By Robert Buran

How to Trade and How NOT to Trade

I have selected the rather generic title, How to Trade, because I am covering a lot of my most treasured stock trading secrets and stock trading ideas and these ideas may seem unusual to many and may in fact defy conventional categorization of stock trading methodology.  So I have used the most generic title I could think of.

My ideas about trading do not fit in with conventional thinking about how to trade nor do I fit in with conventional traders.  But if you want to pick up some invaluable information about how to trade stick with me throughout this long article and you will not be disappointed.

In this article I will disclose fully a critical theory of stock market behavior.  And I will debunk “The Atomic-Bomb- Instruction-Book theory” of market behavior.  And finally I will disclose fully, highly profitable programmable stock trading systems along with an explanation of the theory that makes them profitable.  This article is a must for any frustrated small stock investor.

 DIRTY LITTLE SECRETS

At the outset I am going to let you in on a dirty little secret that has less to do with how to trade than it does to  how NOT to trade.  Of all the forces in the economy that have caused people to lose money in the stock market, none have been greater than the advice of financial experts and brokers.  Brokers and most financial advisers could care less about your financial well being and if you follow the advice of these people it is highly unlikely that you will do anything more than contribute to their salaries and retirement.

We may be hurting but believe me Wall Street is still very fat and still a little stupid.

These Wall Street fat cats are the same people that put much of the world’s economy in the toilet in 2008. But of course the Wall Street Fat Cats had followers and there were a lot of people willing to listen to the advice of these morons also.

But that is all history now.  The good news is that in 2015 is that the market has recovered and we have had a full blown bull market for nearly five years.  Yeah things got a little rough in the summer of 2015 ( see the crash of 8-24-15) but as recently as early September 2015 I woke up to this on one of my screens for a managed account (click this image to enlarge):

  Trading is good and the economy will certainly recover.  And this is a great time for stock market investment.  It is time for the little guy to take revenge.  When I took this screen shot I was using a system called JORDI, but you do not need to buy my software to do good.  Just keep reading.

 DO IT YOURSELF (see Stock Investors)

If you want to make money in the stock market you need to do it yourself.  So how do you do it yourself?  Do you need to study companies and economics or, God help us all, technical analysis?  Emphatically I say no.  All you need to make it in this market is a simple automated trading approach to investing and the discipline and willingness to follow your ideas.

I have been trading automated trading systems for nearly 20 years and starting with practically nothing I have made a pile.  I do not know the names of the companies I trade and the only thing I care about concerning brokers is that I pay them the bare minimum for transaction costs.  The subject of technical analysis puts me to sleep.

I should also define what I mean by automated stock trading.  I am not talking about turning your order execution over to a computer.  What you turn over to a computer is the decision making process, to buy or sell a given market, but you are still going to manually execute the order.  Executing the order manually may be central to the success of our trading methodology .

DOES HOW TO TRADE  HAVE TO BE AS COMPLICATED AS AN INSTRUCTION BOOK FOR BUILDING AN ATOM BOMB?

What brokers, market advisers and a lot of other well meaning people want you to believe is that market behavior is extremely complicated and that the description of any truly profitable automated stock trading system that purports to predict market behavior AND that makes money would, in theory, be equivalent to an instruction book for building an atom bomb.

I know a lot of people that have attempted to become winning traders who have mirrored this kind of thinking in their search for profitable automated trading systems.  Let me tell you a true story:

I knew a brilliant engineer whose creative engineering ideas had made him very wealthy.  But just being wealthy and being a great engineer did not satisfy him.  This brilliant engineer wanted to write the definitive mathematical formula to predict all market behavior.  He was understandably confident of his math skills and he expected to be able to do this with a formula that might run 50 pages or more.

The man actually interviewed me as a potential employee and associate.  What I remember most about my interview was our discussion of the necessity of securing his home from attacks.  Once the world realized that we had the formula to predict all market behavior we would have to secure his property with walls, electrified barbed wire and armed guards.  We would, after all, be holding secrets that would allow us to take over the financial world and as such our secrets were of greater interest to hostile elements than national military secrets.  We would in effect become a financial nuclear power.

This man was not crazy; he was brilliant.  But I did not go to work for him and I nevertheless might have dismissed him and this incident had I not met other brilliant people who seemed caught up with the same idea.  And that idea, the idea that it was possible to find the Holy Grail that could predict all market behavior, also included the necessity of fortifying the trader’s home against outside attacks and intrusions.

THE MOST IMPORTANT HOW TO TRADE RULE

So in order to give you a taste of what I, a successful trader, think about market secrets, I am going to publish in this article and in the printed word you are presently reading, my very accurate formula for predicting market behavior.

This description however will be best understood with a demonstration.  You will first need to find a large yard or perhaps a park with soft green grass.   Take a tennis ball to the park along with a pen and note book.  First look 360 degrees around where you are standing and then write in the note book where the ball will land when you throw it.  Now close your eyes and start twirling around and around until you feel you are about to fall.  Then just before you collapse to the ground throw the ball hard as you fall.  Now open your eyes and note where the ball has landed and compare this with the prediction that you wrote in the notebook.

Now you have just discovered the most important rule of market behavior.    All market movement is predominantly random.   Only a small part of market movement is non random and hence only slightly predictable. (see Stock Market Price)

So my brilliant engineer friend is not going to be able unlock the secret of market movement with PHD level mathematics.  In fact fourth grade math will do just fine.

When you see an advertisement for a trading system that says it is 90 % accurate, you can file it with your trash and garbage because no such thing exists with appropriate testing.  You cannot get 90% accuracy out of data that is predominantly random.  Garbage in and garbage out.

SYSTEMATIC TRADING IS HOW TO TRADE

Keep your stock trading system simple and you can be a rich trader.  When dealing with market data that is predominantly random the only way to get to the part that is slightly predictable is to stick with the simplest ideas with the fewest parameters.

Let me give you an example of a stock market trading system with few parameters.  At the close of a market day you take the LOW of the day and subtract it from the HIGH of the day.  Next you take half of that value and add it to the CLOSE.  So let us say that on Monday WUZOO makes a high of 20, a low of 10 and closes at 14.  Then we will subtract 10 from 20 to get 10 and take half of that to get 5.  Then we will add 5 to 14 to get 19.

The number 19, (.5(H-L)) +C, is the market price to buy on Tuesday.  If the buy price is hit on Tuesday you hold the position until the open on Thursday and then you sell it.  That’s it.  There is nothing more to this simple system with the most limited number of parameters.

 BELIEVE IT, SIMPLE MAKES MONEY

I have been doing this kind of market research since 1984 and I am going to tell you that even without programming and testing this simple system, I know this simple system will work.  But for the skeptics I will offer some data and test results.  Nevertheless I am limiting the amount of data I present here in order to keep this article easier to understand.  But if I wanted to prove my theory in a Court of Law I would use more data.

I randomly selected four markets from the top of my list of stocks I traded a while back and arranged alphabetically.  The four markets I selected were ADCT, ADSK, AMD, and ABGX.

I tested each market using this simple trading system for one year.  I used a formula that commits $10,000 to each trade, hence you buy 2000 shares of a stock trading at $5.00 and you buy 200 shares of a stock trading at $50.00 etc.  I tested ADCT, ADSK, and AMD from mid January 2009 to mid January 2010.  As a check against correlated markets I tested ABGX from mid August 2000 to mid August 2001.

In the real world of stock market trading and trading on margin you could probably trade all four of these markets at the same time with about $10,000 in cash.  Furthermore it is unlikely you would ever get a margin call on a trading system that is out of the trade on the open of the third day.  By the time the margin clerk calls you are out of the trade.

This is the net profits from each market:  ADCT $2,376, ADSK $2,401, AMD $4,308, ABGX $7,299.

If I put the numbers for all four markets together this is what they look like:

NET PROFIT = $16,385

Gross profit = $35,604

Gross loss = $19,219

Number Trades = 111

Number win = 72

Number loss = 39

% profit = 65%

Average Trade (win loss) = $148

MAX intra-day drawdown = -$2,848

This is pretty decent performance for trading random price behavior.  You can repeat this test in all kinds of markets and use data as far back as you want to go and you will get similar results.  It is not the Holy Grail, but it does a good job of taming the randomness of the marketplace while protecting your precious trading equity.

A good trader can take this kind of performance and get 100 % annual return on his or her investment.  And if you can get 100% annual returns you can become a rich trader.

This kind of system will always work because it is simple and has limited parameters.  Don’t give this system to a really smart person because they will screw it up!

I have done this kind of trading in real time for over two decades, but I have not yet had to put walls around my house or put up electrified fencing.  I will let you in on a dirty little market secret.  THERE ARE NO TRADING SECRETS IN THE MARKETPLACE.  What I publish here will make no difference in market behavior.  I put my stuff on a web site; it makes no difference regarding my system performance.

You can see that this is hardly rocket science.  In fact I could come up with four more of these systems that are just as good in any given evening.  If I worked on it I could develop about 100 systems like this in a month.  I know a couple of the most successful fund managers that do exactly this.  If you have $100,000,000 fund to trade you need a lot of trading signals and this approach is perfect.

BUT ALSO PERFECT FOR THE SMALL INVESTOR 

This approach works well for the small investor as well.

I like to take advantage of the short term nature of this kind of system and trade a lot of markets with it.  With short term stock trading we hit and run, spread our money thinly across many markets and we trade a lot.  I am currently managing around 60 stocks with a similar trading system I call “Jordi” and in some of my accounts  I do not put more than a thousand dollars into any given trade at a time (that is only $500 traded on margin).  and so $20,000 covers the margin requirement for 60 stocks, but I think you could still cover 10 to 12 stocks with only $3,000.  But trading 60 stocks gives me a lot of protection against deep draw-down.  If you are trading that many markets something good seems to always happen even on bad days.

And that, by the way, is why I would not consider anything but  mechanical trading, automated stock trading systems, for trading stocks.  I cannot study 70 companies and I cannot watch 70 markets.  But I can program these simple systems and let a computer keep track of everything and beep me when I need to buy or sell.  I sit in front of computers everyday in my pajamas, drink coffee and clean up.  Well most of the time I clean up.  Lol.

You as a small investor need not be intimidated by the marketplace.  If you develop a simple short term approach to trading and trade it systematically and methodically and with discipline, you can beat the pants off the majority of traders, professional and otherwise.  They are the Wall Street Morons.  Be your own boss and do it yourself.  The marketplace is full of morons and usually the morons make huge salaries and dress and talk smarter than we do.   My advice to you, the small investor, is to go after them with solid, systematic, automated trading.  And understanding that is among the most important rules of How to Trade.

Copyright 2010-2015 Short Term Stock Trading        

  By Robert Buran

Understanding Stock Market Price Movement

If you are going trade stocks you are going to have to understand stock market price, how stock market price changes, and in short, what moves the stock market.  My ideas about stock market price are unique and so let me expound a little on this subject.

The Rule of the Screw: ”Stock Market Price must move in such a manner so as to Frustrate, undermine and defeat the best interests of the majority of market players. According to this rule of stock market price movement the majority cannot make money in the stock market.

The stock market will totally ignore technical indicators and fundamentals if the majority of the stock market players act on those technical indicators and fundamentals.

Furthermore I believe that stock market price movement is predominantly random.  Although stock market price movement may not be 100 percent random I believe that it is  predominantly random.

So why is much of stock prices random?  It is because the forces driving stock prices are rooted in human emotion and judgment, and I am even including algorithmic trading in this mix, and the net effect of these various vectors of force or  pressure upon stock market price, adds up to randomness that is impossible to predict with any degree of accuracy.

The Secret to making money in markets with randomly driven stock prices.

The “secret” to making money in the market is locating that small portion of market behavior which is not random and exploiting it. I do not feel that conventional technical analysis is of any value in doing this. The problem with technical analysis is that it will present the illusion of uncovering hidden relationships between price behavior and various indicators.

I would submit that all such indicators are as random as the price behavior they attempt to predict and that all profits and losses realized from trading such indicators will be randomly distributed.

In my opinion technical  analysis is pseudo science.

Isaac Newton and the Market Place:

In place of technical analysis I prefer something I simply call market momentum theory.  For more details see my article, Stock Trading for Dummies.

• First law of price movement is:

If stock market prices move up there is greater probability they will move higher rather than lower.

•  Second law of price movement is:

If stock market prices move down there is greater probability that they will move lower rather than higher.

And from these simple rules comes the most important rule of trading:

• If stock market price goes up you must buy the market and if stock price goes down you must sell the market.

You  may read this and think “well so what?, that is obvious”.  But trust me most traders and trader wannabes do not think that way at all.  When the market goes down they want to buy to get a better price.  And when the market goes up they hesitate because price is too high.

And they do not make money!  They are a part of the losing majority.

Let us look at the following chart:

This is exactly what system sales people show in ads.  They show that their system buys the lows and sells the highs.  But that is a fantasy and it cannot be done.  And successful traders know this cannot be done.  Yet some smart traders see this and they end up buying the system because it shows traders what they want to believe.  Even smart traders can get sucked into this kind of thinking.  We all want to believe in perfect trading.

The problem is that when we look at any chart we want to buy low and sell high. You cannot, however, buy bottoms and sell tops. You can only follow a trend which has already been established through price movement in the same direction as the position you are taking.  To do the opposite is to commit trading suicide.

You must understand that when you elect to buy a market when price rises you are in effect buying the market at the worst possible price at the time of your entry. It’s not going to feel good and it’s not going to look good on the charts. But by “buying high” you are probably going to be placing yourself on the minority side of the market and therefore assuring yourself of profits.  You are on the right side of the rule of the screw.

Exiting a Position using Stock Market Price

Getting out of a stock market position is just as critical as getting in.  In my opinion most of the popular ideas for getting out do not work.  Let us look at just two of those ideas, the stop and reverse method and the trailing stop method.

Stop and Reverse method of exiting a trade:  The stop and reverse method involves utilizing some kind of indicator or a price based on an indicator. If the system is long one contract and the market comes back and the price is hit the system sells 2 contracts and reverses to a short position and so on. If you have read much of my material you know I do not like to short the stock market.

Of all possible trading strategies I have found this to be the least profitable and grossly inefficient with respect to the use of margin money. I will discuss margin efficiency in greater detail later but for now it need only be said that systems that are in the market all the time tie up your margin needlessly (see my article,

In and Out Trading). Markets tend to move sideways about 85% of the time and consequently these systems will have your margin money tied up doing absolutely nothing for at least 85% of the time. These systems can also whipsaw you to death while moving sideways.

A system like Jordi’s Intra-Day2 is, by contrast, very margin efficient.  It gets into a market only when a given market starts significant movement and it is  usually out of the trade the following day.  “Jordi” does not tie up your margin money.

Trailing Stop:

The second most common way mechanical systems take profits is through the use of a “trailing stop.” The idea behind a trailing stop is that it allows you to “let your profits run” while at the same time “locking in” any profits you may have already made. My experience with system design and trailing stops has been that the trailing stop is at best a mediocre method of exiting a profitable position. The problem is that if the trailing stop is too tight it results in your having your stop tagged right before the start of a big move. Conversely if your stop is too deep it results in many small profits going to large losses.

The other problem I have with trailing stops is more theoretical. With a trailing stop you are trying to take profits only after the market has turned against you. Frequently you are forced to sell out your long position when many others are trying to sell too. You are then moving with the crowd and this is almost inevitably going to cause you excessive losses.

Therefore the rule I have developed with regard to taking profits is:
You should try to take profits only when the market is moving strongly in your favor.

This is much more consistent with my contrary philosophy of trading. If you are long a market and the market takes off like a space ship you should sell. By doing so you put yourself on the minority side of the market selling to the majority of panicked buyers. That is how you make money in this game.

What should you do, however, if your position starts out bad, get worse and then threatens an uncontrolled hemorrhage of your account equity?
Unfortunately this happens with about 15 or 20% of our trades and our ability to keep these losses within a normal distribution pattern is what makes or breaks us as traders. This is a particularly critical issue if you are using Systems without stops on day of entry.
Out of  frustration I developed a simple strategy that probably works better than anything I ever developed. If you are sick of always having your stops run, this simple strategy is going to be a big help. If you got into a trade based on a longer time frame such as a time frame based on daily data you need to develop a stop loss strategy that is based on a shorter time frame.

This is why Jordi’s Intra-Day2 is an improvement over my previous systems using only daily data.  Jordi uses two data streams, daily data and 15 minute bar data.

To see how looking at two different data streams can improve our analysis you should kick up a chart on your computer screen and set the bars to something like 3 to 10 minutes. If you are following our trading rules you are going to buy when the market goes up. This upward movement should create some kind of upward wave on the intraday chart. You should measure this wave from its top to its bottom and if you are long the market you should place your stop at the point that represents a 75% retracement of that wave. If you are short the market you simply reverse the process. Hence my rule for placing your protective stop is:

Place your protective stop at a point that represents a 75% retracement (5/8 or 6/8) of the wave/move that got you in.

Let’s look at an illustration:

Here again you see why the “buying high” strategy doesn’t sell systems. Buying point B (which is the high) looks like a terrible place to enter this market. Why not sell at point B? Or if we have to go long why didn’t we buy at point L (which is the low)? Don’t despair.

Because you feel that way others will feel that way also and so they, the majority of market players, won’t buy because it’s too scary. The market in the best tradition of the “Rule of the Screw” will sense this hesitation by the timid majority and move much higher. That will encourage the timid majority and they will then jump into this market in a buying frenzy.

At that time you will calmly sell your positions back to the frenzied majority and take your profits.  The whole scenario looks something like this (click to enlarge):

But the real point I’m making is that when you first get into these trades they seldom look good and you need to use the 75% retracement rule to place a stop so as to give yourself some peace of mind. If you go back and look at Figure 2 you can see how this stop was calculated. I measure from point L (low) to point H (high) and take 75% of that and subtract that from point H to determine the stop which is equivalent to the price shown at point SS (sell stop).

If you are an Elliot Wave purist you may notice that there are other smaller waves in figure

Try to keep it simple and try not to miss seeing the forest for the trees. I’m not an Elliot Wave purist and what I do with a 3 to 10 minute chart is to measure from the highest high after your buy point has been hit to the lowest low on the screen.

Usually that is going to be the lowest low in the last day or two. That’s what I mean by “the wave that got you in.”

The Fibonacci Connection

Some of you sharper readers may at this point notice that maybe I might really just be playing around with Fibonacci ratios. Indeed what we are really saying when we elect to place a stop at “75% retracement of the wave that got you in” is that if the market fails to be supported at the 5/8 or .618 Fibonacci retracement point, it becomes a “Fibonacci failure,” a trend reversal and we need to get out of the way of a collapsing market.

Believe me you are going to be very happy to be out of the market if these stops are hit and it will be very unusual for the market to “tag” these stops and then move higher. This is the most effective stop loss strategy we use.

Some of you technical analysts may at this point feel somewhat vindicated. Here I am telling you first that technical analysis is a lot of baloney and then I turn right around and start using Fibonacci ratios for stop placement.

Of course the ratio .618 wasn’t invented by a technical analyst. It was known to ancient Greek and Egyptian mathematicians as the Golden Ratio or the Golden Mean and was used in the construction of the Parthenon and the Great Pyramid of Gizeh.

 Summary and Conclusions regarding stock price movement

These “laws” (If stock prices move up there is greater probability they will move higher rather than lower and If stock prices move down there is greater probability that they will move lower rather than higher) are permanent, will not break down and cannot change in the future.

Once we have entered a trade based on these rules we will reject traditional “stop and reverse” and “trailing stop” strategies of exiting our trade. Instead we will:

Take profits only when the market is moving strongly in our favor and place our protective stop at 75% retracement of the wave that got us in.

Some of you may at this point be ready to reject these market theories as being far too simple to be useful. Before you toss these ideas in the trash, however, I want you to look below and see at my equity curve for a seven years period when I was just beginning to learn the trading game. Look at the summary of my monthly profits from January 1, 1989 when I started using automated software, through June, 1991. Look at the consistent income and small draw downs.
How many gurus do you know who have included seven years of real-time trading records along with the materials they are selling?

I learned these rules in the marketplace and while attending the “School of Hard Knocks.” On the surface they may seem simple, but implementing them in the marketplace is a more complicated process.

You can integrate these ideas perfectly into your short term stock trading.  Later I will show you how you can consistently gain an edge on the stock market and automate a stock market trading system using these same simple rules. Using these strategies and rules of stock market price you need not fear that these basic rules will break down or stop working. They can’t stop working anymore than Newton’s Law of Gravity can stop working.

Consider reviewing my market momentum theory in the article, Stock Trading for Dummies.

I believe if we stop looking at all those wiggly lines, stock market charts and complicated formulas and concentrate instead on simple up and down stock market price movement we can out perform the best trading professionals. Call this back-to-the-basics trading or call it anything you like. I call it financial security: