Extracted from the book: Quantitative Trading Strategies, Lars Kestner
Studies of human bias in economic situations shed light on how the mind affects trading
decisions. In one such study conducted in 1998, Terrance Odean, professor of finance at the University of California, examined 10,000 accounts at a large discount brokerage firm to determine if individuals’ trading styles differed between winning trades and losing trades made from 1987 and 1993. He found a significant tendency for investors to sell winning stocks too early and hold losing stocks too long. Over his test period, investors sold approximately 50 percent more of paper profits on winning trades than they sold of paper losses in losing trades.
Based on the data, Odean concluded that winning stocks were sold quicker and more frequently than losing stocks. Although the results were a bit surprising, this behavior by investors could make sense. When we buy stocks, we’re placing a bet that a company is undervalued. Stocks that increase in value are logically
becoming less undervalued as they rise, while stocks that decrease in value are logically becoming more undervalued. Winning stocks that have increased in value could be considered not as cheap as when they were purchased. Losing stocks that have declined in value could be considered cheaper than when purchased. In this case, it makes sense to sell the winning stocks that have become less cheap and
hold losing stocks that have become cheaper.
Although the logic is sound, Odean’s results show that the opposite actually occurs. Winning stocks that were sold continued to rise, while losing stocks that were held continued to fall in value. In the year following sales, stocks sold with gains by individual investors outperformed the market by an average 2.35 percent. At the same time, losing stocks that were held underperformed the market by an average of 1.06 percent. Odean discovered, on average, that investors underperform the market by selling their winners too early and holding on to their losers too long. Based on purely economic terms, it’s unclear why they behaved in this manner; psychology may provide the missing link. Clearly, the more profitable course of action suggested by the study is to buy winning stocks and sell losing ones. Two theoretical underpinnings dominate the tendency to sell winners and ride losers: prospect theory and mean reversion theory.
October 01, 2010
September 09, 2010
Common Types Of Order
There is a great range of orders that traders can give to precisely control the execution of their order. Not all brokers will accept the same range of order types, but I list below the most common types of orders that most brokers should accept.
Market Order
An order to buy or sell at the current market price.
Limit Order
An order to buy or sell at a specified price or better.
Stop-Loss Order
An order to close a position if the market price hits a certain level. Note however, that this type of order means that after the stop price is hit the order becomes a market order and you may suffer slippage.
Limit Entry Order
An order to buy below the market or sell above the market at a specified price. You use this type of entry order if you feel that the currency pair will reverse direction from that price.
Stop-Entry Order
An order to buy above the market or sell below the market at a specified price. You use this type of entry order if you feel that the currency pair will continue in the same direction. Just like with a stop order, you may suffer slippage when using this type of order.
Stop-Limit Order
An order to buy above the market or sell below the market at a specified price only. When your price is hit your order becomes a limit order which prevents slippage. However, there is a chance that in a fast-moving market your order won’t be filled at all.
One Triggers Other(OTO)/ Parent and Contingent
A set of orders whereby when the parent order is filled, the contingent order is placed. This is commonly used to make sure a stop and/or limit order is placed as soon as an entry order is filled.
One Cancels Other (OCO)
A set of orders whereby when one order is filled, the other order is cancelled. This is commonly used to set both a profit-taking limit order and a stop-loss order as soon as an entry order is filled.
August 29, 2010
Types of Technical Indicators
Extracted from:
Types of Technical Indicators
The basic one, called a moving average, involves a simple formula that analyzes the average price of a security or commodity over a period of time, and when isolating time periods, it is much easier to spot different trends. Other types of indicators belong to four major groups, as follows:
- Momentum indicators - Stochastic oscillator, Commodity channel index, RSI, Chande momentum oscillator (CMO) and more.
- Volatility indicators - Bollinger bands, projection oscillator, average true range, Trading bands (envelope) and more.
- Trend indicators - MACD, parabolic SAR, linear regression, Forecast oscillator and more.
- Volume related indicators - Ease of movement, OBV, Demand index, Chaikin money flow and more.
In technical analysis, trading indicators can be categorized into three main categories as follows:
1. Leading indicators
This type of indicators tend to give traders buy or sell signals before market makes its turn. The leading indicators predict a top or a bottom of a market but they do not predict specific price levels or duration of a move. Although there are so many leading indicators in theory, it is hardly to find ones that truly lead the markets. The Leading indicators are considered to be the most useful for the beginning traders since they allow ample time for traders to prepare their trades. One thing to remember when applying leading indicators in trading is they are just telling that a move is going to happen but it has not begun yet. While it seems like leading indicators offer traders the best of all worlds, there are drawbacks when using such indicators.
One major problem occurs because it may point traders to enter a trade too early. Exposure to price fluctuations that occur before the beginning of the indicated up or down trend may cause traders to bail out early. When traders are limiting risk in a particular trade but have bought early according to a leading indicator, they may be stopped out and lose all potential for profit.
2. Time current indicators
This type of indicators tend to turn higher or lower at about the same time that a market does. They can be very helpful in long-term trading, and are considered such indicators practically as useful as leading indicators.
Though, the time current indicator does not expose to pre-move price fluctuations as much as the leading indicator does. However, traders have to make their decisions about buying and selling quickly with indicators, as the price should be making its move at the same time they are taking a position.
3. Lagging indicators
This type of indicators are those that lag behind market movements. The market moves,and the lagging indicator moves after it. These indicators are also referred to as trend-following indicators because they just follow trends and do not attempt to predict them. Using lagging indicators to make decisions about buying and selling gives traders disadvantage since this will results in buying and selling after the tops and bottoms of market trends. The goal in using a lagging indicator is that traders will be able to profitably grab a significant portion of a trend before the indicator changes direction again.
1. Leading indicators
This type of indicators tend to give traders buy or sell signals before market makes its turn. The leading indicators predict a top or a bottom of a market but they do not predict specific price levels or duration of a move. Although there are so many leading indicators in theory, it is hardly to find ones that truly lead the markets. The Leading indicators are considered to be the most useful for the beginning traders since they allow ample time for traders to prepare their trades. One thing to remember when applying leading indicators in trading is they are just telling that a move is going to happen but it has not begun yet. While it seems like leading indicators offer traders the best of all worlds, there are drawbacks when using such indicators.
One major problem occurs because it may point traders to enter a trade too early. Exposure to price fluctuations that occur before the beginning of the indicated up or down trend may cause traders to bail out early. When traders are limiting risk in a particular trade but have bought early according to a leading indicator, they may be stopped out and lose all potential for profit.
2. Time current indicators
This type of indicators tend to turn higher or lower at about the same time that a market does. They can be very helpful in long-term trading, and are considered such indicators practically as useful as leading indicators.
Though, the time current indicator does not expose to pre-move price fluctuations as much as the leading indicator does. However, traders have to make their decisions about buying and selling quickly with indicators, as the price should be making its move at the same time they are taking a position.
3. Lagging indicators
This type of indicators are those that lag behind market movements. The market moves,and the lagging indicator moves after it. These indicators are also referred to as trend-following indicators because they just follow trends and do not attempt to predict them. Using lagging indicators to make decisions about buying and selling gives traders disadvantage since this will results in buying and selling after the tops and bottoms of market trends. The goal in using a lagging indicator is that traders will be able to profitably grab a significant portion of a trend before the indicator changes direction again.
The Three M's of Successful Trading
Extracted from the book: Come Into My Trading Room, Alexander Elder
To succeed in trading, you need several innate traits without which you shouldn't even start. They include discipline, risk tolerance, and facility with numbers. In additional, successful trading requires 3M's - Mind, Method and Money.
- Mind means developing psychological rules that will keep you calm amidst the noise of the markets.
- Method is a system of analyzing prices and developing a decision-making tree.
- Money refers to money money management, which means risking only a small part if your trading capital on any trade.
Trading is a journey if self-discovery. If you enjoy learning, if you are not scared of risk, if the rewards appeal to you, if you are prepared to put in the work, you have a great project ahead of you. You will work hard and enjoy the discoveries you'll make along the way.
The first Steps
Trading lures us with its promise of freedom. If you know how to trade, you can live and work anywhere in the world, be independent from the routine, and not answer to anybody. Trading attracts people of above-average intelligence who enjoy games and aren't afraid of risks. Before you rush into this exciting venture, keep in mind that in addition to your enthusiasm you will need to bring a sober understanding of the realities of trading.
- Trading will stress your feelings. To survive and succeed, you will need to develop a sound trading psychology.
- Trading will challenge your mind. To gain an edge in the markets, you will need to master good analytic methods.
- Trading will demand good mathematical skills. A math illiterate who can't manage risk is guaranteed to bust out.
Trading psychology, technical analysis, money management - if you learn all three, you can make it in trading. The market are set to separate the maximum number of people from their money. Stealing is not permitted but markets are heavily slanted in favor of insiders and against outsiders. Markets keep changing, and flexibility is the name of the game. Market operate in an atmosphere of uncertainty. There is no certainty, only odds. Here you have two goals - to make money and to learn. Win or lose, you have to gain knowledge from a trade in order to be a better trader tomorrow. Scan your fundamental information, read technical signals, implement your rules of money management and risk control. Now you are ready to pull the trigger. Go!
Good traders keep good records. They keep them not just for their accountants but as tools of learning and discipline. If you do not have good records, how can you measure your performance, rate your progress, and learn from your mistakes? Those who do not learn from the past are doomed to repeat it.
To succeed in trading, you need several innate traits without which you shouldn't even start. They include discipline, risk tolerance, and facility with numbers. In additional, successful trading requires 3M's - Mind, Method and Money.
- Mind means developing psychological rules that will keep you calm amidst the noise of the markets.
- Method is a system of analyzing prices and developing a decision-making tree.
- Money refers to money money management, which means risking only a small part if your trading capital on any trade.
Trading is a journey if self-discovery. If you enjoy learning, if you are not scared of risk, if the rewards appeal to you, if you are prepared to put in the work, you have a great project ahead of you. You will work hard and enjoy the discoveries you'll make along the way.
The first Steps
Trading lures us with its promise of freedom. If you know how to trade, you can live and work anywhere in the world, be independent from the routine, and not answer to anybody. Trading attracts people of above-average intelligence who enjoy games and aren't afraid of risks. Before you rush into this exciting venture, keep in mind that in addition to your enthusiasm you will need to bring a sober understanding of the realities of trading.
- Trading will stress your feelings. To survive and succeed, you will need to develop a sound trading psychology.
- Trading will challenge your mind. To gain an edge in the markets, you will need to master good analytic methods.
- Trading will demand good mathematical skills. A math illiterate who can't manage risk is guaranteed to bust out.
Trading psychology, technical analysis, money management - if you learn all three, you can make it in trading. The market are set to separate the maximum number of people from their money. Stealing is not permitted but markets are heavily slanted in favor of insiders and against outsiders. Markets keep changing, and flexibility is the name of the game. Market operate in an atmosphere of uncertainty. There is no certainty, only odds. Here you have two goals - to make money and to learn. Win or lose, you have to gain knowledge from a trade in order to be a better trader tomorrow. Scan your fundamental information, read technical signals, implement your rules of money management and risk control. Now you are ready to pull the trigger. Go!
Good traders keep good records. They keep them not just for their accountants but as tools of learning and discipline. If you do not have good records, how can you measure your performance, rate your progress, and learn from your mistakes? Those who do not learn from the past are doomed to repeat it.
August 26, 2010
Trading Formula
Extracted from the book: How to Trade in Stocks, Jesse Livermore
Market Timing - When to enter and when to exit a market trade - "when to hold 'em when to fold 'em".
Money Management - Don't lose money - don't lose your stake, your line. A speculator without cash us like a store owner with no inventory. Cash is a speculator's inventory, his lifeline, his best friend - without it you're out of business. Don't lose your line.
Emotional Control - Before you can successfully play the market you must have a clear concise strategy and stick to it. Every speculator must design an intelligent battle plan, customized to suit their emotional makeup, before speculating in the stock market. The biggest thing a speculator has to control is his emotions. Remember, the stock is not driven by reason, logic or pure economics. It is driven by human nature which never changes. How can it change, it's our nature.
Market Timing - When to enter and when to exit a market trade - "when to hold 'em when to fold 'em".
Money Management - Don't lose money - don't lose your stake, your line. A speculator without cash us like a store owner with no inventory. Cash is a speculator's inventory, his lifeline, his best friend - without it you're out of business. Don't lose your line.
Emotional Control - Before you can successfully play the market you must have a clear concise strategy and stick to it. Every speculator must design an intelligent battle plan, customized to suit their emotional makeup, before speculating in the stock market. The biggest thing a speculator has to control is his emotions. Remember, the stock is not driven by reason, logic or pure economics. It is driven by human nature which never changes. How can it change, it's our nature.
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