Day-to-Day Business Operations
When You Trade for a Living

By Dr. Mircea Dologa, CTA Published with permission.

When a novice trader enters the highly competitive field of trading, he or she should be aware that a new trader is up against the finest, sharpest and toughest minds in business. Not only that, consider the following: These people's economic survival depends on their best judgment.

Using a metaphor, we can surely say, "They have teeth so long and so scalpel-sharp that they can scratch the crystal floor of any exchange."

Taking this idea even further, we can ask: "Is there anything a novice or a poorly trained trader can do to grab a place in the sun?"

The answer is prompt! "Treat trading as a daily business operation: Plan it, perform the right technical and fundamental research while the market is closed, make detailed pre-open preparations, apply the most optimal trading strategy closely associated with the risk and money management, and, above all, treat yourself as a jewel. Get the right training and don't neglect your health, including its psychological aspect."

Is Trading a Business like Any Other Business?

Those of us who have some business experience can readily agree that it's inconceivable to start a business, any kind of business, without a plan, not only for the business opening but also for its well-being throughout the time after the business is up and running. In spite of this, many new "trading businesses" fail within the first two years.

In the absence of a trading plan, every decision is made erratically, and many novice traders are out of business within a few months. It's reasonable to believe that one can define him or herself as a trader only after a minimum of three years in the market. And, even then, well-being depends on the degree of assimilation and applicability of the learning curve to three indispensable parameters: Psychology, risk and money management, and selected trading strategies.

A novice trader should take the example of any other successful new business person: First, train yourself, so you know what is vital and what is not for staying in business. Then, for example, you will learn that capital preservation is the single-most vital component to a business' success. Whatever else you do, you should have its preservation uppermost in your mind at all times!

Forget about looking for home runs or the best deals of your life. Capital preservation comes first; everything else comes after that!

When a novice businessman opens a business, he or she must be prepared, at the very least, to operate it immediately, even if it's done in a spontaneous and likely erratic way. This is what some call the "learn-on-the-job" method. If the business is a simple one, this type of training might work. But, if the business is more complicated and if you're up against the finest, sharpest, toughest minds in the business (as in trading, say?), the cause is lost!

How Many Kinds of Trades Are There, Exactly?

An aspect of trading as a business that illustrates how poorly "learn-on-the-job" works when you begin to trade for living is this: Most folks don't know that there are three types of trades, not two...the long, the short and the "step aside" trade!

A novice trader who learns first how to execute orders and only then how to trade might think that a simple up move is sufficient to make a long trade. Why not? New traders with this mindset believe that they can always get out if the market goes against them!

But, they are forgetting to take into account the influence of the almighty psyche. And, the ultimate salvage operation for these traders will be the conversion of an intra-day trade into a position trade. With this kind of thinking, and using this rhythm, a person's entire trading capital could be wiped out in no time.

Trading is a business, not so very different from any other type of business. Its only product is money…money used to make money. And, then, we can say that trading is the only business where losing money is the business operator's way of life!

It all comes down to an understanding crucial to trading success -- the difference between losing "tiny bits" on average and far less consistent winning (as in the Dax example shown below with eight losses compared to only two wins). Once you learn how to lose these "tiny bits", then and only then, will you really start making money!

Would you be surprised to find out that most novice traders expect to achieve more than a 51 percent winning rate in order to have an overall profit? In reality, most of the consistently profitable traders have a winning rate of less than 50 percent.

The calculation is simple. I'll show you a German Dax trading example, not because the S&P 500 E-Mini will not work, but because the former is my preferred trading vehicle, due to its high liquidity and controlled and synchronized volatility.

If you constantly use a "tiny bits" stop loss size of 200 euros (8 points or 16 ticks), and you have a losing streak of 8 trades out of 10, the total loss will be 1,600 euros (8 x 200 euros). I remind you that an 8-trade losing streak is hardly possible for a well trained trader. Or, should I say for any type of trader…? It's so rare, that even applying Murphy's Law wouldn't make it possible!

So, we are left with 2 winning trades out of 10. Will their profits suffice to recover the entire loss? Well...let's see! If we look at the 15-minute Dax chart, as of February 27, 2009, we observe that the day's activity encompasses the following: An earlymorning up swing of 30 points, a morning-to-noon down swing of 142 points, an afternoon up swing of 122 points and an evening-to-22:00-hours down swing of 60 points.

Now, let's calculate the hypothetical profits of this day's two trades as they relate to the 30-point and 60-point minimal swings. If we calculate the entire profit of 90 points for both trades, that would amount to 2,250 euros (25 euros per point x 90), thus exceeding, by 650 euros, the amount of the losing streak, meaning that we still make a profit.

Moreover, if we study this even more deeply and consider that the well trained trader entered these 2 trades only after the first swing's third was over (28.8 percent of the swing, to be exact), we find that there isn't any loser or winner. The losses of the losing streak equal the winnings of the two profitable trades.

Now that you've realized that, in reality, you need only 2 out of 10 trades to be profitable, let's go even further and try to understand how this is possible, day after day.

Mentoring

In my opinion, the way to profitable trading is paved with learning, and the shortest, most effective route is with a qualified mentor.

To be successful in trading, you need to do one of two things:

Learn by yourself. But, that would take a lot of time and money. In addition, you probably won't be able to grasp, on your own, the principles of money management and the psychological aspects of trading and be able to apply them to your trading correctly and methodically. These two things work together throughout most of the trading process.

Besides, even if you managed to grasp these concepts all on your own, it would take you several years to see measurable results -- providing you don't quit before you get that far or lose all your trading capital!

Learn with the assistance of a mentor. This method takes far less time, and the financial reward will be more visible because you'll have spent funds up front that will pay off in the long run.

I insist that trading is a profession! It can't be improvised as it is by most novice traders. If you act as your own mentor, the money you would have paid the mentor (let's call it "tuition") would go into the market, and you would lose it, without your ever having learned how to be consistent and, thus, profitable. Believe me: I have plenty of real-life examples of students of mine trying to act as their own mentors before coming to my seminars.

One caution about finding the right mentor, though: The new trader should be aware of the fraud occurring in this learning business -- you know -- trading education that's really more like "snake oil". But, there are many ways to avoid being taken in by the snake oil salesmen. Mainly, you just need to verify these people's credentials.

If they trade futures and are not registered with the National Futures Association (NFA), which is controlled by the U.S. government, and do not have the title "Commodity Trading Adviser (CTA)", they can't legally advise anyone in futures trading.

Furthermore, the mentor should be a successful trader, not just an educator or adviser. He or she should be keeping up-to-date with new trading techniques, so the mentor can maintain and improve upon his or her own trading consistency. The best way to determine this is to check to see what the person has published in the way of research in well known, serious technical publications, such as Technical Analysis of Stocks & Commodities or Futures magazine.

Ideally, a mentor should belong to the Market Technicians Association (MTA), a professional organization that maintains high standards of ethics for the science of technical analysis.

Trading from the Perspective of Performance Driven by Your Psychology

Whether you have decided to learn yourself or with the assistance of a mentor, you should be aware that trading is not only an array of tasks but also a psychological challenge. In other words, getting to know yourself will help you climb the difficult slope of the learning curve.

First of all, you should have sufficient trading capital, so its lack will not sabotage your performance. You need a minimum of $25,000 for trading index futures. You can trade currencies or E-Minis with a $1,000, or even a few hundred dollars, but this isn't advisable. It's far better to wait to begin trading until you've accumulated enough capital from non-trading sources than it is to count on accumulating capital from trading, especially when you are a beginner!

In this same vein, another mistake would be to use borrowed money, or worse, credit! Using borrowed money or credit will keep you from achieving full psychological performance potential because you will constantly experience anguish over or fear of losing the money and then having to figure out how to pay it back!

Let's now talk about the passion and fun the novice trader can get out of the learning curve. I often use the word "virus", not in the sense of a pathological virus, but a kind of pleasant "inoculated virus" that grows up inside the trader and stimulates his or her motivation, day after day!

Once you are "infected" by this virus, the result is astonishing…you won't notice the hours spent with books or charts! The only temporal marker might be the stomach's mild aching telling you it's time to eat.

Then, there's the matter of confidence. Nothing can be done without it! No trader will use a trading strategy without having full confidence in its efficiency. But, acquiring confidence is hard work! It takes many months, even years, to get acquainted with the optimal tools that you have tested and re-tested and that are prone to give the best trading results! Confidence is that rare friend who, once acquired, will assist the trader day to day for years to come.

Would you be surprised if I told you that confidence is built on a base of trials, routines and rituals? Of course you wouldn't! Yet, it's the only way to get experience and go to the next step in the learning curve.

We will now "consecrate" attitude as our most important component in the execution of performance tasks. I strongly recommend perseverance as the most important of the attitudes. Why? Well… think for a moment! When you have persevered, and you subsequently find that you must make a hard decision, you will be serene because you know the odds beforehand and because you've seen this same sort of thing play out before.

And, anyway, the loss was planned, and you can't lose more than "tiny bits", right? After a losing streak or, on the contrary, a huge profitable trade, you should experience the same type of mood: Serene, free from anguish and ready to start all over again.

Your attitude is based on the confidence you have in your store of experience. Keep in mind that slumps and joys are frequent during the trading process. But, being under pressure should never change your attitude. There will always be a new day, and the sun will rise again…if you've preserved your trading capital by obeying the rules concerning the "tiny bits" stop losses.

As you can see, the foundation of learning and trading consists of three parameters: Psychology, risk and money management and trading strategy...in that precise order…with the first two, in combination with each other, being the most important.

The Trading Plan

Even if you were lucky and discovered the most consistent and advantageous (for you) trading technique, there remains the problem of assimilating and practicing it!

Epistemology is the science of learning, building the basement for its limits and its validity. Whenever learning or teaching, I try to make full use of it. The method of building knowledge blocks, modules, if you will, is useful in a learning plan and a trading plan because, individually, they are easily assimilated.

Modularity readily aids memory retention and the process of applying what has been learned. Concepts must be simplified in such a way that the novice can rapidly understand them without any or with very little prior technical knowledge.

Trade management can be optimal only if it's well prepared in advance. This is done using a trading plan, which must include procedures that should be strictly followed at every step of the trade.

The trading plan almost forces the trader to obey a set of overall rules guiding him or her to respond to the market flow's action in an orderly, pre-defined way, rather than reacting to it at the impetus of whatever emotion it stirs up. Without a trading plan, the trader will be forced to improvise with a-flip-of-the-coin approach -- not an optimum strategy in the midst of stress.

The trading plan culminates with the post-trade phase, where the Trade Journal functions as the general written ledger of the "just-executed" trade. You must put the actions of executing the trade in writing.

You should study the various aspects of exactly what should be recorded in your Trade Journal, so you have a better chance of remembering, not only what you did, but why you did it; not only the steps you took in the current trade but also how they relate to any overall "lesson learned". I am listing here some of the topics you should cover in your journal entry, but this list is, by no means, exhaustive:

• What was the main reason you made the trade?
• Did the trade evolve as expected?
• How would you grade the trade's feasibility?
• What type of risk (conservative or aggressive) did you assume and was the type of risk the best choice?
• Did any hidden aspects reveal themselves to you?
• What proposals can you make for improvements or specificities that would make this trade better were you able to take it over again?

Moreover, the trader should try to assemble some statistics from his or her Trade Journal that will most likely improve trading results.

Without a pre-arranged specific strategy implemented with workable tactics, the trade will not be anything else but a gross 50 / 50 bet.

The When, Why and How of the Trade

To be immediately understood, I will use the simple principles of "When", "Why" and "How" to explain trade management.

The "When" principle is the initiator of the trade; in other words, it's the timing factor of the trade. It not only signals the timing of the preparatory stage -- the pre-signal phase -- but also the signal phase of the trade.

The former could be the occurrence of a doji (indecision bar) or any reversal pattern. The latter takes over the pre-signal and transposes it into a finite signal phase, expressed in a stronger and more illustrative manner: The opening bar above a previous doji bar's high, the indicator's entrance / exit into an overbought or oversold zone, the bounce on a Fibonacci level, the test and re-test of the median line, the Hagopian line set-up and so on.

The "Why" principle is the dual timeframe momentum confirmation factor of the trade and indispensable to its profitable outcome. Confirmation is our way of keeping the trade honest. The most common example is timeframe alignment -- the upper with the lower (operational) timeframe.

We can perform this either by verifying both timeframe price charts or by looking at how the indicator evolves on the same charts. We are usually guided by the trending upper timeframe expressed by its market price and / or indicator, which coincides in direction with the lower (operational) timeframe chart and indicator set-up.

This is the "bread-and-butter" trading tool; the trader shouldn't perform any trades without it. The corollary is also valid: Not every timeframe alignment will produce a profitable trade outcome. Once the timeframe alignment occurs, it can be supplemented by other confirming factors, such as a breaking bar with a huge volume above the trend line, which can be a curvilinear trend line, a moving average, a slant line, such as an angle line or any orthodox or unorthodox trend lines or horizontal lines showing resistance and support.

The "How" principle is the operational factor of the trade, indispensable to its profitable outcome. This final principle will take effect once the pre-signal and signal phases have successfully occurred. It describes the entry and exit of the trade associated with the risk and money management as practiced with the Three-Pawn Technique, a triple order preparation of the trade execution procedure. It also represents the warranty of consistent profits.

This progressive order technique consists of three steps:

Step 1 -- Find the most optimal entry of various mechanisms and place the first order.

Step 2 -- Look for the best stop loss location -- and then immediately enter a stop order, right after the point of entry order execution. This will be the second order.

Step 3 -- Find the most appropriate logical profit objective and then calculate the optimal reward / risk ratio (R / R ratio), which should not be below the 2.5 value; if that is the case, place the third order right after the stop loss order is on the broker's waiting list. (I seldom take 2 to 2.5 R / R ratio trades and only if they have a high probability. Do not forget that our main purpose is capital preservation. There is always another opportunity but only if you are still in possession of your capital. Our purpose is not to make any home runs. We are only looking for low-risk, high-probability trades.)

Here's a working example:

Entry Phase -- 1 to 3 ticks above the doji's high Stop Loss Phase -- 2 to 4 ticks below the doji's low Target Phase -- First target on the median line (ML) and second target on the upper median line (U-MLH) of a pitchfork

As the price progresses, always have clear in your mind the last swing with its high and low extremity pivots. Also be continuously aware of the level of the Fibonacci price and the time ratio corrections of, not only the last corrective swing, but also of the entire past trend swing.

Most of the time, these three progressive trading orders, collectively called the Three-Pawn Technique, are pre-arranged, at the moment when the trade decision is made. It is vital for the sake of capital preservation, that, once they are established, they should never be changed.

Due to the reliability and automatic nature of this technique, I've named it the automatic trading mode. It is one of the best remedies for the "trigger-shy" trading syndrome. If only two orders are pre-arranged, we are in a semi-automatic mode. If the three orders are not pre-arranged, we are simply in a manual mode.

The Three-Pawn Technique must be understood and then routinely practiced everyday, with no exceptions. This requires discipline and patience: Discipline in respecting 100 percent of the three steps and patience in the process of waiting for the entry order to be executed. The trader must reach a high level of routine, continuously checking and double checking his / her well weighted decisions and actions in such a way that the main task is preserved from everyday noise.

For those traders who have completely assimilated this technique, it will represent the warranty of consistent profits. I stronglyrecommend that all traders go through the six steps of the trading plan: The pre-signal, the signal, the confirmation, the entry, the stop loss and the target phases.

As you may have noticed, I haven't mentioned trading strategies, so far, in this article. This is because they are, in my opinion, the least important factor in getting consistently profitable trading results.

Please don't get me wrong! Without a precise strategy, there won't be any trade, but I consider strategy the part of trading's foundation that comes after the other two parameters (of psychology and risk / money management) in importance!

From the available trading arsenal of an astute trader, I will mention three trading principles that can be the "bread-and-butter" strategies of profitable traders: Trending, sideways movements associated with resistance and support and volatility. It goes without saying that the space in this article won't allow us to describe all of them, so I'll present just a few, the ones I consider the basis for low-risk, high probability trades.

Many traders use trending as their primary tool. They try to get aboard at the beginning of the trend. That they use this approach implies that they have a high degree of trading skill -- if they succeed.

I have created Integrated Pitchfork Analysis for detecting, well ahead of the crowd, the trending phenomenon. Using this tool will give the trader a professional edge. I will illustrate with the following two charts.

Let me underline, again, in closing, that the intricacy involved in trading does not negate the commonalities it shares with other types of businesses. This is valid, not only for the business plan, which becomes the trading plan for the traders, but also for programming the learning curve, through a very well prepared learning plan, based on epistemology modules.

Remember: Your guiding principle as the "owner" of your trading business should always be, "Without a pre-arranged specific trading plan implemented by efficient workable tactics, the trade will be nothing else but a gross 50 / 50 bet."

Reprinted with permission from Dr. Mircea Dologa, MD, CTA, a Commodity Trading Advisor, Stock Investment Advisor and the founder of anew teaching concept for newcomers and experienced traders at www.pitchforktrader.com. He can be contacted, for any questions, at mircdologa@yahoo.com.

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