In the last issue we addressed some of the misinformation perpetuated throughout the trading industry and dispelled some of the myths associated with trading. In today's article we would like to shift our focus to mistakes and misconceptions associated with the tools of trading and finish up this 2 part series with a look at how a lack of a clear cut trading plan and listening to news/tips/opinions can ruin your trading results.

Over Spending on Computers and Software

Traders in general seem to be hung up on technology. It never ceases to amaze us when we hear from traders who've only got $5,000-$10,000 in their trading account, yet possess all the latest technology, having invested thousands of dollars in multiple flat screen monitors, 2-4 state of the art computers and expensive trading/charting/analytical software.

These traders have seen pictures of trading rooms packed with monitors and computers and figure this is necessary to succeed in trading. While all that stuff is nice and impressive, the fact of the matter is that if you can't make money with 1 monitor more monitors won't help!

A more effective use of your capital would be to keep it in your trading account. All that is needed to start trading is an off the shelf, middle of the road system. These days computers are so powerful that any system being offered at computer stores meets or exceeds the minimum requirements for most analytical and charting software packages.

If you are on a budget, rather than spending your money on the fastest CPU, most amount of RAM and the biggest hard drive, focus on the graphics card of the system and the monitor. In other words, buy a low- to midlevel computer and spend your money on a quality monitor with high resolution and a high refresh rate, reason being that you are going to be spending a lot of time in front of that monitor and your eyes will tire quickly if the picture is fuzzy and/or flickering.

Using Commission Rates as the Sole Criterion When Selecting a Broker

While commission rates are increasingly becoming the main distinguishing factor between brokers as trading moves off the trading floors and onto the electronic exchanges they should by no means be the sole criterion in selecting a broker.

If one trades on open outcry markets one quickly finds that the quality of the fills received can make a huge difference to the bottom line. In those markets it certainly pays to spend an extra couple of bucks pr. turn for a good floor broker who will get in there and fight for the best price for you. While we have the greatest respect for those working on the trading floors, it is no different in floor trading than any other profession. There are those who are talented, ambitious and motivated to do the best job they can and there are also those content to show up and go through the motions in order to receive a paycheck.

This brings to mind a memory of a student we had at one of our workshops back when the S&P's traded in 5 cent ticks and were worth $500 a point. This gentleman was convinced that all floor traders were crooks, in it solely for the purpose of ripping him off, and was adamant that he would never pay more than $15 pr. R/T, this at a time when $18-20 was the going rate.

He was quite proud of the fact that he had managed to negotiate such a great rate and the other students at the workshop were clamoring to get his broker's contact info. Then during the live trading days at the workshop he was blown away by the fills we received as we traded in front of students. When asked about the fills he was getting he indicated that he would routinely receive slippage of 20-30 cents in normal market conditions (is actually fairly routine in today's markets, but was excessive back then).

At the same time we were seeing slippage of approx. 5-10 cents on average. Clearly, the floor broker he had selected was doing an inferior job and this was costing our student a significant amount of money. As far as we were concerned he was paying an effective R/T commission of anywhere from $115-$215!!! [i.e $15 + 20 to 40 cents slippage * $500] Needless to say the other students in attendance quickly tore up the broker's phone number upon learning this.

Among the factors important to consider when selecting a broker:

i) For open outcry trading:

a. That trader is calling the arb desk on the floor, as opposed to an upstairs/central trading desk that will be relaying the order to the arb desk.

 

b. Proximity of the arb desk to the pit

 

c. Experience of arb desk staff + floor brokers

 

d. Responsiveness, i.e prompt phone answering, prompt callbacks on fills etc.

ii) For electronic trading:

a. Trading platform should have a direct API to GLOBEX, i.e. the order should be routed electronically to GLOBEX without human intervention/interference.

 

b. Trading platform should allow for realtime position and equity tracking

 

c. Trading platform should incorporate real-time quotes, either natively (PhotonTrader, PATS, Crossfire, J-trader etc.) or via 3rd party (BEST Online incorporates quotes from eSignal or BarChart.com if trader is a subscriber to one of those services).

Belief that More Information is Better

Traders are inundated with confusing information and trading tips. It is everywhere, from the talking heads on CNBC, to the news headlines flashing across the trading screen to the online chatrooms, newsletters, hotlines etc. How does one go about making sense of it all? The short answer is, you don't need to in order to make money from price fluctuations in the market, all that is required is an understanding of crowd psychology.

A number of traders believe they need to gather all the information and understand it because that's what we do in the real world when faced with a decision. Once the information is mastered the secret to successful trading will somehow be magically revealed. Nothing could be further from the truth. No matter how much information you accumulate and sift through you will never have all the pieces to the puzzle - if you are waiting for that you will never make a trade.

What is needed therefore is to develop skills for decision making under uncertainty, (i.e. a keen understanding of probabilities and the ability to assess the risk involved and reward associated with different trade outcomes). A losing trade does not mean the decision to enter it was wrong, it may have been, but it may also be a case of what is referred to in statistics as: "Good decision, bad outcome", (i.e the odds favored a particular move, but the move failed to materialize as expected).

The best advice for beginning traders is: Forget all the conflicting information being disseminated out there. All that is needed is a price chart. Leave it to someone else to worry about all the news etc., the market's collective assessment of that information is reflected in the price action.

The fact of the matter is that everyone has the same set of information to trade off of when it comes to prices and the individual trader will never have the resources to secure better information faster than the large brokerage and proprietary trading houses. All one needs to to is to learn to recognize their "footprints" on the charts, as evidenced by chart patterns.

Lack of a Clear Cut Trading Plan

Along with under-capitalization this probably ranks as the #1 reason traders fail. Beginning (and some more experienced) traders will frequently be swayed by intraday news and price action. They may have started the day with a clear plan for the day, but when the bell rings and the market starts they lose focus and become mesmerized by the next tick as the price action unfolds, alternately looking to buy or sell every couple of ticks/minutes and getting whipped all over the place.

A trading plan should give one criteria to measure trend against and determine a direction to trade. Once the direction has been decided the picture is significantly clearer as one side of the market has been taken out of consideration and one is free to focus on locating low risk opportunities to enter in the direction of the trend.

Overtrading - Trading Round the Clock

The aforementioned lack of a trading plan coupled with today's lightning fast executions available through electronic trading as well as the extended opening hours for electronic trading get a number of traders in trouble. When they see all the price movement and translate it into dollar terms it is very easy to become impatient waiting for good trading opportunities.

One may get caught up in the minute to minute fluctuations to the point where he loses sight of the overall picture and starts buying and selling every couple of minutes (seconds even) to grab a couple of ticks, just because the trading software is so responsive and the fills so fast that he thinks he can get away with it.

We are so used to getting paid for our time in the real world (i.e by the hour) that it is difficult to sit in front of the screen patiently waiting for a trading opportunity (that may or may not present itself for another hour or two). Seeing all this fluctuation the trader is tempted to "hurry up and make some money" and take a couple of quick trades to get paid for his time while waiting for the next trade that qualifies under his trading plan, however illogical that may sound.

Clearly, if the trader knew this type of trading to be profitable, based on his research, he would have incorporated it into his trading plan. The very fact that it is not part of the plan should eliminate such trades from consideration, but it is easy to get bored and impatient and hard to resist forcing things when the next trade is but a mouseclick away.

It may sound cliche, but it is true that the patience to wait for proper setups and the discipline to act on them when they occur is the hallmark of a good trader. When there is nothing to do under your trading plan, that's what you do - nothing. If you need more excitement in your life try bungee-jumping, sky-diving or other similar pursuits to spice it up. Don't look for excitement or to alleviate boredom in the marketplace, it is no place for that and will quickly eat up your capital if you try.

Ron Schoemmell and Valdi Thorkelsson

R.S. of Houston Workshop

www.rsofhouston.com

About the authors: The authors have accumulated 25+ years combined experience in trading and have been running the R.S. of Houston Workshop since 1996. Info about their workshops can be found at www.rsofhouston.com