Trading Insights

The Best of Louise Bedfords Articles Congratulations on purchasing Trading Insights.
These articles have been compiled from years of writing for Shares magazine, Personal Investor, Your Trading Edge and a variety of other publications. There are droplets of trading wisdom that you wont find in any of her books, all presented with humour and a style that will make the concepts easy to remember. The best way to navigate around the articles is to use the list of hyperlinks shown in the Index to go directly to your article of choice (and the Back to Index link at the bottom of each article to return to the Index). For more information, about trading, refer to www.tradingsecrets.com.au and www.tradinggame.com.au
www.tradingsecrets.com.au Copyright Trading Secrets Pty Ltd
Index
-Articles on Options and Downtrend Strategies1) 2) 3) 4) 5) 6) 7) 8) 9) Getting Started With Options Downtrend Doesnt Have to Mean Doom Short Selling Strategies Cheap and Nasty The Option Pricing Puzzle 8 Option Traps Volatility Trading Trading Volatile Markets The Naked Truth
-Articles on Trading Psychology1) 2) 3) 4) 5) 6) The Art of War Temples of Doom In Your Dreams Know Yourself the Key to Super Profits Affirmations Avoid Primal Urges
-Articles on Technical Analysis1) Relative Strength Comparison 2) Failed Signals -General Articles1) 2) 3) 4) 5) 7 Deadly Sins Pyramiding House of Cards Position Sizing The Derivative Kicker Handling a Windfall Profit
-Articles on Options and Downtrend Strategies1) Getting Started With Options Novices tend to overestimate the returns that they can derive from the sharemarket, yet underestimate the amount of effort that becoming a successful trader will require. Often influenced by a slick sales pitch, many nave hopefuls begin trading options prematurely, to their detriment. Lets have a look at some of the ways that you can safely begin trading options. The Covered Call The covered call is a simple way that you can generate a solid cashflow if you currently own shares in the Top 15. This is when you own the underlying stock and you write calls over it. If you are exercised (ie you are told to sell your shares at the strike price) and you have written a call with a strike price (eg $20.00) greater than your purchase price, you will realise a capital gain on the share, in addition to the premium (eg 38 cents) that you received for writing the call. This is the best way to begin trading in the options market. Only write options against shares that you are willing to sell, or you will need to take defensive actions to remove yourself from risk before being exercised. Bought options depreciate in value. Once you have sold another trader an option (ie written an option), if all other things remain equal, the option will expire worthless. You will have the money in your bank account and the buyer of the option will be holding a worthless asset at expiry. In fact, up to 85% of people lose money when buying options. Lets have a look at an example. Imagine you own 5000 BHP shares, and you decide that you would be happy to sell your shares if BHP goes up to $20.00. You could write a $20.00 call due for expiry at the end of April and receive a premium of 38 cents. 5000 shares x 38 cents = $1900. If the share price stayed below $20.00 by the end of April, $1900 would be yours to keep and you would get to hold onto your shares. However, if the share price was greater than $20.00 by the end of April, you would in all likelihood be required to sell your shares for $20.00 per share, but you would still get to keep the $1900 that you had earned in options premium. This strategy is suggested for shares that are trending gently upwards, moving sideways or trending gently downwards. A share with high levels of volatility is not suited to this concept. At all times
be aware that the premium that you receive by writing calls will not outweigh the capital loss you will make by holding onto a downtrending share. Set your stop losses and stick to them, even if you have open written call positions over that particular share. The other concern is that you may miss out on the additional capital gain that you could receive if the share trended upwards suddenly. Written calls are rarely exercised prior to expiry (in contrast to written puts). If your share becomes very bullish, it may be best to close out your call position. Alternatively, a sound re-entry strategy to repurchase your uptrending shares may be required. For this strategy, always choose options that are liquid (ie have large open interest, or many other buyers and sellers). If you do not deal with liquid options, it may be difficult to close out your position if the share trends against your initial view. By consistently writing calls over shares that you own, you will receive a cashflow similar to receiving a dividend cheque in the mail every month. Put Option Writing A put option writer is of the opinion that a share will be trading in a sideways band, or bullish in their view. They are under obligation to buy the shares from a put option taker at the strike price should they be exercised. You could implement this strategy if you were happy to buy the share at a certain value below the current market price. As an example of this strategy, imagine that we wrote an ANZ put option at $14.00, and the current price was $15.00. We would be of the view that ANZ would not go below $14.00 by expiry. If ANZ stayed above $14.00, we would keep the premium that the taker had paid (eg 20 cents). One contract provides exposure to 1000 shares, so if we wrote 5 contracts, we would receive $1000 in premium, providing exposure to $70,000 of ANZ. There are defensive actions available if the trade does not trend in the expected direction, however, as an option writer, technically our loss is unlimited. It is for this reason that monitoring is an essential component of trading options, particularly for written put strategies. Never write a put if you have concerns that the share will downtrend, or if you have reason to believe that we are due for a market correction. If you do not have a clear view regarding the direction of the share, do not write or buy options. Do not write more puts than you can cover if the market suddenly trends downward sharply. Make sure you have a clear exit strategy in mind before you enter into any position in the sharemarket. If you have difficulty trading
shares successfully, it would be foolhardy to move into a leveraged area such as options, warrants, or the futures market. For experienced traders however, options can multiply the available rewards. Many traders mistakenly believe that a Utopian Risk-Free trade exists - and they spend their lives searching for this elusive goal. Options do not represent a shortcut to untold profits. As with any leveraged instrument, options will escalate your speed of failure if you do not fully understand the principles of analysis, strategy and discipline. Back to Index
2) Downtrend Doesnt Have to Mean Doom There is no such thing as a born trader. Every principle of trading is learned. It is easy to feel daunted by the jargon involved in the sharemarket, but with effort you can learn how to trade like a professional. Professionals make money regardless of the market direction. Most people know how to make money in a bull market, but few know how to profit from a bear market. Lets have a look at some of the methods that you can use. Act on Your Stops Aldous Huxley stated, "facts do not cease to exist because they are ignored". If you recognise that a bear market is in place, the first step is to review your existing portfolio. Take a close look at where you have set your stop losses, and make sure that these levels are consistent with your trading plan. If your stop is hit, exit immediately. Do not hope that your shares will recover. Traders tend to hold onto shares that are trending down, yet sell shares that are trending up prematurely. This trait will ensure that you will stay amongst the mediocre masses, and never fight your way to the top of the class. Writing Call Options There are two types of call options a covered call and a naked call. A covered call is where you own the underlying stock. If you are exercised (ie you are told to sell your shares) and you have written a call with an option strike price greater than your share purchase price, you will realise a capital gain on the share. This is in addition to the premium (eg 40 cents a share) that you received for writing the call. This is the safest way to begin in the options market. Be aware that you must only write options against shares that you are willing to sell, or you will need to take defensive actions to remove yourself from risk before being exercised. By consistently writing calls over shares that you own, you will receive a cashflow similar to receiving a dividend cheque in the mail every month. If you do not own shares, you can write a naked call. Writing a call assumes that you have a sideways or downtrending view on the future share price action prior to the expiry date of the option. As long as the share price stays below the strike price of the option, then you will get to keep the full premium that the option taker paid you. If the share price goes above the option strike price, you are likely to be exercised, and told to deliver shares to sell to the option taker. Unless you own these shares, you will be required to buy them at market value, and then deliver them to the option taker. This
strategy is best reserved for professional traders, or traders that fully understand the risks involved. Bought options depreciate in value, right up until a defined expiry date. This is called time decay. Once you have sold another trader an option, if all other things remain equal, the option will expire worthless. You will have the money in your bank account and the buyer of the option will be holding a worthless asset. In fact, up to 80% of people lose money when buying options. Buying Put Options Writing options involves collecting a small fixed premium, yet incurring a theoretically unlimited loss. Buying options has a lower probability of success, yet due to the leveraged nature of this strategy, the rewards from the 20% of trades that do work, may outweigh the losses from the 80% of losing trades. In the options market, as the share price drops, the price of put options increase, often very dramatically. If you buy a short dated option, then time decay will erode your profit. For this reason, it is preferable to buy an option that expires in at least 4 months or more, and exit before the final month. Short Selling Usually when we buy a share, we are hoping to buy it at $5.00 for example, and sell it at $10.00 at a later date. Short-selling performs this same process, but in reverse. In effect, you borrow shares that you do not own, sell them with the expectation that the share price will drop, then buy them back at a later date. Your profit or loss is the difference between your sell price, and your buy price so if the share price drops, you make a profit. If the price increases, you will incur a loss. It is actually quite a simple concept, yet less than 1% of transactions in Australia are executed utilising this method. There are approximately 300 shares that can be short-sold on the Australian market. In the majority of cases, a leverage of 5:1 applies as brokerage firms usually require you to lodge 20% of the value of the initial share price in a cash management account. Be aware that you will be margin called, and required to place more money into this account if the share price trends upwards, (against your initial view). Remember that these strategies must be used with shares that have sufficient liquidity, or you will have trouble extracting yourself from the position if the market suddenly turns bullish. This is absolutely essential, as there is nothing worse than being trapped in a trade due to of lack of
volume. The sharemarket will continue to redistribute wealth to the people that are determined to educate themselves. Much of our success is ultimately determined by the strategies that we implement, as well as our discipline and mindset. Your financial future is in your hands. Back to Index
3) Short Selling Strategies Short selling is similar to buying a share, only the buying/selling order is reversed. Instead of buying a stock and then selling it, you sell the stock first and then buy it back at a later time. In effect, you borrow shares that you do not own (your full-service broker will organise this for you), sell them with the expectation that the share price will drop, then buy them back at a later date. Your profit or loss is the difference between your sell price and your buy price so if the share price drops, you make a profit. If the price increases, you will incur a loss. It is actually quite a simple concept. A significant benefit with short selling is that unlike the options and warrants market, there is no time decay issue. (Bought options and warrants decrease in value as they approach their expiration date). The US Market Many of the texts available on short selling originate from the US market. There are a few differences between the Australian market and the US market. The good news is that in many ways, these differences serve to improve our efficiency as traders, rather than detract. Although you cannot short-sell online in Australia at this stage, you at least do not have to wait for an uptick in price to short a share. The uptick rule means that in the US, you have to place an order one tick above the last sale. US traders are more likely to have the trade trend against their initial view, prior to it co-operating and ultimately dropping in price. It is likely that in the near future, an online shorting facility will be introduced here, but for now, you must use a full-service broker in order to short the market. Contrary to the views of some journalists, you cannot drive the share price downward by short selling. You are not legally allowed to short sell at a price below the previously recorded last sale price. This is one of the main execution differences between short selling and the usual method of merely buying a share. It is also one of the likely reasons why there has been a delay in establishing short selling as an online facility. Complications such as this tend to delay programming. From my understanding, there is no legal reason as to why an online facility could not be introduced. Broker Considerations Some old-fashioned brokers may lead you to believe that you are required to pay a daily fee to cover their costs, but this practice is largely being phased out of the industry. Other brokers purport to
only allow short sold positions to be active for a limited time period, for example 3 days, before they will close your position. This is not an ideal situation, and I would question this rule with your broker. It is becoming more common practice for brokers to enforce deadlines of 3 or 6 months. Unless you can be convinced otherwise, it is likely that time limits are negotiable. Alternatively, you could close out your initial position and then reopen it. Unfortunately, you will incur additional brokerage fees, but if your system suggests that you reenter your position, you should follow it. When you place your order with your broker, make sure that you stipulate that you want to short sell. By just asking your broker to sell, it could appear that you are requesting a sale of an existing share position. Not all Australian shares can be short sold. A complete list can be obtained from your broker or from an online broker. There are approximately 200 shares that can be short sold on the Australian market, so the field is wide open for you to make money from a downtrending share. This list varies only to a minor degree on a month-to-month basis. You cannot short sell any shares involved in a take-over bid and if you are in a current position with a share involved in a take-over, you will probably be instructed to close out. Especially smaller brokerage firms may have difficulty borrowing the scrip required for you to open a short position, and they are more likely to enforce a maximum amount of time for the position to be active. Dealing with one of the larger brokers for this type of transaction will help you to avoid a multitude of problems that smaller brokers are likely to experience. A large brokerage firm should be able to borrow any scrip on their short sell list to enable you to perform your transaction and there are fewer limitations on the minimum position sizing and time limits. Some firms require a minimum position of $10,000 for you to execute a short sold position, although this varies according to company policy and your own personal relationship with your broker. In the majority of cases, a leverage of 5:1 applies as brokerage firms usually require you to lodge 20% of the value of the initial share price in a cash management account. Although when you are starting, it is astute to consider that you have short-sold the entire value of the share, so that you will not be margin called. Being margin called means that you will be required to place more money into this account if the share price trends upwards (against your initial view) to maintain the original leverage ratio. Convince yourself that you do not have this advantage of leverage and that you are responsible for
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the entire value of your position (ie the total number of shares that you have sold, multiplied by their share price). By doing this, it is unlikely that you will run into difficulties with margin calls. It is important to know how to trade successfully before you apply any form of leverage, as leverage will multiply your results, whether they be positive or negative. Remember that a short selling strategy must be used with shares that have sufficient liquidity, or you will have trouble extricating yourself from the position if the market suddenly turns bullish. You will need to arrive at your own rule for liquidity, but as a guide, you should not open a position in a share where you are trading more than 1/5 of the average daily volume over the last 3 months. There is nothing worse than being trapped in a trade due to of lack of volume. Leveraged Equities Leveraged Equities have a short sale product called ShortShare. This is available through most brokers who short sell. Using this method, there is a slightly reduced list of shares available to short, however the costs and time limitations (if your short sell broker enforces them) are reduced. Your broker will charge you their fee, as per usual, and Leveraged Equities will also charge a small one-off establishment fee. You have up to 12 months in the position without further fees. There is a minimum position size of $50,000 which requires between 15 - 25% of this amount to be lodged in margin. If you are learning how to short sell, I would suggest that a minimum position size of $50,000 is far too large, regardless of the level of capital that you have set aside for trading. The main advantage of this type of product is that there is no problem with Leveraged Equities borrowing the scrip (ie shares) required to perform a short sell transaction. They always have the stock available because they are holding it as collateral for others who are long in that stock (ie have bought positions). Personally, I am not certain that this is enough of an advantage to use this product. Sometimes the best way to learn about short selling is to try it and see how you go ideally with a small position size when you begin. This will teach you the lessons that the sharemarket is seeking to reveal to you with amazing clarity. The distance is nothing; it is only the first step that is difficult Marie De Vichy-Chamrond (1697 1780).
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Entry Strategies To some extent, to enter a short position in the market, all you need to do is to reverse the entry signals that you would usually use for a long position. This certainly simplifies your search routines. Here are some of the signals that you could look for:

A share trading below its 30-week moving average that has just dropped through support on a bearish black candle. A gap downwards during an existing downtrend. A top reversal pattern of a temporary uptrend, during an existing, overall downtrend. Divergence in a momentum indicator to show a sign of weakness, prior to entering a short position on a black candlestick that has punctured an uptrend line. A share that bearishly trades below a candlestick bottom reversal pattern, without responding to its potential to reverse the trend, could also trigger an entry. Consider the sector that the share belongs to. A share that has been underperforming its sector, in a sector that has been underperforming the All-Ordinaries Index is preferable.
There are many other patterns that assist in a profitable entry into a short-sold position. The list is only limited by your familiarity with technical analysis. Volume There is an important difference between my assessment of a high probability uptrend and a high probability entry into a short sold position. For an uptrend to commence, I place a significant emphasis on the importance of heavy relative volume levels. Contrary to this view, if other set up signals are present but volume is not increasing during downticks in share price, I am still likely to short sell the share. It becomes a higher probability trade if increased volume levels are evident as the share drops in price, but it is not an essential pre-requisite. The emotion of fear is much more pervasive than the emotion of greed or hope. A ripple of fear will spread very quickly throughout a market. It only takes one small stone to begin an avalanche. It only takes one seller at a price below the current market value to create a selling frenzy.
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Exit Strategies Consider the term of your view regarding the strength of the downtrend, prior to determining an effective exit strategy. Traders with a medium term view can attribute a wider stop to their positions and be prepared to weather the discomfort of several periods of counter-trend reversal. Shorter-term traders may find that their short sold positions are closed out within just a few days. Stops can be set utilising any of the same methods used to exit a long position, only in reverse. Examples of stops may include:

A break upwards past a resistance level. A top reversal pattern of a temporary uptrend within an existing downtrend, that fails. 2 or 3 ATR above the point of entry A technical indicator that has provided a bullish signal
Position Sizing Position sizing for a short sale can follow the same principles that you apply to your long positions. You will also need to decide whether you are comfortable pyramiding into your position if it continues trending downwards. Some traders take full advantage of their leveraged situation to pyramid very aggressively to short sold positions. The Implications of Dividends A good knowledge regarding the implications of dividends while short selling is essential. Make sure you check the dividend status of the company that you are trying to short sell, prior to entering into a position. Occasionally a brokerage firm will absorb the dividend payment, especially if they are insisting upon a daily fee to hold the position open. Most firms will make you pay the dividend out of your account, as well as any franking credit benefit that may be derived to cover the tax implication. This can be an unexpected shock for the newcomer to the shorting market. As a suggestion, when you are learning to short sell, dont short anything where the underlying share is due to pay a dividend, or you may end up being responsible for the amount of this dividend, plus any associated franking credits. One strategy that you could consider is short selling a share that is in an existing downtrend, after it has gone ex-dividend. This will help you to avoid any of the consequences of being ultimately responsible for the dividend, while capitalising on the additional momentum that an ex-dividend gap may provide in favour of the existing downtrend.
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For shares in an existing downtrend, a gap downwards may act as a trigger to open a short position. A gap that drops through a previously well-established level of support is a particularly bearish signal. Pay particular attention to the trend of the share prior to the presence of a gap, and trade in line with the direction of the trend. The lead up to the gap, and whether it is confirmed by subsequent trading activity must be taken into account if you are to trade effectively using this method. With knowledge about how to short the market - you need never fear a bear market again. Review
1. Define short selling. 2. Describe a signal that would be likely to trigger your entry into a short-sold position. 3. How do you plan to exit your short-sale position?
4. How does an ex-dividend situation effect the share price action? If there was a fully franked dividend of 26 cents declared on a share, what would be the likely share price drop when it went ex-dividend? Answers
1. Short selling is similar to buying a share, only the buying/selling order is reversed. Instead of buying a stock and then selling it, you sell the stock first and then buy it back at a later time. Your profit or loss is the difference between your sell price, and your buy price so if the share price drops, you make a profit. If the price increases, you will incur a loss. 2. This is a personal decision, but any bearish chart pattern, preferably within an existing downtrend could trigger your entry into a shortsold position. 3. Exits can be made on the same basis as the signal required to exit a long position, only in reverse. For example, you could use a volatility stop loss, a pattern recognition stop, or a bullish technical indicator.
4. An ex-dividend situation will often create a bearish gap in a chart. If a fully franked dividend of 26 cents is declared, the share price is likely to drop approximately 39 cents ie 26 cents + (0.5 x 26c) Back to Index
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4) Cheap and Nasty It is an inbuilt instinct for people to hope. Cheap options, just like Tattslotto, feed into this delusion that you could be an overnight millionaire with no skill required. The slight probability of winning is overcome by the small amount of money required for a Lotto ticket, and this seems irresistible and worth the gamble. In the options market, you will not get rich because of some lucky break. It will take hard work and discipline before those elusive profits find their way into your bank account. Novice buyers of options are particularly attracted to "cheap" options, which ironically have little probability of appreciating. This helps explain why a vast majority of option buyers end up net losers in the market. In terms of risk/reward and probability, buyers of low-priced options make a trade with a low probability of success, where the rewards are high and the risk is minimal. Why are they cheap? Traders often buy options that have nominal time to expiry, which means that their bought asset is depreciating like a time bomb. Most options expire worthless and are only ever traded once. People don't like to be "wrong". They would rather sweep their bad trade under the carpet, along with any remaining value that they could claim by closing out their position, than confess that the trade didn't work. There is no room for this type of ego in trading. Often, naive traders underestimate the strength of a move required to affect the price of the option. These unfortunate souls believe that, even though BHP may have increased by only 10 cents in a month, it could potentially jump $10 within three days (when their option expires). Magically, BHP should recognise the brilliance of the trader with the deal in play and co-operate! The concept of delta and gamma becomes extremely important in this situation - but, rather than learn what these terms mean and how to use them, overly optimistic traders would rather just place their orders and take their chances. Delta measures the sensitivity of an option price to changes in the share price. Gamma measures the curvature of delta, so it can act as a precursor indicator when to exit a position. For advanced option
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plays, these two "greeks" or "option sensitivities" can greatly assist your chances of extracting a substantial profit. When you next see that amazing bargain option at two cents, ask yourself why it is that price. Maybe there is a reason that you haven't explored. Perhaps you are about to buy an option that is actually worth that small amount, not an option that has been mistakenly under-priced by market dynamics. Brokers Brokers receiving commission based on the number of contracts you buy - rather than your overall exposure - may urge you to buy cheap options with a short time before expiry because they make more money. This way, they convert your trading capital to brokerage with lightning precision. Don't rely on your broker to guide you in this arena. Stand on your own two feet and take responsibility for your future by educating yourself about options, and identifying trades with a higher probability of success. There is much less risk on the part of the broker when dealing in bought positions in comparison to written positions. Written positions contain contingent liability. This requires careful monitoring by both the client and the broker to eventuate in a profitable trade. Alternatively, your trading account can be loaded up with bought positions without the need for close monitoring. With bought options, the worst thing that can happen is that you will lose everything you placed into the trade -you can't lose your house. This is much simpler for brokers to monitor, and has the side benefit of their not ending up behind bars for inaccurate suggestions that led to their client's financial collapse. Buying at or in the money options with two to four months to expiry will often seem like a more expensive trade, but it is much more likely to eventuate in a profitable trade. Written positions When I first started writing naked options on NAB, I reached a startling conclusion. I was presented with two choices. I could choose to write five close-to-the-money option contracts, where I would seemingly take on more risk as the share price could easily break through my strike price, or I could write 28 option contracts that were miles out of the money, yet receive the same amount of money
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overall. For a brief moment, I thought I was completely brilliant! Can you see the problem with writing more contracts but receiving the same amount of money in total? If you can't see the problem with this, stop writing options immediately! I have one word that you must learn about before you progress: EXPOSURE. By writing many more cheap option contracts, it seems as if your trade has a higher probability of success. However, what happens if a huge announcement is made, or if the share price goes ballistic? Your exposure is completely blown out of the water! Rather than being liable for 5000 NAB, I would have become responsible for 28,000 NAB if the trade had backfired. Yikes! When we begin our trading career, we are strong, brave and bulletproof. The market had better not cross us. Unfortunately, the trading world doesn't work this way, and often the market will provide a proverbial kick to our soft underbelly to ensure that we don't repeat our past errors of being too cocky. Back to Index
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5) The Option Pricing Puzzle Many factors have an impact on the price of an option or a warrant. It is crucial to understand these to determine whether these instruments represent "fair value" to trade. These factors also affect the cost and timing of the defensive actions that you may take if the trade turns against you. Rather than provide you with a revolting array of mathematical formulae, we will show you some general principles that affect the premium value of options and warrants. Pricing models are available to help calculate the theoretical premium value of these instruments at specific strike prices. Some are available online, and require you to enter in a few basic details such as the strike price, share price and interest rates. A difficulty with these models is if the derived price is not backed by market support, we have gone to a lot of effort to calculate a figure that is largely useless. We prefer to let the market dictate the "fair value" based on the following concepts: Degrees of risk As a rule, the greater the risk, the greater the potential reward. This definitely holds true when referring to the sharemarket. The closer the strike price of the option or warrant to the share price, the more the inherent risk, and the greater the premium price. If you do not understand the ramifications of in-, at- and out-of-the-money strike prices, you need to do more research. A call option/warrant is in-the-money when the share price is more than the strike price. A put option/warrant is in-the-money when the share price is less than the strike price. Option/warrant buyers will pay greater premiums if the option is in-the-money, but this equates to less risk. If you are intending to write options, this means that you will receive a greater premium if you write in-the-money or at-themoney options, but you are exposed to much more risk. At-the-money options/warrants show the strike at about the same price as the share value.
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Options strategies Conservative WRITE BUY out-of-the-money calls and puts in-the-money calls and puts Aggressive at- and in-the-money calls and puts at- and out-of-the-money calls and puts
Out-of-the money instruments show the reverse of the conditions required for in-the-money positions. If you are an option writer, outof-the-money options represent a more conservative trade with less reward, but also less risk. Buyers with an aggressive nature will buy out-of-the-money instruments for a low price and high rewards, but with less probability of success. Apprentice buyers of options/warrants are particularly attracted to "cheap" out-of-themoney options, which have very little probability of appreciating. Buying strategies have a lower probability of success than writing strategies, yet due to the leveraged nature of bought positions, the rewards from the 20 per cent of trades that are profitable may outweigh the losses from the 80 per cent of losing trades. A quick reality check, however - only experienced option traders can achieve these results. Despite popular opinion, it is still a tricky proposition to profitably buy options and warrants. Complete at least one year of trading shares successfully before you even attempt to trade these instruments. If you want to follow a conservative strategy, buy in-the-money options/warrants and write out-of-the-money options (see table). Delta Delta measures the sensitivity of option price to changes in share price. For example, if a call option delta is 0.7, for every one dollar in share price increase, the option premium will increase by 70 cents. (Put option deltas are expressed as negative figures.) Therefore, if we buy an option that is worth 70 cents, we will approximately double our money when the underlying share increases in price by one dollar. The delta approaches one as the instrument becomes deeper in-the-money. Share volatility The more volatile the share, the higher the premium price. A simple way to see the effect of volatility is to have a close look at a share
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chart. The days that have higher volatility or candlestick length are the days that attract a higher premium. Choppy shares with greater distances from the peak to the trough of the share price action are more volatile and will attract higher premiums. For shares with a lower volatility level, the option/warrant premiums will also be lower. Although this description is simplistic, it can provide you with a basis of understanding why some shares attract vastly different premiums than others. In volatile conditions, options and warrants become more expensive. This information feeds into a calculation called historical volatility. If the market expects future volatility to increase, this affects a statistic called implied volatility. The effect of implied volatility was apparent after the events of September 11. Not even the market makers could accurately predict the future, so option and warrant prices went ballistic. This was because the implied volatility spiked in a dramatic way. Uncertainty about future market conditions tends to drive the prices of options and warrants upward. Volatility strategies can be implemented more effectively in the options market than the warrants market, as warrants tend to be written at high implied volatility levels. Warrant trades involve a directional bias, rather than a volatility bias. This actually makes it more difficult to make money using bought warrants as a vehicle in comparison to a correctly aligned volatility bought option trade. If your understanding of this concept is a bit foggy at this stage, you will need to educate yourself so that you can trade fairly priced instruments based on volatility, not just expected future direction. Time decay The longer an option has until maturity, the greater the time value reflected in the price of the premium. For example, a July option/warrant will incur a higher premium than a June option/warrant. Options lose value at an ever-increasing rate as they move towards the expiry date (when all Option Time Decay else remains equal, such as the price of the share, volatility and so on). The graph at right refers to the entire life of an option. As is evident, the closer the option is to expiry, the more steeply the curve slopes. The time decay curve is flat at the beginning of an option's acceleration downwards as it nears the expiry date of the option.
Price
Time
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As a buyer of an option/warrant, it is prudent to buy an option with at least two to three months' expiry. For writers of options, this time decay curve provides a greater degree of encouragement to write shorter-term options so that the buyer will have bought a rapidly depreciating asset, rather than a less dramatically depreciating asset. Other influences There are many other influences to option pricing. Although it is interesting to consider these influences, when you are starting to trade options it is not essential to analyse them all. It is not even necessary to understand every definition in order to trade options effectively. I find that if I get too sidetracked with details, I miss many trading opportunities. Other factors affecting option prices are: Theta - the sensitivity of option price to the passing of time
Gamma - the sensitivity of delta to changes in share price Vega Iota - the sensitivity of option price to a change in share price volatility - the sensitivity of option price to interest rate changes
Clever young players sometimes try to jump into the deep water of trading with leverage, without sufficient knowledge about how to trade more conservative instruments successfully. With enough bravado, even the most stupid of us can convince ourselves that we can outwit the market. Good luck to you if you hold this attitude. We wish you the best of luck when the debt collectors start knocking on your door. Trading options and warrants is designed to add spice (and additional returns) to the lives of experienced traders. Your trading habits and results will be the best guide to whether you should start trading options and warrants. Successful trading relies on developing your skills over time, so don't feel pressure to dive headlong into using leverage if your ability does not match your ego. Back to Index
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6) 8 Option Traps Consistent sharemarket winners have a series of strategies for rising markets, but they also know how to benefit from a sideways or downtrending share. If you can make money regardless of the direction of the market, you have guaranteed yourself an income that will last as long as you keep trading. This skill ensures that you will be able to effectively trade any market around the world, as long as you know the rules of the stock exchange. Your longevity and security will be assured. Many naive traders begin trading with leverage prematurely, often to their detriment. Trading a leveraged instrument will multiply your results. But, if you are not already trading proficiently, leverage will only speed your demise. However, if you are already a skilled trader, then using derivatives and leverage may be worth investigating. Learn about options, warrants, futures and short-selling so you will be better placed to make money in all market conditions. A quick review Options and warrants are very similar tools. There are traders who write call or put options, and traders who buy call or put options. Warrant traders can only buy to initiate the trade. Buying options and warrants has a lower probability of success than writing options, yet due to the leveraged nature of this strategy, the rewards from the 20 per cent of trades that do work, may outweigh the losses from the 80 per cent of losing trades. You will need to make your own assessment regarding which strategy you should engage. Other forms of leverage include short-selling and futures. Shortselling is similar to buying and selling the physical share, but the order of the transaction is reversed. Short-sellers look to sell to initiate the transaction and aim to buy back the share at a lower price, locking in a profit. Futures traders deal in standardised contracts that do not experience time decay, and can benefit from upwards as well as downwards movements. The table below describes the market moves required by traders of different strategies in order to profit.
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Strategy Buy Shares Short Sell Buy Call Options and Warrants Buy Put Options and Warrants Write Call Options Write Put Options Trade Futures
Market Trending Up
Market Trending Down
Let's have a look at the mistakes that many traders make when using leverage and derivatives. 1. Not analysing the share price direction Would you like to make money in the sharemarket beyond your wildest dreams? Trade in the direction of the overall trend and you'll be amazed at the results. This sounds obvious, but in reality you'll probably spend the rest of your trading life trying to achieve this goal. There are two main rules in the sharemarket - if it is trending up, buy it. If it is trending down, sell it. When you add derivatives into the picture, this ends up being a little more complicated. If the instrument is trending upwards over the time period that you are interested in trading, you can buy a call option/warrant, write a put option, or buy the physical share. If the instrument is trending downwards, you can buy a put option/warrant, write a call option, or short-sell the share. Futures contracts can be used with any of these trends. All of these leveraged strategies involve trading with the trend. Be rule-oriented but maintain a degree of flexibility and adapt to changing market conditions.
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The nature of the derivatives market means that you will need to get used to "thinking on your feet". Share traders may make a decision each week, but with derivatives, depending on your trading style, you may need to make several decisions every day. This adds to the complexity of this style of trading. If you are not up to the task, there is no harm in refining your skills in shares and then returning to leveraged instruments when you are ready. The first time you come into contact with any particular trading scenario, it is likely to make your adrenalin pump at a furious rate. The key to controlling your emotions is to think about every conceivable scenario in advance and to plan your actions in meticulous detail. 2. Underestimating the role of volatility There are two broad categories of analysts who trade derivatives. There are traders who use volatility to determine the types of trades that they are likely to enter, and there are traders who focus on direction. A successful strategy is to combine these two methods and trade using a hybrid approach. To ignore either direction or volatility will not enhance your profits. Choppy shares with greater distances from the peak to the trough of the share price action are more volatile and will attract higher derivative premiums. For shares with a lower volatility level, the option/warrant premiums will also be lower. Although this description is simplistic, it can provide you with a basis of understanding why some shares attract vastly different derivative premiums than others. Volatility strategies can be implemented more effectively in the options market than the warrants market because warrants tend to be written at high implied volatility levels. Warrant trades involve a directional bias, rather than a volatility bias. This actually makes it more difficult to make money using bought warrants as a vehicle in comparison to a correctly aligned volatility bought option trade. If your understanding of this concept is a bit foggy, you will need to educate yourself so you can trade fairly priced instruments based on volatility, not just expected future direction. 3. Only analysing direction when trading derivatives Trading with leverage can be complicated. So many traders assume the derivative will behave in the same way as the share. If this is your belief, then your wake-up call may be in the shape
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of massive losses. Trading derivatives relies on a greater level of skill than that possessed by the average share trader. Most traders only look at "direction", but options require a consideration of several additional components that share traders do not require knowledge about, such as:

Dividend knowledge. Knowing the correct type of derivative to trade. Understanding the implications of time decay. Effectively analysing implied and historic volatility. Being aware of the importance of liquidity.
Many traders buy out-of-the-money options/warrants and write in-the-money options. They allow their bought option/warrant positions to expire worthless and have no idea about how to set an appropriate stop-loss. They write long-dated options and buy short-dated options/warrants, and have little understanding about how to control their risk levels. This is the opposite approach to that of the professional derivatives trader. If you are not familiar with these terms, give yourself some time to learn about the importance of these concepts. There is no harm in paper trading to establish your foundation of knowledge, before you jump headlong into some of the more complicated methods of trading. It makes sense to bide your time and invest in your own education. 4. Searching for the totally 'risk-free' trade Many traders mistakenly believe that a utopian "risk-free" trade exists - and they spend their lives searching for this elusive goal. No risk means no reward. Derivatives do not represent a short-cut to untold profits. As with any leveraged instrument, options and warrants will only escalate your speed of failure if you do not fully understand the inherent principles of trading successfully. 5. Dealing in illiquid instruments If a trade turns against us in a liquid position, we can usually find a market to buy back our option so that we can "close out" our position. This is not the case if we deal in illiquid derivatives. We may want to escape from the trade, but there may be no market available for us to exit our position. This is a terrifying situation. Save yourself from unnecessary stress by refusing to deal in illiquid instruments.
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6. Using strategies that are too complex Because derivatives represent a more sophisticated trade, many people believe that this will lead to a greater chance of success. Don't delude yourself into thinking that just because something is complex, it will make you money. Often the simplest ideas and strategies are the most effective. 7. Letting your losses run If you do not know how to set a stop-loss, then for goodness sake, stop trading immediately. An initial stop-loss is designed to preserve your trading capital. A breakeven stop will help lock in a no-loss trade. A trailing stop-loss will assist in preserving your profits. Learn how to set a stop and then follow it. If you can keep investing in the markets for long enough, you are bound to learn the secrets about how to succeed. There is no such thing as a "born trader". Every principle of trading can be learned. Develop a ruthless quality when it comes to taking a loss. To quote author and chairperson of the US Strategic Learning Institute Chin-Ning Chu: "The killer instinct is not solely reserved for the vicious and cunning; it can benefit the virtuous and righteous as well". If you lack discipline in being able to take a loss, you may have difficulty trading in the derivatives market. Trading with leverage is not for everybody. Recognise your own strengths and weaknesses and be prepared to maximise your strengths. If you struggle with the application of discipline, perhaps stay with tools that are not quite as leveraged, such as shares. There is no shame in this. 8. Inadequate money management Having conducted many courses on trading, I can usually assess how much experience participants have in the market based on the questions they ask. As a trader matures, the questions they ask tend to involve psychology. Ultimately, traders evolve to conquer the final frontier... money management. I dare you to go boldly where few traders have gone before. Separate yourself from mediocrity. Consider position sizing, stoploss procedures and capital allocation based on risk. Here are
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some basic guidelines to ensure that you don't get blown up while frolicking in the financial jungle. Commit a maximum of 20 per cent of your total equity to higher risk sectors of the market as well as derivative trades. As an example, with a trading float of $100,000, $20,000 can be devoted to speculative shares and derivatives. This will allow you to maintain a maximum of four to five lower risk positions and up to three to four speculative shares. This will still provide exposure to potential high returns, without the potential to devastate you financially if the market does not co-operate with your view. Before you enter a trade, determine where you will exit if the market turns against you. If you only permit a loss of a maximum of 2 per cent per position of your capital base, even a string of losses won't destroy your equity. Your number one goal in the market must be preservation of capital. When traders have learned how to consistently make more money than they lose, they enter the realm of the professional trader. Successful traders are among the most highly paid professionals in the world, yet many beginners in the market expect to earn the income of a brain surgeon without undue planning and effort. Profitable trading does not rely on luck. It demands the highest levels of skill and discipline. Your trading habits and results will be the best guide to whether you should start trading options/warrants, short-selling or trading futures. Summary of the Eight Trading Traps 1. 2. 3. 4. 5. 6. 7. 8. Not analysing the share price direction Underestimating the role of volatility Only analysing direction when trading derivatives Searching for the totally 'risk-free' trade Dealing in illiquid instruments Using strategies that are too complex Letting your losses run Inadequate money management
Back to Index
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7) Volatility Trading Amateur traders are a predictable bunch. Most seem obsessed with finding the magic indicator/software/set-up that will help them become a monumental success. In sharp contrast, professional traders form a view and back that view, using a variety of strategies most suited to the markets at that time. Let's imagine that you have formed a view on News Corp (NCP) shares. You think that, by the end of October (two months from the time of writing), it will rise by 10 per cent from $10.50. We can use this view to add specifics to some potentially profitable strategies. NEWS CORPORATION (NCP)
2002
(Please note that this is a hypothetical example; good traders don't give tips and they don't listen to tips.) After you have completed your analysis, you will need to work out the appropriate strategy to use in order to profit from your findings. You will need to decide which vehicle is best to make money from your observations - for example, shares or derivatives. These are some of the strategies you could choose: Buy the share Most technical analysts tend to follow a trend. For trend-followers, there are a few simple rules. The first rule is that if a share is trending up, buy it. The second rule is that if it's going down, sell it.
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There are some traders who continually try to trade against the prevailing trend. People who trade against the trend will ultimately run out of money and self-destruct. Using the above chart, if you purchased NCP at $10.50, for example, and sold it three months later at $11.55 (10 per cent higher), you would make 10 per cent return on your initial investment, minus brokerage costs and such. This equates to an annualised return of 40 per cent, which is substantial. When we apply some leveraged strategies, it is possible to enhance this return even further. Buy a call option/warrant Buying options is often similar to a Tattslotto ticket mentality. Novice buyers of options are particularly attracted to cheap options, which have little probability of appreciating. Although the chance of winning Tattslotto is minuscule, millions still gamble on it. The slight probability that you will win is outweighed by the small amount of money needed for a ticket. This reasoning helps explain why the vast majority of option buyers end up net losers in the market. Buyers of low-priced options enter a trade with a low probability of success where the rewards are potentially high. If the call option buyer's view is correct, however, and the share increases in value, they can either sell the option at a profit, or if they choose, exercise their rights. They have the right to purchase the writer's shares at the strike price (which will represent a lower-thancurrent market value). Most players in the options market do not exercise their rights. They sell their options if their position has cooperated to experience a capital gain. The bulk of options are only ever traded once and then left to expire worthless. Strategies
Strategy Buy Shares Buy a Call Option/Warrant Write a Put Option Pros Easy to execute Easy to understand Terrific for strong moves Excellent income potential High probability of successful trade Cons Lack of coverage
Confusing to novices Limited income but unlimited liability
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If you are looking to buy an option there are a few simple rules to follow:

Buy an option with a significant time until expiry. This will help minimise the negative effects of time decay. Always exit your bought position before the final stages of expiry. An option close to expiry will incur exponential time decay, sweeping away your capital at an alarming rate. Buy an option that is in the money, which by definition will not be the cheapest option available. Betting that NCP will go up by $10 within two weeks is not a high-probability trade. Buy an option that gives the share a bit of room to move, just in case it does not co-operate immediately. If you do not fully understand the implications of in, at and out-ofthe-money options, do not buy them. Do not buy options if you do not understand the impact of delta and volatility on option prices. Bought option positions work well as a short-term trade. If this perception matches your view, but this time horizon does not suit your trading style, do not buy options. Only buy (or write) options that have sufficient levels of liquidity.
Using our hypothetical example of NCP rising 10 per cent in three months, you could choose to buy a $10 November call option for $1.29. This is slightly in the money, and provides you with reasonable relative open interest and a suitable delta of 0.61 (at the time of writing). The implied volatility is relatively low, which suggests that the option is undervalued and would be suitable for an option-buying strategy. So, by buying a November $10 call option, you would expect, based on this delta, that the option would be worth $1.93 by expiry - an option price increase of 64 cents. In reality, you would probably close out your position by the end of October to avoid the last month of dramatic time decay. This represents a 49.6 per cent return on investment in three months, or an annualised return of 198.4 per cent. Although it is unlikely that you will achieve these terrific returns consistently, the occasional extremely profitable trade can be essential to a professional trader's survival. Another strategy that you could consider either separately, or in addition to buying a call, is to write a put option.
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Write a put option A put option writer either thinks that a share will be trading in a sideways band, or is bullish. They are under obligation to buy the shares from a put option taker at the strike price, should they be exercised. You could implement this strategy if you were happy to buy the share at a certain value below the current market price. You could also write a put if you were of the view that NCP would not penetrate a certain price within a certain period. Most written positions are taken out with three to six weeks before expiry, so you could use this strategy at least twice within our three-month view. Trading Terms
Implied volatility - This is the value that you would derive after plugging all of the variables into an option pricing model (underlying price, days to expiration, interest rates, and the difference between the option's strike price and the price of the underlying security). Historic volatility - This describes volatility observed in a stock over a given period of time. It is the standard deviation of share price changes over a particular time period which will match the time until expiry of your option. Delta - Measures the sensitivity of the option price to changes in share price. Option pricing factors - Effective option trading requires a consideration of several additional components that share traders do not require knowledge about. Factors that can influence the price of an option include direction, type of option, time decay, volatility and strike price.
As an example of this strategy, imagine that you wrote an NCP put option at $9.00, and the current price was $10.50. You would be of the view that NCP would not go below $9.00 by expiry (within five weeks). If NCP stayed above $9.00, you would keep the premium that the taker had paid. In this case, using the option pricing current for this period, you would be paid 40 cents from the option buyer. Assuming you repeated this trade in the subsequent month and earned a similar premium, you would earn 80 cents in total per share per contract that you wrote. Do not write more puts than you can cover if the market suddenly trends downward sharply. For example, in the NCP example described, if your contingent liability is $100,000 (that is, 11 contracts), it would be prudent to have enough cash or shares at hand available to cover this level of exposure. So in keeping with your view that you expected a 10 per cent rise in NCP in the short term, you could choose to buy the share, buy an appropriate call option, and/or write a put option. Each strategy has
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unique advantages and drawbacks that you need to evaluate before entering a position. There are also many defensive strategies that you could implement if the share did not co-operate with your initial view. As well as knowing appropriate strategies, it is also essential to understand which strategies would not be effective, given a bullish view. These include writing a call option, buying a put option, or short selling the share. Each of these strategies would be trading counter to your view of the potential trend, and they are unlikely to be effective if the market moves in this bullish direction. Even though these strategy examples provide some ideas about how to make money by backing your view, the trading world is not so clear-cut. Unfortunately we are not given crystal balls as soon as we decide to become share traders. Successful technical traders have a defined set of rules to enter a share, and to exit from the market promptly at the first sign of a downtrend, or to preserve their capital after the share or derivative has retraced in value. They maximise their profit potential through dedication to the principles of money and risk management. Back to Index
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8) Trading Volatile Markets I have a challenge for you. Call up any three share charts at random. Take a few minutes and write down your observations. I can almost guarantee that you will spot an over-riding similarity. (Yes, Ive been practicing my skills with amateur clairvoyance). I can bet you that each of the three random charts, have one major thing in common. In the current market (late 2002), almost without exception, share charts seem to be displaying vast levels of volatility. Peak to trough drawdowns are entering the extreme danger area. Many traders have found that they have been getting stopped out of their long positions, as well as their short positions prematurely, despite the share continuing in the expected direction after they have exited. Previously easy to read charts which showed ripples of calm directional activity have erupted into tidal waves of undisciplined violent share price action. If youve been getting stopped out regardless of the direction youve been attempting to trade youre probably ready to jump off the proverbial cliff, especially if you have any grain of emotional attachment to your bank balance. Take heart. Help is on its way. Here is how to survive and thrive in the current trading environment. 1. Set Stops Carefully The golden rule of trading is: Keep your losses small and let your profits run. Stop losses provide a sign that it is time to exit your position, as the trade is no longer co-operating with your initial view. Every successful trader has pre-meditated the point of exit, prior to entering the trade. You may remember that there are several methods available to set a stop loss. Volatility and pattern-based systems tend to work well for short-selling, or trading shares. Hard dollar stops are terrific for option/warrants and futures positions. Pattern based stops are a very popular way to set a stop loss. When the share is no longer trending upwards, exit your position. An appropriate exit can be made if the shares price closes below a trendline or below a support/resistance line. Volatility is a measure of movement, not a measure of direction. Shares can be heading in an overall direction upwards, or downwards, but this general direction is characterised by dramatic
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peak to trough drawdowns. This is typically characteristic of the current market that we are experiencing. Volatility based stops imply that you should to exit your position when the volatility of the instrument increases dramatically, or beyond a pre-defined level. To assist in this goal, an indicator called Average True Range (ATR) can be utilised. For an exact definition of the ATR indicator, refer to the glossary in the FAQs at www.tradingsecrets.com.au. A simple definition of ATR is the move in cents that a share could reasonably be expected to make during a particular period. On a daily chart, it shows how much the share price is likely to go up or down in a day. It typically shows a figure compiled from the last 15 20 days price activity. You may choose to exit if the share goes up (for short positions), or down (for long positions) by greater than a multiple of 3 or 4 times ATR. For example, if the ATR is 10 cents, and the share goes up by 30 cents, you could exit your short position. A drop in share price of 30 cents, would suggest that you should exit your long position. During volatile periods, set a wider stop loss. Otherwise you will exit your position only to see the share continue in the expected direction, without your involvement. A hard-dollar stop can be effectively utilised for bought options/warrants, or futures. For example, when youve lost a maximum of 2% of your allocated trading equity in any particular trade, exit that position immediately. You may decide to exit when your position has a drawdown of $1000, for example. Alternatively, for a trailing stop, you could exit when the option has pulled back your equity $500 from the maximum profit peak that you had attained in that position at any time. This is an effective method of controlling your losses, and letting your profits run. A wide initial stop, but a tighter trailing stop tends to be the best strategy in the present market conditions. 2. Learn How To Trade Long and Short I moderate a trading forum for traders where members can ask trading questions and receive answers (located at www.tradinggame.com.au ). Recently I was asked a question regarding searches. A particular trader was wondering whether he should loosen up his search parameters as he could not find any shares to buy that fitted his criterion. Previously, he had identified numerous opportunities. However, in the current market he was
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struggling to find two or three potential positions per month. Obviously he was frustrated. Can you see the problem with applying more liberal searches during periods of volatility? By changing our trading system to supposedly more accurately reflect market conditions, sometimes we just end up kidding ourselves about the calibre of opportunity available. If your trading system is telling you to buy shares you should buy them. If your system is suggesting that it would be more effective for you to sit on the sidelines and not trade due to insufficient opportunities in the market, ignore this advice at your own peril. Alternatively, learn how to recognise a downtrend. Reverse the parameters of your usual searches. Use an option or short sold position to capitalise on your observations. 3. Use Margin Wisely I recently had lunch with a trader who could be characterised as a bit of a cowboy, but had managed to generate a good trading plan and consistent profits without the benefit of margin. From the first few minutes of the conversation, I knew that he had a problem. He excitedly explained to me about a new online system that he had discovered that allowed him to trade long and short, using minimal margin to open substantial positions. The conversation went something like this: They only want to take 20% margin from my account to open any position. Oh my gosh do you realise what this means I can leverage myself up to the hilt! I can open up as many positions as I want. My $100,000 will allow me to trade up to $500,000 worth of shares! Im going to be rich!! Now, at risk of bursting his bubble, I decided to curb his enthusiasm, (lest he couldnt afford to pay for his own coffee the next time we wanted to meet). Too many traders decide to position size based on the margin that they are requested to deposit, instead of the total exposure of their position. If you do not immediately recognise the drawbacks of this rationale, you owe it to yourself to work through this example.
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Lets say that your system suggests that you can short sell $15,000 of a particular share, but your broker only requests a 20% margin. The logical thing to do would be to reserve $15,000 in your equity account, and give your broker $3000 in margin to open your position. (Brokers require a margin in order to open short sold positions and written option positions). Imagine that you had identified a $4 share that you wanted to short sell. This means that you could short sell 3750 shares at $4, which equates to a total position size of $15,000 (even though the broker is only going to take $3000 in margin). If the share did not co-operate, then at least you would have the remaining $12,000 of liability available at a moments notice to answer any potential margin calls. This is a conservative approach. It works. It means that you wont end up losing your house if the market ricochets upwards against your position with meteoric speed. On the other hand, you could consider the $15,000 that you have available for this trade to be the margin. Rather than only selling $15,000 of the share, now you could short sell a position size of $75,000! Yikes!! Instead of short selling 3750 shares at $4, you would now short sell 18750 shares! Think of the implications of this move. It is five times the exposure of your original calculation. It leaves no room for error, and opens you up to the threat of a very nasty margin call that you are unlikely to be able to cover. The current market chews up and spits out non-conservative traders with ruthless efficiency. Position size based on the position itself, not the margin required to open your position. Only use leverage when you have developed your skills as a trader. If you insist on doing otherwise, your career as a trader will be shortlived, but spectacular. 4. Limit Contingent Liability Positions Writing naked options involves collecting a small fixed premium, yet incurring a theoretically unlimited loss. This is the meaning of contingent liability. Written naked option can surprise novices with their effectiveness to deplete trading equity. Many traders are attracted to this concept because the chances of success of this strategy are high. Approximately 80% of options are only traded once and never exercised. On the surface, this
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sounds like a great chance to make money. When you look at the risks involved however, which contain contingent liability, this strategy should be left to sophisticated traders. With any position that has the ability to wipe out your bank account within one foul swoop, apply caution, limit the number of this type of position, as well as limit position sizes. To trade spreads in options, it is essential to understand both sides of the transaction both buying and writing options. By spending some time learning about these types of strategies, you can work out creative ways to minimise your risk and maximise your profit. Trading during volatile times can multiply your rewards. Take advantage of this trading environment, but remember to use caution and common sense. Back to Index
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9) The Naked Truth Novice traders often take on incredible levels of risk without realising the consequences of their actions. This can lead to a short career in the sharemarket. Professional traders tend to quantify the risk involved in any strategy, weigh up the rewards and make an informed decision as whether to engage the market. One of the most common questions asked is whether a trader should write naked options. Naked options involve a high probability of receiving a limited reward in return for an unlimited level of risk. They imply that you are selling to initiate an option position where you do not own the underlying entity. In the right circumstances, writing naked options can be the ideal strategy. However, if you get it wrong, the consequences can be dire. There are several factors to consider. Let's review ways you can limit your risk. Pricing factors Many factors have a large impact on the price of an option. It is critical to come to an understanding of these factors to determine whether these instruments represent fair value to trade. These factors also have an impact on the cost and timing of the trading tactics you may consider implementing if the trade turns against you. Some of the main factors determining the price of an option are:
The level of risk - the greater the risk, the greater the potential reward. The closer the strike price of the option is to the share price, the more the inherent risk, and the greater the price of the premium. The level of volatility - in general terms, the more volatile the share, the higher the premium price. Choppy shares with greater distances from the peak to the trough of the share price action will attract higher premiums. For shares with a lower volatility level, the option/warrant premiums will also be lower. This information feeds into a calculation called historical volatility. If the market expects future volatility to increase, this affects a statistic called implied volatility. The time to expiry - the longer an option has until maturity, the greater the time value reflected in the price of the premium. Other factors such as delta, gamma and interest rate fluctuations also have an impact.
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If the naked option trade I am considering does not provide an ideal combination of all of these factors, I walk away from using this as a strategy for that particular instrument. There is no point in entering into an option trade that contains unlimited risk unless the set-up is ideal. The risk must justify the rewards. The perfect combination that would encourage me to write a naked option rather than employ an alternative strategy would be where the option had a limited time to expiry in a highly liquid share and option series. Ideally, the volatility set-up would suggest that the option is over-priced and likely to decrease in value. Comparing the implied and historical volatility levels will assist you in this quest. Before plunging into writing a naked option, also consider the expected strength of the move. If a strong move downward is expected, writing a call does not often represent significant profit potential. It will result in a small fixed profit, regardless of the strength of the ensuing move in the expected direction. Another choice would be to buy a put option or short sell. If a strong move upwards is expected, then writing an unprotected put position will not capitalise on this. Alternatives would include buying the share or buying a call option or warrant. Alternatives There are several other methods you can implement that do not involve writing naked options. Covered calls One way to learn about the options market is to write "covered" call options over shares you own. When you write options, you receive a small, fixed amount of money because you are selling to initiate the transaction. The risk with written covered call options is that if the share increases dramatically in price, beyond the strike price of your written option (the level at which you wrote the option), it is likely your shares will be "called away". When you write a call option, you are under obligation to sell your shares to the option buyer, which is usually enacted if the share price exceeds the strike price. If you are exercised and the strike price is above the initial price you paid for the share, you will experience capital gain of the share as well as keeping the premium from selling the option. By writing these
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covered calls, you are making your portfolio work hard. Writing a call will bring in some regular income in particular circumstances. Many traders have found that by implementing this strategy, their returns have safely increased, and that the additional cashflow has been a welcome contrast to awaiting dividend payments. If you want your blue-chip portfolio to return an extra 5 to 15 per cent per year, this may be the strategy for you. Credit spreads The concept behind some of the most effective credit spreads is that you limit your downside risk by "covering" your written position in some way with a bought option position. Written straddles and strangles also fall under the banner of credit spreads, but we will save the discussion of these concepts for another time. An excellent text to enhance your knowledge of these types of strategies is Chris Tate's Option Trader Home Study Course, available through www.tradinggame.com.au A call bear spread involves writing a lower strike price call and buying a higher strike price call with the same expiry date. This is usually written out of the money, above the share price action. It is profitable if the share stays at the same level or drops in price. Some people think of the bought position as being a form of insurance against a catastrophic loss. Any potential loss is quantifiable and known in advance, so provides a degree of consolation to the trader. The payoff diagram in Fig 1.1 shows the construction of this option spread. A call is sold at A and a call is bought at B. Fig 1.1 Call Bear Spread
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The reward is limited to the credit received, so it is probably not the ideal strategy if you expect an explosive move to the downside. For explosive moves you could short sell, or buy a put option. This strategy will not benefit from a change in volatility either, because you have both a written and a bought option position. If the share price moves up, this will damage the position, so you can use an effective stop loss in order to recoup some of your investment. This is often a more effective alternative than letting both positions expire. A put bull spread is where you sell a put option, and then buy a put option with the same expiry date, at a lower strike price. This is usually written out of the money, below the share price action. Share price action that moves sideways or upwards will lead to profit in this situation. This strategy yields a credit and limits your downside risk by capping your potential loss. The payoff diagram in Fig 1.2 shows the construction of this option spread. A put is sold at A and a put is bought at B. Fig 1.2 Put Bull Spread
Both this strategy and the call bear spread benefit from a rapid loss in time value. Traders who implement these strategies will benefit from a gradual progression in price, rather than dramatic or volatile directional price movement. Call bear spreads and put bull spreads are of advantage to new option players because they give them a capacity to write options but with a risk management component built in. Along with covered calls, they represent a great learning ground so that you can learn the basics without exposure to unlimited downside potential.
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Index options When trading some instruments, such as index options, sometimes it seems almost impossible to avoid the possibility of writing naked positions. In order to limit your risk in this situation, remember to employ an effective stop-loss procedure, and to use a spread to mitigate potential disaster. Some of the spreads that you could implement involve a call bear spread or a put bull spread as shown in the pay-off diagrams. It would be foolhardy to write puts under an index without some form of protection such as a put bull spread. Any severe drop in the index would involve an unlimited potential for disaster. Several traders totally eradicated their last five years' worth of profit by ignoring this risk before the September 11, 2001 index corrections around the world. By building a put bull spread, they could have limited their downside risk, yet still backed their view. As James Rogers states in Market Wizards by Jack Schwager: "Be very selective. Never trade for trading's sake. Have the patience to sit on your money until the high probability trade sets up exactly right." This attitude will ensure your longevity in the markets and give you a chance to develop profitable strategies. Back to Index
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-Articles on Trading Psychology1) The Art of War Sun Tzu was a military genius who wrote a classic treatise entitled The Art of War. The principles in this ancient text are relevant whether you are planning a military coup, aiming for success in the boardroom, or desire to excel as a trader. The fact that his ideas were expressed approximately 2500 years ago ensures that these concepts have stood the test of time. Lets have a look at some of his key concepts and apply these to assist our trading results. 1. Possessing the ability to calculate the difficulties and danger is a basic requirement for a good general" Your number one goal in the market must be preservation of capital. If you have not evaluated the risks involved, you should not take the trade. Effective money management skills allow you to quantify the worst-case scenario before engaging the market. 2. To be prepared beforehand for any contingency is the greatest of virtues. The degree of success depends upon the extent of planning for the anticipated victory" Meticulous planning Before engaging in battle, you have already won the war. Careless planning Before engaging in battle, you may have already lost the war. No planning Your defeat is certain.
Traders who work to a written trading plan stack the odds in their favour. The market is a more efficient, bigger and scarier opponent than you have ever faced in your life. You cannot defeat it unless you out-think and out-plan it. 3. You need to strengthen yourself and prepare yourself mentally to be the target of attack. "Know the enemy and know yourself and in a hundred battles, you will never be in peril" The more knowledge that you can muster about the market, the more likely you will be to succeed. Trading favours the strong of mind.
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4. Those who carefully calculate their strategies will be led to victory. Those who carelessly calculate their strategies will be led to defeat One of the key trading strategies is to let your profits run, and cut your losses. Unfortunately, the majority of traders have this rule around the wrong way. They become risk-seeking when faced with a loss, yet risk-averse when a trade is profitable. Sometimes the old wives tale of you'll never go broke taking a profit or leave some thing on the table for the next person comes into play, and they exit the trade pre-emptively. It is difficult for traders to obey the rules of trading because their own psychology often defeats them. 5. Within the universe, there are no eternal conquerors You are only as good as your last trade, so the killing you made in the tech boom is no longer relevant. Even the bravest among us have learned that Out of orderliness comes chaos. Out of courage comes cowardice. Out of strength comes weakness. You cannot afford to let your guard down, or you will suffer the consequences. 6. When the victory is not certain, adopt defensive tactics. When the odds for victory are overwhelming, adopt offensive tactics One of the key premises practiced by effective traders is to trade with the trend. If we are experiencing a bear market, this requires different tactics in comparison to bull market strategies. Make sure that your trading is consistent with the overall market environment. These principles have been utilized throughout the ages to build effective strategies and enduring victory. If you use them properly, they will bring you success in the trading arena. Profitable trading does not rely on luck. It demands the highest levels skill and discipline, and lucratively rewards the people who develop these qualities. Back to Index
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2) Temples of Doom There are three things that we need to achieve happiness in life; someone to love, something to believe in, and someone to blame when things go wrong. Enter the share market guru Cashing in on these major needs, this dashing species has all of the hallmarks of success. A rags to riches story that is difficult to verify, the ability to arouse emotion previously only realised in religious cults, and a sound message: If I can do it, you can do it. This combination of popular psychology and extreme promises hypnotically encourages us to pay copious amounts of money for seminars - in pursuit of share market happiness. Yet, since the bull market decided to grow claws, these gurus have taken on some nasty characteristics. Just like sharks, confined to a fishpond, they are gnashing their teeth and showing signs of aggression. To encourage seminar attendance, they are making outrageous advertising claims. How to Spot a Guru The flowing swami robe has now been replaced with an Armani suit. Here is a list of indications that your share market trainer may have their heart in the wrong place. Be wary if they tell you: Youll make returns of greater than 70% per year. A quick reality check Ed Seykota is one of the greatest traders in the world. Ed could practically buy the small island of Australia with his vast bank balance, but he only makes returns of 60% per year. (No this is not a typing error). Unrealistic benchmarks will sell a seminar, but they will set you up for catastrophic losses. What makes you think that you can outperform Ed? Ive been trading for the last 3 years. Dont confuse brains with a bull market. The worst traders can make astounding profits if the market conditions are right. Find someone that has weathered a few share market crises and knows how to make money out of a downtrend. Three years is a blink of an eye in the context of the share market. I make profits 80% of the time. This is a ridiculous yardstick. Most good traders will talk more about their losses and the lessons they have learned, in comparison to their
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profits. This is not just a case of admirable humility. The share market has a way of punishing those with inflated egos. Here is a no-risk strategy. The search for the no-risk trade has achieved Holy Grail status in the share market. Novices believe that it exists. Professionals know that it doesnt. If there is no risk, then there is no reward simple as that. Entry is the key. Money management includes position sizing, pyramiding, stop losses and trade management. These arent sexy topics, and wont sell a seminar but they do separate the professionals from the mediocre masses. Natural selection dictates that for a particular characteristic to evolve, it must be attractive to those we seek to impress. We have no one to blame but ourselves. The gurus have emerged because we have encouraged them to do so. In our desperate and pathetic pursuit of a higher authority, we willed them into existence. Unfortunately, the guru of yesterday is the despised charlatan of today. There is no short cut to trading success. You will need to stop relying on fairytales and begin trusting your own written trading plan. The best traders have read widely, sparingly attended high quality seminars, and been discerning when it comes to listening to other traders. Dont blame the guru for your trading results they only had power over you because you allowed them to. Back to Index
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3) In Your Dreams Once upon a time there was an intelligent guy with movie-star good looks. He traded the stockmarket for a year and then, at the age of 42, left his job as a NASA astronaut to be a full-time trader. In his first six months, he made twice his usual salary and laughed merrily. Then he took a two-year holiday on his fabulous shiny yacht in the Mediterranean, with a harem of beautiful, scantily clad girls half his age. Trading was so much easier than he had ever expected... Quick reality check - this is a fairytale. It will not happen to you. There is a popular myth that trading is more like a trip to the fun park than a job. I hate to burst your bubble, but trading is a precise and somewhat boring activity, where decisions are made long in advance of any contact with the market. The world's best traders realise this, and they plan with meticulous care. This approach may not appeal to those who believe that trading should be frantically yelling "buy" or "sell" to your broker on a mobile phone while admiring the upholstery on your new Porsche. Trading has a way of forcing you to bare your soul. It will make you come face-to-face with your inadequacies. The stockmarket tends to highlight all of your flaws while minimising all of your strengths. Sounds like visiting your mother-in-law, doesn't it? Only the persistent and emotionally strong will ultimately achieve trading prowess. You'll also need a significant tolerance for following a routine mechanical system. Only traders who define their plan and reevaluate it consistently can hope to make consistent returns. Before you quit your job or business to be a full-time trader, you should consider how you would handle the isolation. There may be times when you will want to dial 000, purely to hear the sound of another human's voice. Some people also have trouble organising their time, especially if they are used to being kept on a tight leash by an employer. To get incredible trading results, you must commit an incredible amount of work. To create a business-like profit, you cannot treat trading like a hobby. The best investment that you can ever make is in yourself. If you look at successful people from all walks of life, you'll see that this philosophy acts as their common denominator. Trading follows this principle to the letter.
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There are benefits to full-time trading. If you are successful and consistent with your approach, you can catch up on the sleep that you missed over the past decade and reacquaint yourself with those small beings that share your household, commonly known as your children. On about the third day of full-time trading, you may even come to the realisation that day clothes are completely unnecessary. Pyjamas are a much more comfortable trading attire and because the market doesn't open until 10 in the morning, you can sleep in without fear of being late for work. Trading is more like a marathon than a sprint. If you're out for the glamour of the quick dollar, your hard-earned capital will quickly be redistributed into the hands of the professional traders. Back to Index
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4) Know Yourself the Key to Super Profits Just imagine that you have the opportunity to have lunch with the most successful trader in the world at a lavish restaurant. As you prepare to meet this living legend of the sharemarket, there are many thoughts running through your mind. You know all about the history of this incredibly skilled individual and you are in awe of his outstanding list of accomplishments. Such a unique opportunity! You will no doubt be the envy of your trading friends. What is the first question you would ask? Take a minute to think about it dont rush in this could perhaps be the most defining moment of your trading career to date. Generally when presented this scenario, there are three broad types of questions that traders tend to ask. The type of question that they ask tends to define their experience and expertise in the market. Novices to the sharemarket usually ask questions revolving around indicators and entry signals. They seem totally focussed on determining the ideal set-up which will give them confidence to pull the trigger and engage the market. Their questions may include:

What moving average do you use? What is the effect of dividend yield on future share price action? What is the calculation of the Stochastic indicator?
These types of queries tend to dominate 90% of the question time of any seminar that I have run. Some never progress beyond this level, even though they may have been trading for years. Once a trader has moved beyond their fixation with entry, indicators and set-ups, it will dawn on them that money and risk management is a very important concept. How to handle risk, position sizing and setting stop losses then become a focus. Questions may include:

How do you set your stop losses? Do you handle highly volatile shares differently from the Top 20? What percentage of your capital do you allocate to each market that you are trading?
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Traders asking these types of questions are well on the way to developing a level of professionalism that very few traders achieve. At last these traders have come to the realisation that entry is a minor determinant of a traders profitability. The novice refuses to acknowledge this fact and insists on pursuing an area that is almost irrelevant to experienced traders. Evidence such as this suggests that entry decisions and indicator selection have little to do with your ultimate success in the sharemarket. There is a small but sophisticated group of traders who have moved beyond these two broad categories of questions. These veterans have usually had many years of experience in the market, and come from the school of hard knocks. They have come to realise that an individuals mind-set, and their psychological make-up will be the ultimate determinant of a traders success. Questions asked by this group include:

How do you maintain a sense of detachment from the market? How do you handle a windfall profit? After you have made a loss, what do you do?
Most professional traders would be able to teach you to trade their system in about 2 hours. Why then do so few go on to achieve profitable results, even after being taught by some of the best minds of the trading world? It is because the majority of people are not instinctively set up to trade. There are very few naturals in the trading world. Successful traders have had to learn how to trade and how to handle the inevitable losses that will ensue. Ed Seykotas achievements rank him as one of the best traders of all time. In times of trading pressure, I find it useful to remember some of Seykotas wise thoughts; There old traders and there are bold traders, but there are very few old, bold traders. When asked for some of the main contributors towards his success, he states that I handle losing streaks by trimming down my activity. Trying to trade during a losing streak is emotionally devastating. Trying to play catch up is lethal. Win or lose, everybody gets what they want out of the market. Some people seem to like to lose, so they win by losing money. There are two main traits that Seykota looks for to identify the winning trader personality:
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1. He/she loves to trade; and 2. He/she loves to win Those who want to win and lack skill can find someone with skill to help them, but they must have the desire in the first place. By working on your system for engaging the market, you are only taking the first two steps towards developing skill. 95% of traders never seek to improve their overall mindset, and as a result inadvertently deprive themselves of extraordinary profits. These profits are achievable only to the 5% of traders who are prepared to get out of their comfort zone and work on their own innate deficiencies and acknowledge their personal strengths. The first step is to develop your self-awareness. Your level of financial success will rarely exceed your level of self-development. Back to Index
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5) Affirmations Have you ever wondered what sets professionals, in any walk of life, apart from the mediocre masses? A key factor is self-belief. But if you weren't lucky enough to be born with a high belief in your own abilities, there are still ways that you can cultivate this enviable quality. Affirmations can help you towards your goals. An affirmation is a short, positive, powerful statement that you repeat on a consistent basis. Many of our actions are guided by our self-talk and our subconscious. The conversations we have in our minds can either encourage or discourage success habits in the sharemarket. Affirmations can block out those nagging voices that sometimes prophesy failure, and substitute positive thoughts in their place. According to many professional psychologists, affirmations can reprogram our subconscious patterns and lead to a higher level of success in any field. From my experience, I believe sharetraders can receive these benefits as well. Here are some guidelines for setting affirmations. Those brave traders who have written some affirmations down may wish to alter just a few words to have them gain more impact. Step-by-step guide 1. Have a specific goal in mind. 2. Write it down once a day, 15 times in a row, using this type of format for at least one week: "I (insert your name here) will get/do/accomplish ... (whatever the goal is)." "I (insert your name here) am an exceptional trader. I follow my trading plan every time I trade." You could also emotionalise the statement and speak about the goal as if it has already happened. The more emotional you can make it, the more vivid the impact on your subconscious. For example: "It feels great to have achieved ... (insert goal here)." "Every time my stop is hit, I exit calmly and decisively."
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3. If you have imposed a time-frame for your goal, make sure you are being realistic with your desires. For example, winning the next 400 metres Olympic freestyle event is hardly practical if you can barely dog-paddle. 4. Don't state that you "want" something to happen (your subconscious already knows this), or that you will "try". You are already trying. Make the statement concrete and positive. 5. Write down your affirmations on flashcards and tape them to your mirror or carry them with you to read while you wait for appointments. Combine reading the affirmation with an everyday routine, such as cleaning your teeth. If you find you're no longer reading the cards after a few weeks, rewrite them on cards of a different colour. Alternatively, add some new ones or alter the others slightly to maintain your interest in the task. An example Here is a statement by a fellow trader: "I must believe in myself and my judgment if I expect to make a living from trading." He believed it was an affirmation, but a few alterations are required to make it more effective. To change this into an effective affirmation, he could state: "I make an exceptional living from trading and I believe in myself" or "I make such a good living from trading because of my judgment and self-belief levels" or "I choose to trade for a living and I believe in myself." You have the power to alter your levels of self-belief. Affirmations can help you achieve the goals that you desire. Back to Index
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6) Avoid Primal Urges Our instincts helped get us out of caves and into centrally heated homes but can they help us become better traders? Imagine you are one of our primitive ancestors. The world is a frightening place. Virtually everything is bigger, faster, hairier and stronger than you are. The only advantage that you have is your ability to think but thinking is of little value in a life or death struggle. Risk-Seeking Suppose that you are out hunting in the primeval forest when suddenly, a vicious predator leaps out from behind a tree and attacks. The only behaviour that will offer any survival advantage is to attack, and become risk-seeking. To run would only invite an attack from behind, as your predator is superior in speed. This is the same behaviour that traders exhibit when faced with a growing loss. The evolutionary behaviour is to attack, to hold onto a trade, or to average down by buying more. It does not matter that the trader is faced with losing trade rather than a sabre tooth tiger. We feel psychological pressure to become risk-seeking. The sharemarket does not reward this impulse. Risk-Averse Lets return to our primeval scene and imagine that this time you have come across a bounty. It may be a fruit tree, or a fresh animal carcass. The instinctive behaviour is to grab as much you possibly can, stuff your mouth full and then run. There is likely to be something lurking in the bushes, waiting to attack you. Profitable traders go against their own instinctive pressures. When a trade goes against them, they become be risk-averse and instantly exit. They become risk-seeking when a trade is profitable by pyramiding and adding more money to their position. Unprofitable traders follow their instincts and let their losses run, yet cut their profits short. By giving into their own biology, they deplete their bank account. Classification In ancient times, decisions had to be made rapidly, with limited cognitive input. Is the movement in the bushes simply the wind, or is it something more sinister? The only thing that would ensure survival
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was a snap judgment. We often feel compelled to transfer this primitive level of thinking to our trading. The popular belief is that trading is a series of instant decisions made in the hostile environment of the market. Effective traders plan with meticulous care and consider every aspect of their trade before committing their capital. They do not make rash statements such as BHP is a good share. (The implication is that good shares do the right thing and go up). This is a primitive classification made by very primitive behaviour. Gossip Traders love to listen to gossip and rumour. This is also an evolutionary behaviour. In primitive tribal communities, gossip was the only form of news communication. Those who understood this were able to secure a competitive advantage. Sweet talking cavemen impressed the women, and rose up the political hierarchy of the clan - so this behaviour was passed on from generation to generation. The desire to listen to gossip and rumour (or to search for the next big tip) is hardwired into us. We are programmed to respond to it. As traders, it is totally meaningless as a form of behaviour and effectively works against us. In trading, our own evolution has conspired against us. The behaviours that in the past ensured our success have, in essence, guaranteed that the majority of people will never excel. The only way to overcome this is through self-awareness. Trading is not about feeling right - it is about making money. Back to Index
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-Articles on Technical Analysis1) Relative Strength Comparison There are two broad approaches that consistently locate shares with a high probability of trending upward. (Simply reverse all of the signals discussed to identify shares with a high likelihood of trending downward.) Of critical importance is the concept of relative strength. The RSC The relative strength comparison (RSC) takes the progression in price of one instrument and compares it to another. A share may be trending upwards, but in comparison to the All Ordinaries Index, it may not have been performing as well as the other shares represented. If a share or Sector displays a positive relative strength in comparison to the All Ordinaries Index, this share would have, in effect, been outperforming the index. The ultimate aim is to identify shares that have been outperforming their sector, in sectors that have been outperforming the All Ordinaries Index. This is the goal of Top Down analysis. As a minimum, it is wise to purchase shares that have at least been performing more strongly than the All Ordinaries Index. These shares can be identified via Bottom Up analysis. Top Down Analysis Top Down Analysis involves relatively comparing each Sector Index with the All Ordinaries Index. Once these Sectors have been identified, the next step is to find the stocks in those sectors that are outperforming their respective Sector Index. If the sector has been trading positively in comparison to the All Ordinaries Index for the past 5 weeks, this is a positive bullish sign. This will lessen the chances of a sector performing well for only a limited period of time, prior to collapsing back into under-performing the All Ordinaries. Have a look at www.tradingsecrets.com.au for the current Hot Sectors. Here is an example of a chart that shows RSC:
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CONSUMER STAPLES
RSC ALL ORDS
Bottom Up Analysis Bottom Up Analysis involves searching for shares that are outperforming the All Ordinaries Index, regardless of which market sector they belong to. Review these shares to seek entry signals using other technical indicators such as candlesticks, momentum indicators and volume. Even though the RSC analysis is a powerful tool, it will only identify which stocks to focus on, not when to enter. It should always be used in conjunction with other indicators to determine timing of entry. Back to Index
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2) Failed Signals by Louise Bedford & Chris Tate As traders, our search for trading opportunities usually begins with a positive expectation. We may look for instances where price action confirms our perceptions of a move. These can be tools such as using various oscillators, moving average cross-overs or chart patterns. But what happens when the signal we were expecting fails to materialise? In this situation, most traders simply move on and look for another signal. This is a mistake, as the failure of a signal to eventuate is a powerful trigger. This reversal away from your expectation is known as a failed signal. The failed signal is among the most powerful and reliable signal in technical analysis. By recognising these failed signals and acting appropriately, you can profit. This holds true whether you use instruments such as futures, shares, short-selling, options or warrants. Bull and bear traps are breakouts that are followed by a sudden reversal of sentiment. This sudden reversal of sentiment is often indicative of major highs or lows.
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Bull traps
ADOBE SYSTEMS
MACD
VOLUME
Consider the Adobe Systems graph. The price had been making a recovery from a September 2001 low and had entered into what appears to be a classic congestion, or a "Stage 3 formation", according to Stan Weinstein's classic text Secrets for Profiting in Bull and Bear Markets. Stage 3 is characterised by a sideways progression at the top of a trend prior to a share price decline. Towards the end of this formation, price gaps upwards, out of this sideways band, and makes a new four-month high. Ultimately, the high fails to hold and the price drops back into the congestion zone, meanders for a few weeks and then collapses. During the collapse, the share price more than halves. In trading this style of formation, we have the following time line:
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1. Price enters a congestion zone. The high and low of the price action defines this zone. 2. Price then tries to break to the high side of the congestion zone with only a modest increase in volume. This is one of the major clues that a sustained bullish break is unlikely. A significant increase in volume would have been a major bullish sign. 3. The failure to sustain a break to the high side is now a set-up condition. The price has tried to set a new high and failed. This failure indicates a change in psychology. 4. A trigger to enter a position is given by a break to the downside and the share price halves. You could enter a written call position, a bought put position, or a short sale. Price direction and volatility should guide your decision. Bull traps are not usually obvious until it becomes apparent that a move to the upside has failed. However, there are a few warning signals that can alert the astute trader to their formation. The breakout has a minimal increase in volume, thereby conveying a lack of commitment to the move by traders. In addition, the MACD is demonstrating a bearish divergence. Bear Traps Bear traps are exactly the opposite of bull traps. They indicate that a new low is in place. As such, the methodologies used to interpret and act upon them are the same. Consider the Coates Hire graph.
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COATES HIRE
VOLUME
The price breaks to a new low under moderate volume, only to reverse back into the congestion. As this move unfolds we can predict with a certain degree of confidence that a new low is in place. This new low and reversal are now a set-up condition, and the trigger is given by the break to the upside. The use of a failed signal as a setup condition requires a degree of psychological flexibility. Unfortunately, the tendency for most traders is that if an expectation is not met then they move on to the next stock, unaware of the fact that the market has provided them with a powerful signal to act. You can combine your knowledge of other chart patterns to help you to examine failed signals. Let's look at the failure of triangle patterns, in particular the ascending and descending triangles. Triangles Traditionally, triangles come in three generic styles - symmetrical, ascending and descending. A symmetrical triangle is characterised by a convergence of an uptrend and downtrend line. Symmetrical triangles suggest trader indecision. Traditionally, price stalls and future direction is questioned. Typically, the contrasting psychology of bulls and bears fights for ascendancy. As the trend lines converge, the force of their convictions is almost equal. Price movements higher are met by selling by the bears. Dips are seen as an ideal entry point for bulls attempting to catch a retracement. Eventually, the triangle narrows to an apex.
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Volume may also drop during this final phase. From a trader's perspective, the symmetrical triangle generally resolves itself in the direction of the primary trend. As such, they are often characterised as a continuation pattern. Because symmetrical triangles are simple continuation patterns, it is difficult for them to fail.
NATIONAL AUSTRALIA BANK
VOLUME
The traditional wisdom of trading a symmetrical triangle is to trade in the direction of the breakout. The National Australia Bank graph shows the formation of a symmetrical triangle. An ascending triangle displays a series of higher lows, with a strong zone of resistance characterised by highs at the same price point. They usually form during a strong medium-term uptrend. In ascending triangles, the prevailing psychology of traders initially resists pushing prices higher. Bullish sentiment then re-enters the market and prices move to the old highs where trader conviction fails once again. This thrust and retreat may occur several times. Each time, the price makes higher lows and trader psychology becomes more focused upon moving through the old high.
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COMMONWEALTH BANK
VOLUME
Eventually, price breaks through the old highs. As such, ascending triangles are strong breakout signals and should be traded as such (see the ascending triangle formation on the CBA graph). A descending triangle is the reverse formation to an ascending triangle. In this formation, the bottom part of the triangle appears flat as bulls resist any attempt to push prices lower.
RESMED
VOLUME
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The dominance of the bears is reflected to add to their positions as they attempt to in the prevailing downtrend. However, the bulls see any halt in price as a justification bargain hunt or bottom fish. The small retracements are seen as triggers for bears to engage in retracement trades (see the descending triangle on ResMed graph). Triangle Failure The ability to correctly act upon a failure of a triangle will add an important tool to the arsenal of traders. However, as with all trading tools, it is the failure to act upon a signal that most hampers the performance of most traders. The use of these patterns as entry signals is no different. It is pointless to be able to identify patterns but then take no action to potentially profit from the unfolding price action. To overcome this hesitancy it is necessary to generate some simple rules to prod us into action.
DOW JONES Triangle Failure Ascending Triangle
Downtrend Channel
VOLUME
The Dow graph shows a failed ascending triangle unfolding. As you would expect, this pattern was mirrored in the S&P 500 index and its smaller cousin, the S&P 100 index. The rules for such patterns are quite simple. In the example of the Dow, the long-term trend was still down. This implies that we would discount the breakout to the upside. Our interpretation would be that initially this breakout would be a countertrend rally. If the move progressed and the long-term trend changed, then we would enter the market in the direction of the new bullish trend.
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However, this was not the case with the Dow, as a new uptrend failed to materialise. The move stalled a few days after the breakout. This is in line with the predominant bearish direction of the Dow, so it is not surprising that the attempted break to the upside failed. The failure of price to break higher confirmed the strength of the existing downtrend and provided an ideal entry signal for anyone wishing to trade in the direction of the trend. The signal to enter comes after the collapse of the move back below the line of initial resistance. Some traders may choose to stipulate a number of successive closes below the line of resistance before entering a position. The trading of failed signals requires a high degree of flexibility. Too often, traders will correctly identify an embryonic formation, but walk away from it as it fails. Failed signals offer powerful entry triggers, so be flexible in your approach and more profitable opportunities will be revealed. Back to Index
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-General Articles1) 7 Deadly Sins I recently heard about a group of Silicon Valley psychologists who specialised in the treatment of Rapid Wealth Syndrome. This modern day affliction was reaching epidemic proportions in the 20something geek demographic at the start of the year (2001). However, since investors fell out of love with the word dot.com, I wonder if these psychologists are now treating clients suffering Rapid Wealth Depletion Syndrome? As traders, there are many lessons that we can learn from the recent market shenanigans. Here are the 7 deadly sins of the sharemarket: 1. Trading Against The Trend Self-delusion is a wonderful thing. It can make the trauma of being a modern adult so much easier to bear, without the need for medication! However, convincing ourselves that the sharemarket is trending up when it is not, can be a lethal mistake. To assist in your quest to become a trader extraordinaire, consider hiring an 8-year old child. About $2 per hour and the bribe of a chocolate biscuit should suffice. After they have programmed your VCR and cleaned up the viruses on your computer, conduct a simple experiment show them a chart of a share in your portfolio. Explain to them that it is picture of how the share has been performing. If your new mini-employee says that the share is downtrending believe them! Find a share that is uptrending to buy, or your capital will suffer the same fate as the curry that you had for dinner last night. 2. Greed This ones a sure thing! In a couple of weeks, with the money youre going to make, youll be able to buy New Zealand!! says your broker confidently. If you believe this, and engage the trade without doing your research, you are the chump, not your broker. Your broker will still profit from the commission, while you are licking your wounds and mournfully expecting sympathy. When traders lose money, they usually blame bad luck, poor advice etc, rather than their own personal qualities of arrogance, fear and
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greed. External attribution of blame is a sign of immaturity. Take responsibility for your own actions or your trading ability will never improve. This is one of the most difficult lessons to learn in your trading life. 3. Pride Feel free to beat your hairy chests; men it helped get us out of caves and into centrally heated houses. Unfortunately, there is no public killing of a predator in modern times. If you have made a windfall profit, what makes you certain that you were the cause, and not just the hand of lady-luck? Put pen to paper and work out entry, exit and money management techniques. If you dont have a written trading plan, develop one quickly, or get the heck out of the market. Without defined rules you will lose in the markets over the long haul. Stay loyal to your system and be aware that there is no holy grail in share trading. Every system will encounter a string of losses, but as long as you ultimately make more money than you lose, then you will be profitable. 4. Envy As a teenager, with crooked teeth and a few too many kilos, I remember looking at the popular girls with abject envy. Damn them why were they born so pretty, skinny, clever, blonde etc? As my Grandmother told me: comparing yourself to others only leads to heartache. Although it seems as if everyone around you is making a killing on the markets, it is likely that they are only telling you about their good trades. Traders who tell you that they consistently get in at the bottom and out at the top of a trend are liars. Good traders have achieved a sense of detachment from the market and have divorced themselves from chasing elusive profits. 5. Dividend Lust But it pays a good dividend is the justification that many traders use for hanging onto a losing trade. This is equivalent to saying that you are a compulsive gambler because they provide free coffee at the casino. Even rats will put up with being zapped by an electric current if they are regularly fed tasty pellets!
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Contrary to popular opinion, companies that pay dividends may not have their shareholders interests at heart. If these companies retained their dividends, and invested in developing their strategic superiorities over their competitors, their earnings per share would increase. Investing in a share buy-back scheme, rather than paying a dividend would naturally drive the share price upwards. Whenever demand outstrips supply, a significant return on investment for shareholders is the result. This is inherently more beneficial to investors than a dividend, (or a tasty pellet) to keep them interested. 6. Wrath The market does not know that you exist. Dont seek revenge if you have made a loss on a share, or if your dog has just bitten a chunk out of your best slipper. Fight your battles with an opponent that you can make eye contact with. 7. Capital Destruction Dr Alexander Elder, a great trader, explained to me that there is a popular Russian saying that translates to: Dont step on the same rake twice. Learn from your past errors. Decide to exit a trade if it hits a certain point below your purchase price. The golden rule of share trading is: keep your losses small and let your profits run. Your first aim must be capital preservation. Making money is a by-product of following your trading rules. Money flows naturally from the many to the few. Trading is definitely not for the faint-hearted, but the potential rewards ensure that there will always be a continual flow of new punters willing to try their luck. Luckily for skilled traders, these people still exist. It ensures that the sharemarket will continue to redistribute wealth. Just make sure that you are the one that the wealth is being redistributed to! Back to Index
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2) Pyramiding House of Cards When I was a little girl, my sister and I raised the skill of building card houses to an art form. Each day we would try to out-do our previous record. Sometimes we would succeed in creating the Taj Mahal of card houses that would practically withstand an earthquake (in our minds at least). Other times, we could barely make it past 2 levels. The method that I learned all those years ago is exactly the same as the technique that I use in trading to add more capital to a winning position. Lets review some of the major success factors when pyramiding into a trade, or building card houses. Don't go too high Unless you are aiming to enter the Guinness Book of Records for card house building, three layers will usually be enough. With trading, if you pyramid more than three times, usually your position size will grow to be too large in relation to your trading equity. This does not represent effective risk management. Pyramid position sizes
0.25% 0.5%
Second pyramid point First pyramid point
1% Percent risk per position Don't go too quickly
Initial Entry
Wait until your trade is at least profitable before attempting to add money to it. Set your pyramid points slightly above a level of previous resistance, and above a round dollar figure. This suggests that the share must bullishly break through a psychologically significant price, before you show continued faith in the upward potential of the stock. Make sure each layer is smaller than the previous one
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The strongest card houses have a firm foundation. If you are used to position sizing in trading based on a percentage risk, you could follow a method that looks like the diagram. Per cent risk per position If you are used to adding fixed dollar amounts to your trades, you could use this diagram to signify units. For example, you may commit $10,000 to a position. The next position could be $5000, and the final position $2500. Never average down If the card house is looking shaky, don't add more cards. If the trade is not co-operating, don't throw more money at it. Averaging down means adding more money to a losing position. It doesn't work... and I can prove it to you. Let's say that you decided to buy 500 shares at $15. Imagine that the share price drops, so in your infinite wisdom, you decide to buy another 500 shares at $12. As the share price dropped further, you also decided to buy an extra 500 shares at $10. After this, your average price would be $12.33. Now you own 1500 shares in a stock that is downtrending. Well done - you must feel very proud! Instead of buying more of this downtrending share, it would have made more sense to exit at your initial stop loss of $14 and capped your loss at $500 ($15 - $14 x 500 shares). To contain your loss to only $500 after you have averaged down, the share has to trend from $10 back up to $12. How likely is a share price increase of $2 or 20 per cent when the share is already in a confirmed downtrend? This is a very unlikely event in the near future. This is why averaging down doesn't work. The more times you average down, the greater the commensurate increase in share price is required in order for your total position to break even. Only add money to a winning position, or suffer the consequences. Unfortunately, most traders do not have a clear idea about how to pyramid effectively, and they end up devastating their own trading results, even if they have correctly identified the trend. If you follow these suggestions, pyramiding, and building card houses, will be so much more effective for you. Back to Index
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3) Position Sizing Position sizing can save you from committing financial suicide in the sharemarket. Few people realise the importance of this essential skill because, at first glance, the benefits are not immediately tangible. Money management and position sizing suggests you know how many shares to buy and how much of your account to commit to a given market. Studies have shown that even random entry systems can be profitable using effective stop-loss procedures and good money management. When people begin trading, they often believe that as long as they hitch a ride with a share that is headed for the moon, they will accumulate untold riches. Few trades co-operate to this extent. Ironically, 90 per cent of my trades do not amount to a significant profit. It feels like I'm treading water, waiting for a trend to unfold. The majority of my profits are produced by just 10 per cent of my trades. Trading is often not a consistent income-generating activity. Many people give up or run out of money before they turn a profit. It could take you 20 trades in a row of mundane, frustrating, breakeven or loss results to hit the one trade that will bring in an extreme profit. There is no 'normal distribution' of wins to losses in the market when you look at a small sample size. Money management and stoplosses will help keep you in the market long enough to experience a few terrific winners, even if you hit a cluster of losses. Sector Risk If you cannot sleep at night, or if you are continually thinking about the performance of your shares, your position size is too large for you to handle. Be aware, however, that if you own more than one stock per sector, then you are effectively trading the same instrument. For example, if you have four bank stocks, and own call options on CBA, you have ineffectively diversified your trading capital. It is as if you are trading the one position only. Make it a rule never to trade more than one position per sector. If you don't, you are opening yourself up to an unacceptable level of sector risk. Your trading account will eventually suffer when the tides turn against your favoured index. There are several models to help answer the question: 'How much of my capital should I devote to this trade?' Each has pros and cons.
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Ultimately, you need to choose one position sizing model, or a hybrid of the available models, before buying a stock. Equal Portions Model This model is where your capital is divided into equal amounts. For example, you may have $100,000 equity and decide to split this into 10 different positions of $10,000 each. There are some inherent difficulties with this concept. It assumes a consistent risk factor across all trades. This is an illogical assumption. This method will lead to your demise if you trade derivatives. In all likelihood, you will be committing too much equity to an illiquid and complex trade. This is likely to damage your overall trading equity. The Capital Allocation Model This model divides your capital between areas of risk. One of the underlying principles behind the market is the theory that if a stock has a significant market capitalisation - for example, top 100 or top 300 - then it is likely to behave in a more predictable fashion. (Market capitalisation is the number of shares that have been issued in total, multiplied by the share price.) The market capitalisation will affect whether a share is included in Australia's benchmark All Ordinaries index. How To Use This Model The maximum number of shares that most people can manage at one time with a larger portfolio, for example $300,000-plus, is about 15 separate positions. People with a smaller portfolio often feel more comfortable holding six to 10 stocks. This is largely anecdotal evidence, because according to my knowledge there is no reliable data regarding the ideal number of shares to hold. As a guideline, the minimum number of positions in a portfolio should be at least three stocks, in order to give you a chance to learn how to trade well. Hopefully out of those three stocks, at least one will be trending in the right direction, although there is no guarantee. As a suggestion, it may be best to allocate more money to the top 100 stocks (lower-risk), such as 50 per cent of your capital. You could allocate a moderate amount to the bottom 200 stocks of the top 300; for example, 30 per cent (moderate-risk). The least amount of money (for example 20 per cent) would then be allocated to all other stocks
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not appearing in the top 300. All derivative trades are also included in this category. This would mean that from an initial starting equity of $100,000, you could allocate $50,000 to lower-risk shares, $30,000 to moderate-risk shares, and $20,000 to higher-risk shares and derivative positions. For the sake of simplification, let's say that you're happy with holding 10 shares. This could be split into the equivalent of three separate portfolios defined by the risk inherent within the market capitalisation level. Your low-risk portfolio of top 100 shares could contain three stocks, from different sectors, with a position size of $16,666 each. Your moderate-risk portfolio could contain three stocks with a position size of $10,000 each. Your high-risk portfolio could contain four stocks or derivatives with a position size of $5000 each. Make your capital allocation rules with regard to high-risk areas explicit. You may decide to commit a maximum of only 15 per cent or 10 per cent of your total equity to higher-risk sectors of the market, depending on your risk profile. This will still provide exposure to potential high returns, without bursting the seams of good judgment. There are refinements to this method, but if you relate to the concept, then this can be a simple way to position size with a higher degree of sophistication than the equal portions model. There is a principle called the 'Kelly principle, which suggests that you should not have more than 25 per cent of your trading equity placed in any single position on the sharemarket. This is in line with the rationale of minimising the effect of an unforeseeable potential catastrophic event. Many traders do not utilise the Kelly principle because it seems to be in contradiction to the concept 'let your profits run'. However, if your losing trade is conducted using too much of your overall trading capital, you could violate this rule easily. If you appropriately size your positions, then the chance of a one-off shattering loss leading to devastation is slim indeed.
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Capital Allocation
Market Capitalisation Top 100 Trading equity (%) Number of positions Top 101-300 Top 300 +
50
30
20
There is a fine line between letting your profits run, and planning just in case a catastrophe strikes. You want to back the winners, but have an efficient threshold that determines when you have placed enough of your equity into a particular position. The key is to not allow your overall position size to exceed 25 per cent of your total trading capital. Take into account the positions that you hold in different sectors and ensure that their combined size per sector is also less than 25 per cent. For larger portfolios, you could consider keeping overall positions to less than 15 per cent or 20 per cent of the overall trading capital. Remember to take into account the effect of pyramiding. If you have decided that you would like to add more money to your winning positions, you must make sure that you stay loyal to the Kelly principle. Back to Index
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4) The Derivative Kicker If your knowledge of option/warrant trading is up to par, you could consider using bought options to pyramid your positions, rather than buying more of the physical share. For example, if your pyramid point on CBA was hit, yet your overall holding was likely to creep above 20 per cent if you took that pyramid, you could buy call options instead. This would provide exposure to this instrument in a leveraged manner, so that it is unlikely that you would risk violation of the Kelly principle. This is also an effective method if you are looking to pyramid a shortsold position. Rather than short-selling more of the physical share, you could consider buying put options or warrants. I have implemented this strategy effectively in the past. It has the benefit of providing you exposure to the trade, without risking violation of your maximum position size rules. It is also a terrific way to begin learning about bought options and warrants. Because you are already involved in the physical share, you are most likely closely watching its behaviour. There are several position sizing rules that it pays to follow:

Take into account sector risk. Divide your capital according to market capitalisation. Use derivatives to pyramid if you are becoming 'overweight' in a particular share or sector. Monitor your positions carefully to make sure you are staying loyal to the Kelly principle.
If you follow these rules, you are more likely to limit any downside potential produced by a disastrous sharemarket event. Back to Index
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5) Handling a Windfall Profit Youve heard the saying Start with the end in mind. In the sharemarket, this strategy can be counter-productive. Some traders in the sharemarket tend to limit themselves unnecessarily by exiting their positions when they have hit some pre-determined superstitious level of profit. For example, you may be happy with a 30% profit from a particular trade, and exit your position once this target has been reached. What a shame the share wasnt aware that it should have stopped at a 30% increase, instead of going up an extra 250%! It is impossible to predict how long a trend will take to unravel. You are capping your profits by setting profit targets. Your share may have had the ability to jump higher, dragging your capital with it, but you have put a false cap on your potential. Many traders experience psychological pain when they exit from a position, only to see the trend continue in the expected direction. Sitting there stunned and wounded will not help you. The best thing to do is to re-enter the position, secure in the knowledge that you had the discipline to exit and preserve your profits had the share continued spiralling towards bedrock. To survive all of the nasty small losses in the market, you need to make the occasional windfall profit. If you cap your profit potential, you may just end up a net loser in this game. Ride the trend until it reverses. An effective stop loss strategy will help you recognise when the trend has reversed, and prompt you to exit from the trade. The traders rule is to cut your losses short and let your profits run. Mania From time to time in the markets, you will hook onto the right side of a trade that goes absolutely ballistic. Good news from overseas, a new technological breakthrough, or handsome profit results may lead to an incredibly bullish performance, all on one day. Sometimes if the uptrend has caught the attention of the relevant authorities, the share will be issued with a speeding ticket, and be placed on suspension. This means that you will not be able to buy or sell the instrument, pending some significant announcement. There is no rule of thumb to assist in determining whether the announcement will be positive or negative. On returning from suspension, the share may trade well above or below the last close. For example it may surge 15%. This is a windfall
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profit situation. In this situation, it may be prudent to exit your position, and re-enter if you receive a signal that the share is likely to continue in a bullish direction. Selling into mania allows you to protect your profits, and let the emotion wash out of the existing shareholders. Some traders make the decision to sell part of their holdings, to protect their profits, but continue to ride the bullish trend. Once comparative calm has been re-established, you will be in a better position to react with cool detachment. Remember to take a small percentage of your winnings and buy something for yourself and your family. Whenever you look at that asset, or remember that holiday, then you will create a feedback loop where your subconscious will seek further rewards. This is one of the reasons why winners in the markets go on to create even bigger wins in the future, and losers continue to lose money. Winners reward their own good behaviour patterns. With trading, you can attribute a windfall profit to a back-tested system, and therefore, ultimately duplicate your results in the future. Setting profit targets in advance will only end up eroding your eventual results. Plan For the Worst If you interview any top professional in the world, from a prize boxer to an Olympic runner, they will tell you that they have considered and planned for a potential disaster. Traders should follow the same principle. Three potential catastrophes should be at the top of a professional trader's list: 1. Computer crash Bang, splutter, and smoke or maybe just a flicker, before refusing to start up again - you have just experienced a trader's worst fear. Anyone who has experienced a computer crash knows the frustration that follows. Traders using online systems are cut off from the trading world. Those charts and statistics you rely on are suddenly impossible to access. The stops are placed, and the active buy orders are inaccessible. Oh, the horror!
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At some stage this will happen to you. Here are some steps that you can take to minimise this impact: Deal with an online broker that has a back-up telephone service. This means that you'll be able to find out what your shares have been up to in your absence. Back-up your computer at least once a week, including your end-of-day data, as well as copying any essential files that you need to keep organised. You could network your computers, store information on CD, or rely on a web-based back-up system. It doesn't matter which system you use just use one. Keep a manual trading diary. Record your current positions and stops, either as a printout from your computer, or handwritten in an A4 binder.
2. In sickness and in health Is there someone who knows your trading positions and can act on your behalf if you were suddenly taken to hospital? Can your online system set automatic stop losses to protect your trading capital? Using an ostrich mentality, this is something that often people avoid thinking about. Have you investigated an "enduring power of attorney" which enables a loved one to act on your behalf if you become physically or mentally incapacitated? This lets you appoint a legally authorised person to look after your financial affairs should you become incapable of doing so. Forward planning lifts a burden of responsibility from the shoulders of your friends and relatives. If you don't appoint an enduring attorney and lose mental capacity, family or friends will have to apply to the Court of Protection to appoint a receiver to handle your affairs. 3. System failure From time to time, even a previously effective trading system can create ongoing losses. Have you set yourself a limit regarding these losses? How do you decide when to stop and take stock of your system before jeopardising the majority of your trading equity?
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Most traders reach a psychological failure limit, where if they lose 10 times in a row, for example, they feel demoralised. However, if they were only risking 0.5 per cent of their trading equity per trade, they have only lost 5 per cent of their bank balance in total - an acceptable risk. I urge you to stop trading if you have lost 20 per cent or more of your trading equity because you will need to make a 25 per cent profit to break even, which can be a tall order. Stop temporarily, consult a more experienced trader, and review your own psychology and trading system before diving headlong into financial oblivion. If you consider these issues in advance and plan your reactions, you're more likely to achieve longevity in the sharemarket. Back to Index
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For more information on the training courses and sharemarket services offered by Trading Secrets, check out www.tradingsecrets.com.au. You can also order these other titles by Louise Bedford
Video Program
This course is designed to be a complete introduction to the world of Candlestick Charting. There are exercises to be completed throughout the program and plenty of actual trading examples to help cement your knowledge. Whilst suitable for the novice trader, this course will also take the more experienced trader to a greater understanding of the markets by delving into the psychology behind the price action.
On DVD
The Secret of Candlestick Charting Poster The Secret of Pattern Detection Poster Valuable quick reference tools for the main charting patterns using candlesticks and technical analysis.
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The Best of Louise Bedfords Articles Congratulations on purchasing Trading Insights.

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Market Trending Down

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Second pyramid point First pyramid point

1% Percent risk per position Don't go too quickly

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