PREPARING YOUR INDICATORS

Once your mind is ready to trade, it's time to focus on the market. In fact, the preparation and study of your indicators and technical analysis of the market go hand-in-hand with clearing your mind of any outside distractions.
When I began trading, I would pour over price charts for an hour every morning, committing the prices on the paper to my memory. Today, my technical review time is compressed. For one thing, as a large independent trader (or "local") at the Chicago Mercantile Exchange where I trade S&P futures, I am on the frontlines of the market every day; I am part of the market every day. In addition, I employ the services of technicians who provide a synopsis of the market and indicators.

As we'll discuss in Week Two, you cannot devise a trading plan without first studying previous market patterns. Looking at such things as previous highs and lows, moving averages, and so forth, you can determine the type of market you're in – rangebound, trending, or setting up for a trend-reversal.
My technical study of the market spans the macro to the micro. I'll look at price patterns over the past year, half-year, month, week, day, hour and even minute. I'm looking, in particular, at where the market is at that moment compared with the high and low for the year, month, week, day, and in relation to recent moves.

While I focus on S&Ps, no market moves in a vacuum. That's why at the start of my day, I look at what happened overnight on Globex and in overseas markets. I want to know what the market reaction has been to news that has come out overnight, and I want to know what news events – such as major economic reports and/or speeches by Greenspan – are scheduled for that day, which may also have an impact.

I also want to look at what's happening in other markets, which might influence the tone, if not the direction, of the S&Ps. In August 2000, for example, the S&Ps have been outperforming the NASDAQ futures. However, sporadic selling pressure in NASDAQ has been tempering the moves in the S&Ps.

Regardless of whether you're an active daytrader or a short-term trader waiting for the next set-up, you must dissect the market every day. You have to see where the market is, where the market has been and, based on that technical study, where it's likely to go (as we'll discuss in Week 2 of the course).

In time you'll be able to couple technical analysis with your own experience, recognizing patterns that you've seen numerous times. What develops is a kind of "gut instinct" that's really equal parts of technical analysis and experience in the market. You place trades based on the probable outcome, gauged by what you've seen or experienced on numerous occasions.

INDICATOR PREPARATION EXAMPLE

Here's an example. In our "Morning Meeting" recently (at which the traders who work for me and I discuss the market), we identified good support in the market at 1470.50. Further, we knew that 1478.50 was a 50% retracement level of a recent major move. Above that, we saw 1491.40 as a 61.8% retracement level. (As we'll discuss in later sessions, we believe that key retracement levels - 38.2%, 50%, 61.8%, 88% -- act as magnets in the market.)

In the S&P trading pit at the Chicago Mercantile Exchange, I perceived the market firming up at 1470.50 with solid buying activity. At that point, I knew that the market had made a bottom, and I jumped on the long side. I played the long side all the way to 1478.50, the 50% retracement level, at which point I exited.

What were the factors that played into my decision-making process? Our technical research that identified support at 1470.50 and a retracement level at 1478.50; my perception of the market firming at 1470.50; and my experience that told me the market should at least hit that retracement level.

Now the market later moved higher, going to 1490.50. But I was out of the market (and in meetings) by the time that happened. I didn't bemoan money I "could" have made by hanging in there. Rather, I executed my trade from 1470.50 to 1478.50 based on my experience, my perceptions and, above all, my technical research.

DEVELOPING A MARKET "FEEL"
Every golf instructor I've ever studied with has told me about "visualization." When you step up to the tee, you see the shot that you need to make. In your mind, you see yourself making that shot. And then you execute the shot.
There is an analogy that can be drawn to trading. Granted, you cannot make the market move a certain way just by thinking. (If only that were true.) But you can develop a market "feel," a sense of "knowing" that will help you to identify and execute low-risk, high-probability trades - as long as it's based on thorough technical analysis.
Your technical analysis will encompass the recent highs and lows, support and resistance levels, and key retracements. Then, since I've been a part of the market day in and day out, I know the "feel" of the market as it gets bogged down in a range, is choppy and thin, or builds momentum for a breakout. From this perspective, I can then "visualize" the likelihood of the market making a particular move.
· Technical analysis plots the course.
· Market behavior sets up the trade.
· Based on my experience, I can "feel" (or "know") the likelihood of the market making a particular move.
WHAT KIND OF TRADER ARE YOU?
Any discussion of the mental game of trading must, obviously, focus on the individual trader. Over the past few years, daytrading has exploded. The Internet and electronic brokerages have made accessibility to the market greater than ever before. People who would normally consider themselves buy-and-hold investors are trying to make shorter-term plays in the market and calling themselves "daytraders."
Those of us who have traded futures are among the original breed of "day traders." On the majority of days, I go home "flat," without a long or short position. Day trading has been my living for nearly 20 years. But like everyone else, I followed a learning curve that had plenty of tough lessons along the way. What many novice traders don't plan on - and as the veterans among us have experienced - is the fact that you'll be lucky to break-even the first year you trade. In fact, I tell the young traders I bring on board that I don't expect them to turn a profit the first year. What I want to see them do is make a lot of mall trades to build their knowledge of the market, and their skill and confidence in executing trades.

Remember, to be a successful daytrader, this must be your primary professional endeavor. It will be how you pay your bills, finance your mortgage and pay your kids' college tuition. Can you handle that reality and still trade with a clear head?

The average Joe and Jane investor like to believe that they are good "traders" when they pick stocks that go up, courtesy of a bull market. (The common adage for this is confusing brains for a bull market.) This year-to-date, we've seen a big spike up, a big spike down, and now a range-bound, consolidating market. These are the market conditions that reveal just who the really good traders are. A good trader has the ability to survive, and indeed thrive, in all types of markets - bull, bear and range-bound.

A daytrader can find opportunities each day and intraday, whether buying dips and selling rallies within the range, or looking for the breakouts to the up or down side. They are 100% technical. The price, time and market momentum are their guides.

Others may discover that they do better on position trades of a few days, or even longer. They combine the technical with the fundamental. Perhaps they are more patient and, perhaps, more cerebral. They are studying a company, dissecting the dynamics of the market, and placing trades infrequently - but expect to make trades that have a big payoff.

Daytraders, by definition, are making frequent trades, only a percentage of which will be winners. (In fact, as we'll discuss later, if your risk/reward ratio is 1:2 or better, you can have only 40% winners and still turn a profit.)

At the end of the year, both the daytrader and the position trader can make a substantial living. The importance, however, is first to know what suits you best, because if you're trading outside your style or personality, successes will most likely be short-lived. No one can answer that for you. There may be some trial and error involved. Perhaps you love the fast action of "scalping" in and out of the market, moving quickly and decisively. Or perhaps you enjoy being more strategic, plotting longer-term moves.

Whatever your choice, be aware of your own style. And keep in mind that you can have different styles in different markets. For example, I don't daytrade stocks. In stocks, I'm definitely an investor. But when it comes to S&Ps, I may trade 3,000 contracts a day!

How do you know what suits you best? Again, use your own trading as a guide. Keep a log of every trade you make: time in, time out and size of trade, Did you enter on the long side? The short side? What was your profit? What was your loss? This log will be your guide throughout your trading career. You'll see how and when you make your best trades. The results might surprise you. As we'll discuss in later weeks, your trading mistakes will tell you much about your own style, how you can improve and what type of market conditions suit you the best. But first, let's take a look at three types of "traders" - the trend-follower, the "fader" and the break-out player. Over time, you may combine all three of these. But when you look at your own trading log, you'll see the kind of trades you make the most frequently and the kind of trades that have the best results.

Next.......

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