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TRADER'S NOTEBOOK


Do You Want To Trade Today?

08/05/10 11:05:19 AM PST
by Martha Stokes, CMT

So many choices, but which is right for you?

Nowadays when you go on the Internet, you see an overwhelming number of advertisements for traders: forex, options, commodities, stocks, bonds, eminis, exchange traded funds, credit swaps, special derivatives… the list goes on and on. As you wade through this ocean of trading opportunities, how do you decide which one is right for you?

Fact: most retail traders lose money trading, regardless of the trading instrument they select. This is because they do not do their homework first, choosing instead to leap into the markets without a plan or even any idea about what it takes to succeed in a given market. Not only that, it’s not a given that trading in one market is like trading in another; each market has specific requirements.

Before you jump into any form of trading, take a moment to understand the limitations, capital requirements, risk, and knowledge you need to succeed.

THINGS YOU SHOULD KNOW
Trading any market requires you to understand the trading instruments involved and how that market interconnects with the economy. To succeed as a trader, you must be familiar with far more than just a candlestick pattern or an indicator crossover pattern.

Here are some of the things you should know when you’re selecting a financial market and the trading instrument you will use for it:

  • All financial markets are tied to a primary real-world asset. To succeed, you must understand the relationship between the underlying asset and the trading instrument you are using.
  • Trading instruments are set in particular time periods for the trade. Some are strictly short term, while others vary from long term to intraday trading. Time is a primary factor.
  • Your trading style is a key factor when choosing a trading instrument.
  • While all forms of short-term trading require technical analysis regardless of instrument, each market is unique and requires different settings, indicators, and formulas to make trading as efficient and effective as possible. Required technical skills vary depending on which financial instrument you choose to trade.
  • Degree of complexity varies with each financial instrument. The more complex the instrument, the more experience you will need in order to succeed.

MARKET ELEMENTS
Each financial market has elements that set it apart from others. These elements play a crucial part in your decision in whether you choose to trade that market. Elements include but are not limited to factors such as:

  • Foreign exchange tied to the asset: a national currency with two currencies bound together for each trade.
  • Commodities tied to the asset: raw materials, foodstuffs, and precious metals.
  • Futures tied to stock indexes, stocks, commodities, and derivatives.
  • Bonds tied to corporate debt, municipal debt, federal government debt, and credit derivatives.
  • Exchange traded funds (ETFs) tied to stocks, indexes, commodities, currencies, debt, mutual funds, and derivatives.
  • Options tied to stocks and indexes.

TRADING STYLES
Before you select your financial trading instrument, you must first choose your trading style. Selecting your style must be based on your risk tolerance, time available to trade, amount of capital available, level of financial education, your trading experience, and general personality. Here’s an example: Just because you want to daytrade doesn’t mean daytrading is right for you.

Your trading style will dictate which instrument you should use. Some primary styles are:

  • Intraday trading (high-frequency) trading. This is the fastest-paced, riskiest trading style and requires the highest skill level in terms of chart analysis, technical analysis, risk assessment, order calculation and execution, money management, and self-discipline. Professional-level education and extensive experience as well as thousands of trades are necessary for consistent success in intraday trading. This style is not meant for beginners or intermediate-level traders and is also the most demanding in time and commitment. It also requires professional-grade computer equipment, execution software, and a large capital base. Typical lot sizes are 5,000–50,000.
  • Daytrading. Also a fast-paced and high-risk trading style, daytrading requires experience in chart analysis, technical analysis, risk assessment, order calculation and execution, money management, and self-discipline. Daytrading requires advanced education and years of experience with thousands of trades. Again, this style is not recommended for beginners or traders with limited experience. Daytrading requires at least near–professional grade computer equipment and execution software and a moderate to large capital base. Typical lot sizes are 1,000–10,000.
  • Velocity (momentum) trading. This fast-paced and relatively risky trading style requires moderate to high skill levels in chart analysis, technical analysis, risk assessment, order calculation and execution, money management, and self-discipline. With sufficient simulated trading experience, intermediate to novice traders can succeed using this style. A minimum two- to three-monitor computer system linked to a fast reliable execution system would be sufficient, as well as a moderate capital base. Typical lot sizes are 1,000–10,000.
  • Swing trading. This relatively fast trading style requires moderately high skill levels in chart analysis, technical analysis, risk assessment, order calculation and execution, money management, and self-discipline. With sufficient simulated trading experience, intermediate to novice traders can succeed with this style. A minimum two-monitor computer system linked to a reliable execution system should be sufficient. This form of trading requires sufficient capital to swing 500–5,000 shares at a time.
  • Position trading. This is the lowest-risk and easiest short-term trading style to learn. It is suitable for beginners to advanced traders, and for traders with time constraints. At least a moderate skill level of chart analysis, technical analysis, financial analysis, institutional holdings analysis, growth analysis, risk assessment, order calculation and execution, money management, and self-discipline are necessary for this style. It requires a moderate capital base with average lots ranging from 100 to 5,000 shares.
  • Intermediate-term trading. This lower-risk trading style is a longer version of position trading. It is suited for longer-term investors just learning to short-term trade. A low skill level of chart analysis, financial analysis, institutional holdings analysis, growth analysis, technical analysis, risk assessment, order calculation and execution, money management, and self-discipline are adequate for this style, and a small capital base should suffice. Average lots range from 100 to 1,000 shares. Beginners will find this trading style to have good return over investment (ROI).
  • Long-term or retirement investors. This is least risky of all, so long as technical analysis is used in conjunction with fundamental analysis and cyclical trend patterns are applied. Financial, product cycle, business cycle, and technical analysis are important for long-hold investments. A small capital base will suffice. Lots range from 100 to 1,000 shares on average. Beginners will find this trading style to have good ROI.

    Although most traders are only concerned with making a steady income from the financial markets, everyone needs to establish and maintain a retirement account. Knowing how to properly invest for the long term is necessary along with your short-term trading style.

WHAT ARE YOU TRADING TODAY?
What do you feel most comfortable trading? Each type of trading has strengths and weaknesses, reflected in not only the type of trader it attracts but how it trades, skills and education required, and the level of risk tolerance. Here’s a partial list of pros and cons:

Stock Trading
Asset: Publicly traded stocks, OTCBB stocks, ETFs, and exchange traded notes (ETNs)
Trading styles: All
Experience required: Varies on trading style
Risk tolerance level: Depends on trading style. Leveraged ETFs and ETNs are higher risk due to the inherent nature of leveraging
Capital base required: Depends on trading style
Technical analysis skill level: Depends on trading style
Time required for trading: One hour a week to 10 hours a day depending on trading style
Market participants: All
Degree of difficulty: Low to moderate
Education required: Basic to advanced professional training courses

Forex Trading
Underlying asset: Currencies
Trading styles: Intraday, daytrading, velocity
Experience required: Extensive; should have experience in other trading instruments before attempting forex trading. Stock, option, and futures trading experience would be helpful
Risk tolerance level: Extremely high
Capital base required: Moderate to high
Technical analysis skill level: Professional-level training; experience using technical analysis with other trading instruments
Time required for trading: A few minutes to all day
Market participants include: Large institutions, banks, foreign governments, corporations, small retail traders, and professional speculators
Degree of difficulty: Extremely high
Education required: Training in other financial trading instruments, experience trading other markets, professional-level technical analysis, economics, and training on impact of various global and other market conditions and how it affects currency pricing

Commodity or Futures Trading
Underlying asset: Raw materials, precious metals, foodstuffs, stock indexes
Trading styles: Intraday, daytrading, velocity, swing, position
Experience required: Other market trading experience and simulated trading. More experience needed than trading stocks or options. Option experience would be helpful
Risk tolerance level: High
Capital base required: Moderate to high
Technical analysis skill level: Higher skill level needed than for stock or option trading
Time required for trading: One hour a week to 10 hours a day, depending upon trading style
Market participants include: Small farmers, conglomerate farms, commodity traders, wholesalers, professional pit traders, speculators, corporations, and small retail traders
Degree of difficulty: High
Education required: High level of experience and market training

Emini Trading
Underlying asset: Indexes of stocks
Trading styles: Intraday, daytrading, velocity, swing, position
Experience required: Stock trading experience helpful
Risk tolerance level: Moderate; lower than other futures contracts if trader has stock trading experience
Capital base required: Low to moderate
Technical analysis skill level: Moderate to high. Experience with index analysis critical
Time required for trading: One hour a week to 10 hours per day depending upon the trading style
Market participants: All
Degree of difficulty: Low to moderate
Education required: Stock market training is essential along with strong technical analysis skills. Chart analysis skills desirable. Market condition analysis training essential along with a strong understanding of market, stock, and economic cycles

Option Trading
Underlying asset: Common stocks and indexes based on stocks
Trading styles: All
Experience required: Depends on trading style
Risk tolerance level: Moderate
Capital base required: Low
Technical analysis skill level: Requires analysis of both the stock and the option contract
Time required for trading: One hour a week to 10 hours per day, depending upon trading style
Market participants: All
Degree of difficulty: Moderate
Education required: Basic to advanced professional training courses on stocks and options

Bond Trading
Asset: Debt, government, corporate, municipality, and other.
Trading styles: All
Experience required: Varies
Risk tolerance level: Varies
Capital base required: Varies
Technical analysis skill level: Low to moderate
Time required for trading: One hour a month to 10 hours per day, depending on style
Market participants: All
Degree of difficulty: Low to moderate
Education required: Moderate

The derivatives market is the largest financial market with numerous trading instruments. Not all derivative instruments are readily available to retail traders, and many new derivatives being created are as yet untested and have insufficient historical data to determine their impact on other financial instruments.

No matter what financial instrument you choose, you need to be aware of which derivatives are most likely to affect that financial market.

WHAT ARE YOU GOING TO TRADE?
The challenge facing most retail traders today is the confusing array of trading instruments, styles, and opportunities. The tendency is to rush into trading without understanding the financial instrument being traded or understanding your own trading personality. The result is the loss of capital and an erosion of your self-confidence as well as eroding risk tolerance. Statistically, the lower a trader’s risk tolerance, the higher the risk the trader tends to take, resulting in huge losses or a total wipeout of capital.

To avoid this trap requires diligence and patience, and that practice, simulated trading, and gaining skills are all required. A few free weekend seminars may get you intrigued in the subject, but they will not provide the education you need regardless of which trading instrument you choose. If you want to succeed, you will need to invest in your education, and a big part of that is experience.

The financial markets are not the lottery, nor are they a casino. There is no "house," no one entity. If you were trading against just one entity, trading would be far simpler. But you are trading against numerous groups of market participants, all with different agendas, experience, and knowledge bases. Being aware of who you are trading with and who you are trading against are crucial to your success.

If you look at trading as "you against the market" or trying to "beat the market," you will fail because you do not understand your situation. Instead, choose your trading style with care and thought, select the financial market and trading instrument that suit you best, and then put the muscle of a sound education with plenty of experience behind your trading. When you do that, consistent success will come more easily.

READING AND REFERENCE
Stokes, Martha [2010]. "Volume, The Forgotten Oscillator," Technical Analysis of STOCKS & COMMODITIES, Volume 28: July.
_____ [2007]. "The Angle Of Ascent," Technical Analysis of STOCKS & COMMODITIES, Volume 25: September.
_____ [2007]. "The Missing Cycle," Technical Analysis of STOCKS & COMMODITIES, Volume 25: April.
_____ [2007]. "What’s Your Trading Style?" Technical Analysis of STOCKS & COMMODITIES, Volume 25: Bonus Issue (no. 4).
_____ [2006]. "Tools Of The Trade," Technical Analysis of STOCKS & COMMODITIES, Volume 24: October.
• Decisions Unlimited, Inc. (codeveloper TechniTrader)



Martha Stokes, CMT

Martha Stokes, lecturer and author of Cycle Evolution Theory, is a master-rated technical analyst for TechniTrader stock market trading courses, workshops, and virtual classes. In addition, she writes several educational newsletters for active traders. To learn more, visit www.technitrader.com or www.marthastokes.com.



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