Trade Like a Pro

15 High-Profit Trading Strategies

Noble DraKoln

• Publisher: Wiley
• Year: 2009
• Print ISBN: 9780470287354
• eBook ISBN: 9780470449127
• Edition: 1
• Topic: Business
• Subtopic: Investments & Securities
• Index: Business

Praise for Trade Like a Pro

"Noble's commitment to the individual trader is exactly what traders need during these volatile times. He has knowledge that spans across markets and is worldwide. He is a valued contributor to the TraderPlanet.com community, and this book further demonstrates his dedication to educating traders and helping them become more successful."
—Lane J. Mendelsohn, Publisher, TraderPlanet.com

"In a time when, on a global level, important things are happening to the financial industry, when new profit opportunities as well as risks are revealed, the book Trade Like a Pro offers a complete picture concerning the risk administration techniques."
—Teodor Ancuta, President and General Manager, Sibiu Stock Exchange

"Trade Like a Pro is a comprehensive presentation of all the basic trading strategies that belongs in every investor's library. Whether your specialty is futures, options, or stocks—or, for that matter, a combination of all three—you will find yourself going back to this valuable reference guide again and again. Everything rings true. Moreover, the author gives you the pros and cons of each respective strategy without imposing his own point of view. Well researched and presented."
—George Angell, author of Small Stocks for Big Profits and Winning in the Futures Market

"Armed with good intentions, most new traders are unaware of the realities involved. Although there is often the belief among novice traders that profitability will be easy, the evidence strongly suggests otherwise. In his new book, Trade Like a Pro: 15 High-Profit Trading Strategies, Noble DraKoln offers a thoughtful approach to making the transition from unsuccessful retail trader to the arena of the professional, which is imperative for lasting success as a trader."
—Ron Rossway, President, Denver Trading Group

PART I

Designing the Trade

The next few chapters lay out a set of ideas and concepts that help you make the transition from a retail trader to a professional one. Professional traders approach the market with three distinct differences that their retail counterparts don’t have to consider.

First, the majority of professional traders are working for someone else. This means that they have what is known as a fiduciary responsibility to their clients. They must, at all times, act in the best interest of their clients at all times. This means that when choosing between risk and rewards, managing risk takes precedence in order to preserve the client’s principal.

Second, professional traders don’t get paid unless their clients get paid. While this can be stressful, it is the only way to keep the professional traders focused on what’s important—making their clients money. This philosophy creates a spirit of cooperation in which everyone wins. If the client doesn’t make money, then the trader doesn’t make money. This is a simple philosophy that should be embodied in all forms of investing.

Finally, professional traders are looking for returns that are meant to beat stock and bond returns, not necessarily to break the bank. For anyone who has ever played baseball, you know that you don’t hit for the fences every time you are up at bat. In fact, you always take into consideration what has happened before and what will happen after your turn. That might require you to be conservative or loose with your playing, depending on the situation. Trading is no different. Historically stocks have returned 12 percent annually and bonds have returned 7 percent; any program that beats these returns is considered a success.

The ability to set aside greed is one of the professional trader’s biggest assets. If done correctly, setting realistic goals does not hinder opportunities; it simply diminishes the need to take unnecessary chances for unlikely rewards.

When a retail trader recognizes that he has a fiduciary responsibility to himself, pays himself from his profits, and makes greed take a backseat to the reality of the situation, he has taken some solid steps to trading like a professional.

CHAPTER 1

From Retail Trader to Professional Trader

October: This is one of the particularly dangerous
months to invest in stocks. Other dangerous months
are July, January, September, April, November,
May, March, June, December, August, and February.

—Mark Twain

When it comes to the futures and forex markets, it is important to understand the difference between trading and investing. The fast-paced nature of these markets, the high degree of leverage, and the limited nature of the contracts (from a few days to a few months) make it difficult to invest in them for the long haul. It takes a significant amount of active involvement in these markets to have even a chance at being successful. This means that as an investor you have two mental transitions to make. The first transition is your ability to change a buy-and-hold mentality to a buy-and-hold-as-long-as-I-need-to mentality. The second transition is to make the leap from approaching the market like a retail trader to approaching the market like a professional trader. Let’s tackle the first transition.

Investopedia defines a trader as “an individual who engages in the transfer of financial assets in any financial market, either for themselves, or on behalf of someone else.” It further states that “the main difference between a trader and an investor is the duration for which the person holds the asset. Investors tend to have a longer term time horizon where as traders tend to hold assets for shorter periods of time in order to capitalize on short-term trends.”

While all investors who make the transition to futures and forex believe that they are traders who focus on profiting from short-term trends, it quickly comes to light that they really do not know how to do it properly. In my last book, Winning the Trading Game, chapter after chapter was devoted to dispelling classic stock market beliefs and busting various myths that can be fatal to would-be traders. While the transition from investor to trader is not easy, it can be accomplished through planning and a constant vigilance of your mental attitude.

The second mental transition is a lot more difficult. Taking the leap from the mentality of a retail trader to that of a professional trader is one of the most difficult, yet rewarding, transitions any trader can make. While there is nothing inherently more difficult about being a professional trader, there are several factors, both personal and market oriented, that the retail trader needs to take into consideration.

It is often said that the difference between amateurs and professionals is that professionals get paid for their work. It is the same in the trading industry. The professionals are typically paid a salary plus a bonus based on their performance. While for many of them this setup is well-deserved, for others, not so much.

From a December 18th, 2007, news report on Bloomberg, Goldman Sachs announced a bonus pool of $12.1 billion, up 23 percent from the prior year. Some of the top officers were expected to receive bonuses in excess of $60 million, with average compensation per employee to reach $661,490. What makes Goldman Sachs significant is that they are one of the few investment banking firms that generate a significant portion of their revenue from their own in-house trading operations. This is no small feat for a company with a market capitalization of over $74 billion.

Your average retail trader is lucky if he can put together $50,000 to trade, much less the $9 billion that Goldman Sachs has allotted in its own fund, GS Capital Partners. This type of disparity between the Goldman Sachs’s of the world, professional traders, and you, the retail trader, leads many to believe that the leap from retail trader to professional trader is not only difficult, but impossible.

This is the wrong way to think. If simply the amount of trading capital available to professional traders is what separates them from retail traders, then we wouldn’t see so many so-called professional firms having difficulties. In just the past few years we have seen two huge fiascoes. We have seen a $6 billion meltdown occur at the Amaranth hedge fund in the natural gas market and a $7 billion loss at Société Générale SA, each of them collapsing because of the actions of just one of their traders. These were both preceded by the well-publicized collapse of Barings Bank at the hands of Nicholas Leeson in 1995. These large losses prove time and time again that it’s not just the amount of money you have to work with that makes you a professional.

In each one of these public debacles it is clear that the “traders” working for these companies were far from professional when it counted the most. Their motivations, financial attitude, and psychological makeup made them operate more like amateurs with access to a lot of money, as opposed to professional traders with a strict agenda and plan. These problems were further exacerbated by the lack of basic corporate checks and balances.

In this chapter we explore what it takes to transition from a retail trader to a professional one. We gain insight into professional traders’ motivations, financial savvy, and the psychological differences from most retail traders. Successful professional traders are supposed to operate with constraint and discipline and have loss minimization at the forefront of their market trading strategy. We look to replicate this mindset for retail traders. Finally, we review the impact that outside accountability to regulatory bodies, clients, and peers plays in keeping the professional trader honest and the significant amount of pressure on professional traders to simply do things right.

By mimicking the same high level of responsibility that professional traders feel, retail traders can accurately assess their strengths and limitations while developing the necessary attitude it takes to trade in this increasingly competitive market environment. By taking a proactive role in acting like a successful professional trader, you can make a realistic assessment of whether you should be trading or if you should hire a professional trader to work for you.

There is little doubt that the market is becoming more saturated every day. With trading competition going global and a huge breadth of contracts strewed across every time zone, you need a competitive edge. To not only survive, but thrive in this ever-changing environment, it is imperative that you, the retail trader, take a page out of the professional trader’s handbook and ultimately tighten up your approach to the markets.

TRANSITIONING FROM RETAIL TRADER TO PROFESSIONAL TRADER

They say “money can’t buy happiness,” but the appropriate extension to that is “nor can it turn you into a professional trader.” As a retail trader, the secret to transitioning to a professional trader is not about how much money you bring to the table but a combination of your motivation, how you deal with the money you have, and your mindset. From the outset you must ask yourself the million-dollar question, “Are you more interested in being right or being profitable?” The stage is set for your ultimate success or failure depending on how you answer this question, and your answer will guide your motivations, how you manage your capital, and how you mentally approach the market.

Many retail traders assume three things about professional traders that are simply not true. First, they assume that almost every trade that professional traders pick is a winner. Second, they assume that it takes a lot of money to be a professional trader. Finally, they assume that professional traders are secretly doing something that can’t possibly be done by retail traders.

None of these assumptions is correct and in fact we see time and time again that it isn’t the number of winning trades you pick, how much money you have, or your privileged access to contracts that makes the difference—it is how you behave.

Motivation

So are you more interested in being right or being profitable? Answer carefully.

When asked this question, many people’s knee-jerk response is to say “profitable.” What makes this strange is that they oftentimes do the opposite. They would rather pick the right market direction, regardless of how fruitful the move itself may be. Then they will find any reason to support their market-picking prowess; while the market is prepared for a reversal or has actually gone in the opposite direction.

What motivates you more, being right or being profitable? This is a crucial question you must not only ask yourself, but also listen to your heart’s answer intently in order to make the transition from retail to professional trader. The majority of retail traders are conditioned to believe that being right about the market’s direction is the same as being profitable. Every advertisement on TV and trading system touts the percentage of successfully picked trades. Whether they are real world results or hypothetical scenarios (which are more likely), many gurus do their best to optimize the results of the system they are promoting in order to boost the number of successful picks over the number of losing ones.

You only notice a kink in any of these programs when you run the numbers yourself. While the programs appear to be highly successful, it quickly becomes apparent that there is a schism between the number of successful picks and the actual amount of money made. In black and white you can see that when the system fails, it really fails. Although there are allegedly fewer losing picks than winning ones, the amounts of the losses can add up to being greater than any individual win. You soon realize that not only are there significantly more losses than wins, but if you were to incur them at the wrong time in the system your account would be wiped out, and you could never realize the potential pyramided profits that the programs tout.

The Commodities Futures Trading Commission and the National Futures Association have developed regulations to make sure that these programs state “past results are not indicative of future returns” and clearly show the difference between hypothetical and actual results. Nevertheless, the average retail trader consciously or subconsciously equates the number of times that a system successfully picks the market’s direction with how successful the system is at making money, which are not necessarily the same thing.

The need to correctly pick the market’s direction can quickly deteriorate into an almost obsessive fixation with beating the market. There is a need to anthropomorphize the markets into a person or entity that has feelings and emotions and that you are attempting to outwit. In this way you make the markets into your own personal archvillain. Somehow, by your wits alone, you can become more clever, faster, or insightful than your foe, the amorphous unemotional market you are attempting to beat. This is simply not the case. The market makes you money and the market loses you money, on its own terms, in its own ways. No matter how successful you are at picking the market, it can switch direction at any time. That alone makes it important to fixate on the success of the trade itself, not necessarily on how well you picked it.

A trader who fixates on market picking gets only one thing—that warm fuzzy feeling of being right—while missing the fact that the success of a trade comes from the ability to manage the trade itself. The constant insistence that you be right about every trade you pick is a common mistake of retail traders. The approach to being right about the market’s direction over being profitable rarely leads to success. In fact, it does quite the opposite; it pits the trader against the very system he hopes to make money from. The constant struggle ends up clouding the trader’s judgment and driving him to treat the market as an adversary that must be battled as opposed to an ally that he is sharing opportunities with.

Needing to be right about the market’s direction rather than being profitable is not the domain of just the retail trader. Professional traders can find themselves on the wrong side as well, focusing on getting the market right as opposed to being profitable.

Following are some examples of traders who chose being right over being profitable.

In 1974 Dany Dattel of Herstatt Bank lost a total of $360 million (unadjusted for inflation) trading the USD/DEM. Clearly one of the first, if not the first, currency trading meltdowns, Dattel’s actions led to the collapse of Herstatt Bank, originally founded in 1792 (Borse Online, www.graumarktinfo.de/gm/grauestars/firmen/dickedinger/:Herstatt-Bank:Dany-Dattel-und-die-DM-Deals/493304.html ).

In 1994 Robert Citron drove one of the most prosperous counties in the nation into bankruptcy. Citron used derivatives to support his bet that interest rates would not increase. If not for the fact that he was using the county’s money, his mistake would not have been noticed. Instead Citron lost his interest rate bets to the tune of $1.7 billion. Orange County, California, had to file bankruptcy and cut back on various municipal services for years in order to recover, solely because of Citron’s actions (“The California Wipeout,” Time, www.time.com/time/magazine/article/0,9171,982029,00.html).

The need to be right about the market’s direction is an endemic disease of the industry. While we would hope that traders and companies would learn from mistakes made a decade or two ago, we still see the same patterns repeating themselves, from Amaranth Advisors losing big in the natural gas market, Barings Bank taking a nose dive in the Nikkei futures market, to Société Générale losing the most money to date, trading European Index futures. In each instance the management was willing to turn a blind eye to the activities of their traders as long as they kept getting the right picks, but they were quickly ready to abandon them and label them rogue traders when they were no longer picking the right markets. Instead of putting the necessary safeguards in place that would protect the banks or hedge funds from loss, management operated with the belief that it was good enough to have someone who could pick the right trade.

This was just such a case at Amaranth Advisors. In 2005 thei...

Table of contents

• Title Page
• Copyright Page
• Dedication
• Preface
• Acknowledgements
• PART I - Designing the Trade
• PART II - Basic Strategies
• PART III - Advanced Strategies
• About the Author
• Index