Money, Cash & Finance

Anyone looking to trade basically has 3 choices : Stocks (common or options), Futures, or Currencies. Sure there are bonds and a few other more exotic things, but for most people those are not an option. The most well understood trading vehicle is stocks, and least is probably currency pairs. Most people have heard of futures and they are not too hard to understand given a bit of research and reading.

First off, futures inherently have leverage far beyond stocks. Most stocks you can get 2:1 leverage overnight and 4:1 intra-day for day trading. Futures are leveraged by default because of how they are constructed. This can be a double edged sword when it comes to risk and reward. For one, you can trade futures and have a reasonable rate of return with as little as a few thousand dollars. Stocks this is not possible (unless you delve into the murky waters of penny stocks). This allows returns to be amplified UP and DOWN. It is not that uncommon to have $5000.00 in your account and on a single trade make or lose $300-$500 depending on which future you trade - a 10% return (or loss!) on your principal investment in the account. If this type of risk makes you nervous - then futures are not for you.

Second, futures by nature are actively traded and lead the market pushes and selloff's. This can create volatility which means lots of trading opportunities. With this type of behavior and volatility comes the forced ability to think quickly. You often times only have a few seconds to get an order in or you will miss the move. It is also desirable to anticipate a direction and have an order in ahead of time. This is another area that requires skill and fast thinking abilities. If this is not your strong suit, or you are very analytical, futures day trading or swing trading is probably not for you.

Lastly, you must be able to assess risk and stop levels quickly, almost second nature. You should not enter a position long or short and then subsequently try to figure out your stop and target placement. A trader should already know this before entering any orders. Since futures are leveraged a lot, you should always assess the stop first (read risk level) and determine the odds of that stop getting hit in the next 10-15 minutes BEFORE actually placing a trade. Why 10 or 15 minutes only?? Most futures trades only last this long on average unless they are swing plays which can last hours to days. Most futures traders choose not to hold overnight - there is risk of gaps and additional overnight margin requirements because of this risk. Traders close out positions at the close of each day.

Most people have heard the futures market mentioned on TV occasionally. However, a lot of people dont understand what the futures market is. Learning how to utilize it properly will help with entry timing when day trading, swing trading, and even investing (after all, who wants to be down immediately after entering a position?)

It’s actually quite simple. The futures market is just a bet on where an index will close at a future date in time. It is no different than saying ” I think GE will be 5 points higher in 3 months”. Now imagine thousands or people, or even hundreds of thousands all betting on where GE will be in 3 months. Not tomorrow, the time is 3 months from now.

This aggregate valuation call would be considered a futures market. It may be higher or lower than where GE is now, but you also have to consider the people have 3 months to be right - that is a lot of time. Time always has a value, because the more time you give yourself to be right, the easier that bet is. The market puts this time value into the price of the futures, each day that goes by a fraction of that is taken out. This 3 month time in this example is a fixed time, it does not scroll forward. So if the bet is a close of at least X price by july 31st, 2 weeks from now the date to be right is the same but the time left is less.

If this still seems confusing, think about this example:  Every day an analyst says “The market will fall 300 points today."  If that happens in 1 day, he gets a bonus of $40,000.00.  The more days you give him to be right, eventually, even just by random chance, he will be right.The time increase you might give a person to be right would actually decay the value of the prediction being right.If the guy is given 1 month to be right, that is only worth $10,000.00.It the time to be right is 3 months, that is only worth $1000.00.00 and so forth, this is a type of time decay.

This basic concept is then carried over to the stock indexes. Traders and investors place bets based on current and anticipated information and research for what they think the value of the index wil be in the future. One key to always remember - futures and cash are equal on expiration as the futures are converted into cash value. So if the S&P 500 index is at 1400 on expiration, so will the futures contract trade to this price. Because of this, that difference can be arbitraged between the two (cash and futures) since they trade separately. Anyone can make a bet on the futures market without even touching the cash index or stocks. In just the same way, I can buy a large basket of stocks in the index without touching the futures market. This give and take causes the 2 of them to fluctuate independently.

If the futures push to high relative to stocks (the spread widens), there is free money since at expiration the value is equal. The idea is to sell the futures and buy the basket of stocks that comprise the index and lock in the free money if held until expiration. There are whole other program trades that simply day trade stocks vs futures all day long based on the premium to cash being too high or too low.  By selling the futures, you have agreed in principal to sell the basket of stocks comprising the index at that futures price. If the futures are 1430 and the cash is 1400, and the time value is 20, theoreticaly the futures should be at 1420. At 1430, I can sell the futures, then buy the stocks and lock in 10 points for free. Doing it in real time is not this easy, but the basic underlying concept is.  Anyone who wants to learn to trade needs to understand how the futures market works.

Everyone wants a shortcut to learn day trading or any other kind of short term trading – someone to teach them the “secret sauce” that will take 10-20 years of experience and allow them to come up to speed in a few months. If you needed brain surgery, would you want the guy who got his degree online in 6 months OR the guy who spent 10+ years in med school + residency + specialization? Is that even a fair question?? Well, it's lucky for everyone that trading is far harder than brain surgery … not really but it can seem like it. In reality there are some easy things everyone can do to dramatically increase the chances of winning and decrease the learning curve - but do not expect a single, easy secret that will solve all the issues and make it easy. That knowledge is learned. The one huge key to the path of winning is simply to do things that will not cause you to lose money.

First off, you really need to treat  day trading as a profession. This means act like its a real job and your only way to make money. You need a dedicated computer to trading with at least 2 monitors. Older computers are fine for some things, but do not try to use an older computer that is underpowered for trading. I can assure you that computer will fall behind of the task. Nothing is worse than lagging data (meaning the market is at place C but your computer is showing its at place A still) and failed network connections. Trading is super data intensive, make sure you have a computer with at least the following specs:

1. A minimum dual core chip, ideally you want a quad core chip. Each core on the chip can run a separate application, and this really lessens the chance the computer will stall out. Make sure the processor you choose has a decent amount of L2 cache also - this increases speed as well. If you dont know what this is, ask a local computer nerd, they will help you.

2. A minimum of 2gb of memory, the more the better, and the faster the better. If you want more than 4gb you will have to use a 64 bit operating system. Before you take this step, make sure whatever software you are using is fully compatible. You should be able to get by with 2-4gb fine. The faster the memory the better, but no need to really pay up for special memory.

3. An add on graphics card from Nvidia OR AMD. Make sure the card can handle at least 2 monitors. You do not need a high end gaming card, you should be able to get something decent for about 100-150 bucks easy. Do not use thebuilt in graphics on the motherboard - they are really cheaply made and are underpowered. Trading is extremely graphics intensive - think about real time charting, indicators, order entry, bid ask in real time etc - it adds up.

You only need this on the main computer you will be trading on and doing your charting. You want 1 dedicated screen for order entry and 1 screen for charting. If you have any other computers that are older, those are totally fine for surfing the net, getting news, IM chat and other stuff. I would always keep your trading computer as uncluttered with add on applications as possible. You do not want to be in the unfortunate predicament of the computer crashing or locking up during a trade.

You need a dedicated work area that will serve as your trading area and workplace. It needs to be setup no different than a desk in a normal working environment - phone, lights, supplies, computer, printer etc. Remember to succeed, you really have to treat learning trading as a real business, not some kind of hobby. A hobby is fine, but you cannot expect to become an expert unless you treat it seriously. When you are in a trade or watching a setup to enter, don't let outside junk distract you. This means chatting on the phone to friends, watching tv shows, and doing other things while “kind of watching” the market. If this type of behavior would not be acceptible in a normal office, it will not cut it for trading either.

Once the office is setup, it is time to get serious about how learning the in's and out's of the market. The internet and free blogs are a great source of information, but you should not expect to learn everything online. Go to amazon.com.com or Traders Galleria and search for the term “stock charts”. You want a beginning book and an advanced book on charting. In order to learn about trading, you have to figure out the mechanics of price movement and become and expert at charting. This will take some time, its not easy. But as you get more proficient, it becomes much easier to add new ideas and concepts because you have the background framework to understand them.

Expect learning charts to take about a year to get good, but in a month or 2 you can get a good start. Again, do not fall into the trap of thinking “if I throw some money at this, someone will show me secrets and shortcuts”. If you don't have the foundation to understand what is going on, no amount of shortcuts will fix that since you dont understand the underpinnings of how stuff works. One word of caution - do not attend any seminars until you have at least mastered basic charting - your money and time will be wasted. IF you think you know enough to tackle the advanced book, then it is probably time to attend a seminar to learn more. Again here there is no substitute for experience. Every day you have to plan time to watch the markets live, even if its just for an hour or two - ideally for the whole day if possible.

Static charts are fine to go over when the market is closed, but you really need to watch it live as well. If your time is impacted because you have another full time job and cannot watch the market here is a secret: Get some screen capture video software (records your screen to video) and an external usb hard drive, probably 500gb will do. Set up a real time chart of the market and a few stocks on your screen before you leave for work. Set up the recording software to save to the external usb hard drive. You can set up a macro (there are free programs out there that can do this, search Google) if you are not home when the market opens. Set i to record at least an hour of video of the market open and any charts you have open. Then when you get home at night, you can play this back in real time and work on watching for chart patterns. If this does not appeal to you, some of the brokerage firms or data vendors have market replay that can replay parts of the prior day for you.

One last thing I have not touched on yet - charting software. There are tons of them out there. I have my own preferences I like, but that hardly matters. You need to find what you are comfortable with. Some programs are very complicated, some are simple to use, and yet others will let you code custom indicators and trading systems. If the beginning , I would suggest everyone go with simple. What good is having 500 things you have no clue what they do or how they work?? All that can do is to lead to confusion and add a bunch of things that are too complicated. Just make sure its a fully robust charting package – meaning all charts are live, you can put tick charts AND minute based charts up (not delayed data, live data) AND its not web based. Web based means the program is running in a browser, rather than running as a separate executable. For the most part, you always want a standalone, executable program - they are far faster and speed is money. If your trading platform is integrated with the charts that is totally fine, just make sure its not web based order entry either. It is too slow in general to be of any use. Web based is totally fine for buy and hold, longer term investing. Winning at trading is about time, even 5 seconds delay can cost you 50c or more per share in lost profit if the market is moving fast. That cost is real and can result in a winner turning into a loser.

While this was not a tutorial on how to trade, I tried to touch on a few subjects often overlooked when people are trying to learn to trade. They overlook these because they either cost money (charting software, real time data, computers) or they think they take too much time so lets find a way to skip this or that part.

As in every business I know, there are some fixed, monthly costs that are a part of doing business. Data costs and chart program costs are one of many costs you will incur as a trader. Often you can get them minimized or waived if you are active, but for probably the first year expect to pay for them as you are learning.

Undeniably, the most important tip anyone can give you when learning to trade, is that you should never entertain the idea that trading is the same as investing.

Unfortunately, a large percentage of people first discover trading via the stock markets and as a result, they associate trading with investing and therefore don’t get in the right trading psycology.

Admittedly, trading can in a sense be compared to investing simply because one is putting money at risk in the hope of good returns. Of course, just because you’re willing to risk loosing your money does not necessary mean you’re investing though.

Perhaps a more accurate assessment would be to compare trading to gambling as they have much in common such as:

• Plenty of action and rarely a dull moment.

• Fast pace.

• Probability. This is the equivalent to what gamblers call “odds”.

• Uncertainties such as political or market related influences. With gambling these would be the cards, dice and other players.

• Just as you get high stake games, you also have high stake trades.

• Distorted reasoning resulting from uncontrolled emotions.

• Just as gamblers want to beat the house, so too do traders want to beat the markets.

• The majority of traders and gamblers loose more money than they make.

• Wagers are always present.

So, trading isn’t wagering?

Let me remind you about “Trading Places”; a movie starring Eddie Murphy. In the movie Eddie was recruited to operate a brokerage and when the owners explained how the commodity markets work, Eddie replied, “You’re bookies”

Almost immediately, Eddie is able to offer quality trading advice. Of course this has nothing to do with his understanding of the markets, but rather because he’s a master of betting. Accept the fact that trading is betting and you’ll be taking the best possible approach.

Rather than getting into investments, you’re getting yourself into a betting game. Essentially, each time you buy or sell, you’re betting that the markets will behave in one way or another while someone else may be betting the exact opposite.

I should of course mention that there’s one major difference between Las Vegas casinos and trading. In a casino when you make a bad bet, you’re simply stuck with it. On the other hand, if you make a bad trade, you can for the most part get out of it simply by making a different one. Because of the sheer number of people involved in trading, one can almost always find someone to take the bait, particularly between those who are new to the game.

Of course in certain markets they may not be much activity, so there’s always a chance that you won’t get a break to get out of a bad trade.

The hardest part of trading is being able to remain level headed and to stick to the system you’re using. As such, we can confidently say that trading is essentially a game of self control and good discipline.

The hidden trap within trading, as I’ve mentioned already, lies in the fact that people compare it to investments and the safety factor which goes with investing. Realistically though, trading is betting and in fact, it’s like being in a room with millions of other bettors.

Strangely enough, very few people would be willing to try and earn a living from gambling and yet there are literally millions who think they can make a living instantly with trading. Please believe me when I say it simply doesn’t work like that.

Just remember, you get gamblers and you get professional gamblers. Likewise, you get professional traders, and you get those who are simply wishing for the impossible.

Let’s see how the dictionaries define gambling:

1) To become engaged in hazardous or reckless behaviour

2) To expose oneself to risk or hazards

3) An act or undertaking which has an uncertain outcome

Now let’s see how “calculated” is defined:

1) Determined by mathematical calculation

2) Undertaken after careful estimation of the likely outcome

3) Made to accomplish a certain purpose; deliberate

Lastly, let’s take a look at how “risk” is defined:

1) Possibility of hard, loss or danger

2) An action which involves an uncertain danger

3) The variations in returns on investments

4) Possibility of unpaid debts

Professional traders don’t go with gut feelings but instead, they stick to the rules of their systems. They take risks but they’re calculated risks and the closely monitored. Professional traders aim to be ahead at the close of each month.

The plain and simple truth is, traders aren’t gamblers. Yes they are also faced with many uncertainties but unlike gamblers, the outcome for traders is not uncertain. They have their systems and they know the markets. Above all, they know that they either enter a trade well prepared, or they face heavy losses.

Whether it’s with gambling or whether it’s in trading, gamblers very rarely follow a set plan or system. Likewise, they fail to manage their finances accordingly just as they fail to calculate risk. The bottom line is, they simply cannot help themselves from being caught up in the excitement.

The last tip in this article is that as a trader you need to focus on taking calculated risks with the sole intention of generating consistent trading profits. Of course this is a far cry from the way in which gamblers operate, given the gamble more for thrills than anything else.