The Commodity Futures Knowledge Network ®
Special Report #6
The Truth About Trading and Trading Systems
a number of reasons why successfully
vast majority of commodities traders lose money ... there are many
reasons for this. That is the Bad News. However, the
Good News is once you manage to get in the small Winner's
Circle you too may achieve profitable trading. Then
you may reap the rewards with the money lost by the
many losing traders flowing to you and richly rewarding
you for being a winning trader!
trading commodity futures is achievable but not easy!
Read the many reasons so many commodity futures, stock market traders and options traders lose money (so you can avoid these problems), starting right under our related trader's website links list below.
This Free Special Report was originally written by the Editor of CTCN some years ago. These typical and common commodity futures, stock market, stock indices and options trading problems are just as evident (perhaps even more so now) as they were in the early 1990's when this Special Report was first written. The main difference after almost a decade is the fact the prices used as examples may be different. Actually, the price levels themselves make no real difference.
Also, we originally used Daily Bars for time-frame examples, as applied to daily bar charts. Since then day trading is much more popular with commodity futures, stock market and options traders.
Therefore, we have changed the word "Days" to the term "Bars," as in barcharts. The Time Frames can by identified as inter-day (daily) bars or even long term basis weekly charts, or intra-day tick-bars, like 1-minute, 5-minute, 15-minute, 30-minute, 60-minute bars (barcharts), etc. It really makes little, if any difference, as the concepts and theories are basically the same.
About Trading and Trading Systems"
One reason for losing in the markets is the commodities, futures, stocks or options trader is not really sure which time-frame or trend he is trading, or he is not matching his target objective price level to the time frames' expected movement. Perhaps the trader wants to capture a move which he expects to take about 4-bars (or 4-days).
However, the volatility increases so the 4-bar (day) trend is actually over in 2 bars and he does not realize it and stays with the trade 2-bars too long. Thus, he gives up all or most of his profit, because he expected the move to last longer.
The opposite can occur ... this happens when the volatility is low and after just 4 bars he gets tired of waiting for the expected move and exits the trade early, perhaps at a loss or small profit. Suddenly, over the next 2 bars the trend and move he anticipated happens; too late, as he is already out of the trade.
Of course, the 4-bar example above also occurs with traders expecting 2-bar moves which may occur in 1-bar or vice versa. Also, 6-bar moves which end-up occurring over perhaps 8 or 9 bars or vice versa, etc., and various intra-day time periods.
Another common occurrence, is the trader not using a specific stop-loss order. Thus, a small loss ends up as a big loss. For example, a trader believes a stop (loss) of $400 is reasonable, based on either technical analysis or on money-management rules. However, perhaps due to discipline problems the trader has, it's not actually used.
Once out $400, he relies on HOPE the market will go back in his direction, and he fails to execute the planned exit point. Frequently, the market fails to move back in a profitable position and the trader is finally forced out of market with perhaps a huge $2,000 loss, instead of the maximum $400 loss anticipated.
Note: More often than not, it seems once the trader who over-stayed the position finally decides to get out, the market frequently reverses the exact day (or next day) he got out! That seems to be an uncanny and almost unwritten law!
The stop-loss order is used, but the stop is not sufficiently precise. More frequently than you can imagine, the stop is hit by just a very small margin. For example, the market may be at 54.60 and a long position stop is placed to sell at 52.50. The market goes down to 52.47 and then reverses back to beyond 54.60 very quickly after stop was barely hit.
Sometimes the stop price of 52.50 may end up being the EXACT low price for that swing . . . very frustrating and upsetting when this occurs! For A Special Report on CTCN's Unique Method for calculating amazingly accurate stop-loss prices Special Report 2 - Click-Here
Why does this happen so often? Because many times the stop-loss price level happens to be a support area based on a trend line, gann angle, old bottom or old top formation, Fibonacci numbers, a chart price gap, or just simply an obvious natural stop-loss area, such as a whole or even number.
Thus many other traders use the same logic to place stops at or near the same level. The market gets drawn to that area because that's where orders are sitting that the market (and Floor Traders) wants to get filled. Because of those orders resting in that obvious place, the market price actually moves to that area, almost like magic or magnetic attraction.
Failure to place a stop-loss order with your broker (unless you are always closely following the market using real-time intra-day data, when you are in an open trade) will result in the great likelihood of you losing all or most of your money (eventually) due to one or a couple huge losses caused by the price continuing to drop after going thru your stop-loss price. Sooner or later (probably sooner) it's almost certain to happen, if you don't use and place stop-loss orders to you.
There is an exception for day-traders who are using real-time quotes and watching their real-time quotes and price charts continuously. Sometimes a day trader may achieve better trading success by using so called mental stops vs. actually placing the stop-loss orders with his broker.
Another reason for failure, is you may be right on a trade, but don't know when to exit the position and take your profits. More often than you would believe, a trader has excellent profits, but ends up giving back all or most of the open equity profits because of not knowing when to get out!
For example, a trader is long at 62.40 and the price moves to 63.90 for a huge open equity profit of say $1,800. He has held the position for a few bars, but after looking at the chart and the powerful up-move, he decides the market should easily go to 64.40 within the next day or two. That way his profit will be $2,500, much more than the current profits of $1,800.
Perhaps the next day the market goes to 64.30 (just slightly under his objective) but ends up closing "weak" because it's "over-bought," and closes for the day at 63.92. The trader is mad about giving up some open profits so hopes it goes back to at least 64.30 again the next day. Unfortunately, some bad news comes out overnight and the market "gaps" down on the next opening and opens at much lower at 63.00.
The trader still hopes for an intra-day rally to get back some of his lost open profits, instead it goes lower all day and the trader finally gives up hope and gets out at a break-even price of 62.40. Because the market was "over-sold," over the next couple bars it eventually recovers back up to the anticipated 64.40 price, but the trader is now out of the market with no profit! This type of scenario is all too common an occurrence. To varying degrees, this happens more often than you would believe!
One solution to this problem is for the trader to take small profits or not use specific targets and place very tight trailing stops just under the market. This is poor practice because you will end up getting stopped out with very small profits most of the time. That will result in your average winning trade being quite small compared to your average losing trade, resulting in poor results.
The best alternative is to use targets scientifically based on the market's volatility. Unfortunately, not many trading systems do that. Ideally, a system should have each and every trade uses a specific and dynamic target price based on the market's actual recent volatility. With a dynamic approach based on volatility and past bar size, the market itself will reveal how far a move should progress, based on actual movement and recent volatility.
Still another reason many traders lose, is because they are using a methodology or trading system which is NOT in actuality fully mechanical, but its trading track-record does not reveal it's not mechanical.
For example, a system's advertisement may claim 60%, 70%, 80%, or perhaps even 90% winning trades. However, these promotional claims are usually based on 20-20 hindsight and subjectivity, and not on real-time actual trades. Perhaps the system says buy/sell when there is divergence between the price and a Stochastics or RSI Study. That divergence is very difficult to recognize in real-time trading, but easy to see with 20-20 hindsight looking at an old chart.
Another popular but subjective approach is to watch for turning points at certain times, also known as time-windows. This approach may say to enter or liquidate the trade after an obvious pivot-low or pivot-high occurs, and providing it's during the projected time-window. It's mostly subjective and easy to do by looking at the past, but hard to do in actual real trading. However, some system developers have in fact used hindsight or subjectivity to arrive at their ridiculous percentage of winning trade claims.
Another popular and no doubt over-rated method are Elliott-Wave approaches. Elliott-Wave methods are popular, because there are obviously waves in the markets and the idea of using market-waves to predict market turning-points and also riding these waves, is naturally very appealing to traders.
What I am about to say may upset some proponents of Elliott Waves, but the plain truth is Elliott-Waves used by themselves are allegedly of little value in actual trading.
If you want evidence to back-up that statement of their questionable value, just do the following: Show the SAME identical chart to 5 traders (make it a mystery chart - rather than a widely published chart the trader may recall).
Next, ask the 5 traders to specifically define the number of waves they see on the chart. You you will likely end up with 5 different (frequently widely diverse) wave-counts. The chances of even 2 of the traders seeing the same exact elliott-wave-counts are extremely unlikely.
Why is this so? There are in fact "waves" in the markets. However, defining what constitutes a "wave" is near impossible, because a wave is largely a matter of visual interpretation and judgment and is highly subjective. It's difficult for a mostly subjective technical analysis method like Elliott-Wave Counts to be used successfully in trading?
Is there a way to overcome these basically of little, if any value subjective approaches?
Yes! Use a Trading System, which does not rely exclusively on Elliott Waves and other subjective approaches. However, using Elliott Waves as part of a trading plan in conjunction with another time-tested methodology may work for you.
Still another reason traders lose, many follow Time Cycles. Cycles do in fact exist in the markets. For example, Live Cattle may have a reliable long term cycle of 9 to 11-months, low to low. The Stock Market, Wheat or T-Bonds may have a short-term cycle averaging 28 to 30-bars, low-to-low.
The problem is sometimes the cycles may come early or late, or skip a beat entirely. For example, you buy on day number 30 at a price of say 3100, thinking the low is now at hand because the average is 28 to 30-bars and the market closed near its high on Bar (Day) 30.
However, because of either fundamental or technical reasons the market's cycle this time will run 35-bars (a common occurrence). During those 5 extra bars, the market goes down sharply to 2900 and below your stop-loss point forcing you out of the trade at a large $1,000.00 loss. Shortly thereafter, the cycle bottoms and the expected move occurs . . . but too late for you because you are out of the market by then!
Alternatively, you buy on day number 30, but you did not realize the low ALREADY happened (4-bars earlier) and at a lower price. You actually ended up buying (without knowing it) 4-bars into the NEW cycle, and at a higher price. Because of it, the market goes up only slightly higher for just 1-bar and then drops sharply because a 12-bar cycle (you perhaps were not aware of or not tracking) is now coming into play, and effecting the 30-bar cycle you are trading. The 12-bar cycle makes the 30-bar one drop down and form a double bottom pattern.
This forces you out of the market because of the sudden loss, your stop-loss being hit, or lack of discipline, etc. If your thinking why not trade the 12-bar cycle, forget it, because there's likely a 6-bar cycle effecting the 12-bar cycle, and a 3-bar cycle effecting the 6-bar, etc. Note: Many traders are not aware of the fact there are usually one-half (50%) time-cycles within every cycle.
Still another all too common happening is the cycle "skips a beat" and simply disappears for one repetition. The next cyclic repetition works perfectly, but by then you are out of the market with a loss and disgusted and not even following the now working well cycle!
Is there a way to solve these problems with cycles? Yes, don't use cycles at all, or perhaps use them in conjunction with other sound trading methods or technical analysis.
Still another reason many traders lose, they follow SEASONAL TENDENCIES or subscribe to Seasonal Newsletters, or use seasonally based Trading Systems. There is no question seasonals exist in the markets. This is particularly true in Agricultural where seasonals are very well documented. Seasonals also appear in financial's, but not as reliable as agricultural. Seasonals work mostly because of fundamental reasons, frequently tied to the growing season or the weather.
However, it's real difficult to make money using seasonal data, regardless of the history of the seasonal tendency. This is because like market time-cycles, sometimes seasonals can be early or late, or worse yet not work at all, also known as a "contra-seasonal move."
A perfect example of a contra-seasonal move, are major bear markets in the grains occurring several times during the 1990's. According to extensive and well-documented research going back to the 1800's, the grains should move up during late Spring and early Summer. However, at certain times in the 1990's they trended sharply down, when they should have been trending steadily higher according to the seasonals.
Unfortunately, the seasonal experts will be mad about this, but probably the best way to deal with seasonals are to ignore them, especially in markets other than Agricultural markets. Note: Occasionally Seasonal characteristics may be used successfully as a way to enhance or compliment other methodologies. There is no doubt the commercials can tell if the seasonals are early, late or contra-seasonal, but they keep that information to themselves!
Another major problem is you or your system can trade good, but selects the wrong market to trade!
A very common happening. If the market is either far too volatile, or on the opposite extreme too dull or flat and sideways, the best system in the world will have lots of difficulty.
Commonly a system or trader gets "married" to a particular market or market group. For example, perhaps the system is advertised to trade only Coffee or S&P, etc. The trading system may do well if that particular market is acting good or trending well or steadily. However, once that market gets either too choppy or flat, that system, no matter how valid the algorithm will very likely lose money or not make money.
What can be done about that problem? Figure out a way to trade only good trending markets. Use software which has a built-in Portfolio Manager and Automatic Trend Ranking Module which selects based on proven scientific methodology, the best markets to trade.
One requirement to do that effectively is to have a trading system which uses the same methodology (patterns) to trade all markets. Still another requirement is the system should be able to select from widely diverse markets.
After reading this Special Report "The Truth About Trading and Trading Systems" Special Report, you may visit the following trading and investment related links for more specific trading and investing knowledge covering all aspects of commodity futures, stocks, options trading and financial issues for all traders & investors. By tracking a number of diverse markets, you can expect about one-quarter to one-third to be trending well.
We are in the process of adding additional websites to this list, including links covering financial planning, public stock offerings, financial accounting, corporate communications, emerging markets, bonds and savings, estate planning, insurance and other financial subjects to help you with free financial knowledge.
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