A good example at present is thermal coal, where a massive ramp-up in production since 2000 led to an oversupply situation, exacerbated by prices falls and lower demand in the post-GFC period. While price and demand recovery is still a couple of years away, the world’s major thermal coal producers have implemented production cuts over the past three years that have led to a stabilisation in prices and ultimately will lead to modest price recovery.

The situation in the iron ore industry is vastly different. Rather than reacting to plummeting prices with significant supply cuts, Rio Tinto and BHP Billiton have continued with their implementation of new mine expansions, further dampening prices.

The rationale for this is threefold: firstly, they can weather the iron ore price downturn because they’re used to operating at even lower price levels (as evidenced by the price chart below); secondly, it’s a great opportunity to drive competitors to the wall; and thirdly there’d be a huge loss of face in reducing output after hundreds of millions of dollars have been spent on expanding infrastructure over recent years.

The lower prices of iron ore have appeared to be inevitable for much of 2014. Supply side growth has looked likely to outpace demand growth in China, and steel production has been slowed as the government looked to tackle over capacity in the industry.

So the medium-term outlook for iron ore producers isn’t hugely appealing. Chinese steel production is expected to moderate due to a combination of slower macroeconomic growth rates and transitioning away from investment-led growth to consumption-led growth. All of this will coincide with a sizeable growth in world iron ore supply between 2014 and 2018.

Global iron ore exports are expected to increase by 10% (or 144 Mt) during 2014, whilst the period from 2015 – 2018 is also expected to generate continued strong growth, with annual supply increasing by 5.7% (or 88 Mt). This growth will essentially be led by the Big Four miners, which are expected to average 85 Mt of annual production increases for 2013 – 2015, compared to 45 Mt average annual growth during the course of the previous decade. The chart below highlights the location of new sources of iron ore supply:

In terms of the pricing outlook, iron ore prices are likely to trade between $140 on the upside and $110 on the downside, but with an overall weakening of prices. The reason is that supply is growing to meet demand, meaning the iron ore market surplus will most likely expand. This surplus is forecast to persist during 2015 and 2016, driven by continued large supply increases out of Australia and Brazil combined with slower steel production growth in China.

The iron ore business has for decades been dominated by three major players – Rio, BHP and Vale – which together have accounted for as much as 80% of the world’s seaborne iron ore trade. There’s a simple reason for this – iron ore is a bulk commodity, which means it’s typically a low-margin business, requiring mining and movement in enormous volumes to generate a reasonable profit. Being a bulk commodity, infrastructure costs are huge, with returns typically generated over a significant period of time.

The fundamental characteristics of the iron ore business – high capex/ low-margins/large volumes/massive funding requirements/medium to long-term pay-back – are not features that typically attract smaller players into the industry. The ultra-high pricing environment of the past decade or so that encouraged smaller hopefuls into the sector is in no way typical. Prices leveled off and have since receded sharply as supply catches up with demand.

As a result, iron ore is predominantly the domain of mining heavyweights that can utilise their sizeable balance sheets to minimize exposure to potentially crippling debt levels and periods of price volatility.

The big miners however appear to have badly miscalculated in terms of future iron ore demand. As Richard Knights, a mining analyst at Liberum Capital Ltd told Bloomberg this week: “I’ve always taken the view that the miners had the best intelligence on this as large investment decisions are based on it. But if they get it wrong by a just a small margin, that has major implications for profitability and the share price for years to come.”

What he’s referring to are predictions by the Big Three that China’s demand for iron ore wouldn’t peak until around 2025 – 2030. However, Wolfgang Eder (Chairman of the World Steel Association and chief executive officer of Voestalpine AG, Austria’s biggest steelmaker) this week commented that China’s steel output would peak in as little as three years, prompting plant closures rather than expansions.

“There has to be a restructuring of the Chinese steel industry,” Eder said. “The iron-ore producers are getting more and more aware that their growth expectations have to be redefined. There are enormous over-capacities and more is coming on stream. This will increase the pressure,” he said.

To put things into perspective, every year for the past decade, China has added new mills with the capacity to exceed the annual production of Germany, the largest steelmaker in Europe.

But iron ore production has risen at an even faster rate, to the point where the market shifted to a point of structural surplus during the middle of this year. Citigroup forecasts that this surplus will widen to almost 300 million tons by 2017. Against such a background of excess supply, it is difficult to see a significant and sustained recovery in iron ore prices, particularly if Chinese demand is set to peak and residential construction growth continues to cool.

One of the lowest cost produces in the world is Rio Tinto (RIO). While the negative effects of a falling iron ore price are clearly having an effect on the share price, RIO has also been in the news for other perhaps more positive reasons. Glencore’s CEO, Ivan Glasenberg has been reported in the press to still be considering some sort of mega merger deal with RIO. Having said that, can we learn something from the chart of RIO? Can we anticipate an end to the current downtrend?

Since the beginning of 2013, RIO has provided us with the same reversal pattern on two occasions to indicate that the uptrend was over. On this weekly candlestick chart, I have circled with a solid line where RIO peaked in 2013 and then once again in 2014. Both patterns are what are known as a “bearish engulfing pattern”. This is where the share price of RIO opens the week above the body of the previous candle but by the end of the week it has finished below it. This dark candle engulfs the body of the prior candle. When you see this occur after a stock has been trending up for a while, then it could indicate the end of the uptrend. In both cases this proved to be correct. Now, if we look at where RIO is currently trading at, you will notice that by drawing an uptrend line connecting the prior two lows, the share price is now sitting on that line. This means that currently there is support for the RIO share price at these levels. I have also circled the prior two candles on the chart. Looking at the dotted line circle, you will notice that the body of the most recent candle is wholly contained within the previous dark candle. This is what is known as a “bullish harami”, or users of bar charts will recognise it as an “inside week”. Either way, it is also potentially signifying the end of the current downtrend. There are no certainties of course, so it will be very interesting to see how RIO trades from here and whether we receive “confirmation” of the reversal by seeing RIO edge higher.

Michael Gable is a member of the Australian Technical Analysts Association (ATAA). The ATAA is a not-for-profit association that has the primary aim of promoting the correct use of technical analysis. Membership consists of both professional technical analysts and private individuals who use technical analysis to assist with decisions related to trading and investing in the financial markets.

Most self-directed investors and traders have found trading from a desk at home is at times lonely. If you have been trading for a while this is not news. When markets are going their way there is no one to celebrate with, and conversely when trading is not going well there is no fall back into the comforting and encouraging dialogue of the psychology coach which everyone seems to look for in dark times of trading.

Or is there? What about that little committee of voices that we sometimes listen to? That little voice that sits on our shoulder constantly coming up with different scenarios and debating a course of action when a decision is required? That committee is the voice that suggests we stay in a winning trade a little too long to watch the profits whittle away or stay in losing trade just one more day with all the correct reasoning for the decision that actually makes sense at the time. Regardless of the action, the committee is able to provide justification.

Firstly let’s look at what a committee is supposed to do. As described above, a committee is subordinate group brought together to provide discussion and to vote on an outcome. This is then relayed higher up for further decision making.

As described, the committee will provide several different answers. And each one is formally voted on and passed to a higher level. When we shrug our shoulders and say “ I don’t know”,  this simply means the committee has not come to the vote.

Taking the next step
One of the hardest questions I was ever asked is: what do you want from your trading? This really was a lead in to ask, why are you trading? If you cannot write the reasons for why am I trading down on a piece of paper, get one out now and make a start.
The other questions to answer are:

• Why do I take an interest in the markets and risk my capital?
• Why do I go to those trading meetings and listen to webinars?

As experienced traders find out and every trader will eventually discover, this endeavour may be the hardest vocation ever attempted, so there needs to be a very clear “why”. This reason must be so strong it will keep the trader focused on his or her target outcome no matter what the market provides in the way of price movement and volatility. If this “why“ is about “beating the market” for returns, rethink! This is far from a specific outcome and does not take into account bear markets and market corrections. If beating the market is about losing less than a falling market, this is not trading – it’s just managing capital.

Cutting to the chase

Committees came in different shapes and forms. One of the strongest is the personal ego. When the ego committee gets hold of the “why” there are all sorts of debate and the requirement for more information to come to a conclusion to satisfy the ego itself. Bad move!
This ego driven decision making often has nothing to do with the market movement itself, but rather holding out to the originally desired outcome (in effect holding on to bad trades waiting for the outcome that will satisfy the personal ego of the trader).

It’s very easy for the trader to identify ego trading when a number of indicators or reports are referenced to justify the position. The other way to know it’s ego trading? Have you ever heard the words “it will come back”?

Rule based trading
Everyone knows about it, but very few master the ability to put the committee aside and let the market trade for you with rule based trading.

There are an infinite number of potential trading systems based on types of market and different time frames. At a common level, however, the trading system that works is price-based entry and exit, as all markets offer this daily.

A trading system can be designed by a trader to suit their lifestyle and risk profile. At the end of the day the system itself has to trade not the trader. The trader is best advised to work on ways of eliminating the committee based trading system and letting the rule based trading plan do its work.

This is where survival in the markets begins.

Rule based trading has fixed entry signal and fixed exit levels. Rule based trading does not refer back to the committee for information or clarification. Rule based trading is a trading plan written down. Rule based trading has the actual trade identified and mapped out before the entry order is placed, and this includes risk per trade and position size for the position. Finally, rule based trading know the maximum risk before the trade is placed.

Gary Burton is a technical analyst with First Prudential Markets with more than a decade experience trading in the Australian stock market. He is the president of the Sydney branch of the Australian Technical Analysts Association and a regular on Sky Business Lunch Money.

Act on Your Stops
Aldous Huxley stated that “facts do not cease to exist because they are ignored”. If you recognise that a bear market is in place, the first step is to review your existing portfolio. Take a close look at where you have set your stop losses, and make sure that these levels are consistent with your trading plan. If your stop is hit, exit immediately. Do not ‘hope’ that your shares will recover. Traders tend to hold onto shares that are trending down, yet sell shares that are trending up prematurely. This trait will ensure that you will stay amongst the mediocre masses, and never fight your way to the top of the class.

Writing Call Options
There are two types of call options – a covered call and a naked call. A covered call is where you own the underlying stock. If you are exercised (ie you are told to sell your shares) and you have written a call with an option strike price greater than your share purchase price, you will realise a capital gain on the share. This is in addition to the premium (eg 40 cents a share) that you received for writing the call. This is the safest way to begin in the options market. Be aware that you must only write options against shares that you are willing to sell, or you will need to take defensive actions to remove yourself from risk before being exercised. By consistently writing calls over shares that you own, you will receive a cashflow similar to receiving a dividend cheque in the mail every month.

If you do not own shares, you can write a naked call. Writing a call assumes that you have a sideways or downtrending view on the future share price action prior to the expiry date of the option. As long as the share price stays below the strike price of the option, then you will get to keep the full premium that the option taker paid you. If the share price goes above the option strike price, you are likely to be exercised, and told to deliver shares to sell to the option taker. Unless you own these shares, you will be required to buy them at market value, and then deliver them to the option taker. This strategy is best reserved for professional traders, or traders that fully understand the risks involved.

Bought options depreciate in value, right up until a defined expiry date. This is called time decay. Once you have sold another trader an option, if all other things remain equal, the option will expire worthless. You will have the money in your bank account and the buyer of the option will be holding a worthless asset. In fact, up to 80% of people lose money when buying options.

Buying Put Options
Writing options involves collecting a small fixed premium, yet incurring a theoretically unlimited loss. Buying options has a lower probability of success, yet due to the leveraged nature of this strategy, the rewards from the 20% of trades that do work, may outweigh the losses from the 80% of losing trades.

In the options market, as the share price drops, the price of put options increase, often very dramatically. If you buy a short dated option, then time decay will erode your profit. For this reason, it is preferable to buy an option that expires in at least four months or more, and exit before the final month.

Short Selling
Usually when we buy a share, we are hoping to buy it at $5.00 for example, and sell it at $10.00 at a later date. Short-selling performs this same process, but in reverse. In effect, you borrow shares that you do not own, sell them with the expectation that the share price will drop, then buy them back at a later date. Your profit or loss is the difference between your sell price, and your buy price – so if the share price drops, you make a profit. If the price increases, you will incur a loss. It is actually quite a simple concept, yet less than 1% of transactions in Australia are executed utilising this method. There are approximately 300 shares that can be short-sold on the Australian market.

In the majority of cases, a leverage of 5:1 applies as brokerage firms usually require you to lodge 20% of the value of the initial share price in a cash management account. Be aware that you will be margin called, and required to place more money into this account if the share price trends upwards (against your initial view). Remember that these strategies must be used with shares that have sufficient liquidity, or you will have trouble extracting yourself from the position if the market suddenly turns bullish. This is absolutely essential, as there is nothing worse than being trapped in a trade due to of lack of volume.

The sharemarket will continue to redistribute wealth to the people that are determined to educate themselves. Much of our success is ultimately determined by the strategies that we implement, as well as our discipline and mindset. Your financial future is in your hands.

Louise Bedford (www.tradinggame.com.au) is a full-time private trader and author of four best-selling books – The Secret of Writing Options, The Secret of Candlestick Charting, Charting Secrets and Trading Secrets. Register on her website to receive a free trading plan template and a 5-part e-course to get you trading like a machine.

A more accurate way to measure volatility for any market
Instead of the broad VIX reading, the most accurate way to measure volatility is using the Average True Range (ATR) indicator, introduced by J. Welles Wilder. The ATR measures how much a market is moving, taking into account any overnight gapping. This indicator is critical, as it can be applied to any time frame chart you are trading.

ATR calculation and different time frames
Calculating the ATR is as simple as applying the indicator to your chart on one of the popular charting programs, such as MT4, cTrader, Metastock or AmiBroker. However, it’s always good to have an understanding of the maths behind each indicator.

Below are the three values which are averaged to get the Average True Range:

• Today’s high minus today’s low
• Today’s high minus the previous close
• Today’s low minus the previous close

Once you have those figures, you take the average over a set number of periods. The default on most programs is 14, which accounts for two trading weeks on old charting programs ( which includes weekends). Today many modern traders use 10 as the default value as charting programs haven’t plotted weekends for decades.
More importantly, you can use the ATR reading on any time frame. So if you are charting on an hourly chart, then the ATR reading will look back over the last 10 periods (10 hours) and give you the average range over that period. Likewise for 5 minute charts or 1 minute charts.
Below is a chart of the ATR on the Euro Dollar on a daily chart. Note how much the volatility has spiked in recent months. The Forex market in the middle of this year had near record low volatility, but a number of factors have changed that, including the Russion/Ukraine tensions, ECB hinting at quantitative easing through a new bond purchasing program, and sanctions for Germany plus others. Together these events have pushed the average daily movement on the Euro Dollar up 250%, from 42 pips per day to 147 pips per day in 10 short weeks.

Applying the theory
How can you use the ATR in your trading:
1. Use the ATR to filter your opportunities.
2. Use the ATR to calculate your initial stop and trailing stop.

Let’s take a look at each in more detail.
1. Use the ATR to filter your opportunities
We have the greatest opportunity in the markets when they are moving, and when the volatility shrinks, so to does our opportunity. Therefore we can be more selective and only trade stocks, forex, commodities or indices when they are moving a certain amount on a daily basis and look elsewhere when they are extremely low in volatility.
As an example you could run daily scans across the entire ASX market and only trade those stocks that move at least 1% per day. In Metastock the code would be ATR(10)/Mov(C,10,S)>0.01 indicating that the 10 day ATR is moving at least 1% relative to the average closing price in the last 10 days. The same concept can be applied across forex, indices and commodities.

2. Use the ATR to calculate your initial stop and trailing stop
Knowing where to place your initial stop stumps a lot of traders, especially those who have the grand vision that all their trades are going to be instantly successful. Smart traders build an initial stop loss into their process so if the trade doesn’t work out, they can exit with their capital intact.
Ideally your initial stop needs to be more than 1 average daily movement or else (on average) you stand a very good chance of being stopped out on the same day. With an initial stop it is best to place it at a distance of at least 2 ATR. Here is an example and this is why it is so important to constantly monitor how much a market is moving.
On the 5th of August, the Euro Dollar was moving around 42 pips per day and the closing price was 1.3375, so if you were buying your stop calculation would be:
Stop = 1.3375 – 2*ATR
Stop = 1.3375 – (2*0.0042)
Stop = 1.3375 – 0.0084
Stop = 1.3291
Fast forward to October 16th and the Euro Dollar is now moving 147 pips per day. If you had maintained an initial stop of 42 pips, you would be well and truly within 1 average daily movement and likely to be constantly stopped out, ending in a great deal of frustration.

Applying it to your trailing stop loss
So now you know how to identify a reasonable initial stop loss, you can then start to apply the same technique to your trailing stops. The advantages are very clear. Instead of just using a set figure (ie 30 pips or 30 cents), you can now adjust your trailing stop, taking into account the volatility of the instrument you are trading, which, as shown above, can vary considerably.
Your trailing stop will kick in once your initial position moves enough in your favour to move past break-even. Then it’s simply a matter of trailing the 2-3 times ATR from the open, high, low or close and continue to raise it until you get taken out of the market, making sure to never lower your stop.
Understanding the volatility of the markets you are trading is critical and can help give you the additional tools needed to become a well-rounded trader. Be sure to apply this to your trading plan and I wish you every success going forward.

Ashley Jessen is the author of CFDs Made Simple and Director of Communications at Invast Financial Services, one of the largest global markets brokerage firms offering Forex, CFDs, Direct Equities and their proprietary ST24 platform.

With some investors taking a view that markets could recover from here, some will want to know what the charts are saying about a defensive stock such as Telstra. With the share price having fallen dramatically with the broader market, at what point does the share price start to look attractive?

Sometimes stocks will trade within a fairly defined range for a period of time. BHP has famously spent most of the year trading between about $35 and $39, before recently breaking down from that. Telstra has also been in a range for the last year and a half. However, the range itself has been trending higher over time. As seen on the chart, the stock could have potentially been bought at the lower limits of this channel each time and it would have seen the stock trade higher. It neatly satisfies the definition of an uptrend which is a series of higher highs and higher lows.

Once again the stock is at the bottom of its range. There appears to be some support here and we may now get a bounce in Telstra towards $5.50. However, the next dividend is not due until February, so we do not have the prospect of an upcoming dividend to keep the share price additionally supported. So after bouncing here in the short term, there is the potential for Telstra to then dip down towards lower support in the $5.10 – $5.20 range. That would be consistent with a volatile market that is beholden to movements in the currency. This level was derived by noticing that it appears to have been “touched” a few times by the share price. Also, it represents the previous low in the recent uptrend. Telstra is currently on a yield of about 5.7% plus franking.

Michael Gable is a member of the Australian Technical Analysts Association (ATAA). The ATAA is a not-for-profit association that has the primary aim of promoting the correct use of technical analysis. Membership consists of both professional technical analysts and private individuals who use technical analysis to assist with decisions related to trading and investing in the financial markets.

Why are they cheap?
Traders often buy options that have nominal time to expiry, which means that their bought asset is depreciating like a time bomb. Most options expire worthless and are only ever traded once. People don’t like to be “wrong”. They would rather sweep their bad trade under the carpet, along with any remaining value that they could claim by closing out their position, than confess that the trade didn’t work. There is no room for this type of ego in trading.
Often, naive traders underestimate the strength of a move required to affect the price of the option. These unfortunate souls believe that, even though BHP may have increased by only 10 cents in a month, it could potentially jump $10 within three days (when their option expires). Magically, BHP should recognise the brilliance of the trader with the deal in play and co-operate!
The concept of delta and gamma becomes extremely important in this situation – but, rather than learn what these terms mean and how to use them, overly optimistic traders would rather just place their orders and take their chances.
Delta measures the sensitivity of an option price to changes in the share price. Gamma measures the curvature of delta, so it can act as a precursor indicator when to exit a position. For advanced option plays, these two “greeks” or “option sensitivities” can greatly assist your chances of extracting a substantial profit.
When you next see that amazing bargain option at two cents, ask yourself why it is that price. Maybe there is a reason that you haven’t explored. Perhaps you are about to buy an option that is actually worth that small amount, not an option that has been mistakenly under-priced by market dynamics.

Brokers
Brokers receiving commission based on the number of contracts you buy – rather than your overall exposure – may urge you to buy cheap options with a short time before expiry because they make more money. This way, they convert your trading capital to brokerage with lightning precision. Don’t rely on your broker to guide you in this arena. Stand on your own two feet and take responsibility for your future by educating yourself about options, and identifying trades with a higher probability of success.
There is much less risk on the part of the broker when dealing in bought positions in comparison to written positions. Written positions contain contingent liability. This requires careful monitoring by both the client and the broker to eventuate in a profitable trade.
Alternatively, your trading account can be loaded up with bought positions without the need for close monitoring. With bought options, the worst thing that can happen is that you will lose everything you placed into the trade -you can’t lose your house. This is much simpler for brokers to monitor, and has the side benefit of their not ending up behind bars for inaccurate suggestions that led to their client’s financial collapse.
Buying at or in the money options with two to four months to expiry will often seem like a more expensive trade, but it is much more likely to eventuate in a profitable trade.

Written positions
When I first started writing naked options on NAB, I reached a startling conclusion. I was presented with two choices. I could choose to write five close-to-the-money option contracts, where I would seemingly take on more risk as the share price could easily break through my strike price, or I could write 28 option contracts that were miles out of the money, yet receive the same amount of money overall. For a brief moment, I thought I was completely brilliant!
Can you see the problem with writing more contracts but receiving the same amount of money in total? If you can’t see the problem with this, stop writing options immediately! I have one word that you must learn about before you progress: EXPOSURE.
By writing many more cheap option contracts, it seems as if your trade has a higher probability of success. However, what happens if a huge announcement is made, or if the share price goes ballistic? Your exposure is completely blown out of the water! Rather than being liable for 5000 NAB, I would have become responsible for 28,000 NAB if the trade had backfired. Yikes!
When we begin our trading career, we are strong, brave and bulletproof. The market had better not cross us. Unfortunately, the trading world doesn’t work this way, and often the market will provide a proverbial kick to our soft underbelly to ensure that we don’t repeat our past errors of being too cocky.

Louise Bedford (www.tradinggame.com.au) is a full-time private trader and author of four best-selling books – The Secret of Writing Options, The Secret of Candlestick Charting, Charting Secrets and Trading Secrets. Register on her website to receive a free trading plan template and a 5-part e-course to get you trading like a machine.

In search of the Holy Grail

Expectations are a powerful thing and unfortunately, many trading related articles paint the illusion of the fast road to riches and incredible wealth by following a simple red line crossing above the green line. Often the expectation is set in place that the system you are about to purchase, the Expert Advisor (EA) you are about to download or the trading educator providing their ‘life’s work’ is going to be the Holy Grail, finally providing you with enough profits to say goodbye to the daily 9-to-5 grind. In reality, there is no Holy Grail when it comes to trading systems, but instead, successful trading is a combination of consistently identifying sensible risk reward opportunities with persistence and discipline.

What is the risk reward ratio?

In its most basic form, the risk reward ratio is exactly what it says on the box. It is the amount of potential reward, relative to the risk you take on. In the table below I’ve listed the various trading instruments with hypothetical stop loss and profit taking levels and the risk reward levels that these generate. By way of example, you can see the risk reward ratio is a function of the size of the stop versus the size of the potential reward.

Risk reward levels can be applied to all time frames across any asset class and can even be used for other investments as well – such as managed funds, property or business – but today we’ll be focused on applying this to our trading.

How do you calculate the risk reward for potential trades?

Calculating your risk reward is relatively simple and is often done using technical levels on your chart, such as support/resistance levels, Fibonacci, Average True Range (ATR), Ichi Moku and price projection based on chart patterns. While not exact, they do provide a method to determine the potential risk reward on your upcoming trading opportunities, allowing you to focus on those with the highest potential.

Three ways to take advantage of the risk reward ratio in your trading.

1. Only trade opportunities that meet your risk reward levels and are within your tolerance for risk

Ultimately you need to understand that you control when you pull the trigger to execute a trade, which means you are responsible for each trade you take. For the savvy trader, this is good news. You have the flexibility to take trades that meet your criteria and more importantly, reject those that aren’t up to scratch. Set a benchmark for trades you will accept, such as only trading those opportunities with a 1:2 or 1:3 risk reward ratio.

2. Remove the emotion from your trading

No trader enjoys being wrong, but since most trading systems are wrong 40-60% of all trades, some traders cannot help but get caught emotionally and let this deter them from taking the next trade. It is not uncommon for traders to be immobilised by the fear of loss and just the thought of executing the next trade is enough to induce a cold sweat, and in some extreme cases, being physically ill. By focusing on the risk reward of the trade and understanding the numbers of your trading system (percentage win and average size of wins compared to losses), traders are able to confidently take the next trade, knowing full well that the outcome is unknown but they have put the odds of a successful trade in their favour. This factor alone is one of the most powerful ways to gain control of your trading edge in the markets and will allow you to fully exploit the advantages you have built into your trading system.

3. Scale up once you have built the confidence in your trading system

You’ve now identified the risk reward of every trading opportunity and only take those that meet your strict criteria. You’ve also removed yourself emotionally from the thought of being right or wrong on the next trade. You’ve also managed to discipline yourself over the past six months with these principles and you’ve built up your confidence enough to scale up your capital base to the next level from your current base. Congratulations. This is the path of a mature, successful and constantly improving trader.

By applying the concept of risk reward when identifying your next possible trades, you have, over time, put the odds of success in your favour and are now able to allocate a sensible amount of risk to your trades, but at a higher level than before.  For example, when testing over the first six months, you allocated say $200 risk to every trade (1% of $20,000 capital base), just to test the validity of your system and to build confidence in your trading system. Now you have $50,000 in capital to allocate, of which you will still allocate 1% risk – but now it will be $500 per trade and your profitable trades will potentially be a multiple of your higher capital base.

Imagine doing this over a two-year period, building confidence in your system(s) every six months and upon evaluation, considering whether you can scale up to the next level, always staying within a dollar risk amount that allows you to sleep comfortably at night. What level of trader would you be two years from now or perhaps five years from now?

Hopefully those are motivating thoughts and inspire you to utilise the power of risk reward ratios in your trading and more than surpass your trading goals and financial objectives well into your future.

Ashley Jessen is the author of CFDs Made Simple and Director of Communications at Invast Financial Services, one of the largest global markets brokerage firms offering Forex, CFDs, Direct Equities and their proprietary ST24 platform.

The stock market feeds straight into our primal instincts of survival. These instincts were there with primates to survive in the wild and have continued to now, although it’s not just simply physical safety and food that are the primary concerns any more. Now it’s in the form of money, the currency of survival.

Each of us expresses this survival instinct differently when it comes to money. Some just want to protect what they have and the fear of losing is pronounced. Though this instinct is inherent in all, to some it’s more pronounced and dominant. This dominant tendency may be in the group of people who have lost money in the past due to failed businesses, scams or bad investments (or just bad investment decisions) in addition to those who do not have the capacity to replace their savings. For this group, the fear of losing tends to be the dominant factor in their decision making when it comes to money.

Negative news and noises tend to be given higher credence when it comes to decision making. This “noise” or information tends to ignite the fear quicker than the average person. Warning signs may be taken as alarm bells and preventive actions may be taken prematurely.

For example, these reactions could be in the form of selling shares too early to lock in small profits whilst missing out on the big rally. It could be acting irrationally and impulsively by over-reacting to negative news and stories in the media. Inactivity (when one should be acting) is another product of this tendency.

Nevertheless this sensitivity can have a positive effect if one learns to use it as a signal “to pay attention”. Traders with a higher fear of losing can be more careful investors than the average and this tendency can translate to more circumspect strategies in managing risks of negative events, like gradual profit taking or the taking on of downside protective strategies or investing in less risky investments.

So, while thefear of losing is normal, if it is dominant then there are strategies to balance it out when investing and dealing with money. Firstly, recognise that it is dominant in you. Then one can invest differently to reduce the incidences of this sensitivity being triggered resulting in impulsive decisions. These can be investments with downside protection, those that have less volatility and lesser risk for big movements. Thirdly, as a longer term strategy, consciously overlay money decisions with a filter of neutrality when it comes to information and the consideration of risks to the downside and losses, asking yourself questions like; “Am I being objective here, am I only focusing on the negatives, or is there more upside to the fear of possible downside?” or even, “Am I overly negative and biased in this decision?” This helps and forces one to be more neutral and objective and hopefully reduces decisions that are biased by this dominant factor of fear of losing.

Do you have a question for Wai-Yee Chen about trading? Send your question to editor@traderplus.com.au 

Wai-Yee Chen is an investment author and a derivatives specialist adviser. With almost two decades of investment experience, she is regularly sought by the media and shares her insights on radio and TV networks such as CNBC and SKY Business. Wai-Yee is a well-respected contributor/columnist for the Australian Financial Review and other business media. Her latest book NeuroInvesting uses neuroscience and real-world stories to explain how successful investors think differently.

Entry Signals

To actually enter a position requires a set-up, and then a trigger. The set-up may alert your attention to a possible trend, but a trigger is required for you to actually enter a position. Describe some of the key set-up signals that you would look for that indicates that a share is in an uptrend and the conditions that would trigger your entry. List as many as you can.

If you mentioned any of the set-ups and triggers listed here, then you are on the right track:

• Share prices are predominantly above a 30-week exponential moving average (Set-up)
• A golden-cross with two moving averages of different time durations e.g. a 30- week exponential moving average and a 15-week exponential moving average (Set-up)
• A rising momentum indicator at a historically low level (Set-up)
• An upwards sloping trend line (Set-up)
• A momentum histogram showing higher highs while the share price is also displaying higher highs (Set-up)
• Heavy relative volume when a share moves upwards in price (Set-up)
• Low relative volume when a share moves down in price, compared to when it moves upwards (Set-up)
• A predominance of white candles compared to black candles (Set-up)
• Longer white candles compared to black candles and/or a series of candle tails pointing downwards indicating buyers moving into the market (Set-up)
• Ease in the share’s ability to break through round dollar value figures e.g. $5.00, $5.50, $6.00 etc (Set-up)
• A series of higher lows and higher highs (Set-up)
• Buy when a share breaks out from a base formation on a white candle or a gap (Trigger ie a breakout trade)
• Buy when a top reversal pattern that fails (Trigger)
• Buy when a gap hurdles a previously established level of resistance, particularly on heavy relative volume levels, during an existing uptrend (Trigger ie a breakout trade)
• Buy when there is a breakout through a significant resistance line on heavy relative volume, preferably initiated with a white, bullish candle, or a gap (Trigger ie a breakout trade)
• Buy on a confirmation of a recovery (eg white candle) from a period of retracement (Trigger ie a retracement trade)
• Buy when a resistance line that becomes a line of support (Trigger ie a retracement trade).

You may have added in a few more, which is terrific. The key is to put into writing the set-ups signals and the triggers to ensure your entry into a particular share. Make the wording unambiguous, and define each signal as carefully as possible. In times of trading pressure, you will need to have some simple methods to ensure that you are thinking clearly.

Exit Signals

Would you be able to instantly spot whether a share is in decline? This may assist in helping you avoid buying a share that is currently trending downwards. It can also help when trying to identify ‘shorting’ opportunities, which is a specific strategy that enables you to make money out of a downtrending share. Try writing down the indications that you would use to suggest that the sellers are more aggressive, and that the share has turned bearish. Think about a set-up and a trigger as you did in the entry examples.

You are doing well if you wrote down any of the signals listed here:

• Share prices are below the 30-week exponential moving average and a downwards sloping trend line (Set-up)
• A dead cross between two moving averages of different time durations e.g. a 30- week exponential moving average and a 15-week exponential moving average (Set-up)
• A falling momentum indicator, especially at a historically high level (Set-up)
• Heavy relative volume when a share moves downwards in price (Set-up)
• Low relative volume levels when a share moves upwards in price (Set-up)
• A predominance of black candles compared to white (Set-up)
• Longer black candles than white candles and/or many candlestick tails pointing upwards showing seller pressure (Set-up)
• Failure to push upwards through round dollar values e.g. $2.00, $2.50, $3.00 etc (Set-up)
• A series of lower lows and lower highs (Set-up)
• Enter a short sell position on a gap downwards past support in an existing downtrend (Trigger)
• Enter a short sell position a break downwards through a significant support level, especially on heavy relative volume, preferably initiated with a black, bearish candle or a gap (Trigger)
• Enter a short sell position when the share price trades at a lower price than a bottom reversal pattern (Trigger)
• Enter a short sell position when the share prices close beneath an upward sloping trend line (Trigger)

Once you have been able to express in writing your exact entry and exit signals, then you may be able to program these parameters into your trading software package. This will help you search for buy and sell signals that fit your own unique trading style. You need to spell out your search requirements precisely or the results derived will be useless.

To help you pursue your trading goals, if you would like to download a trading plan template called a ‘Trading Plan Review’, there is one available for free from my website www.tradinggame.com.au. It will help you work through all of the vital issues that need to be included in a sophisticated trading plan to give you an edge in the sharemarket.

Louise Bedford (www.tradinggame.com.au) is a full-time private trader and author of four best-selling books – The Secret of Writing Options, The Secret of Candlestick Charting, Charting Secrets and Trading Secrets. Register on her website to receive a free trading plan template and a 5-part e-course to get you trading like a machine.