"What Trading World Do You Wish To Trade In?"

One of the biggest challenges facing novice traders is to determine what trading world they would like to trade in. On the one hand they would like to make large profits by trading a fast, sustained move. On the other hand, they would like to place a stop-loss order close to the market in order to lower their initial risk and to lock in their profits quicker when the trend they are trading ends.

At first glance, this appears to be a sensible goal. The novice is trying to have the best of both worlds.

Unfortunately, the two elements of the strategy - trading a long trend, and maintaining very close stops, are incompatible over time. The close stops would regularly be hit, leaving the trader out of the market as the long move progressed. Traders, therefore, need to define the trading world in which they wish to trade.

A simple way to define your trading world is to determine the average length of the time you wish to be in a trade. For example, if you wish to hold stock market trades for a period ranging from several months to several years, you would consider using a weekly chart. For an average trade of several days to several months, you would use a daily chart, and for an average trade of several hours to several days, an hourly chart. For even shorter-term trade durations, 5-, 10-, 20- or 30-minute charts would be appropriate.

Once you have determined your trading world, that is, the main chart you are going to use for your trading, you can proceed to devise, document and test your trading strategy or strategies. Factors you should consider include the phase of the market cycle, how you will select strong stocks, your entry technique(s), your trade management technique(s), your trade exit technique(s) and most importantly, your risk at the time you enter your trade.

If you are to survive and prosper as a trader, you must control risk. Your initial risk on any trade is the difference between your likely entry price, and your stop-loss price. For stocks this should never exceed 10 percent of your account balance, and preferably be a much lower percent.

The reason you should strictly limit your risk is because all trading systems will, eventually, produce a run of losing trades. By strictly controlling your risk, when you experience such a sequence of losing trades, you will be able to keep trading without exhausting your trading account. If you are to build your trading account consistently, without taking undue risks, risk management is essential.

(Having established your risk per share, you can now calculate the maximum number of shares that you can trade, without risking more than your predetermined percentage of your trading account.)

If you plan to take longer-term trades and use a weekly chart as your primary chart, you need to establish how you will enter your trades (while controlling your risk) and where. A simple technique is to use a longer-term moving average as a trend indicator, and to then only take trades in the direction of this trend indicator.

I have tested this extensively, and found that a moving average between a 30-week and a 40-week duration works well. The Stockmarket Master course uses this highly effective approach, utilizing a 34-week moving average (but only on very strong stocks) as follows:

If the 34-week moving average is flat and turning upwards, or is rising, only take long trades. If the 34-week moving average is falling, only consider taking short trades.

A Weekly Market Analyst chart of Telstra with a 34-Week Moving Average

An alternative approach is to use a longer-term chart as your trend indicator, and a shorter-term time frame chart as your trading chart. A popular combination is the monthly/weekly chart for stocks, and the weekly/daily chart for position trading futures.

Regardless of which approach you use, it is vitally important that you determine the trading world in wish you wish to trade. I trade stocks in a weekly-chart trading world, as I have no doubt that the biggest profits are made trading the big moves. This approach also minimizes my brokerage, slippage and stamp duty. By placing a stop-loss order with my broker, this longer time frame also allows me to 'have a life'!

Colin Nicholson, in his excellent presentation to the Australian Technical Analysts' Association Conference in October 2000, cited recent research which concluded that longer-term stock traders made more money than shorter-term stock traders. The reason? Transaction costs more than negate any benefits that may be gained by entering and exiting stocks more frequently, as opposed to holding for a longer period.

In my opinion, strongly trending futures markets are best position traded on a daily chart. Intra-day entry techniques can be used to minimize the risk on entry and to ensure that the entry is in the direction of the daily trend.

"For more information on how you can maximize your trading profits while strictly controlling your risk, click here..."

Neil A Costa