I’ve never spent any time on elite trader’s forums, but this morning I looked around. I didn’t know whether to laugh or cry. I felt like the ask a ninja guy… I kept thinking “I look forward to taking the other side of your trades soon!” (If you’ve never watched Ask a Ninja, then you won’t get that, but it’s not really important.)

My favorite quote of the morning:

“My problem is when the trade goes against me I should double down cause it always ends up a winner but I don’t … “

I had to read it twice, just to be sure. This person says their biggest problem is they don’t double down on losing trades enough! It always ends up a winner? Ha!

The number of people that said “a stop loss is a crutch that hurts your P/L,” with no one disagreeing with them, was astounding to me. Crazy Stuff.

I finally made a trade this week! I was beginning to think I had forgotten how…

If you glance at my stocktickr watchlist, you will see that it is bright green! It’s been a good week for it, with Terex Corp. (NYSE: TEX), Steel Dynamics Inc. (Nasdaq: STLD), Furniture Brands International Inc. (NYSE: FBN), and Hexcel Corp (NYSE: HXL) among others all moving through my targets. I hope if you are following along with me, it has given you some profitable ideas. But, for one reason or another, I have been unwilling or unable to enter any of those trades! At least, I can stroke my ego about my stock selection skills. That doesn’t keep the electricity on, however…

Today, I got the alert email for Building Materials Holding Corporation (Nasdaq: BMHC) right after the open. This is a short entry I’ve been waiting on. I thought “great, another one I’m going to miss,” because it’s too easy to get chopped up in the open. But, I watched it, and saw it run back up to my price and halt just under it. Here was my low-risk entry! So, I got in and out pretty quickly for 1.5 R. With the markets flat near the open, I wasn’t inclined to try to hold for a longer run. I’ve been out of the trade for 15 minutes or so, and the price on BMHC is almost 10 cents above my exit, still, so I’m happy. Not a bad way to start a morning.

Stocks Mentioned In This Article
Stock	Links
TEX	| |
STLD	| |
FBN	| |
HXL	| |
BMHC	| |

More and more people are moving to 15 and 30 minute charts for day trades, since it helps them avoid overtrading, and avoid getting chopped up in fast chart noise. It’s also just a lot more relaxing to watch! But, is that the best way to achieve these goals? In this article, I’ll describe an alternate approach to trading off slow X-minute charts.

A Motivating Example
I’ve been looking at examples of so-called Dummy Trades recently. I’m no expert, but it seems a major element is locating a narrow range 30 minute bar, and then trading with the overall trend. For long plays, the entry will be a break of the narrow bar’s high, and the initial stop will be below the bar’s low. Other than being a convenient way to identify a tight stop, I think the narrow bar represents a mini-consolidation period, after which a breakout on volume is likely to propel the price enough to make a good risk:reward trade.

But, this got me thinking… on a 30 minute chart, you’ll see consolidation from 10:00 to 10:30, no problem. But what if the consolidation is between 10:20 and 10:50, with bigger moves on either side? There’ll be no narrow bars on the chart, but isn’t this 30 minutes of consolidation just as good for trading?

(I’m using dummy trades as an example because I’ve just started reading about them, and they are fresh on my mind. But, I believe this article is applicable to any trading system.)

How 30 Minute Charts Can Hide Trading Opportunities
Slower charts like 30-minute or 15-minute candles can lead to better decisions, because they don’t bombard the trader with lots of noisy information. But, they do this by breaking the day into a few large-grain chunks, and a lot of useful information is hidden inside.

I’ll continue the dummy-trading type of example. Here’s 2 hours of (fake) 1-minute chart data (click to enlarge). There’s no time or scale on it, but let’s say this chart goes from 10:00 to 12:00, so it’s easy to talk about:

See how there’s a period of very narrow price action right before the drop at the end? Here’s the 30 minute candle version of this chart:

Where’s my consolidation? Where’s my low-risk entry? It’s invisible… Further, I’ll claim that all intraday bar and candle charts put a false significance on “open” and “close” values. I know what it means for a stock to close at $11 on Tuesday. I’m not sure I understand what difference it makes where a stock “closes” at 10:30, and 11:00, etc, other than you can sometimes see the effect of lots of traders looking for specific candle shapes.

An Alternative Approach
There’s more than one way to de-noise data, and I’m going to suggest that breaking my day into 30-minute chunks may not be the best way. What I’d like to do is retain the slow-changing, summary-level properties of 30-minute chart data, but get back the precision and responsiveness of a 1-minute chart. Clearly I’m going to have to compromise, somewhere.

In my past life as a computer scientist doing signal analysis algorithms, one way I would make just such a compromise is by applying sliding window techniques. As the name suggests, this method is like cutting a hole into a piece of paper, and laying that over a chart. You can only see the data in the “window.” So, you do your analysis on that window of data, and then slide the window over a little and repeat your analysis. A moving average is an example of a sliding window calculation, as are many other standard indicators. If it’s not clear yet, hopefully the next paragraph will shed some light.

The most important thing about sliding window techniques is that the windows overlap. Why is this important? Well, look at the 30 minute chart above. That’s an example of non-overlapping 30 minute windows. All we’ve got is 10:00 to 10:30, and then 10:30 to 11:00, and some useful data is invisible to us. But, what if we had all the overlapping candlesticks for 10:01 to 10:31, and 10:02 to 10:32, and so on? If we did, a few of those candles would show us the consolidation area we can spot in the 1-minute charts, even though we’re still always looking at 30-minutes of data at a time. That is how sliding windows bridge the gap between summary data and noisy precision.

Finishing the Example
So, if we’re looking for 30 minutes of narrow-range activity, we could just chart the 30-period high and 30-period low from our 1-minute data. This is an example of a sliding window calculation, since the first data point for the 30-period high represents the high from 10:00 to 10:30, and the second point is the high from 10:01 to 10:31, and so on.

A chart of the 30-period high/low data is below. Notice that we aren’t superimposing the data on top of the one-minute candles themselves–that’d reintroduce the noise and confusion that we’re trying to avoid. We’ll just look at the slower, derived data:

You can see, it’s a little noisier than the 30-minute bars, but nowhere near as distracting as 1-minute candles. That’s our compromise, and what we get for it is the ability to see that period where the range contracts. Now we can spot any half-hour period of consolidation, and can take our entry.

What, no Bars? No Candles?
A lot of us take for granted that when we’re trading we should look at the open-high-low-close price data, usually in candle or bar form. But, why do we think this? Candles and bars are just summarizing indicators, no different than moving averages or bollinger bands. We tend to think of them as “raw” market data, but one look at the 30-minute chart above shows that this is clearly not true.

So, what should we be looking at? I’d say you should consider devising a set of indicators that are designed to show you exactly what your system looks for, and little else. If you need to see a half hour of narrow range, the price channels above are a good way to go (for extra credit, plot them as % of the price, so that a 2%-wide channel looks identical for every stock you watch). If you want to know the direction of the overall trend, put a single +, -, or 0 on your screen that corresponds to slope of an appropriate moving average.

I realize some ideas like this would require custom programming, but the closer you can get to these ideals, the better. How many good trades have I passed up because I noticed something random on my charts that made me hesitate? How many bad trades have I gotten into because I noticed something random on my charts that I liked? All that extraneous information just begs a trader to step outside their system. Try to get rid of it!

Summary
We all have a goal of eliminating distracting and unwanted information from our screens. Fast charts can make us overtrade, or choose entries that leave us chopped up. As shown here, though, slow charts come with their own set of problems. By using summarizing indicators, and sliding window techniques, you can eliminate fast chart noise while retaining fast chart precision. Think about what conditions trigger your trading system, and then figure out which indicators will point out these conditions in the most obvious and precise way. Consider leaving bars and candles off your screen unless you really need to see the data they’re presenting. If you do watch intra-day candles, keep in mind that a small time-shift of the time-and-sales can drastically change the look of the chart even though the price action is identical.

I decided to only trade hits from my watchlist today, and just observe things otherwise. Which made for a boring day as I didn’t notice anything on my watchlist hit. yawn…

I didn’t have CNBC on, but around the 2:15 time, I didn’t see hardly any movement in the markets. Maybe 10 minutes later, there was a bit of a drop. I imagine that lots of people had loaded up long, expecting a positive reaction. So, when they were disappointed, they started dumping their shares. Just my speculation.

So, I hope tomorrow feels like a normal day, since I saw relatively little effect from the big meeting today.

Blog Additions
On the blog, I’ve added a couple buttons at the top. One tries to provide organized links to articles I’ve written. The other is where I’ve started to add book reviews (just 1 so far, maybe I’ll add another tonight).

Well, what can I say? There were more trades this week than the previous two. And, if you add in the paper trades from Wednesday, it would be 7 trades for the week. But, I’m still in an awfully cautious mode right now. I’m trying to learn what makes these recent sessions “tick,” if you know what I mean. Consider today, for instance. If you look at the indices at the close, it was a flat day. But, since everything opened so far up (the Dow was at 130+ within minutes of the open), it played out like a big down day. I guess I need to start focusing more on the market direction, and pretty much ignore the amount it’s changed from yesterday.

I shouldn’t complain about a 60% win rate, but I’d really prefer to win 4 of 5… I got chopped out of a winning trade Tuesday that would have made my results much better. I’m going to keep in mind that I should widen my stops a little on sideways choppy days.

Ever wonder why a 1:3 Risk:Reward ratio is so prevalent as a rule of thumb? Ever since I’ve been reading about trading, I’ve heard people say that they ideally look for at least a 1:3 ratio, even if they’ll settle for 1:2. In this article, I’ll talk about how you can derive this value form the expectancy equation. Further, I’ll show how you can predict what kind of Risk:Reward ratio is right for you.

If you are math-averse, you can skip the equations; examples are given and explained.

What Should My Minimum Typical Gain Be?
Let’s say the minimum acceptable trading performance is flat. That is, at a minimum, you should not be losing money over time. How much money should you be making on your winning trades to achieve this performance? If you know your historical win rate, and assume your typical loss is a full 1 R, then this is the equation you need:

gain = (1 - winrate) / winrate

This equation answers the question “What typical R gain will make my expectancy equal 0, assuming I always lose a full 1 R when I lose?” So, obviously, typical gains greater than this value will give you a positive expectancy.

Let’s work an example: Say my win rate is 40%. Then, the equation above is (1 - .40)/.40, or 1.5. That means I should only enter trades where I average at least a 1.5 R gain when I win. If I always trade at that minimum, my account will not grow or shrink, long-term. To intuitively see how this works, imagine I take 100 trades. I will win 40 of them for 1.5 R each. I will lose 60 of them for -1 R each. That’s a gain of 60 R and a loss of 60 R. My account hasn’t budged. Taking trades with a reward smaller than 1.5 R would cause my account to lose money over time, at this win rate. In the same way, taking trades with a reward greater than 1.5 R would cause my account to grow.

Here’s a few more values:

Translate this to Risk:Reward
So, is the above saying a 40% winner should enter trades whenever they estimate a Risk:Reward of 1:1.5 or better? Probably NOT. You see, if you are like me, or any other traders I know, you don’t hit your estimated reward target all the time (or even most of the time). So, you need to understand, based on your trading history, what kind of adjustment to make in order to get the gains you need.

The adjustment is to divide the R gain you need by the percentage of your reward target that you tend to win. The example will make this clearer…

So, to continue the above example, recall that my win rate is 40%. I know from the table above that I need to average a minimum of 1.5 R gain on my winning trades. But what Risk:Reward estimate gets me a 1.5 R gain when I win? I’ll need to look through my trading journal. My records show that I tend to take home about 50% of the reward I estimate for winning trades. So, I’ll divide that 1.5 R by 0.5, to get 3 R. That means I should enter trades when I estimate a 1:3 Risk:Reward. That way, I’ll tend to win 1.5 R or greater, and my account will be healthy.

… And there’s our magic 1:3 number! My example case was not an accident. You see, I think the number is so prevalent because of what you can assume about the typical profitable trader. It’s pretty safe to assume that they generally win 40% or more of the time, and that they get around half the gains they thought they would. Given that, 1:3 pops right out as the kind of Risk:Reward they should be looking for.

And, it follows that if your stats aren’t anywhere close to that hypothetical trader’s, then 1:3 is a meaningless guideline for you. For instance, if you win 60% of the time, and tend to take home a third of the projected reward, then 1:2 is a more appropriate minimum ratio. Of course, we are calculating the minimum for profitability here… traders should always strive to find the best risk:reward trades available within their style of trading.

Summary
After reading this article, you should have an idea of why conventional wisdom says 1:3 Risk:Reward ratios are good. You should also have the tools you need to find out what your minimum Risk:Reward targets should be. If you need help with this calculation (which is not to be construed as investment advice), just drop me a line.

Being a mostly up day, my mostly short watchlist tends to suffer. I’ve been attempting to put more long options on it, so that I’m equally ready no matter what happens.

Today, Hansen Natural Corporation (Nasdaq: HANS) dropped through my 41.8 entry in the opening minutes. I didn’t take that trade, as I don’t chase opening volatility. It promptly turned around and made a valiant attempt to fill its gap:

I did have one watchlist success, though. Later in the day, Terex Corp. (NYSE: TEX) ran a little past my 45ish long entry point, and then fell and bounced off it again. That’s always a very good sign. I wasn’t at my desk at the time, so I missed the trade. I got the alert on my blackberry, but all I could do is verify that it wasn’t running fast right after it hit 45. By the time I checked again, it was too late. If I were at my screen, I would have gotten in above the black line. That’s the point where it showed me it can run higher than its initial push through 45.

I am proud to report that I have several StockTickr friends now, thanks primarily to my interview there, I think. So, I hope if you are following along with my watchlist that you got in on TEX and made some money. I am user idempotent there if you want to befriend me, as well. Of course, just like everything I do, that list is for informational purposes only, and is not to be considered investment advice.

See you tomorrow!

Stocks Mentioned In This Article
Stock	Links
HANS	| |
TEX	| |

I’ve been getting feedback on the site, so I’ve made two additions recently: First, you can now subscribe via email. The button is over on the left sidebar with the RSS subscription links. Secondly, I’m imitating Trader Mike and am going to post links that I think are interesting. The last 5 entries will be over on the left sidebar, and you can just view it on del.icio.us as well.

Please keep the suggestions coming… the ones I’ve gotten so far have been good! Thanks, everyone.

Just a short note: I was feeling sick today, so I traded in demo mode, and only for part of the day. The sad part is, had I traded my real account, this would have been a good day. In fact, in terms of my goal of holding onto stocks, it would have been just about a perfect day. Go figure…

As I expected, I got some follow through on Qwest Communications (NYSE: Q) today, just buying at the open and holding till I stopped trading. I also went long on Hansen Natural Corp. (Nasdaq: HANS) at the break of its opening range @ 45.50, and held until 46.50. See how clearly it set up under 45.50 on the 15 minute chart before pushing through (sorry, no sloppy annotations today)?

… the only thing I didn’t like was how wide those three candles were… a lot of times, since I’ll use such a tight stop on entry, I get shaken out of these trades. But in this case, it tapped 45.50 again around 12:30 and then didn’t look back for a couple hours.

Stocks Mentioned In This Article
Stock	Links
Q	| |
HANS	| |

It occurs to me that some readers out there might have a passion for the stock markets, but know in their heart of hearts that trading and investing are not for them. That doesn’t mean they don’t want to participate in the market action, all the same. But how? Normally, this blog is exclusively about helping traders evolve, but I’ll take this one detour into how a trader can DEvolve. Get ready, because just about anyone with dreams of participating in the stock markets can enter the exciting and dynamic field of: stock market reporting.

Stock Market Reporting
Stock Market reporters are like the Gym Teachers of the financial world. You know the saying “those who can’t do, teach?” Well, even if you can’t teach, you can still teach gym. It doesn’t even matter if you are an overweight chain smoker. For stock market reporters, it’s really the same deal, only you can’t make anyone run laps around anything.

“I sound perfect for that,” you might be thinking, “but, I don’t know anything about financial reporting.” Nonsense, pessimist! In just a few minutes you will know everything you need to know. There are really just two steps. Be careful, though, because step one is a two-parter…

Step 1: Prepare!
For this step, you need Yahoo! Finance and CNN.com.

Part A: Go to Yahoo! Finance. Look to the left. Do you see the “Market Overview”? (Hint: if you see your kitchen, you have looked too far… try to lock your eyes on-screen. Seasoned reporters can do this without even moving their heads.) Note whether the Dow arrow is a happy arrow (pointing up) or a sad arrow (pointing down).

Part B: Now, go to CNN.com. I can already hear some of you groaning. I know, there’s lots of words there, and it looks scary. But remember, you are a financial news reporter, so just read the top story’s headline (that’s the words that are bigger than the other words).

Step 2: Report!
If today has a happy arrow, then report: “Markets up on news of” + headline. If today has a sad arrow, then report: “Markets down on news of” + headline. Now, you are going to need several paragraphs below this line to establish that you are an insightful and credible reporter, but don’t panic! No one reads anything but the first line, so you can just talk about your favorite flavor of ice cream. Reporters new to the field will need to build up about fifteen of these paragraphs. Once you have a back catalogue, simply pick three at random every day and add them to today’s headline.

Once you are familiar with the basic story format, try to branch out like this: If you happened to notice that the number beside the happy or sad arrow wasn’t very big, you can choose to say “Traders still digesting news of” + headline.

Example: “Markets down on news of golden globes nominees announced.” You get the idea.

Advanced Technique: Historical Context
This technique is only for veteran financial news reporters. That is, you need to have been reporting for at least one day. If today’s arrow is different than yesterday’s arrow, you can provide your public with important historical context for the current market action. This is a way you can really distinguish yourself from the short-sighted competition. For instance, you could say: “Markets are up on news of a growing gerbil population in France, despite yesterday’s concerns over Shuttle Atlantis rolling to the launch pad.”

Pitfalls
Make sure that the headline you got in Step 1 was from a news story, and not an advertisement. You don’t want to report that the markets are up on news of a three day sale at Macy’s, beating analyst estimates of a two day sale.

If you are giving historical context, make sure today’s top story and yesterday’s top story are different. Otherwise, you’ll say the markets went up and down for the same reason. You could research today’s story, looking for any change that could explain the difference, but that’s a lot of work. Alternatively, you could switch from news story headlines to one of the news categories. These are vague enough that people reading will fill in the details on their own. For instance: Markets down on news of weather.

Variation: TV Analyst
Do you have receding clown hair and a propensity to yell and sweat profusely in front of a large audience? You may be qualified to appear on TV every day. Do you also like to decapitate toy animals and press shiny red buttons? Then you are definitely qualified to appear on TV every day. Congratulations. The added benefit of this path is that no one will care if your views are inconsistent from day to day.

Summary
This was just a bit of fun, but there’s a message in it… I suggest you don’t bother with Stock Market news. All they do is point to some event, and point to the market indices, and try to make you think they are correllated in some way. It gets even more comical when you read a service that updates a few times a day. They are reporting on a level that puts significance into market noise. It’s worse than misinformation, if you buy into it… traders should do their best to suppress the urge to attach meaning to noise. Market news just reinforces bad habits.

I hate to post such mediocre performance right now, when my blog is getting so much traffic. But, oh well… The only stock to reach my watchlist’s price was Qwest Communications International Inc. (NYSE: Q), but it hit around 3:30PM so I stayed out. I see that it didn’t move much after that, but maybe tomorrow it will have a nice follow through.

So, without any big moves in front of me, and faced with a sideways market, I got confident enough to try some pivot point plays. The results were average. I took 4 trades, for a net of 0.36 R. 2 winners and 2 losers, all small. I think I need practice picking stops on these choppy market plays. Here’s one of the losing trades:

That was the 10 minute chart for Centex Corp. (NYSE: CTX). The red horizontal line is the pivot line, and the sloppily drawn arrow was my entry. I was wary of how steep the ascent to the line was, so I traded small and with a tight stop. You can see, it shook me out on the red candle after almost 20 minutes of stasis. Then, it turned around and didn’t look back for 80 cents. Ouch!

So, I almost had 2 small winners, 1 small loss, and 1 big winner. That would be just about the perfect trading day, as far as I’m concerned. I guess I’ll keep trying until I don’t have to say “almost” anymore!

Stocks Mentioned In This Article
Stock	Links
Q	| |
CTX	| |

I can’t believe the amazing company I’m in as an installment of the StockTickr Blog’s Interview series. There have been interviews with Van Tharp, Trader-X, Bill Cara, and many other well-known experts. And now, there’s one with me!

If you read me here, you know my posts can be on the long side… I revised my interview answers once or twice to try to make them short enough … did I succeed? Go read it and decide!

Those “pick 3″ questions were really hard for books and blogs. I made a longer list of blogs here at movethemarkets, and one of this weekend’s projects will be to do a similar list of books I’ve thought were helpful.