General Concepts for Trading
For general information only, not for trading purpose.
A. Essential Elements:
1. Preservation of capital. This means "Don't over-trade" and "Don't put all eggs into one basket". It is very important that we learn how to avoid losses before we learn how to make profits.
2. Consistency. i.e. Consistently profitable. This is very very important. "Consistently profitable" will lead us onto a stage of "exponential growth". The only way to have consistency is to minimize losses. ( i.e. Cut losers quick. )
3. Superior returns. ONLY after the first 2 goals were reached, we then attempt to achieve superior returns. The key to building wealth is to preserve capital and wait patiently for the right opportunity to make the extraordinary gains. ( i.e. Ride winners. )
4. A mathematical edge. We need a good trading method that provides a high probability of winning. Then, if we do have a good method, we shall play only the hands that had a mathematical advantage according to the method. In trading, our profitability depends on our edge (good method) and how many times we get to apply that edge.
5. Risk control. Even if we have a mathematical edge, there are going to be periods of significant losses. When that happens, we have to cut back our bet size in order to avoid the possibility of ruin.
B. Psychological Factors:
1. Patience. If we don't have the patience, we cannot wait for the high probability trades according to the method. Never trade for trading's sake.
2. A plan. A plan that is well defined according to the method. Don't worry about what the markets are going to do. Worry about what you are going to do in response to the markets. If we have a plan before we put in a trade, then we know exactly how to react in response to the market actions. In other words, pre-determine your exit point before you get into a trade.
3. Worst case scenario. We need that. So, we won't bet the ranch.
4. Discipline. No plan will work if you don't follow it.
5. Selective. Every trader is going to have tons of winners and losers. You need to determine why the winners are winners and the losers are losers. Once you can figure that out, you can become more selective in your trading and avoid those trades that are more likely to be losers. Sometimes the reason people lose is that they are not sufficiently selective. Upon analysis, a trader may find that if he only concentrates on the trades that do well and lets go of the other types of trades, he might actually be successful.
C. Fundamental Factors:
1. Revolution. Anyone who had predicted "personal computer is the future" or "internet is the way to go" before it happened could make tons of money. Sadly, few had the insight.
2. Positive feedback and far-from-equilibrium state. I used these concepts to develop my Far-from-equilibrium Macro Economic Theory, or FFEE. I believe it works!
3. Change. Observe the world. The world is always changing. Be aware of change. After the Shah of Iran was overthrown in 1979, traders who bought oil stocks and defense stocks were rewarded handsomely.
4. Buy value. If you buy a very good value, you will not lose much even if your timing is wrong. (Unfortunately, I don't know how to do that. (Warren Buffett knows how to buy value, so he is very rich. )
5. Wait for a catalyst. You need a catalyst to trigger a big move.
D. Technical Factors:
1. Always follow the trend.
2. Consider every trend as a driven oscillation. If it is at non-resonance, enter the positions during the retracements. (Risk: Lowest)
3. If the trend is at non-resonant state AND no retracements occur, we shall avoid trading it. The reasons: (1) This type of trends is rare; (2) A non-resonant trend that doesn't retrace often retraces immediately after we get in. Exception: If a non-resonant trend that doesn't retrace is backed up by the fundamentals, we can enter the position but remember, under-trade! The risk is the highest for this type of trends. (Risk: Highest)
4. If the trend is at resonance, go with the breakout rule. (Risk: Medium)
5. Use 7-day MA and 50-day MA to determine the state of the trend, but not the spot to enter.
E. Chart Patterns:
1. Time. The longer the pattern forms, the more significant it is. If the price moves away from a 3 month range, it is more meaningful than another one moving away from a half month range.
2. Space. The tighter the pattern, the better the breakout. A loose triangle often has false breakouts. A breakout from a wide range is less significant than one from a narrow range.
3. Platform. It is very rare for price to go up or go down non-stop. Usually, the price will slowly climb to a platform before it blasts off into the space. Opposite is also true: the price often slowly declines to a platform before it suddenly descends into abyss.
4. Converge. If price starts converging, watch out. This is similar to the stress-strain relationship for a metal. Beyond the yield point the metal stretches with a small increase in the stress. However, a small increase in the stress does NOT mean "everything is fine". Strain continues to increase and the breaking point will not be far away. Is it any wonder that sharp breakouts usually occur after converging patterns?
5. Range expansion. If there is a sudden range expansion in a market that has been trading narrowly, human nature is to try to fade that price move. When we get a range expansion, the market is sending us a very clear signal that the market is going to move in the direction of that expansion.
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