Getting started - developing a system

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IronFist

So I never realized how hard this actually is.

I've got everything I need. I have a margin account. I have QuoteTracker (thanks to the Software forum for the recommendation). I have two monitors (at work and at home). I understand basic candle formations. I know many of the indicators (and the rest are just a google search away).

But yet for the past few days I've sat and watched the charts update before my eyes and I can't even decide on a good entry point. I'll see a huge down trend (like VOL today) but I'll never enter because I think "it's probably about to end and as soon as I jump in it will reverse." I'll have a few indicators give typical long entry signs (like MACD, TRIX, and CCI), but I won't take it, because I seem to only be able to locate good entry points after they've already happened.

The one time I actually made a day trade (on 12/29/06) it ended up going against me, but I only lost like $35 after comission so i wasn't too upset.

Is this "paralysis from analysis" or whatever they call it? Everytime I learn about a new indicator I think "omg, this indicator is awesome" but after watching it for a day on the charts I think it sucks. I swear I did better when I was paper trading using ONLY candlesticks and volume.

So how did you develop a system that works for you? How do you weed out the crap, or the contradicting indicators, or the ones that you don't like?

And how do you determine risk/reward ratio? I see all the time "oh yeah, my system has a 1:2 risk to reward ratio." So you're risking $1 to make $2. Ok, that's awesome. Is that just because your stop going with your trade is twice as far away from your entry point as the stop going against your trade (ie. I enter @ $20 and will exit @ $20.50 or $19.75)? How do you look at a chart and determine risk/reward?
 
I got another indicator for ya. Try it next week. Pick a half a dozen stocks and write down the strike price and see how close they get on Friday. Option traders rule the market next week.
 
It doesn't matter imo. Just that I found it very difficult to ascertain a direction of a stock during options week. Stocks just tend to cluster near strike prices or split directly in the middle of strike prices. Not a good week to trade. Also, I think it is very difficult to capture value during the week, you might though if you put in enough work at it. I wasn't interested.

As far as options, I'm just aware of them, studied them but don't trade them.
 
No, if you can read an option chain it shoudn't be too hard. For example, look at the GOOG chain.

http://finance.yahoo.com/q/op?s=GOOG

Scroll down to where the the rows are not highlighted in yellow in the "call" options section.

$500 is in yellow because goog is currently over $500, $510 is not in yellow because its not above $510.

Say next Thursday at close, GOOG is at $495, on Friday, it will either cling towards $500 or at $490 at the close.

I remember when it was at $500 at expiration a couple of expirations ago, it was easy money. The stock will run up towards a price, so people purchase the $500 calls in masses, then it drops down to say $497, and they sell. This happends several times throughout the day. The options expire at the market close (although you can exercise them after the close, see your broker) , and if the stock is sitting at $500.00 at market close, then both the $500 calls and the $500 puts expire worthless. This serves as an advantage to those that sold the puts and calls.

There are some videos on thestreet.com that give a more detailed explanation. You can just go to the street.com and search for "pinning" .

If you realize how to play it, you can do pretty well. Stocks don't always cling to strike prices, but I think GOOG is a regular in this category.

Pivot points also can help you determine where to precisely set your risk reward.

For example, if your stop loss was going to be $19.75, but you knew there was support at 19.70, you'd be pretty pissed if it tagged 19.71, only to rebound.

In a case like that, you'd be best setting your stop underneath the known support, maybe at 19.60 . Only problem then however, is that some people might have their stops at $19.69, and one sell order can start others and well then you have a domino affect, leading down to your $19.60 stop fairly quickly, and then your stop gets hit as well.

I know pivots are used frequently in futures, but I don't know how well they work with individual equities. YMMV.
 
Quote from IronFist:...
Is this "paralysis from analysis" or whatever they call it? Everytime I learn about a new indicator I think "omg, this indicator is awesome" but after watching it for a day on the charts I think it sucks. I swear I did better when I was paper trading using ONLY candlesticks and volume.
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That's exactly what it sounds like. Seems like you don't really want to be an indicator trader at heart based on your comments about them. Why not stick with candles and volume? As you spend more time using them you will just keep getting better at it.

So how did you develop a system that works for you? How do you weed out the crap, or the contradicting indicators, or the ones that you don't like?
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You really need to start by figuring out a lot of things about your trading personality. Timeframe, risk, and market are all part of that, but so too is stuff like a comfort with certain trains of thought. For example, I trade using volatility as a guide. It's something I've studied a lot and am comfortable with. I've never been comfortable with most oscillators.

And how do you determine risk/reward ratio? I see all the time "oh yeah, my system has a 1:2 risk to reward ratio." So you're risking $1 to make $2. Ok, that's awesome. Is that just because your stop going with your trade is twice as far away from your entry point as the stop going against your trade (ie. I enter @ $20 and will exit @ $20.50 or $19.75)? How do you look at a chart and determine risk/reward?
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That depends on your method. If you go back to using candles and volume it could be a question of saying "If I buy here, where do I think the market is going, and if I'm wrong, where will I be getting out (stop point)?"
 
thegazelle,

Thanks for the detailed post. I will read it again when I get home from work today. When do options typically expire? Is it a certain week each month or something?

Rhody,

I do like indicators, but I keep reading that people who have become successful tended to go from using indicators to not using indicators at about the same timeframe that they started becoming successful.

I think I like the intraday timeframe. I've done some long term trading and some swing trading before, but I really dig the intraday stuff. I like the fact that I can see relatively quickly if it's going in my favor or not (as opposed to having to wait days, or weeks).

I hate the thought of scalping (ideally I'd like to make 1-3 trades per day), but the more I watch the intraday charts, the more I think scalping might be worthwhile ($20 here, $30 there, etc.) cuz I see these little moves that don't have enough momentum to be profitable if they were my only trade of the day. However, I'm not MTM and I know I won't always have winners, so I'm afraid to do that because of wash sales when tax time comes.

The thing that annoys me with indicators is that I'll find a trade that went well based off of an indicator, and then another trade that didn't go well based off the indicator giving the same signal, and I can't identify anything else that was different between the two trades. It seems random that one was good and one was bad because the setup was identical. It seems like I'm missing something.
 
Quote from IronFist:

I do like indicators, but I keep reading that people who have become successful tended to go from using indicators to not using indicators at about the same timeframe that they started becoming successful.
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I actually went through that myself. For a while I was a real indicator geek. Over time, though, I just got focused and got better and better at reading charts and evaluating volatility.
 
Welcome to the real world of trading. If indicators worked everyone would be rich. They can be helpful, you just need to figure out what percentage of the time they are right and whether you want to base a system around them and /or what other factors you can introduce into the mix.
 
Quote from HolyGrail:

Welcome to the real world of trading. If indicators worked everyone would be rich. They can be helpful, you just need to figure out what percentage of the time they are right and whether you want to base a system around them and /or what other factors you can introduce into the mix.
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I guess I'm asking for tips on how to do that.

Rhody, you said you use volatility as a guide. Are there specific indicators you use for this?

Is there any free software that lets you backtest indicator strategies, like "go long when MACD turns positive and CCI crosses 100 going up and sell when CCI crosses 100 going down" or anything like that?
 
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