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Basic
Rules for Building a High-Performance Trading System
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CSI will be closed for voice communication on Thursday, July 4th for the
U.S. Independence Day holiday. Data from open markets will be available
at the normal posting times, and the CSI host computer will be accessible
as usual.
Basic Rules for
Building a High-Performance Trading System
I was
introduced to the futures markets by a master trader. He was a coworker
and friend, who had a unique set of skills that brought him success. Patience
was his forte, and the reason he realized what most investors fail to achieve.
Thirty-five years ago he and I worked together on the top of a mountain
in Pennsylvania. It was the height of the cold war. As contractors of GE,
we wrote computer code to process azimuth and spherical information on
electromagnetic, optical and seismic signals. Our objective was to triangulate
the likely point of a nuclear attack against the U.S.
In addition
to our regular work on that classified military project, my friend patiently
waited for opportunities in the futures markets. One day he took a small
long position in sugar. His reasoning was that the price of World Sugar
Futures was "impossibly low," at less than one and one-half (1.5) cents
per pound. He felt he couldn't go wrong because the price was significantly
below the cost of production. Along came the Cuban Missile Crisis and the
Bay of Pigs invasion, resulting in a surge in the price of sugar by nearly
1000% to over 13.5 cents per pound! My friend used pyramiding to skillfully
parlay a couple of sugar contracts that were margined for perhaps $800
into over a million dollars. This spectacular success in the world sugar
market involved a rare moment in history, but similar opportunities can
and do surface from other commodities over time. Patience paid off for
my friend in this trade and many others. He continues to invest using the
same strategy, and consistently does quite well.
Like
a lion on the prowl, this trader waited for a suitable opportunity to present
itself. Then he acted decisively. When the position exploded into a remarkable
windfall, he kept his wits about him to play out the scene and reap a fantastic
bounty. It takes patient watching and waiting to know when a market suggests
the right opportunity. It takes honesty and good relationships to continue
the journey begun with that first successful trade - to trade for a living.
Today we humbly offer some basic insights into how one might hold on to
the gains that may fall your way, allowing you to not only earn profits,
but to also, perhaps, earn a living through your investments.
Know Thyself
The accumulation
of wealth requires honestly knowing who you are and knowing that rewards
come only when you are not fooling yourself or others. When setting out
to make a living off the markets, you must ask yourself if you have what
it takes to be an exceptionally successful trader. Measure your prospects
carefully, because the bigger the package of benefits you seek, the bigger
the risks required to achieve it. Honesty and patience are more than virtues.
They are prerequisites.
Making Money
With Money
Most
people make a living by selling their services. They earn a wage for performing
a task for which others are willing to pay. Trading is a different, more
difficult way to make a living. Based on the idea of making money with
money, it is the art of capitalizing on price fluctuations.
I have
had the experience of trading for a living, albeit somewhat vicariously.
I sold my services as a registered Commodity Trading Advisor (CTA), staking
my reputation and future employment on my market successes. For the bulk
of the trades I have booked, the at-risk capital and profits were not my
own. My first client was a New York executive who hired me to trade his
commodity account while he was out of the country. Profits rolled in and
soon I was asked to move my family to Florida so I could work exclusively
for him near his winter residence. My original client unexpectedly passed
away, whereupon I bought the computers and transformed CSI into a data-vending
firm. Although I successfully managed several accounts in the ensuing years,
data vending and software design eventually replaced the advisory business
entirely. This line of work rests more easily on my shoulders.
Making
money with money may appear to be easy when the stakes are low and the
rewards are moderate, but the difficulty factor increases exponentially
with investment dollars. At lower levels, the emotional attachment to positions
is relatively minor, and decision-making is easy to control. Add a couple
of zeros on to both the investment risks and the reward, and things materially
change for the worse.
Setting Goals
Trading
for a living involves assuming the perils of an uncooperative market. Losses
are likely to occur even under the best of circumstances. You must know
in advance how much account value attrition you can afford before you will
exit from the market. In order to attain a viable risk-reward ratio, it
is crucial that you know in advance what will be the expected value or
outcome of your trading experience. The Trading System Performance Evaluator,
a product within CSI's Unfair AdvantageŽ system, can show you the probability
of returning a profit with your investment capital. This is important because
even a highly profitable system can turn into a loser if your goal is statistically
unreachable. Balancing investment funds with a reachable level of achievement
is a mandatory requirement.
As you
move forward in your trading success (or failures), your goals will change.
In a series of successful experiences, your goal should increase, provided
the ratio of your goal to investment capital does not increase. Just as
statistical confidence is derived from a large sample, frequent profitable
experiences will add to your confidence in trading.
When
long-term goals are realized, spend some time becoming accustomed to your
newly found wealth by taking a vacation from trading. Relax. Pay taxes
on your gains and set a new future goal. In the event of a large loss,
it is time to change your focus and scale back your investments.
On Relationships
If you
are in any way unfamiliar with the terms, risks, conditions, procedures,
etc. in trading, I highly recommend opening a traditional account with
a full-service broker. An online Internet-based alternative would likely
offer lower fees, immediate trade confirmations and other automated services,
but they won't make up for the disadvantage of being on your own. A full-service
broker offers procedural market knowledge and a possible assessment of
situational conditions that can be useful to anyone - even an expert trader.
When
dealing with a broker, make sure everyone involved recognizes that the
money in your account is yours. It does not belong to the broker, and he
or she does not have to know your objectives. You should be in control.
Open an account with the expectation of making one or two trades. No broker
should expect continued business from you. Keep a minimum of resources
available for trading, and don't feel guilty about withdrawing your money;
you are not required to keep your broker solvent. If you are happy with
your broker and the way your account is being handled, keep it funded and
use it to your best advantage. A good relationship with a trusted broker
is a valuable asset.
Be wary
of tips and unsolicited advice from your broker recommending the liquidation
of existing positions or entry into new ones. Brokers are not necessarily
qualified advisers, so check the track record and reputation of your broker
before taking any action. If you have your own trading plan, don't let
the broker lead you astray. If you don't want advice, say so. A good broker,
however, will point out delivery risk notices for futures, margin requirements,
limit-move risks, and perhaps relevant news and relationships between products,
etc. Your broker should routinely offer procedural information that may
be useful, but you should do your homework so that minimal assistance becomes
necessary.
Loose Lips
Your
relationships with peers, and especially with your broker, can impact your
decisions, and not always for the good. Avoid the temptation to share stories
about trading experiences with your broker and friends. Such publicity
tends to elicit feedback that is not conducive to uninhibited trading.
If you must talk about your trading adventures, balance stories of triumph
equally with stories of humbling failures. Each success story will bolster
your courage to take on more risk, perhaps more than you can afford. There
is no advantage in adopting a behavior that can lead you to shed assets.
Great traders don't boast of their successes because they know that losses
are always on the horizon.
If you
honestly evaluate your ability to sustain a trading life, it is likely
that you'll find yourself better suited to selling your services than to
making money with money. There's no shame in that. In fact, it is the best
course for most of us. Even if you don't earn a living from the markets,
you can still benefit from investing disposable income. We hope these suggestions
will help you along the way. Focus on patience, honesty and relationships.
These are the intangibles that separate the master traders from the rest.
I wish you
great success.
Best Regards,
Bob Pelletier
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