounts of cash out of tiny accounts. This is completely unrealistic and is a recipe for disaster on a larger scale than WorldCom!
Now that we know how much money can be made realistically, efforts should simply be directed at two things. First we would like to improve the number of winning days in an average month from twelve out of twenty to maybe fourteen or fifteen out of twenty. Second, each day, we simply look for the quickest and fastest one trade that can obtain our objective -- concentrate on trading in the first hour when liquidity is tremendous, and look for a high probablity setup. This becomes our sole mission. We do not sit there all day and try to trade everything that might move; instead, we spend our time doing research to refine methods that help us pick and choose the right moment to strike and exit with cash. There are eight-one five-minute bars per trading day in the ES. Our job in this market is to find one or two that go our way, and we're done. Our reason for trading intraday is to generate income as an operating business on a day to day basis, with as little exposure as possible. P.S. If you want to trade more than one market as we do, calculate the capital required accordingly.
CONCLUSION
The time frame suitable for each individual's participation in the market is a function of a number of factors such as the amount of capital, objective, personality, and time available. From our point of view the long-term investor and the trader approach the market from opposite ends of the spectrum. The investor seeks to accumulate positions for home runs with savings/risk capital, while the trader looks for base hits to make regular income with working capital. Either way, knowledge of the markets and appropriate risk and money management strategies need to be in place in order to ensure long-term survival.