My recent summer vacation was great for my trading.  By having some time off (3 weeks!) to think things over I was more productive than had I just continued pounding out the same trades over and over.  Let’s take a step back and have a closer look:

I’ve been using the sine wave for so long that I can’t even remember when I started using it.  I think it was March of 2009.  The videos at Eminiwatch made so much sense and the moves seemed so obvious I just had to try it out.  What I liked most about it was that it provided a context for interpreting the markets.  A market was either cycling or trending, in various timeframes.  After several months of backtesting and forward testing on simulator I started trading the eminiwatch cycle method with real money.  The first two months were a good success, I was averaging over $200/day.  And then I fell off my rocker.  I’m still not sure exactly what happened.  I have some theories but they’d just be excuses.  I’m sure I didn’t follow my plan exactly, I remember not taking a few stops that turned into big losses.  I also remember my 6 pt targets weren’t getting hit.  But more likely was just that the market was changing and I didn’t keep up.

After that I spent some time investigating other ideas.  Mainly “naked” trading without any indicators.  Taking breakouts and such.  I had some luck with that and then some bad luck and in the end I don’t think it was profitable.  I even concluded that it was impossible, because I believed that “price can’t predict price” and trading without volume was a handicap.

This is also when I learned about scaling out of positions.  This was a very important lesson for me.  In my swing trading, which was mostly breakeven with a few big losses that kept me in the red, I often watched price go in my direction only to turn around and hit my stop.  In October 2009 I started scaling out of swing trades and trailing my stop.  That marked the beginning of a great run in swing trading where I had very few losses and they were very small.  This great run is still continuing as I write this, but this story is about daytrading so let’s continue (more on the swing trading later).

So I went back to cycles but still realized I was missing something.  So at the beginning of 2000 I started learning about Market Profile and order flow.  This was a great learning period for me and it helped me to understand the markets.  I spent a lot of time learning the volume ladder. I even tried a trading room.  I also did lots of webinars and bootcamps.  All that helped provide context for my cycle trading.

After good results on simulator I went back to trading the cycles with real money.   My first month was May, and a few days later we got the flash crash.  I was profitable that month without a single loser.  The next month I only had 4 losers which gave me a 95% win rate.  Sounds great right?  But under the hood all was not well.  First, I was using very loose stops or no stops at all.  Second I was “scaling in”.  I still have mixed thoughts about that but one thing was for sure:  If I was going to step it up and take my trading to the next level (which for me was trading size) then big stops and scaling in was not going to work.  I could easily scale in from to 2 to 4 or 6 contracts and be within my risk tolorances, but I could not scale in from 100 to 200 or 400.  And I could take a 10 pt loss with 2 contracts and not get hurt too bad, a 10 pt loss with 100 contracts would be devastating.  So to accomplish my long term goal of trading 100 contracts I was going to have to start trading 2 like I would be trading 100.

This was right about the time I went on vacation, and so I spent my free time writing down my beliefs about the market and formulating a new trading plan.  What I realized was that my cycle trading up until that point had been very discretionary.  Well I knew that all along and I even believe that mechanical systems couldn’t work because discretion was necessary.  However what I realized was the extent of my discretion.  It had its consequences.  Sure I could have a month without a single loss, but I also took very few trades and didn’t make a lot of money.  I decided it’d be better to make more trades and have more losses as long as the profit at the end of the month was greater.

Being 100% discretionary meant it was hard to track myself and make improvements.  I’d see trades that I had missed but I didn’t have an easy way to correct that since at the time my discretion told me to stay out.  Fear of losses played a role in this as I was so worried about taking a loss that I skipped any setup that looked risky.  That second month, the month in which I had 4 losses, I was actually happy when I got my first loss because I had been trading 5-6 weeks without a loss and the pressure was great.  That first loss relieved the pressure.

So my goal in the new trading plan was to be more mechanical.  That way I could track my progress.  Was I following the plan?  Why did I miss setups?  Did I exit early?  Etc.  Those would be questions that I wanted to track on a daily basis in order to improve my trading.  And when I got back from vacation I started trading the new plan on simulator.

Speaking of simulator, I’ve said this before but I think it’s really important so I’d like to say it again:  Whenever I make a major change to my trading I always go back to simulator for a while so that I can test it out and collect some stats.  Once I’m confident that it’s profitable I then start trading real money.  I strongly recommend the simulator phase.  For a profitable trader it can be just a few days or a week.  For a beginning trader who has never been profitable then I think 3 months is a good amount.  I see no reason to risk real money until a method has been proven profitable on simulator.   There is one catch:  You must trade on simulator exactly as you would if you were trading real money.  That’s not as easy as it sounds.  It’s easy to take a stop on simulator or let your profits run all day and risk giving it all back.  It’s not easy to do that with real money.  I’ve found the longer I trade with good habits on simulator, the more likely these good habits will remain when trading real money.  The converse is also true:  The less time I practice good habits on simulator, the more likely bad habits will return when on simulator.  This is why I said 3 months for a trader who has never experienced profitability.  It takes a while to imprint the good habits into the brain.

So where was I?  Oh yes, I returned from vacation and was trading my method on simulator.  I had tight stops and a way to stay in trades longer to capture the big moves.  I was very happy not only because it was profitable, but because I was more mechanical.  And soon I began taking trades with real money.

Continued in Part 2.