Supergroup

I mentioned earlier this week on the protected Twitter feed that UK stock Supergroup came up on the scan results and looked like a good set up for a long position (refer to chart below).

Proper stop placement

An important thing to remember when placing your stops based on the charts is that these are a solely a guide to the stop placement that you should use. You will see on plenty of charts where price has just touched the exit signals or pierced them very slightly, before price reverts to going in the direction of the trend. This can be frustrating, however what the chart shows may not necessarily mean that you have been stopped out.

Yes, it is really does take only a few minutes a day

Edit: This post has been updated to reflect the use of the new watchlist scans, which identify potential set ups before they trigger. The old scans required you to watch the scans as they updated in real-time, otherwise you may miss an entry signal.

People that I give training to, who are new to trend following, are constantly surprised with the statement that I can spend less than 10 minutes a day trading the markets. The routine is very simple:

• By configuring my scans the way I want them, I can simply click a button and these give me an immediate list of potential stock candidates that meet the criteria programmed into the scan code;
• From there I go down the list generated, looking at the chart of each stock;
• Years of experience looking at the set ups that I know work means that I can tell within 5 seconds if a stock is of interest to me;
• If it is, one click of a button and its added to a watchlist - if it's not, I move on to the next one on the list. 

Once I've gone through all the scans (which cover longs and shorts, in different countries) I go to my trading platform, key in those stocks and look to see what the bid/ask spread is like, together with any restrictions on trading that stock. If the stock satisfies my criteria, I will either place an order at the market if it reaches my trigger price, or place an order to open at the desired level (as well as my initial stop) there and then. Job done.

As for my existing positions, I simply observe the charts and see if my stops need updating (they are only ever moved towards current price). Again, this takes a couple of minutes.

Then, in theory I could switch the trading platform off, and close the charts. With the watchlist scans you can go through these in the evenings, after themarkets have closed, and update your lists ahead of the next trading session. The scans update in real time, so you can do this as many times you want, but that is my preference.

Once the trainees in the mentoring programme who I meet have watched me go through the above, see what I look for, and how the charts and scans (as well as the system rules themselves) eliminate the need for a lot of  'interpretation', they begin to understand how I can spend so little time actually 'trading'. Over time, people can learn how to do the same - if I can do it, then so can anybody else.

If you have read Market Wizards, you will see a similar routine in Ed Seykota's interview (conducted over 20 years ago). He simply gets his end of day data, and places his orders ready for the next day. And then switches his PC off. Bill Dunn, profiled in Trend Following, has something similar, a single PC sounds an alarm when a signal is given - that's the only time his operation goes into the market. If you read the story of the Turtles, they spent most of the day reading the paper or playing table tennis.

For those who want to participate in the markets, and who may have other commitments or full-time employment, this sort of apporach is ideal. If however sitting in front of a PC for hours staring at charts, and wanting 'action' is your idea of trading, then trend following is not for you.

Logica, and the use of guaranteed stops

Earlier this year I was long UK stock Logica CMG, and profited from the uptrend that ran until I was stopped out in early April. This then quickly reverted to a possible short position, and although I did not trade the short, it was generating a nice profit, until late last week when a possible takover was announced, which sent the share price soaring. As the chart below shows, this created a massive gap up through the intended trailing stop level, surpassing the intial entry price and even that of the intial stop level, which would have resulted in a loss larger than the original amount risked.

These kind of events can cause significant damage to a trader's equity if robust controls, along with sensible position sizing, are not in place.

I risk 2% of my current equity on each trade, which some people may regard as an agresssive level. However, as my trading is carried out using spreadbetting via IG Index, I would have avoided such an event as on all my positions I use the 'controlled risk' option which acts as a guaranteed stop level. This means that, in the event of a significant gap like that as seen on the Logica chart, my stop level is adhered to and I am stopped out at that level. In this particular example, this would have still enable saved me the majority of the profits earned on the short trade. Some points to note regarding the guaranteed stop facility:

• Guaranteed stops are not available on all stocks - if they are not available, I do not trade that stock;
• The stops have to be placed a minimum distance away from the current market price (e.g. for the majority of US stocks that arev available to trade, the minium stop distance is 10% of the current market price);
• There is a small premium to pay when opening a position, which is paid for via a small adjustment to the entry price.

Although this may slightly limit the number of possible trading opportunities available to me, I have the peace of mind that I can never lose more than 1R (or 2% of my equity) on an individual trade as a result of a gap or slippage through my stop levels.

For new and/or unsuccessful traders - a blueprint to follow

In my e-book I talk about the three areas that you need to consider when trading. All three are linked, and if you are lacking in one of those three areas, you will struggle to make money. Think of it as a three-legged stool - if you are missing one of the legs it will fall over. These areas are:

• Money management;
• Self management;
• System management.

These three areas are often mentioned, yet a lot of trading novices simply focus on the system management (i.e. the entry and exit rules), with little regard for the other two areas.

I always have placed the greatest importance on money mangement, and here's why:

It is far easier to ingrain good trading habits when you are trading at your smallest. As Market Wizard Larry Hite says, you can have an 'emotional indifference' towards a position when your risk is under control. If you are trading too large a position relative to your equity, the mind can make you do funny things, such as exiting a trade when you should be staying in, or not closing a position when you get an exit signal.

Even the greatest traders (including some Market Wizards) cut back a ridiculous amount on their trading size after making a mistake (usually resulting in a significant loss), until they have re-ingrained good habits.

For anyone starting out trading, or those who have struggled to make money, I would suggest this approach:

1) Decide on a preferred methodology for your trading, that fits in with your personality and the amount of time required in front of a PC each day that suits you. If this is something you have devised yourself, you should have done some form of testing to ensure that it has a postive expectancy. If you are following somebody else's method, you should follow and log down some example trades WITHOUT committing any money, to ensure that you fully understand the method, and are following the entry and exit signals as required.

2) Once you have passed this stage, you can now start to think about committing money in the markets. As we all know, when 'real' money is on the line, the psychological aspect of trading comes to the fore. Because of this, you need to start trading using the absolute minimum required to trade that instrument. If you happen to spreadbet, for example, you can trade foreign exchange pairs from 50p per pip with IG Index, or stocks from £1 per point on UK stocks (This part is where a lot of people who try and trend follow struggle, closing trades when no exit signal has been given is a popular mistake - trading a very small position will help you stay in a position until that exit signal is given).

3) Only when you are happy that you are following your trading rules TO THE LETTER should you consider increasing your trading size to a more realistic level. What is that level? Well, the general rule of thumb is to risk no more than 1%-2% on each trade. I know of some very successful day traders who risk less than 0.5% of their equity on each position.

4) Maintain a detailed trading log recording all your trades, paying particular attention to any trades whereby you did not (for whatever reason) adhere to your rules.

If you have a day (we all have them) where we make a stupid mistake, or risk goes out of the window, cut right back again so that you regain your poise and start to see more black, rather than red, ink. For those who have read it, Marty Schwartz's story in his book Pit Bull of the day his wife was out of the office buying a mink coat highlights this very well. I also have read of day traders who, after having a bad day, will simply watch the following days market action all the way through WITHOUT placing a trade. Would you be able to do that?

In my opinion, money management has a direct effect on your self management. There are plenty of methods for trading successfully in the markets. I passionately believe in trend following, as this suits my personality best, coupled with the amount of time I want to spend in front of a screen all day. However everything stems from your approach to risk management.

If you can follow the basic blueprint outlined above, you have an excellent chance of becoming successful.

Being comfortable with your losses

You can learn a lot both about your trading system and your compatibility with it during those periods where you suffer a drawdown.

In these periods you will quickly find out if you are comfortable or not with the individual losses you incur, and the overall drawdown you suffer – that will give you a clue as to whether you are trading too large a position relative to your equity. In addition, if you are using a trend following system, you will also find out if you are comfortable with the process of coping with the “bend at the end of a trend” (the giving back of profits before an exit signal stops you out of a position) that all trend followers have to endure.

Remember that a complete trend following system ensures that stops are properly placed to limit your risk to your preset parameters. You should NEVER move a stop further away from your initial entry point, hoping to give a position a bit more leeway before starting to move back in your favour. That immediately flouts your pre-set risk parameters, opening up the possibility of a loss running away from you.

If you are a UK resident and spread-bet via IG Index, you can avoid the thorny issue of gaps through your stops by using the ‘controlled risk’ guaranteed stops in your position, meaning that you can fully quantify your absolute risk at all times, without having to worry about gaps and/or stop slippage in fast moving markets.

Although my current year to date performance in my standard system is showing a negative result, I am quite comfortable with this. Of course, I would like it to be positive, but as mentioned in a post earlier this week, I did not trade the early part of January, which was the best time to enter long positions given the breakout to the upside in the indices.

Due to the lack of direction since mid-February, and the looming possibility of being given a sell short signal, I have been stopped out of a number of positions, meaning that as of this morning I am now only in one long position in my standard portfolio. This also means that my exposure to the market has reduced. This will increase, and new positions will be opened, when a new entry signal in the general indices is given.

Remember also that historically trend following systems have been used to trade foreign exchange and commodities as well as stocks and indices. A well designed trend following system should be robust, giving you the opportunity to trade these other markets, ideally with no changes to the system parameters. Therefore, you still have the opportunity to trade markets such as gold, oil, and the major forex pairs while the stock market makes up its mind before making its next move.

Some fallen stars...

The vast majority of investors operate solely on the long side of the market, looking for good growth stocks, with promising fundamentals. After a while though, those stocks plateau before drifting downwards, or alternatively there is a sharp plunge when the company announce a sea change in the fundamental picture (think Enron). Just looking through a number of charts and there have been quite a number of stocks that shot up massively during the last year or two in percentage terms, only to have fallen right back down to earth.

Just three of those one time big winners in the UK, with the signals indicated by my longer term system:

Pursuit Dynamics - buy at 74p, exit at 407p - currently at 95.5p;
Beowulf Mining - buy at 3.2p, exit at 44.5p - currently at 10.4p;
Arian Silver - buy at 8.2p, exit at 37.5p - currently at 15.4p.

I can also think of plenty of US stocks that I have traded myself in the past that have done this, only to fall dramatically - just look at charts of stocks such as First Solar, DryShips, and James River Coal back in 2007 - 2009 to name just three.

Other stocks that are no longer with us, such as Southern Cross Healthcare and SMC Group also exhibited the same characteristics.

There are other stocks such as Google, Apple, Baidu and the like where a sound trend following method would have allowed you to capture significant chunks of the upwards move in price, and neatly sidestep the sharp downtrend in late 2008/early 2009.

Of course, if you have the ability to go short (perhaps trading via spreadbetting or CFD's) you can also profit from the often violent downtrends. One only has to think of Northern Rock and RBS (or pretty much any bank) as examples in 2008, together with countless others.

Investors are often wary of playing the short side of the market, because of the possibility of a sharp reversal, and the fear of having unlimited risk. The fact is, stocks do not always go up. As I've said before, even the strongest stocks fundamentally are likely to get hit in a bear market. Quite often, you can make more money in a shorter period of time if there is a pronounced downtrend in the general market, such as 2008, or the end of the dot com boom in the US. If you are a UK resident, trading via spreadbetting on a platform such as IG Index (who offer guaranteed stops on the majority of stocks) means you can profit from the down times while being able to fully quantify your maximum risk at any time. And spreadbetting carries the added bonus that, under current UK legislation, any profits made are exempt from Capital Gains Tax.

There are always stocks exhibiting these types of moves - as I have said before, the trick for investors is to have a clear plan as to when to sell, and maybe even looking at trading the short side. The thing is, no one knows when the music will stop and the party will end. You need to ensure that you avoid being caught in a downtrend wondering when to sell, or whether to hang on.

Think of it as going to visit the hallowed area called 'Profits' on the top floor of a building. You get in the escalator at the bottom. The escalator travels slowly upwards, until you reach your destination. The bell rings to signify you've reached your exit point, and you get out - it would be a bit silly not to. It is exactly the same in trading and investing - you need to get out when you get a signal. You've been patient on the way up - make sure you've got out before the escalator starts going down again.

Utilising a sound trend following method such as described in my e-book or which is discussed in the members area gives you the best opportunity to maximise your profits in these stocks in either direction, giving the share price space to wiggle around and ensure you are not kicked out on a minor reaction, but not too much so that you lose the vast majority of your profits.

To learn more about spreadbetting with IG Index, click here.

Recommended platform - IG Index

As I have mentioned here on more than one occasion, I use the IG Index platform to carry out my trading. Trading in this manner via spreadbetting has the advantage, under current UK tax laws, of being exempt for Capital Gains Tax purposes on profits generated.

The combination of the range of available markets to trade, ease of execution, trading platform stabililty and the charting package mean that I highly recommend their platform to anyone thinking of trading in this manner. On the majority of markets you can also use guaranteed stops on your positions, thereby enabling you to quantify your exact risk in the market, without having to worry about overnight gaps, for example.

I am delighted to be acting as an introducer on behalf of IG Index. Opening an account is easy, and usually can be completed in a matter of minutes.

To have Trader Steve identified as the account introducer, and for more details, please follow this link.

IMPORTANT: Applying for an account via the link above does not increase the level of any commissions or dealing spreads that you may incur.