Ray Barros - The Nature of Trends: Strategies and Concepts for Successful Investing and Trading (Wiley Trading)

Introduction

The trader today has assistance that the traders of old would have given their right arm for; certainly, I would have. They have unheard-of computing power, and the benefits of the gigantic leaps made in the study of neurology, decision making, psychology, and learning. Thanks to Neuro-Linguistic Programming, we now have the tools to model success.

But the sad fact remains that the ratio of financial successes to losses is not too different from when I placed my first order. Anecdotal evidence suggests that 8090% of traders consistently lose money. Part of the problem is the computer. Computing power is both a blessing and a curse. Its a blessing in that statistical power is now available to allthus providing the opportunity for better risk management. Its a curse because it has led traders away from the search for the principles that underlie market action, to a search for angles that are profitable but which have a use-by date. The black joke is that no one has told the newbie trader of the difference between the two. Nor has he or she been told why that difference is important.

What is an Angle?

Peter Steidlmayer called angles behavioral parameterspatterns that will make money as long as not too many traders use them. The market, being a complex, self-adapting system, renders angles ineffective (that is, they lead to a loss of your trading dollars) as soon as too many traders use them.

In the early days of Market Profile, there was a behavioral parameter called the Value Area rule. This rule stated that if on a rotational daythat is, a day that moved from high to low, low to high, as distinct from a directional daythe market accepted prices below the Value Area, there was an 80% probability that the market would go to the opposite boundary.

Well, for a while it was money for jam. But then the word spread and . . . I remember one day seeing this angle set up in the Australian 10-year bonds. The only problem was, this time, the next trade after the market accepted below the Value Area was at the opposite end! Yes, it was a particularly thin market, but from that day the hit-rate for this angle dropped for that instrument.

Another reason for the lack of success is the nature of the newbie trader. Until he learns that the market does bite, he believes that success is easy. After all, he can see the chart points for himself, cant he? Its so easy! Heres the high, sell it; and theres the low, buy it! And theres enough hype out there to reinforce this fantasy. Sure, hes heard the stories about the high failure rate, but that wont happen to him. Its strange that the newbie wouldnt dream of performing surgery without first undergoing years of medical training, while at the same time believing that all he needs to succeed in trading is money and courage.

Trading is a profession where the road to success is both difficult to follow and yet simple to pursue. Its hard because the application of the rules of success runs contrary to our nature; its simple because the map to success has been clearly laid out.

Is there a solution? There is, and that is to think in terms of principles. My goal in The Nature of Trends is to explain the principles, or trading concepts, that have worked for me, and to relate those principles to the elements of a discretionary trading plan. Those elements are:

• Identify the trend, and where the market is located within the trend. Once you determine that, you have your strategythat is, whether for this trade you are to be a buyer or a seller.
• With your strategy decided, you are ready to look for a low-risk entry. Five elements comprise low-risk entry:
  • Zones: for a responsive trader (a buyer on dips in uptrends; a seller on rallies in downtrends), zones are support (uptrend) or resistance (downtrend) areas that contain the correction.
  • Setups: chart patterns that provide confirmation that a zone is holding.
  • Entry patterns: chart patterns that confirm the zone has held and the trend resumed.
  • Initial stop: the cut-loss method based on time or price.
  • Risk/reward: the money management calculation that says there is value in the trade.