Phantom's Chat

It's always difficult to get a group of people together at a time and place and equally difficult to get Phantom to be available to work on a specific project especially when he is working on so many already.

We were able to set a time and discuss various aspects of questions on trading of interest to our traders. It often times seems that much of Phantom's insight is more general when specific questions concerning his rules are presented. I asked him about some of his trading as it would pertain to long term and short term trading both. His answers were that while you may travel 100, 1000 or several thousand miles it is travel just the same as to whether you take a car, train or airplane.

Answers to your questions may not be as timely as you wish but we will try to elaborate on some of Phantom's aspects of trading as they refer to both long and short term trading.

ALS: Pop, give us some of your observations on your reflections of the reception of your trading rules since you presented them to the traders.

Phantom of the Pits (POP): Many remarks have been made as to the rules being more for short term traders than long term. I would like to dispel that notion. The big reason for that belief is that traders are still OVERTRADING their account size. The rules work for both long term and short term if over trading is not a problem.

I have seen a couple of posts, which are accurate in regard to, how large of a trade should be made. I think most traders want to be short term traders or day traders. It is a fact that trading futures requires prompt actions, which leave the trader to feel that all trading should be short term. Markets swing and reverse back and forth often in moves, which can wipe out an account so fast if over trading is a problem. Nothing will wipe out a trader faster.

The rules are a must in long term trading just as well as short term trading. If you have a signal to enter a market and two weeks later the market is not doing what you expected and you are still in the position you should have used rule one and not rule two. You will not have added to your position because it didn't prove you correct. By not overtrading you may have been able to hold the position for two weeks without going to an extreme of losing on the trade by big time.

Still if you have a two-week position on because you are expecting the trend to continue or develop you must approach the initial trade by not overtrading to a point of having to lose on minor fluctuations. If you overtrade you will be forced somewhere to pull the trade off at an unfavorable situation and with a loss you had not counted on taking.

By using rule one with long term trading you are far better off to under position with smaller positions. It is rule two, which will make up for the smaller positions in long term trading. In long term trading your window of the position proving to be correct would perhaps be a little wider and a longer time frame. While this longer-term time frame and window may give you a greater chance of losing, you still have a better position by not overtrading the position from the start.

Keep in mind that entry signals are not always good entry points. That alone says not to overtrade the position. You must also be prepared to pick a range and not a price, which leads us back to not overtrading the initial entry. This leads to rule two in allowing you the opportunity to get larger once the position proves to be correct. We are talking a wider window than most traders think about for rule two to work properly in the long run.

Much frustration develops in trading when the initial position is overtraded. Each trade should not make a difference in your account. The problem with that statement is that each trade does make a difference to almost all traders. If the trade makes a difference in your account then you are going to allow the market to make decisions for you and that is always inconsistent with good trading. Keep in mind too that the statement is not saying that each trade should not be important in your trading.

I have seen the smallest trade become significant to traders because they didn't use rule one and remove the position once it failed to prove a good position. The loss becomes larger and larger. Believe me that it will make a difference if not protected properly. It is much easier to follow the required rules if your plan has a plan for removal if not proven to be a good position when your position is small and not larger upon initial entry.

I have had several email indications from traders telling me what works for them. Good for them as they have a plan and can use it correctly. It must be a plan which you incorporate into your trading and it must work for you. I can't stand to sweat or to swear for that matter and that is what happens if you don't keep each initial entry insignificant position wise. Rule one can stretch from minutes to weeks or months but the important part is to know you must remove the position and not leave it to the market when not proven correct.

Don't worry about not having a good size position on a big move because your plan has the other side of the coin. Rule two always says to increase a proven position and to do it correctly. What is correct for me may not be correct for you because you may be more removed from the market than I am.

ALS: Pop, do you want to go into detail more on long term trading with your rules?

POP: Unfortunately I can't narrow situations down for a specific plan for all situations. The correct way to use the rules for long term trading is to always keep in mind that small is certainly a key to success when used with proper rules.

I saw a post and please forgive me for not remembering who posted it that the position taken by that person is always going to be smaller than most but at the end of the year they would have made more money than the larger positioned trader. Yes, that statement is a correct one for several reasons.

Up front is the behavior modification. A smaller position is kind to you in allowing the proper response from yourself in protecting your account. Of course there are times when being aggressive is required and that is where my rule two comes into play for myself. As I have said before a trader on the CBOT with a single letter acronym continues to astonish me in his proper aggressive use of rule two. Not that he uses my rule two specific but that he aggressively adds properly at the proven points.

I have observed many posts over the past year and the "SMALL" secret is starting to get out. There are ways of trading small. You certainly can trade MidAmerica contracts with good results and you can with options into smaller exposure in markets as long as the markets are liquid. Any futures contract, which has options, can downsize your position exposure on any exchange.

What I want the smaller trader to do is to be realistic about return expectations when becoming long term traders. You won't start with ten grand and make a million by being long term traders. Oh yes it is possible but you are putting yourself at too much of a disadvantage to think you will do it without making a full time effort and becoming more of a day or short term trader. Even then it is remarkable if it can be done.

ALS: So mainly you are saying that long term trading with your rules require you to be small but aggressive at the proper times?

POP: You aren't wrong! It seems like a trick but it is not. You'll have to pull that sack out of a sack and see there is actually something to it. Small can always become larger but when you start larger you are actually setting yourself up to have to become smaller somewhere in your career. It is the sad truth.

I have watched posts from various traders and it's easy to see that many traders are overtrading. I think the only complaint I have against the experts, authors and researchers is that while they are making the effort to help traders admirable, they must present the problem of overtrading more clearly.

Since I have walked the road of trading and often observe various writers and experts I can say that I believe they are usually on the right track but times change and they can not always predict that change. It is not their blame but the small trader must be aware and on top of it. The small trader can recognize that change better if they are not so large.

I watched a mutual fund trader come out of positions just yesterday as he believes the market is not topping but that he is too large to get out when it does top. Recognition of the situation is very important and to me that is a very smart mutual fund to be in with your funds. Now for the small trader it isn't always necessary to remove positions before the reversal because of being too large. That to me is a very big advantage for the small trader provided they have their surprise side trade plan always in place.

I want to point out another major problem I see with what I have observed over the past year of observation of the small trader.

What is the one thing, which can most likely change your odds in trading? If someone could actually give you M.J.'s shoes that now allow you to jump five feet higher, could you better play basketball?

In trading we can have those shoes. First we must think about being small from initial entry because the position has not been proven. The only thing we have upon entry is that we have a signal based on what has happened. We know that the direction is pointing but not that the direction will continue.

Because we are small we must have the plan to become larger (rule two) or we won't ever exceed a 50/50 expectation in the long run.

Where do we get the pair of shoes? Secondly our efforts must be different than what we are presently experiencing in expectations. Every trader who learns of trading is expecting to make good sums of money. They also count on that outcome.

The expectation of making good sums of money is WRONG in trading. The CORRECT EXPECTATION is that you will have a large amount of losses. It is a fact! It is up to the trader for the large amount of losses to be kept small or they will certainly be large.

I am not saying that you can not expect to make large sums of money but that you should never have that expectation in trading. The only expectation in trading is that you should expect to take a large amount of losses.

Here comes your pair of shoes that help you jump five feet higher!

Your job as a trader is to have a good plan for entry, adding, exit and use of good rules for your protection from being removed from the trading arena. You must not concentrate on how much money you can make or expect to make in your trading. Your plan and objectives of your plan will give you your proper signals and your rules will give you your proper protection.

(YOUR SHOES) You must concentrate at all times on keeping your losses small and never on what you expect to make but on what you expect to lose. The five foot gains come when you don't expect them and they do come. They come when you are concentrating on keeping your losses small at all times.

Keeping losses small is a full time job and takes action on your part. You may ask how do you keep losses small at all times as you have taken positions and in minutes the position went massively against you before you got the fill back. The answer to keep losses small in relation to the size of your account is to expect the unexpected disaster and limit exposure from the start of an initial position when the position has not proven to be correct.

I want to give you the best example of what I mean in keeping losses small. I listened to a trader accurately state that he had 80% of his trades make money. I watched his trades and judged his trades. When a trade went against him, he would hold that trade until it became a winner. The 20% losers were large losses. Yes indeed he was correct in his statement of having 80% winning trades. His net income was negative because of not understanding that trading has nothing to do with what percentage of winners you have.

Trading has the most important statement in the end! It is that your income is based on not how many winners or losers you have but on how small your losses are of those losers. How large your winners are is second to how large your losses are.

I am a very poor percentage trader in that I lose more trades than I win. I would hate to tell you exactly the percentage for I am sure you would not even want to read my input anymore. I am not a good winner but I am the best loser I know. Losing well is what gives me my income.

MJ is good in scoring! It is not always how many shots you take or how high the percentage. It is the score at the end that actually counts.

ALS: Ok you have a few raised eyebrows. I know your percentage and you are correct, as it would shock most people. I won't divulge it. What do you suggest traders do in order to use their new shoes in trading?

POP: Frame of mind is what we are talking about from the start of a position. Let me say I have 5-10 grand in an account. Am I to start out to make a fortune or to continue to survive forever in trading? Of course the trader and I want both. But keep in mind that without long-term survival you will never reach the goal of making a fortune. So survival is the more important of the two. Let us devise a way to accomplish that.

We will use soybeans as an example. If I put a 5,000-bushel contract on I can expect to lose 3,000 on a limit move. Notice I said I can expect to lose and did not say I can expect to make. You see I will not limit my gains as I will be able to hold gains longer than losers. Notice I also said expect to lose 3,000 as a limit move is 30 cents but I use the limit to limit exposure rule. What I am saying to myself is that I have an exposure upon entry of limit to limit.

By having a good entry plan I can reduce the expected loss and by having a good exit plan I can reduce the loss also. I am not going to have a plan to put a position on at limit up or down in either direction. Or am I? Perhaps at times with the use of rule two I will add at limits if I can but we are talking about initial entry here.

With a possible worst-case loss expectation of 3,000 and an account of 5-10 grand we are looking at 30-60% possible loss from the start. Even so we want to trade the entry signal in beans.

What should we do? How should we trade? First reduce the exposure before putting the trade on from the start. You can reduce it by trading smaller. You could trade a one contract of 1,000 on the MidAm exchange. Another method is to look for an option with say 60 days to go before expiration and a delta of 20%. In a break out and that is what your entry should be looking for in a trend, you will have the opportunity to participate without the trade making a difference in your account. If you are worst case loss in the first day you will lose 600 and not 3,000.

Ok so we have the exposure to less than 600 of a 5-10 grand account. Next let us reduce the exposure further by knowing when the position has proven itself correct. Let us say you are only able to look at the close in the newspaper at night and must work away from communications to the floor during the trade part of the day. Your entry is now more important. If you position in the top possible third of a market or the bottom third in that direction, you are allowing almost the entire risk of 600. By having a good trade plan which does not allow you to position the top third of a possible trade range you will reduce your risk by 1/3rd. In this case your allowed risk is now 400 at most.

Yes you will miss some moves by not buying the top third or selling the bottom third of a days possible range but the survival aspect is worth the lost trade. This also keeps you from chasing a market, as we know markets have highs, lows and ranges each day. Use it to your advantage by not chasing markets into the hole even if you miss the trade at the cost of long term survival.

The next part of your entry is to limit your loss possibility. There are positions that during a day should be removed for the sake of protection of being limit locked into a larger possible loss the next day. You are going to have to accept the fact often events can take a market limit one way or the other and at times they will reverse from that limit. You must never allow yourself to be locked limit against your position. The only way of doing that is to have a plan to remove the position before it happens.

If you are long in beans and the market is in the bottom 5-10 cents of the possible range for the day, you had better have a plan for removing the position even with the possibility of the market recovering after you get out. Let us say you went long ten cents higher and now the market is 30 cents lower and only ten cents above limit down. Since your plan says not to sell the bottom third for entry the only reason for selling is to limit your losses. At what point do you give up the opportunity of recovery in a position now showing bad? When the market in beans has moved within ten cents of limit you can pretty well accept the fact that any recovery is going to be a fluke most of the times. We will consider the bottom ten cents too much risk against us so our plan could be to exit on a stop when the market is in the top or bottom ten cents against us.

This ten cents on exit with a stop can reduce our risk now by another ten cents. So now we have a total possible loss of 300. This is 1/10th of the original size contract risk. We are talking maximum loss of 3-6% of our account size at this time. This we can live with.

By having several trades working and with much smaller size your odds of removal from the game will diminish but you must have a plan for each position. Looks more like work doesn't it? Yes it is work but it pays off in the end.

Keep in mind the above example can be suited to your trading but keep your initial position small enough so it won't have a chance of affecting you emotionally or financially in your trading. Your new shoes are your expectation of taking that loss many times but controlling your size of loss.

How much will you make? Who knows? Better yet who cares? It is when you don't care how much you can make that you will better serve the aspect of how much you can lose and how much will you lose. Only then can you judge whether you can control your account properly.

Nothing precludes the importance of having trades that will give you the positive expectation of outcome. You won't take any trades unless you can have a positive expectation of being able to gain more than you lose.

I am only pointing out to you that a high expectation of winning trades over losing trades will point you in the direction of larger draw downs and worst of all holding trades for too long when not good trades.

Limit your thinking on trades to limiting losses at all times. If you trade small enough and decide you are going to try and lose 300 on every example of the bean trade but follow rules one and two correctly, do you think you could do it? I mean lose 300 on every trade. Of course you couldn't lose 300 on every trade unless you have a real bad trade program and entry signal.

Most traders think the other way of trying to make 300 on every trade and then the losses become larger than any possible gain. Not only the larger losses but the failure to add to correct positions is overlooked.

I challenge your thinking on trading as a game of limiting your losses! By properly knowing your worst case loss you can actually do better than you think because your trade plan also has a criteria of telling you when you have a proven correct position based on market conditions. This means that often times you are taking even smaller losses than the worst case and sometimes removing positions which don't prove to be correct at a gain.

ALS: Phantom I know you wanted to bring up many points and I know you have given a time limit on this. We will continue to drive down the road and look at the signs along the way from our traders. It was great to be able to get together on this again. What are your plans forward?

POP: Art, I intend to watch the forums, the web sites, complete my other projects and when time permits to continue what we started with our traders! No time limit but I do request patience from the readers and our great traders.

I would like to change the image I gave our wonderful trader friends. I have learned so much from them and what I hold highly from them is their loyalty. So much good input from all of them. I don't want to leave anyone out so I won't name them. I know that seems like a cop out but it isn't.

If only traders can imagine how important it is to being a good loser than we shall see many more Phantom's appear in the future. I am beginning to see a few already.

ALS: Thanks Pop, you have the rest of the day off.

For those of you worrying about the year 2000 problem, hexadecimal is a base 16 rather than base 10 number system that works in many situations. There are many solutions to the problem and I hope this gives you a lead on 2000 thinking. 256 is a larger year base than 100 and with just a conversion program in assembly will correct many software problems. They are talking billions on this problem. Go get some of it and then trade big time!

" You must concentrate at all times on keeping your losses small and never on what you expect to make but on what you expect to lose. "
---POP