Over the last two weeks we have delved into some of the less obvious elements of trading and execution. As I mentioned previously, Jim says when it comes to trading the difference between success and failure is very small. I have seen this through my own trading as I suspect you have as well. This week we’ll discuss some observations as well as nuances that are “around the edges” yet have a potentially big impact on our bottom line and ultimately, career longevity. In fact, Jim says the real advantages are all around the edges, beyond the numbers, and accumulated over time.
Evolution of a Trader
Preparation—Moving Beyond the Numbers
Jim reflected that over the years he has observed a similar tendency of traders in the beginning of their learning process. What normally occurs, and was my own personal experience, is that we write down all the references and do the more linear analysis as far as prior pit session close, range, POC, value relative to prior day, longer timeframe references, noting poor lows/highs, structure, and so on. We feel like we are diligent and doing the necessary work to be prepared to trade. This is a normal progression in the learning process; however how we ideally want to prepare is markedly different.
Jim’s preparation goes “beyond the numbers”. It is in the preparation, out of the heat of battle, where he opens his mind to consider all of the resonant information that is affecting the auction. This is challenging—abstract—and much different than how I learned as a trader over the years to view markets. This process, this analysis, is ambiguous and requires prioritization of data that requires depth in our market understanding. We seek and record various data that often provide conflicting information which can be unsettling. Yet it is in this mode of preparation we form a contextual understanding—a broad perspective that engages our minds more fully. From here we begin to internalize information and employ more abstract reasoning. We form a holographic view where multiple observations are interconnected. The following Crude Oil example illustrates the interplay between observing market-generated information and big picture perspective and the contextual understanding that results.
Crude Oil—This example is taken from Jim’s comments to our paid subscribers which was written after Wednesday, January 26, 2011 close for the pre-market update for the pit session on January 27th:
The above chart was captured after Thursday, January 27, 2011 to show the outcome, however as mentioned, these comments were sent after Wednesday, January 26, 2011:
“WHAT DOESN’T HAPPEN—Following an outside day most traders and technicians expect meaningful follow-through. If there is that follow-through on Thursday everything is normal and the $88 level will grab the trader’s immediate attention. Overnight activity is generally higher following an outside day.” The first clue was that the overnight activity did not follow through. To continue what I wrote, “What doesn’t happen is very often more important than what actually occurs. Professional traders intuitively sense that something is wrong and are likely to fade the market. On Thursday pay attention to the expected reaction following an outside day.”After the fact the market confirmed what I wrote before the market opened; what didn’t occur was the most important market-generated information. In human communications we talk above “inference logic”; what the person didn’t say may infer the most important information. This way of looking at the markets illustrates a similar dynamic.
Jim has often used the term “ruling reason”; for example, you may have ten pieces of information that are suggesting shorting is in order; however, you have recorded one contrary piece of information that, although is only one observation, overrules all the others. I (and I would guess other traders who receive Jim’s updates) see Jim pick up on something that I had not considered because I wasn’t looking at the market with enough contextual consideration. I believe this reveals where I have not fully internalized Jim’s approach— how a professional trader sees the markets. It is not natural for us to think about data this way yet I’ve come to more fully appreciate “ruling reason” because I see how it can help gain an edge.
To acquire this logic and reasoning, Jim starts with a top down approach beginning with the monthly bar, proceeding to the weekly, the daily, and finally the Profiles. Most traders, particularly short-term traders bypass these important preparation steps. A continuation of the earlier Crude Oil example illustrates Jim’s ruling reason logic for his pre-market update for Friday, January 28, 2011.
“Friday’s very visual, important reference is last month’s low at 85.29. Trading below last month’s low signals an even more dramatic shift in sentiment. For daily preparation, treat 85.29 as you would the bottom of any balanced range; the three following scenarios are the most likely.
1. Fail to take out last month’s low and begin to auction higher.
2. Look below the low, fail to find price acceptance, and reenter the two-month range; these are, very often, big opportunities or what we refer to as asymmetric opportunities—risk is limited and return is proportionally much greater.
3. Trade below the two-month range and discover new sellers. These are also potentially large opportunities.”
This was the ruling reason; remember Crude Oil was sharply falling; there were multiple reasons to short. You will read many reasons in the press after the session ended as to why the rebound on Friday; however, the monthly December low provided the contextual condition that enabled you to come into the pit session with an actionable plan and execute a solid trade. Only a top down approach would have enabled you to identify this reference and imagine the potential move that could result; the failure to take out the December low was the observation to keep in your sights. It was the ‘ruling reason’.
While watching Jim trade I noticed how he is constantly gauging confidence, or lack thereof, throughout the day. This process starts as he views the overnight (is inventory short or long) and will we likely open in or out of balance. He then continues this consideration as he takes in the market-generated information during the pit session. This helps him adjust his perspective and fine tune the trading plan he has prepared pre-open. It is a wonderful observational filter to keep our analysis up to date with current market conditions while also helping us to remain objective.
As an example, say we come into the pit session with a gap open but there is little continuation. Jim is considering confidence as one measure to gauge the odds of acceptance and what timeframe is likely dominating. In our article last week, Part 2, our first example illustrated how Jim used market conditions and the Profile to determine who our competitors were, along with inventory conditions.
Here we contemplate the confidence the market was exhibiting. Jim was watching tempo and volume along with the Profile; he has internalized these observations over time to give him a feel for the market’s confidence. This perspective does not involve technical observations yet it has tangible benefit in helping us understand the odds of acceptance or failure outside of containment.
People ask Jim, “How do you measure tempo? What do you mean by confidence? How can I gauge these?” I also add, how does Jim discern between a liquidation break and a possible trend day starting? How can he discern the difference so effectively with such confidence? How can Jim understand so clearly anomalies and other nuances that affect the odds in his trading decisions? How does he identify so consistently excellent trade location that presents asymmetric opportunities? The answer is quality time in front of his screens; observing, trading, and reviewing his thought process and the trade decisions he made.
Jim has written, “You really learn about markets by being there and learning to observe everything that goes on; what has happened before has a lot to say about the outcome going forward; getting an edge and picking up a nuance here and a nuance there requires total absorption.” I can often identify excellent trade location and an asymmetric opportunity. However to execute this opportunity is an area for improvement. Jim says this disconnect reveals that I have not internalized this concept fully. I would add that it also reveals when I am not totally absorbed—in my prior preparation as well as how I am watching the market as this opportunity presents itself.
A TOTAL ABSORPTION EXAMPLE—I trade mostly Treasury bonds and S&Ps; on Friday morning Jim called and said that following the fourth quarter GDP report the bond market dropped rapidly and was now contained within a very tight range. He said the traders were waiting for some directional indication and that once they got that there was a chance that they would jump on it and begin to push prices directionally for the remainder of the day. He was feeling the pent-up need the traders had to simply trade. I am laughing as I write this because anytime someone uses the word simply you immediately know that what follows is anything but. He knew how volatile the market had been over the past few days as trader’s violently pushed prices up then down; for 35 trading days that is all there has been. The graphic shows the time of the call and what occurred—beyond any numbers—it was seen only as a result of total absorption over the week as well as Friday morning.
I watch Jim trade with focus. I don’t want to suggest that he trades like this all day; I don’t know any human mind that could be that intent for 8 hours straight. He knows himself and has an awareness of his limits. But when he is trading he is not on the phone, on Yahoo IM, emailing people, looking at pages on the web. He is watching how highs and lows are being made, watching the tempo, gauging the level of confidence in the market, and adjusting his perspective as the Profile and longer term charts print.
With total focus we can see prices slowing, we recognize where we are in the balance or trend, or if prices are up against a long term or intermediate reference. We observe over time how tempo, volume, and confidence factor into our market perspective and contextual understanding. We get a feel for the auction. It is subjective and may seem elusive, particularly when this approach is compared to the more technical methods we have learned about trading.
I find oftentimes it is freeing to look at the market more abstractly though it sometimes reveals gaps and a lack of depth in my experience. Weaving together linear and abstract information to gain a contextual understanding is a process that takes time to become Proficient, let alone Advanced or Expert. Yet being Proficient is a worthwhile goal. Once we are Proficient we have the foundation to build more depth inside. Our understanding does not result from an indicator or system results, it is born from our thought process, our ‘connecting the dots’ in our analysis, and the market perspective we develop as a result.
I talked with a trader in Dallas who, after watching the video, commented that the material was so novel and unique. The comment made was “Jim’s approach provides the missing link”. For so many years, this trader had tried mechanical systems that had little depth in their methodology. “When they break down and don’t work out, I have nothing to fall back on. I have little way of making sense of what I am observing. Jim’s approach, although involved, makes so much sense to me. It is what my approach has been missing.”
There are many facets to trading that transcend linear thinking and conventional wisdom. Effective trading is often counter-intuitive to many of the tenets we live by and the principles we have learned over our lifetime. Make no mistake about it, trading is tremendously competitive. Like an Olympic race that is won or lost by thousandths of a second, so it often is with trading profitably. The difference between winning and losing is miniscule; nuances and a recognition of the importance of a depth of understanding warrant attention.
I talk with many traders and hear successes and excitement, as well as traders sharing their doubt as to whether “it’s me and I’m just not getting it”. Sometimes I think we trade under the assumption that others are doing well and we are behind the curve. Statistics show that nothing could be further from the truth. Jim’s approach requires thought, effort, and hours of observation. But the rewards, if we truly want to trade for a living or trade with profitability, are well worth the journey. As the saying goes, “If it was easy, everyone would do it.”