These fish are for trading, not eating (the parable of Bitcoin)

There once was a fisherman from a small Mediterranean coastal village in Malta.

He sailed out one day and had great luck, catching 300 pounds of bass and rock cod.

That evening he sold the fish to a fish broker in exchange for hard currency.

The next morning the broker, in turn, sold the fish to a wholesaler, in exchange for future credit.

The wholesaler, in turn, sold the fish to several merchants in exchange for building products.

One of the merchants sold some of the fish to a farmer in exchange for grain.

The next day, the farmer, who bought more fish than his family could eat, sold several of the fish to a neighbor in exchange for labor.

The neighbor ate the fish, and got sick.

The neighbor went back to the farmer and said, “I recant my promise for labor, the fish were not healthy for eating.”

The farmer went back to the merchant and said, “I want my grain back, the fish was spoiled.”

The merchant went back to the wholesaler and said, “Please return my building products, the fish were not suited for consumption.”

The wholesaler went back to the broker and said, “I am cancelling your credit, the fish were not eatable.”

The broker went back to the fisherman and said, “I want my hard currency back, the fish you sold me made people sick when they ate it.”

The fisherman just shrugged his shoulders and replied ….”No, you cannot have your money back. Who ever said they were ‘eating’ fish. They were just ‘trading’ fish.”

Moral of the story: There are grand claims being made about the extraordinary future for Bitcoin and other cryptos. Just consider some of the claims of the cryptomaniacs: Cryptos are going to take over the world; the future of global finance/commerce belongs to Bitcoin and (name your favorite 8hitcoin); cryptos will bring governments to their knees; Bitcoin will become more valuable than all the Gold that has ever been mined; and, cryptos will replace all fiat currencies. To some degree these claims may become true. But for now Bitcoin has gained almost no traction as a functional medium. In fact, Bitcoin (and the other cryptos) have almost entirely been a vehicle for price speculation. As such, at least at this time in history Bitcoin and its distant cousins are very little different than a pile of dead fish.


Patience … Discipline … Discipline … Discipline … Patience

  I know my sweet spot. Every trader should strive to know his or her sweet spot. We should strive to only take a trade when the market set up is in our sweet spot. We should strive to avoid trades out of our sweet spot. If you, as a trader, do not know your trade set up with great intimacy, then how in the world will you know if you are exercising patience and discipline? Once you know exactly what your sweet spot is and is not, then the real challenges begin. The real challenges for me (and it could be different for you) are different nuances of patience and discipline.
  • Patience to wait for just the right set up
  • Discipline to sit on the sidelines and not getting pulled into a trade that does not fully satisfy my requirements
  • Discipline to pull the trigger when the right trade comes along
  • Discipline to remain detached from open positions and properly manage each trade according to trade management guidelines developed over decades of market speculation
  • Patience to allow a position with a substantial profit potential the room and time to bear full fruit
Read More

Silver — what does the cost of production have to do with anything


Sorry, but Silver is just a commodity

And as such, there is a history in many other commodity markets that shed light on the significance of the cost of production.

Silver bulls claim that the all-in cost of producing Silver is around $25 to $30 per ounce. Nonsense. And even if this were the cost of production, there has never been a guarantee that commodity producers must money all the time. There are numerous cases in the commodity world when a market price remained well below the cost of production for months and years at a time.

Several observations:

  • Silver bulls treat the marginal cost of production as if it should be the floor price. Yuk, yuk. In all commodity markets the rule is that marginal producers will lose money. That is why they are considered to be marginal producers. It is the definition of marginal producers.
  • Much of the world’s Silver is produced as a by-product of mining other metals, meaning that the cost of production cannot be viewed as an “all-in” cost, but rather on a cash basis. A substantial portion of the world’s Silver is being produced for under $12 per ounce.
  • Even if a particular mine is operating at a loss, there is a good chance it will continue to operate. There are two reasons for this. First, producers are, by nature, bullish and will remain optimistic for prolonged periods of losing periods. Second, it costs a significant amount to close and eventually re-open a mine — so producers will keep operating it.
  • Energy prices are a key element in the cost of production. It is possible that the cost of production could decline if energy prices decline.

So, Silver bulls, take your cost-of-production argument to someone who cares.


What does a chart pattern really mean…

…and how and why I changed my mind on Sugar.

Blogging during the past several months has driven home one huge lesson – many, many, many self-professed “chartists” do not have the first clue about the purpose of charting and charts.

Some of these same people frequently tweet about charts. Yet, they appear to be clueless. Frankly, I think it is an ego thing. They self-deceive themselves into thinking they get to create their own theories of charting and they have no interest in seeking out the wisdom of the early pioneers of classical charting principles (Schabacker, Edwards, Magee, others).

So, they make stuff up as they go, using their own opinions as the litmus test for truth.  These folks will always be around – but over time the exact names will change, because each group of these ego-driven “traders” will leave the arena with their pockets turned inside out. I will make one more comment on this subject later in this posting.

So, exactly what purpose do charts actually serve

Charts are a record of where prices have been. At any given time a chart reflects the opinions of all market participants who have acted upon their opinions by buying or selling commodity contracts, foreign exchange pairs, stocks, ETFs, debt instruments, etc. Charts are maps of where markets have been. Over time a bar chart reflecting this buying and sell may form a recognizable geometric configuration. These geometric patterns can be useful for trading … to a point.

A chart is NOT predictive. Some people believe that if they could only study a chart hard enough, and in the right way, they would be able to determine what a market will do. NOT! I do not want you to miss this next point: Charts do not provide a prediction, they provide a possibility! Sorry, but that is the function of a chart.

A chart provides a trader with an edge. Exploiting an edge is how a trader makes money. I am attracted to classical charting for two reasons. Chart patterns:

  • Provide me with clue for what is possible
  • Offer – at least some times – an opportunity to construct an enormously asymmetrical reward to risk trading event

Technical analysis, including chart analysis, has earned voodoo reputation. It deserves this reputation. The reason is that technical analysts go on record with market predictions based on their analysis. Most of these market predictions are wrong. Of course, sometimes the predictions are wrong because patterns fail. Sometimes they are wrong because the chart misreads his or her chart. Now fundamental analysts are wrong just as often, but their methods do not earn voodoo status – this is a subject for another day.

There are five primary things you need to understand about charting.

  1. Most chart formations fail and morph into other patterns, which in turn fail and morph again.
  2. Charting cannot be used to understand a given market all the time.
  3. Major moves can occur without any clue from the charts.
  4. Charts are not predictive. They are a map of where markets have been, not a map of where they are going.
  5. Charts are a trading tool – and when used as a trading tool charts serve a wonderful purpose.

There are times when a chart morphs, morphs, morphs and keeps on morphing until a huge, no-question-about it pattern emerges. Then I get excited. It is at this point when the outcome of a market becomes a real possibility (not predictive). And it is at then point when I develop a “Strong Opinion, Weakly Held” (see post on this concept here).

When a chart pattern provides a real possibility along with a set up consistent with an overwhelmingly favorable reward to risk profile, then I become really interested.

With this discussion in place, let me transition to the current chart of Sugar.

Sugar — Yes, I changed my mind

I have had a strong opinion (weakly held) on the Sugar market. This opinion is based on the longest-term charts (not shown) which indicate the possibility for Sugar to trade at 70 cents. Thus, I have been interpreting the daily charts through the lens of this bias.

I believe that a bias can be very good thing for a discretionary trader because if the bias enables an unusually aggressive trading posture at the right time, huge profits can be made. If someone is against the concept of having a bias, then they should develop a systematic approach and dump the discretionary method.

Consistent with my predisposition, I saw the possibility that the daily chart was forming a continuation H&S pattern (or a cup and handle for you snooty tea drinkers). This pattern was forming in such a way that the right shoulder had balance with the left shoulder and also support from a 4-month trendline.

As a trader, the charts showed the possibility and offered an insane asymmetrical reward to risk profile. My strategy was simple.

  • Buy a layer of longs near the possible right shoulder low, initially protecting the trade below the August 17 low.
  • Add a layer if the market could get above 28.61.
  • Add another layer if the market could complete the continuation H&S.

Thus, I had the possibility of establishing long three contracts for each $100,000 of capital. The maximum risk was 80 basis points (4/5th of one percent of capital, or $800 per $100,000). My potential gain per $100,000 if the continuation H&S was the slingshot to 60 cents would have been $104,160 – a possible reward to risk ratio of 130 to 1.

So what were the odds the possibility would become a reality? Maybe one in 20, one in 10, or one in five at the most! I would have been crazy had I not played the Sugar market the way I played it. I would be equally crazy if I continued to insist upon the bullish play when the chart started to tell me something else.

Let me interject one thing into this conversation. A chartist needs to have patience and discipline to be sure, but there is one other thing required to take advantage of the big moves. That is creative imagination. It takes imagination to talk about 60 to 70 cent Sugar when prices are below 30 cents. But, it took imagination back in 1982 to talk about Dow 1,800 when the Dow had never traded above 1,100 in its history. It took imagination in 2007 to talk about 60 cent Soybean Oil when prices were at 37 cents. It took imagination to think Copper would trade at $3.00 when it crossed $1.60 for the first time in history in 2005.

Please connect with what I am saying here – using imagination to think about the possibility of a chart is NOT the same thing as making a prediction or forecast. Charts are NOT predictive.

When I introduce a new major chart development into this blog, I am introducing a new possibility, not a prediction. If you have a problem with the fact that charts are useful to present possibilities, not predictions or forecasts, then I will strongly suggest that you will walk away from your experience trading charts with less money than your currently have.

Back to Sugar – it all changed on Friday. Trading a chart possibility involves creating a scenario on how prices will play out. The scenario never plays out exactly how I imagine, but there have been times when it has been pretty close. Importantly, market action can be such that the possibility is completely nullified.

The decline on Friday carried prices below the existing right shoulder low from September 12 at 27.21 and penetrated the 4-month trendline. The possible price scenario I had been operating under was negated.

Let me share a secret about charting (as if there really are any secrets). Eighty percent of the time when a chart sets up to offer a strong buy signal, inherent in the same chart will be a strong sell signal. In fact, if a chart pattern you are watching does not provide both, then you are well advised to question your interpretation.

The decline below 27.21 on Friday was a strong signal for me to short Sugar. I did do some shorting, but not nearly enough because it is sometimes difficult for me to switch my mind so quickly from one scenario to the opposite read. Yet, my experience is that if I am strongly biased in one direction, a chart signal in the opposite direction has a strong probability of working.

So, I am short Sugar. The market has a pretty good chance of testing the July low. If the market can close decisively under 25 cents, then we have a double top with a target of the May low at 21 cents.

Some concluding comments

You need to know that 90 percent of the content on the internet is garbage. You need to be prudent and wise consumers of internet trading content. Advice is cheap and way too plentiful. Guard your mind as you guard your trading capital. Choose well who you listen to. There are many wolves dressed as sheep in the trading industry. By the way, the StockTwits blogging community represents some of the best minds on the internet.


Do continuation head and shoulders patterns really exist?

A number of readers have questioned the legitimacy of the continuation pattern. They claim that such a pattern does not exist.

Well, it is time to set the record straight!

Schabacker, Edwards and Magee are the authoritative sources on classical charting principles. The three men never claimed to be the final word on Gann or Elliott or moving averages or candlesticks. But, they are the final word on classical chart patterns.

Here is what Edwards and Magee had to say about the continuation H&S pattern (Technical Analysis of Stock Trends, 5th Edition, pages 181-182):

“Head-and-Shoulders Consolidations.

“All our references to the Head-and-Shoulders formations up to this point…have considered that pattern as typifying reversal of trend, and in its normal and common manifestation that is most definitely the Head-and-Shoulders function. But occasionally prices will go through a series of fluctuations which construct a sort of inverted Head-and-Shoulders picture which in turn leads to continuation of the previous trend.”

“There is no danger of confusing such continuation or consolidation formations with regular Head-and-Shoulders Reversals because, as we have said, they are inverted or abnormal with respect to the direction of price prior to their appearance. In other words, one of these patterns which develops in a rising market will take the form of a Head-and-Shoulders Bottom. Those that appear in declines, assume the appearance of a Head-and-Shoulders Top.”

Now, some folks opposed to the concept of the continuation H&S have parsed Edwards and Magee’s description — pointing out that the exact wording used included “sort of” and “will take the form of.”

I think that such parsing  is equal to hair splitting. So did Richard W. Schabacker. In his manuscript, Technical Analysis and Stock Market Profits, written in 1937, Schabacker alluded to the fact that the continuation H&S serves a different purpose than the reversal H&S, but concluded with the following:

“This formation is not a true Head and Shoulders for a number of important reasons but we must admit that it is difficult to find a better name for it….we shall accept the suggested name and call it the Continuation Head and Shoulders.”

So, when I define a pattern as a continuation H&S formation, I am in some pretty good company. For those of you who still take exception to the labeling, take it up with Schabacker, Edwards and Magee.

By the way, the chart below displays one of the most classic continuation H&S patterns of all time.

I believe Schabacker, Edwards and Magee would have accepted this labeling, and that is good enough for me. Of course, I could start referring to the pattern as the “a reputed, appearing as, but conditionally qualified, sort of continuation H&S pretender.” Nah, I think I will just refer to it as a continuation H&S pattern, same as I have been doing all along.


The “Dominant Fundamental Theory” Explained

[I am preparing for a two week vacation in Minnesota to visit my grand kids. I may post a view misc. items this weekend, but I doubt I will post much, if anything, during my trip. I will, however, post a few charts on]

This past week I read a blog post that nearly knocked my socks off. It was a huge déjà vu moment. It was one of the best postings I have read in years.

Each morning I briefly cruise through the posts made the previous day by the StockTwits blogging community, plus a half dozen other blogs I really like.

For the most part the verb “cruise” is very accurate. I am a very selected consumer of the opinions of others. I have little time for a regurgitation of the news of the day. I mainly look for original research, sophisticated insight into risk management protocols, bold and original thinking and unique market perspectives.

This past week one post led me to a post from October 2010 that knocked my socks off. It was profound. Let me explain.

On Thursday I read a blog post by @EddyElfenbein (Crossing Wall Street), titled Updating the Gold Model . BTW, Crossing Wall Street is one of my favorite blogs. However, this was not the post that captivated me. But, this post led me to a post from October 6, 2010 by Eddy, titled, “A possible model for the price of gold“.

In the October 2010 post Eddy presents a model for Gold pricing based solely on the real (inflation adjusted) short-term interest rates in the Western World, primarily in the U.S. This model has very accurately predicted the fabulous advance in Gold prices during 2011.

But, the accuracy of the model in predicting Gold prices is just part of the story — and quite frankly, where the story becomes interesting.

When I was at the Chicago Board of Trade in the 1970s and early 1980s I was befriended (and mentored) by a man name Dan Markey. Dan was a legend. He was a trader for Cargill (speaks for itself) and probably the best trader I have ever met. Dan’s speciality was picking within a week or two and within 5% or so the annual highs and lows in Wheat, Corn, Soybeans and Soybean Oil.

Periodically he would venture a prediction in markets other than row crops. I remember as if it were yesterday a comment he made about Gold on January 21, 1980. He said to me calmly … “Peter, make sure you are out of Gold because the market topped on the open.”  Of course, it took 28 years for the market to make  a new high.

He was uncanny at doing this — I witnessed it year after year after year. Unfortunately, Dan died in the 1990s of a rare illness.

Dan’s focus was a concept he self described as the “Dominant Fundamental Theory (DFT).” In short, here is what Dan believed:

  1. All markets can be understood with History 101, Psychology 101 and Economics 101.
  2. All major price cycles (lasting from months to years) are caused by one, and perhaps two, fundamental factors. These one or two irreducible fundamentals are the drivers of major trends.
  3. All other factors were irrelevant, although some of the other factors cause some zigs and zags in price. But in the end, all these other factors — many of which market participants think are important — are just plain noise.
  4. The dominant fundamental may be among the things the investment community and financial media talk about, but it is not identified as the real driver until very late in a trend. When the dominant fundamental becomes conventional wisdom the trend is close to completion.
  5. A new dominant fundamental will begin driving the market into a new trend to the knowledge of just a select few traders.
  6. Market watchers who create huge complicated scenarios with multiple factors to describe price trends are full of you know what. They all have brown eyes.

[Think about the stock market since March 2009. The dominant fundamental was corporate earnings. A secondary fundamental might have been irresponsible actions by a bunch of incompetents at the Fed. In hindsight, all other factors were just noise. I believe there is a new dominant fundamental factor driving the market now. We will know what is is at a later date.]

Dan’s ability to identify and understand emerging dominant fundamentals were almost magical. Once he became convinced he had correctly identified the new dominant fundamental, he pursued it like a hound dog on a scent.

Now, let me come full circle back to Eddy’s blog post on Gold. Eddy’s Gold pricing model was about Gold prices, to be sure. But, it was also a commentary on the DFT. Eddy’s model identifies the DFT or a proxy measure of the DFT for Gold, and ignores all the other noise.

Ray Dalio uses another DFT to gauge Gold prices. Bridgewater Associates use a model with the ratio of Gold stocks above ground against the world’s reserve currency supply. From this ratio they will judge Gold to be overpriced or under-priced at any point in time. In effect, Dalio has identified what he believes is the dominant fundamental factor for Gold.

Dalio’s and Eddy’s DFTs are close enough to both be right. The point here is that these two simple measures have accurately forecast the bull market in Gold. Every thing else has been noise intended to confuse traders.

As a trader — and be honest about this — do you chase after all sorts of fundamental news in order to either understand the markets or justify your positions. If you do, you are wasting  your time. If this describes you, please know that your constant attempt to “put the pieces together” is wasted effort. Do yourself a favor and find a different hobby.

By the way, this is why I refuse to watch CNBC or anything of the like. One day the market is down because of X. The next day the market is up because of Y. The next day the market is down because it was up too much the day before. What a waste of time and human energy. CNBC is a circus. Dang, there goes my chance of every being invited as a guest!


Written August 20, 2011



These fish are for trading, not eating

There once was a fisherman from a small Mediterranean coastal village inMalta.

He sailed out one day and had great luck, catching 300 pounds of bass and rock cod.

That evening he sold the fish to a fish broker in exchange for hard currency.

The next morning the broker, in turn, sold the fish to a wholesaler, in exchange for future credit.

The wholesaler, in turn, sold the fish to several merchants in exchange for building products.

One of the merchants sold some of the fish to a farmer in exchange for grain.

The next day, the farmer, who bought more fish than his family could eat, sold several of the fish to a neighbor in exchange for labor.

The neighbor ate the fish, and got sick.

The neighbor went back to the farmer and said, “I recant my promise for labor, the fish were not healthy for eating.”

The farmer went back to the merchant and said, “I want my grain back, the fish was spoiled.”

The merchant went back to the wholesaler and said, “Please return my building products, the fish were not suited for consumption.”

The wholesaler went back to the broker and said, “I am cancelling your credit, the fish were not eatable.”

The broker went back to the fisherman and said, “I want my hard currency back, the fish you sold me made people sick when they ate it.”

The fisherman just shrugged his shoulders and replied ….”No, you cannot have your money back. Who ever said they were ‘eating’ fish. They were just ‘trading’ fish.”

Moral of the story: Who ever said these markets are for understanding … they are for trading.


Why it doesn’t matter if I am right on the U.S. Dollar

Yesterday morning I posted a perspective that both the U.S. Dollar and the U.S. stock market could tank at the same time. The post, “The US$ and U.S. Stock Market Both Down – How is this Possible?” can be seen here.

I knew I would get reaction. And, of course I did.

My friend and fellow trader, Bob Sinn, contacted me and asked if he could post a rebuttal on his blog, The Stock Sage. Bob’s a class guy for asking. I said, “Go for it.”

Bob and I have had our fun with trading issues before (see here, and here and here). 

Bob presented a logical and well-presented macro-economic case for why both of my scenarios could not be true. Well done, Bob. Actually, Bob is probably correct. It is highly unlikely that both the U.S. stock market and the U.S. Dollar will decline together. And herein lies several tremendous lessons for novice traders. As with the last time Bob and I arm wrestled, I want to use this as a teaching moment.

Here are the lessons:

There are many reasons for different opinions on the same market – and they can all be legitimate

Bob is looking at the stock market and US$ from a macro-economic perspective. Is this a great way to analyze markets? ABSOLUTELY! Some of my good friends are macros. Including Bob. Not only do I hope he is right on direction for the right reasons, but, more than that, I hope he makes a lot of money from his analysis.

I look at markets through as a series of high/low/close bars. I could care less about macro economics and the reasons why markets … have, are, will, should, could, would, must, might … do something. When people respond to my technical thinking with fundamental narrative, well quite frankly, I yawn. Borrrrring! Except for when Bob speaks. When he speaks I start looking for different chart interpretation.

In the end, making money is more important than being right

The markets are for trading, not for understanding. At least that is my own opinion. I want to be on the right side of a move. I could care less what causes the move. And I could care even less if I had accurately predicted what caused the move. Bob’s analysis is profit-driven – he wants to make money on his ideas. I think Bob would agree with me that profits trump prophecy.

Markets can have nasty surprises for those who think they have it all figured out. I love the following quote by John Maynard Keynes.

Markets can remain irrational a lot longer than you and I can remain solvent.

How true! Whether our analysis is technical, fundamental, macro-economic, or dart throwing, there is real danger in being too sure of ourselves.

A great trade needs two elements – correct direction and precise timing

Without both, no great trade. Timing is vitally important.

Opinions are not positions and positions are not opinions

I can express a bearish opinion on the U.S. Dollar. That does not necessarily equate to a short position. And, in fact, I am not short. I would go short if the Sept. futures contract moves below 73.00. But not one moment sooner. And even then, if I am wrong, so what! My risk would probably be about 70 basis points. I am not offended by losing trades.

Trading is less about trade analysis and more about risk management

Newcomers to the trading world may think the payoff comes from market analysis. Not so, folks. Sorry to the bearer of bad news. At the end of the day, profitable trading is not about fundamental analysis or technical analysis — but about risk management. I consider myself first and very foremost to be a risk manager, then a trader, then a chartist, then a techician. I use charts because I can fine tune risk. How do I fune tune risk if my focus is on QE3 or interest rate differentials or other such stuff?

The U.S. Dollar – A bullish chart interpretation

I gave a bearish chart interpretation in my last post on the subject. And, quite frankly, I think for now that is the best interpretation. But, it is not the only interpretation possible. While not an ideal labeling, it is possible to interpret the US$ as constructing a 4-month symmetrical triangle bottom on the closing price chart. [It is not ideal because the third low point is lower than the second low point.] And if this is the correct interpretation, I hope I can find good timing for a low risk trade on the long side. 

I would love to make money on Bob’s analysis.

Comment on the U.S. stock market

No comment. I will let the market speak for me. However, the Nasdaq could rally swiftly, back to 2165, and still be in a sharp down trend.

Markets: $DX, $UUP, $DX_F, $SPY, $DIA, $QQQ


The US$ and U.S. Stock Market Both Down — How is this Possible?

In recent weeks I have expressed an extremely bearish technical perspective on the U.S. stock market. Then yesterday I posted a possible bearish interpretation on the U.S. Dollar.

Apparently I stepped into something brown and sticky. I have received comments that the U.S. stock market and the U.S. Dollar have a strong inverse correlation — thus how can a bear case be made for both at the same time?

Yesterday my good friend, a fellow blogger and an excellent technician, Bob Sinn ( or thought the subject could make interesting fodder. I agree. Bob and I have very constructively gone back and forth on various trading subjects in the past. I think we both (and our readers) gain from such dialog.

How can stocks and the greenback both go down? Here is my thoughts on the subject. I am looking forward to Bob’s response.

1. The idea that the two markets are polar opposites is current conventional wisdom. I don’t trust conventional wisdom.

2. I believe all markets must be traded on the merits of their own charts. I am not able to place an order for the U.S. Dollar in the S&P pit. I trade price and price alone. All  the time I hear how one market cannot do such and such because another market is doing such and such.

3. High inverse (or positive) correlations between two different markets do not last forever. The chart below stacks the U.S. Dollar ($DX_F, $DX) and $SPY charts. Note periods when both markets advanced (A), when the US$ dropped, but $SPY ended up going sideways (C) and when $SPY advanced, but US$ chopped sideways (B).

The next chart is $SPY expressed in terms of the U.S. Dollar Index price ($SPY divided by $DX). In the past 13 years $SPY has ranged from two times the price of $DX to 80 percent of the price of $DX. This is not high correlation in my mind.

4.  The marketplace finds all kinds of reasons why two markets must go in different directions. And for long periods of time the inverse correlation may exist. But my experience is that when a certain correlation ends, it ends big time. And most often, the reasons for the change do not become known for a long period of time. Macro economics create strange forces. I think it is a mistake to project current understandings forever into the future.

Bob, your turn.

Markets: $SPY, $DX, $DX_F, $ES_F, $$, $UUP



When does a victory feels like defeat?

When a trade is on a round-trip ticket!

There are two different categories of technical traders, whether their approaches are based on numeric schemes, charts, trend indicators, mean reversion or whatever. The two categories are:

  • Systematic
  • Discretionary

Systematic trading

A systematic trading program is basically an algorithm (primarily computerized) that makes all the decisions in a trading operation. All of the variables such as position sizing, risk management, trade entry, trade exit, markets traded, etc. are built into the algorithm. The concept of systematic trading hinges on two principles:

  1. The implementation is intended to be without subjective interpretation. The trading plan is mechanical.
  2. The job of the trader is to execute. Any modification needs to be made to the algorithm on a periodic basis, not on a trade-by-trade basis.

All of the best judgments of systematic traders and trading firms are specified, quantified and built into the algorithm.

By the way, the vast overwhelming proportion of managed funds in forex and futures are managed according to systematic programs. In fact, only about 10 percent of managed forex and futures assets are subject to discretionary programs. Needless to say, HFT programs are also systematic.

The only blogger I know of who is a systems trader is Michael Bigger. There may be others.  Michael’s blog ( offers wonderful insight on the true nature of risk control. I highly recommend his web site.

Discretionary trading

Discretionary trading, by contrast, relies on subjective judgment to one degree or another during the course of plan implementation. Yet, among professional full-time traders who define themselves as discretionary, the distinction is not as great as you might think. The reason is that most professional discretionary traders have developed plans that are highly rules-based. There are, for sure, some gun-slinging traders who improvise on a trade-by-trade basis in much the same way as a football quarterback who scrambles, but this breed is rare.

I am a discretionary trader, yet I am heavily rules based. My discretionary judgements come into play when I identify a candidate trade and when I detrmine sizing or leverage. That is where my discretionary interplay with a trade ends. Once I identify a trading candidate my decision making is 90 percent determined by the rules and guidelines of my trading plan. I have built rules into my plan for precisely the same reason systematic traders adopt algorithms — to trump my day-to-day emotional urges which usually are counter productive to a long-term profitable trading campaign.

I have rules for how I enter a trade, how I set an initial stop, how I move the stop, how I take profits, etc.

I bring this subject up because it will help you understand my trading actions in the S&Ps. Once I identified the H&S top in the S&Ps my rules took over. My entry on July 29 was subject to a rule I call, “Major Pattern, Anticipatory Entry.” My pyramid on August 1 was based on a rule I call, “Pyramid, Retest Provision.” My entry on August 2 was based on a rule I call, “Major Pattern, Completion.”

The protective stops I used for these positions were based on rules. All the time I was jawboning about my bearish opinion in the stock market in this blog, my actual trading decisions were being executed according to rules, not judgement.

I exited the first layer of the trade on August 8 based on a rule I call, “Profit at Target.” I exited the second layer of the trade on August 9 based on a rule I call, “Profit at Target with Reversal.”

The intraday chart I featured most of last week represented the judgement part of my trading. It was my interpretation that the market was putting in a wedge. This was the subjective part of my trading. Yet, all of the trading that would have been executed based on that small pattern would have been 90-percent rules based.

I retain one layer of my original short position. That position, too, is subject to rules. And now that the market today officially closed above the high of the low day (August 9), the rules specify that I need to move my protective stop to above the high of August 5. I am not going into the complicated reasoning behind the rule. But, even though I my stop is well below my entry point, I will have a sense of defeat if I am stopped out. Who said disciplined traders don’t have feelings?

Do I periodically override my rules? Yes. Do I usually regret overriding rules. Yes again. My trading rules are based on what I know about market behavior, not on how I feel at any given moment. One of the metrics I maintain and review quarterly is how much my rules violations have cost me. Believe me, there has never been a year when rules violations have contributed to the net bottom line.

Battling the emotional pull to override trading rules is the toughest part of my job. There is not even a close second.

The rising wedge I had been watching has now been nulified. I am still bearish, by opinion. I am still short, by position. But in terms of pyramiding my present position I am back to the drawing board. The market is not showing me anything right now, other than a possible flag. I like trading bull flags — I am not fond of bear flags. I would become interested again if the market forms a small reversal or if prices have a more serious test of the top and then form a smaller secondary topping pattern. A move below 1175 by Sept. S&Ps will be some evidence of the bear flag.

I have often commented in this blog that an opinion is not a position and a position is not an opinion. I hope you now have a better understanding of what this means to me. This is a tough lesson for novice traders to learn. But it is a lesson that must be learned.

I have no interest in trading from the long side — it would take at least 10 weeks for a buy signal to even develop. I will leave the long side to folks more heroic. I remain a long-term bear. I believe we have a major H&S top in the stock market. I believe we are going much, much lower. I believe that all near and intermediate-term doubt will be resolved to the downside. But in terms of positions, I will rely on my rules.

Markets: $SPY, $ES_F, $SPX