Come Into My Trading Room: A Complete Guide to Trading (Wiley Trading Book 146)

by Alexander Elder

Repeating a mistake is a neurotic symptom.

A sleepwalking trader buys at 35 and puts in a stop at 32. The stock sinks to 33, and he says, "I'll give it a little more room." He moves his stop down to 30. That is a fatal mistake-he has breached his discipline and violated his own plan. You may move stops only one way-in the direction of your trade.

Key

When the market rewards traders for breaking their rules, it sets up an even deeper trap in their next trade.

Key

The best time to make decisions is before you enter a trade. Your money is not at risk, and you can weigh profit targets and loss parameters. Once you're in a trade, you begin to form an attachment to it. The mark...

Show me a trader with good records, and I'll show you a good trader.

"Good morning, my name is Alex, and I am a loser. I have it in me to do serious damage to my account. I've done it before. My only goal for today is to go home without a loss." When the screen was up, I'd begin trading, following the plan written down the night before while the markets were closed. I can immediately hear an objection-what do you mean, go home without a loss?

We must draw a clear line between a loss and a businessman's risk. A businessman's risk is a small dip in equity. A loss goes through that limit. As a trader, I am in the business of trading and must take normal business risks, but I cannot afford losses.

Tails-The Kangaroo Pattern Trends take a long time to form, but tails are created in just a few days. They provide valuable insights into market psychology, mark reversal areas, and point to trading opportunities. A tail is a one-day spike in the direction of a trend, followed by a reversal. It takes a minimum of three bars to create a tail-relatively narrow bars in the beginning and at the end, with an extremely wide bar in the middle. That middle bar is the tail, but you won't know for sure until the following day, when a bar has sharply narrowed back at the base, letting the tail hang out. A tail sticks out from a tight weave of prices-you can't miss it.

Market tails tend to occur at turning points in the markets, which recoil from them like kangaroos recoil from their tails. A tail does not forecast the extent of a move, but the first jump usually lasts a few days, offering a trading opportunity. You can do well by recognizing tails and trading against them.

The members are likely to sell the market down in order to find whether lower prices will attract volume. Tails work because the owners of the market are looking to maximize income.

Whenever you see a very tall bar (several times the average for recent months) shooting in the direction of the existing trend, be alert to the possibility of a tail. If the following day the market traces a very narrow bar at the base of the tall bar, it completes a tail. Be ready to put on a position, trading against that tail, before the close.

When a market hangs down a tail, go long in the vicinity of the base of that tail. Once long, place a protective stop approximately half-way down the tail. If the market starts chewing its tail, run without delay. The targets for profit taking on these long...

When a market puts up a tail, go short in the area of e base of that tail. Once short, place a protective stop ap...

Keep in mind that support and resistance are flexible-they are like a ranch wire fence rather than a glass wall. A glass wall is rigid and shatters when broken, but a herd of bulls can push against a wire fence, shove their muzzles through it, and it will lean but stand.

What causes false breakouts and how do you trade them? At the end of a long rise the market hits resistance, stops, and starts churning. The professionals know there are many more buy orders above the resistance level. Some were placed by traders looking to buy a new breakout, and others are protective stops placed by those who went short on the way up. The pros are the first to know where people have stops because they are the ones holding the orders. A false breakout occurs when the pros organize a fishing expedition to run stops. For example, when a stock is slightly below its resistance at 60, the floor may start loading up on longs near 58.85. As sellers pull back, the market roars above 60, setting off buy stops. The floor starts selling into that rush, unloading longs as prices touch 60.50. When they see that public buy orders are drying up, they sell short and prices tank hack below 60. That's when your charts show a false breakout above 60.

S&P 500 futures are notorious for false breakouts. Day after day this market exceeds its previous day's high or falls below its previous day's low by a few ticks (a tick is the minimum price change permitted by the exchange where an instrument is traded). This is one of the reasons the S&P is a difficult market to tr...

Some of the best trading opportunities occur after false breakouts. When prices fall back into the range after a false upside breakout, you have extra confidence to trade short. Use the top of the false breakout as your stop-loss point. Once prices rally back into their range after a false downside breakout, you have extra conf...

There are many advantages to risking just a small fraction of your account on any trade. It allows you to he more flexible with stops.

if you get stopped out on a false breakout, don't be shy about getting back into a trade. Beginners tend to make a single stab at a position and stay out if they are stopped out. Professionals, on the other hand, will attempt several entries before nailing down the trade they want.

Beginners tend to make a single stab at a position and stay out if they are stopped out. Professionals, on the other hand, will attempt several entries...

As the market rises toward its previous peak, the main question is whether it will it rise to a new high or form a double top and turn down. Technical indicators can be of great help in answering this question. When they rise to a new high, they tell you to hold, and when they form bearish divergences (see "Indicators-Five Bullets to a Clip," page 84), they tell you to take profits at the second top.

On double tops

As a general rule, the trend that preceded the triangle deserves the benefit of the doubt. The angles between triangle walls reflect the balance of power between bulls and bears and hint at the likely direction of a breakout.

savvy traders tend to place buy orders slightly above the upper line of an ascending triangle.

Experienced traders tend to place their orders to sell short slightly below the lower line of a descending triangle. Let buyers defend that line, but if bulls collapse after a long defense, a break is likely to be sharp. This is the logic of shorting downside breakouts from descending triangles.

A symmetrical triangle shows that both bulls and bears are equally confident. Bulls keep paying up, and hears keep selling lower. Neither group is backing off, and their fight must be resolved before prices reach the tip of the triangle. The breakout is likely to go in the direction of the trend that preceded the triangle.

Neither group is backing off, and their fight must be resolved before prices reach the tip of the triangle. The breakout is likely to go in the direction...

On triangle formations

Markets can move only if enough new losers enter the game to supply profits to winners. If the market is falling, it takes a very courageous or reckless bull to step in and buy, but without him there is no increase in volume. When the trend is up, it takes a very brave or reckless bear to step in and sell. Rising volume shows that losers are continuing to come in, allowing the trend to continue. When losers start aban...

A one-day splash of uncommonly high volume often marks the beginning of a trend when it accompanies a breakout from a trading range. A similar splash tends to mark the end of a ...

Exceedingly high volume, three or more times above average, identifies market hysteria. That is when nervous bulls finally decide that the uptrend is for real and rush in to buy or nervous bears become convinced t...

Divergences between price and volume tend to occur a...

When prices rise to a new high but volume shrinks, it shows that the uptrend attracts less interest. When prices fall to a new low and volume falls, it shows that lower prices attract...

The Triple Screen trading system, described below, overcomes the problem of conflicting indicators by linking them with different timeframes.

Most beginners look at only one timeframe, usually daily. The trouble is that a new trend, erupting from another timeframe, often hurts traders who do not look beyond their noses. Another serious problem is that looking at the daily chart puts you on par with thousands of other traders who also look at it. What's your advantage, what's your edge?

Markets are so complex that we must always analyze them in more than one timeframe. The Factor of Five, first described in Trading for a Living, links all timeframes.

The key principle of Triple Screen, which we will review later, is to choose your favorite timeframe and then immediately go up to the timeframe one order of magnitude higher. There we make a strategic decision to go long or short. We return to our favorite tirneframe to make tactical decisions about where to enter, exit, place a profit target and ...

Use at least two, but not more than three, timeframes because adding more only clutters up t...

Traders who rely on daily and weekly charts usually apply moving averages to closing prices. This makes sense, because they reflect the final consensus of value, the most important price of the day. The closing price of a five-minute or an hourly bar has no such special meaning. Day-traders are better off averaging not closing prices, but an average price of each bar. For example, they can average Open + High + Low + Close of each bar, divided by four, or High + Low + Close divided by three.

To analyze weekly charts, start with a 26-week moving average, representing half a year's worth of data. Try to shorten that number and see whether you can do it without sacrificing the smoothness of your MA.

daily charts, start with a 22-day MA, reflecting roughly the number of trading days in a month, and see whether you can make it shorter. Whatever length you decide to use, he sure to test it on your own data.

The most important message of a moving average is the direction of its slope.

When a moving average points up, trade that market from the long side. When a moving average points down, trade that market from the short side.

When an EMA starts jerking up and down, it indicates a vacillating, trendless market; it is better to stop...

The only time when it is OK to override the message of a moving average is when trying to pick a bottom after a bullish divergence between MAC...

Enter long positions in the vicinity of a rising MA. Enter short positions in the vicinity of a falling MA. Use MA to differentiate between "value trades" and `greater tool theory trades. "Most uptrends are punctuated by declines, when prices return to the EMA. When we buy near the moving average, we buy value and can place a tight stop slightly below the EMA. If the rally resumes, we'll make money, but if the ma...

An exponential moving average is slow but steady, like a directional indicator on a steamroller. EMA works in all timeframes but shines on the weeklies, where it helps you stay with the major trend no matter how hard it tries to shake you off. Trading in the direction of a weekly moving average should help you get ahead of many traders. You can position ...

26-week EMA has tracked the entire glorious bull market in YHOO, from its obscure beginnings, to the breathtaking $250 peak, and back into the doghouse. If you wake up in the morning, look at the weekly EMA, and tr...

When the EMA starts to quiver, as it did in 1999, it is time to stand aside or trade short term, no...

When it flattens it may be time to range trade!

Let the EMA flatten out and tick up before positioning for a n...

When you buy near a rising moving average, you buy value (points D and F). Waiting for such opportunities requires patience, but it is infinitely safer than chasing rallies. Those who buy high above the EMA pay above value, hoping to meet a greater fool who will pay them even more. Anxious traders who buy near the tops ...

Many stocks and futures have typical behavior patterns, and you should try to identify them and use them. At the time of this writing, EBAY likes to have kangaroo tails (A, B, C, and E). The C tail had the most classical shape, but others worked also. Knowing what pat...